America’s health care is the costliest in the world, yet quality is patchy and millions are uninsured. Incentives for both patients and suppliers need urgent treatment

Illustration by Otto Steininger

NO ONE will be astonished to hear that health care costs more in Indiana than in India. However, a few might be surprised to learn that Americans spend more than twice as much per person on health care as Swedes do. And many may be shocked to be told that in Miami people pay twice as much as in Minnesota, even for far worse care.

The American health-care system, which gobbles up about 16% of the country's economic output, is by far the most expensive in the world (see chart 1). The Congressional Budget Office (CBO) estimates that on current trends spending on Medicare and Medicaid, the government schemes for the old and the poor, will rise from 4% of GDP in 2007 to 12% in 2050. The prospect of long-term fiscal disaster is the main reason why efforts to reform health care are gaining momentum in Washington, DC. As Peter Orszag, the director of Barack Obama's Office of Management and Budget, puts it, “that ‘long term' keeps getting closer and closer.”

The system has its defenders. They point out that countries should expect to spend more on health care as people age. Americans are wealthy enough to choose extra health care over other things. Their free-spending approach calls forth the invention and speedy adoption of valuable new drugs, devices and procedures, whereas Europe's stodgy and stingy (not to mention socialist) health-care systems deny coverage and ration care, to the detriment of their people's health.

A poll carried out for The Economist by YouGov highlights Americans' beliefs about the state of their system. Although 68% of them rate the care they receive as “excellent” or “good”, 52% are dissatisfied with the quality in the country as a whole. Only 25% think the system works pretty well and requires only minor changes; 40% think fundamental change is needed and 29% think it should be completely rebuilt. Some results are shown in chart 2. A fuller version is available at www.economist.com/yougovpoll.

The doubters have a better case than the defenders. Granted, medical inventions are readily embraced by American doctors and patients. In specific instances—technology to save babies born prematurely and statin drugs to reduce cholesterol, to take two—the benefits of spending greatly outweigh the costs. But if the system in general were providing value for money, America's vast expenditure would at least be reflected in a healthier population than in more frugal countries.

Alas, it is not. Comparisons with other rich countries and within the United States show that America's health-care system is not only growing at an unsustainable pace, but also provides questionable value for money and dubious medical care. Three troubling symptoms stand out: uneven quality of care, inadequate coverage and soaring costs.

Start with quality. Evidence is mounting that spending more does not necessarily buy better health. On the contrary, it appears that many Americans are getting mixed or even downright dreadful health care. In a recent study economists at the OECD found that America does indeed do well on some measures, such as breast-cancer survival rates and cervical-cancer screening, compared with other rich countries. However, it does worse in other areas. American infant mortality was 6.7 per 1,000 births in 2007, against an OECD average (excluding Mexico and Turkey) of 4.0. The death rate after haemorrhagic strokes was 25.5% in American hospitals but only 19.8% in OECD countries as a group.

Jonathan Skinner, an economist at Dartmouth College, cautions that factors other than health-care systems—attitudes to teenage pregnancy, say, or smoking—may influence the numbers. Even so, he thinks the system is wasteful. In a paper in the Journal of Economic Perspectives last year he and Alan Garber, of Stanford University, argued that America's health system was “uniquely inefficient”, producing too little per unit of input and consuming far too much of the country's resources.

Mr Skinner is involved with another worrying line of research. The Dartmouth Atlas project has scrutinised variations in health outcomes and spending involving Medicare. It has found wide differences in costs across the country—less than $5,000 per person in Salem, Oregon, in 2006; a bit more than $8,000 in San Francisco, in line with the national average; more than $16,000, and rising fast, in Miami—but no connection between higher spending and better outcomes. In fact, the evidence points in the other direction: outcomes tend to be better where costs are lower. Mr Orszag points to the Dartmouth work to argue that up to 30% of America's health-care spending is sheer waste.

The second symptom is coverage. Uniquely among rich countries, America's system of health insurance is not universal. Around 49m people have no health insurance. On current trends, within a decade 60m will be without cover. Studies have shown that not all these people are indigent: a quarter or more can afford insurance, but choose not to buy it.

They know they are unlikely to be left to die in the streets. With the truly poor, the free-riders turn up at emergency rooms. This is hugely inefficient, because pricey late interventions and operations could very often have been avoided with a much smaller investment in preventive care. Insured people and taxpayers are forced to cross-subsidise such “uncompensated” and wasteful treatments to the tune of tens of billions of dollars per year.

