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Competitive Health Care Markets Spur Price Deflation

June 1, 2015 - 4:16pm CDT

Between 1998 and 2014, the price of medical care services in the U.S. (as measured by the Bureau of Labor Statistics’ Consumer Price Index [CPI] for Medical Care Services) has increased by 88.5 percent, or roughly twice the 45.8 percent increase in consumer prices in general over that period (see table on page 5).

On an annual basis, medical care costs in the U.S. have increased more than 4 percent per year compared to an average inflation rate of only 2.4 percent over the last 16 years. Probably the only consumer product or service that has increased more than medical care costs over the last several decades would be college tuition and fees, which have increased more than 7 percent annually since 1998.

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

According to data from the Census Bureau, almost half (47 percent) of health care expenditures in 1960 were paid by consumers out of pocket. By 1990 that share had fallen to 20 percent and by 2009 to only 12 percent. It’s no wonder that health care costs have risen as the share of third-party payments has risen to almost 90 percent and the out-of-pocket share approaches 10 percent. Consumers of health care have no incentive to monitor prices and be cost-conscious buyers of medical services when they only pay 10 percent themselves, and the incentives of medical care providers to hold costs down are greatly reduced knowing that their customers aren’t price-sensitive.

How would the market for medical services operate differently if consumers were paying out of pocket for medical procedures in a competitive market?

Well, for some answers we can look to the $7.5 billion U.S. market for elective cosmetic surgery. In every year since 1997, the American Society for Aesthetic Plastic Surgery has issued an annual report on cosmetic procedures in the U.S. (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.

The table shows the five most popular surgical procedures and five most popular nonsurgical procedures for 2014, the number of each of those procedures performed last year, the total expenditures for each procedure, the average price per procedure both in 1998 and 2014 (in current dollars), and the percent increase in price since 1998 for each procedure.

Of the 10 most popular cosmetic procedures last year, none have increased in price since 1998 more than the 45.8 percent increase in consumer price inflation (the price for the hyaluronic acid procedure wasn’t available for 1998). This means the real price of all of those procedures has fallen over the last 16 years.

For three of the top five nonsurgical procedures in 2014 (botox, laser hair removal, and chemical peel), the nominal prices have actually fallen since 1998 by large double-digit percentage declines (-23.6 percent, -31.2 percent, and -30.1 percent).

That is, those prices have fallen in price since 1998, even before making any adjustments for inflation.

Most importantly, none of the 10 cosmetic procedures shown in the table have increased in price by anywhere close to the 88.5 percent increase in medical care services since 1998. The 33.7 percent average price increase since 1998 for last year’s top five surgical procedures isn’t even close to half of the 88.5 percent increase in the cost of medical care services over the last 16 years.

Of the other dozen or so cosmetic procedures not displayed in the table, but for which there are prices both in 1998 and 2014, only three procedures increased in price by more than the 45.8 percent increase in general prices, but the price increases were all below the 88.5 percent increase in the cost of medical services: chin augmentation (+69.7 percent), upper arm lift (+65.3 percent), and buttock lift (+46.7 percent).

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 out of pocket for 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. Because of that market competition, the prices of almost all cosmetic procedures have fallen in real terms since 1998, and some nonsurgical procedures have even fallen in nominal dollars before adjusting for price changes. In all cases, cosmetic procedures have increased in price by less than the 88.5 percent increase in the price of medical care services between 1998 and 2014.

If cosmetic procedures were covered by insurance, Medicare, and Medicaid, what would have happened to their prices over time?

Basic economics tells us that those prices would have most likely risen at about the same 88.5 percent increase in the prices of medical services between 1998 and 2014. And perhaps another 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. On the other hand, 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.