Between 1998 and 2016 prices for “Medical Care Services” in the US (as measured by the BLS’s CPI for Medical Care Services) more than doubled (+100.5% increase) while the prices for “Hospital and Related Services” nearly tripled (+177% increase). Those increases in the costs of medical-related services compare to only a 47.2% increase in consumer prices in general over that period. On an annual basis, the cost of medical care services in the US have increased almost 4% per year since 1998 and the cost of hospital services increased annually by 5.8%.

In contrast, overall inflation averaged only 2.2% per year over that period. The only consumer product or service that has increased more than medical care services and about the same as hospital costs over the last several decades is college tuition and fees, which have increased nearly 6% annually since 1998 for public universities.

One of the reasons that the costs of medical care services in the US have increased more than twice as much as general consumer prices since 1998 is that a large and increasing share of medical costs are paid by third parties (private health insurance, Medicare, Medicaid, Department of Veterans Affairs, etc.) and only a small and shrinking percentage of health care costs are paid out-of-pocket by consumers.

According to government data, almost half (47.6%) of health care expenditures in 1960 were paid by consumers out-of-pocket, and by 1990 that share had fallen to 19% and by 2015 to only 10.5% (see chart above).

It’s no big surprise that overall health care costs have continued to rise over time as the share of third-party payments has risen to almost 90% and the out-of-pocket share approaches 10%. Consumers of health care have significantly reduced incentives to monitor prices and be cost-conscious buyers of medical and hospital services when they pay only about 10% themselves, and the incentives of medical care providers to hold costs down are greatly reduced knowing that their customers aren’t paying out of pocket and aren’t price sensitive.

Cosmetic Surgery Market

How would the market for medical services operate differently if prices were transparent and consumers were paying out-of-pocket for medical procedures in a competitive market? Well, we can look to the $15 billion US market for elective cosmetic surgery for some answers.

In every year since 1997, the American Society for Aesthetic Plastic Surgery has issued an annual report on cosmetic procedures in the US, both surgical and nonsurgical, that includes the number of procedures, the average cost per procedure (starting in 1998), the total spending per procedure, and the age and gender distribution for each procedure and for all procedures. Here is a link to the press release for the 2016 report, and the full report is available here.

The table above displays the 20 cosmetic procedures that were available in both 1998 and 2016, the average prices for those procedures in each year (in current dollars), the number of each of those procedures performed in those two years, and the percent increase in average price for each procedure between 1998 and 2016. The procedures are ranked by the number of procedures last year.

Here are some interesting findings from this year’s report and the table above:

1. For the top ten most popular cosmetic procedures displayed above for last year, none of them has increased in price since 1998 more than the 47.2% increase in overall consumer prices, meaning that the real, inflation-adjusted price of all ten of those procedures has fallen over the last 18 years.

2. For the three most popular procedures in 2016 (botox, laser hair removal, and chemical peel – all nonsurgical cosmetic procedures), the nominal price for each has actually fallen since 1998 by large double-digit percentage declines of -11.3%, -21.7% and -34.8% respectively.

Patients that pay out-of-pocket are cost-conscious and have strong incentives to shop around and compare prices.

That is, the prices for those procedures have fallen in price since 1998 measured in current dollars, even before making any adjustments for inflation. Note also that the demand for those three procedures has increased dramatically, especially botox procedures (29-time increase since 1998) and laser hair removal (9.5-time increase).

3. The two most popular surgical cosmetic procedures last year were liposuction and breast augmentation, which have increased in current dollar prices by 30.6% and 26.2% respectively since 1998. Both of those average price increases were less than the 47.2% increase in consumer prices over the last 18 years, meaning that the real, inflation-adjusted prices for liposuction and breast augmentation procedures have fallen since 1998.

4. The average price increase between 1998 and 2016 for the 20 cosmetic procedures displayed above was 32%, which is less than the 47.2% increase in consumer prices in general. Of the 20 procedures above, 14 increased in price by less than overall inflation (and therefore decreased in real terms) and only six increased in price by more than inflation.

And most importantly, none of the 20 cosmetic procedures in the table above have increased in price by anywhere close to the 100.5% increase in the price of medical care services or the 176.7% increase in hospital services since 1998. The largest cosmetic procedure price increase since 1998 was the nearly 70% increase for upper arm lift surgery, which is still far below the doubling of prices for medical services overall.

5. As in previous years, there was a huge gender imbalance for cosmetic procedures last year–women accounted for 12.43 million procedures and more than 91% of the 13.65 million total cosmetic procedures performed last year.

The Role of Insurance

The competitive market for cosmetic procedures operates differently than the traditional market for health care in important and significant ways. Cosmetic procedures, unlike most medical services, are not usually covered by insurance. Patients paying 100% out-of-pocket for elective cosmetic procedures are cost-conscious and have strong incentives to shop around and compare prices at the dozens of competing providers in any large city.

The greater the degree of market competition, price transparency, and out-of-pocket payments, the more contained prices are, in health care or any other sector.

Providers operate in a very competitive market with transparent pricing and therefore have incentives to provide cosmetic procedures at competitive prices. Those providers are also less burdened and encumbered by the bureaucratic paperwork that is typically involved with the provision of most standard medical care with third-party payments.

Because of the price transparency and market competition that characterizes the market for cosmetic procedures, the prices of most cosmetic procedures have fallen in real terms since 1998, and some non-surgical procedures have even fallen in nominal dollars before adjusting for price changes.

In all cases, cosmetic procedures have increased in price by far less than the 100.5% increase in the price of medical care services between 1998 and 2016 and the 176.6% increase in hospital services. In summary, the market for cosmetic surgery operates like other competitive markets with the same expected results: falling real prices over time for many cosmetic procedures.

Quick Question

If cosmetic procedures were covered by third-party payers like insurance companies, Medicare, and Medicaid, what would have happened to their prices over time? Basic economics tell us that those prices would have most likely risen at about the same 100.5% increase in the prices of medical services in general between 1998 and 2016.

The main economic lesson here is that the greater the degree of market competition, price transparency and out-of-pocket payments, the more contained prices are, in health care or any other sector of the economy. Another important economic lesson is that the greater the degree of government intervention, opaque prices and third-party payments, the less contained prices are, in health care or any other sector of the economy. Some important lessons to consider as we attempt to reform national health care… once again.

Reprinted from American Enterprise Institute.