Other rich countries cover almost all their citizens in one of two ways. Some, such as Britain, Canada and Sweden, have “single payer” systems, in which taxes support a public service. Others, notably the Netherlands and Switzerland, oblige individuals to buy insurance. France has a mixed public-private system.

After decades of failed attempts at reform, a consensus appears to be emerging in America around the principles needed for universal coverage. One likely change means a restructuring of America's failed health-insurance markets. Firms are today allowed to pick the safest patients and reject the sickest. In future they will have to take all comers. Because this imposes unfair burdens on firms that attract lots of older or sicker people, reform is likely to include government-funded mechanisms for risk pooling or reinsurance. The Netherlands, in particular, uses such an approach.

American health insurers, having long opposed this idea, have performed a startling U-turn in recent weeks. America's Health Insurance Plans, their chief lobbying group, now says it is willing to accept such heavy-handed reforms—if they are accompanied by a requirement that all Americans purchase coverage. This may seem a cynical ploy to expand their business, but some compulsion is needed to get around the selection problem. Any legislation is likely to include subsidies to help the poorest pay for cover.

If done properly, this will in time move America towards the Swiss and Dutch models of universal private insurance. These are not perfect, to be sure. Regina Herzlinger of Harvard Business School observes that the Dutch reforms have led to rapid consolidation of insurers and hospitals, fuelling resented price increases. She favours the decentralised Swiss model, which preserves individual choice and competition. Others note that Swiss health-care costs are high by European standards. But they are a third less, as a share of GDP, than America's, and the country's excellent health outcomes should be the envy of American reformers. Our poll suggests that an individual mandate would be unpopular, with only 21% in favour and 53% opposed. Respondents did favour having the option to buy from the government, by 56% to 23%.

Such reforms would expand coverage, but could exacerbate the third symptom, cost, as the experience of Massachusetts, a trailblazing state that has already implemented a plan for universal coverage, suggests. The state faces possible bankruptcy unless it finds a way to rein in costs.

Your money or your life

Indeed, tackling inflation in American health care remains the most important and difficult part of the treatment. According to our poll, cost is a tender nerve: 61% thought the high cost of care and insurance was a bigger problem than the number of uninsured, against 31% who believed the reverse. Only 21% would be willing to support a reform plan if they had to pay more in insurance or tax; 62% would not.

Some common diagnoses are wide of the mark. One is price gouging by drug companies. In fact, pills account for barely a tenth of health-care spending in America and similarly small shares elsewhere. But aren't costs lower in Europe because of price controls? Europe does indeed spend less on new branded drugs, but also uses fewer generic drugs and pays much more for them. And Switzerland actually has higher drug prices than America (as does Canada). Greedy drugmakers are not the main cause of America's runaway costs.

Nor are baby-boomers, though they are often blamed for health-care inflation because there are a lot of them and they are getting old. Ageing will clearly push up costs in time (see our special report in this issue), but it is not the main culprit yet. The CBO estimates that ageing accounts for only a quarter of the health-care inflation to come in the next few decades, and the share in other rich countries is similar.

Doctors' generous pay is another popular culprit. But doctors in several European countries are well paid too. The OECD estimates that general practitioners in America earn 3.7 times the average wage. Their British counterparts earn 4.2 times their national average. American specialists earn 5.6 times the average wage, against 7.6 times for their Dutch colleagues. Yet health-care costs in Britain and the Netherlands remain lower than America's. The real problem is not how much American doctors are paid, but how. The system of medical reimbursement warps incentives for doctors, insurers and patients that lead Americans to consume more and more medical services. There is strong evidence that Americans use pills, procedures, scans and other expensive forms of health care more often than do patients in other rich countries, and not always to good effect.

America's insurance system encourages overuse in several ways. One is the tax break that favours health insurance provided by employers, which leads to excessively generous coverage and hence over-consumption. Another is the fact that American health insurers earn a lot of revenue from administering the health plans provided to employees by big corporations which, in effect, insure themselves. This leaves insurers with no incentive to curb costs, because more spending means fatter management fees.

The incentives facing doctors are even more perverse. Most doctors are not paid a fixed salary, still less rewarded for better health outcomes. Integrated American systems such as Kaiser Permanente and the Mayo Clinic are exceptions to this rule, and Britain's National Health Service (NHS) is trying to adopt a similar approach. But most doctors and hospitals are paid more if they provide more services, regardless of the results. Predictably, this leads to far higher rates of doctors' visits, specialist referrals, scans and so on.

For instance, the OECD countries have an average of 11 magnetic-resonance imaging machines per 1m people. America has 25.9. America uses them more often, too: 91.2 times per 1,000 people per year, compared with the OECD average of 39.1. Similar tales can be told about other pricey kit.

This incentive problem even extends to patients. If patients pay very little out of their own pockets they have little desire to curb consumption. Though this is a problem in many OECD countries, in America the proportion of out-of-pocket spending has declined sharply in the past few decades. And a new report by McKinsey, a firm of management consultants, identifies a more subtle problem. Having examined insurance and out-of-pocket spending for several health risks, it concludes that Americans are generally “over-insured and under-saved”. It is prudent for individuals to have comprehensive health insurance against catastrophic health risks such as heart attacks or cancer. But McKinsey finds that Americans with private health insurance often have generous coverage for non-essential and even medically unjustified care (see chart 3). This encourages over-consumption.

The power of sunshine

A second big factor pushing up health costs is the lack of competition among operators of American hospitals. Thanks to a wave of consolidation in recent years, argues Harvard's Ms Herzlinger, “most parts of the United States are dominated by oligopolistic hospital systems.” George Halvorson, who heads Kaiser Permanente, insists that “there is an almost total lack of price competition among providers.”

Nimble upstarts and innovators are challenging the incumbents in some areas. Such efforts range from specialist heart hospitals, which get better outcomes at more reasonable prices than local general hospitals, to retail clinics at Wal-Mart stores. Remote medicine, in the form of technology for tele-care or medical tourism to Thailand and Costa Rica, also poses a threat. But medical lobbies are using political influence and outdated regulations to thwart competition where they can (for example, through rules preventing a doctor from treating a patient in another state).

To counter this, reforms could allow federal regulators to overrule state-level obstacles to entrants such as clinics staffed by inexpensive nurse-practitioners. More transparency would help too, by empowering patients to choose hospitals and doctors providing good value and better results. Electronic medical records would make shopping around easier.

Another useful way to promote transparency and value would be to evaluate the cost-effectiveness of new drugs, devices and treatments. This may be common sense, but it is rarely done in America. Britain's National Institute for Health and Clinical Excellence (NICE) pioneered this approach, and other European countries have followed it. Andrew Dillon, the agency's chief executive, accepts that “the NICE model is not transportable in precise form” but he still insists that “one can dissect and apply what is relevant to other countries.”

Illustration by Otto Steininger

In America, the drugs and devices lobbies are violently opposed to a NICE-style agency that could issue mandatory rulings. They paint a scary picture of Americans being denied access to life-saving new drugs by faceless bureaucrats. In Britain NICE has come under fire for rulings that limited access to expensive drugs for Alzheimer's and cancer on the NHS. America could get around this problem by requiring and perhaps even funding studies, but leaving insurers and individuals to decide whether to pay for treatments.

More competition and transparency would help, but the main goal of any reform plan must be to address the perverse incentives that encourage overconsumption and drive up costs. Medicare has been tinkering with “pay for performance”, a promising experiment. Mr Halvorson insists that by rejigging incentives other health providers can also create their own “virtual Kaisers”.

If American reformers doubt the power of incentives, they should visit Sweden. Like other relatively cheap OECD systems, Sweden's single-payer model has been plagued by long waiting-lists—a sign, to American conservatives, of the rationing that goes with socialised medicine. Swedish health officials tried and failed to cut queues by increasing direct funding for hospitals and even issued an edict requiring hospitals to cut queues for elective operations to three months. Then, last year, the health ministry said it would create a fund into which it would pay SKr1 billion ($128m) a year for local authorities that managed to reduce waiting times to that threshold. Nine months ago virtually none of the counties passed, but this month the health minister revealed that nearly all had cut their queues to three months or less.

Anders Knape, the head of the organisation representing county governments, ascribes this to “a dramatic change in incentives”. In the past, he explains, hospital bosses believed waiting lists were a sign of being overloaded, so they tolerated them in the hope of winning more funding. With the new scheme, however, “no queues means more resources”.

If getting incentives right can mobilise even a state-run health system like Sweden's, surely there is scope for such reforms to fix America's mess too. If the United States couples its efforts to expand coverage with such a radical restructuring of the underlying drivers of cost inflation, there is every reason to think its health system can become the best in the world—and not merely the priciest.