Why are Health Care Costs Rising So Fast?

Everywhere you go Americans are concerned with health care costs. It seems like every few months insurance companies raise rates and providers raise prices. What's going on?

Since the late 1960s, increases in health care costs have steadily accelerated to a present rate of 2.5 times that of inflation. This out-of-proportion increase began with the establishment of Medicare and Medicaid in 1965, and with the massive amount of money they began to channel into the health care market.

Why is this? There is one central reason. Economics 101 says when money chases a market, the price of that market rises. This is called demand-push inflation. Since the introduction of Medicare and Medicaid, the huge amounts of money forced into the health care market by the US government has caused health care costs to skyrocket.

Think of it this way. Imagine the US government decided to initiate a major spending program to buy, say, lots of pinwheels for every American. Now you might not want a pinwheel and I might not, but that doesn't matter because the government is creating the market. Say it earmarks $10 billion for pinwheels and increases that amount every year. What do you think would happen to the price of pinwheels? If you said "go up" give yourself a Ben Bernanke gold inflation star. That's exactly what would happen. And that's what has happened with health care costs.

Massive government spending on health care is the main cause of its severe inflation, and all other causes depend on or are related to this main cause.

What are some other reasons? One is the amazing advances in health care technology. Health care is just a lot better than it was fifty years ago. That jump in technology is in part due the profit potential companies see in the health care market. You can bet the one thing every health care company and entrepreneur counts on is that the government is going to be channeling a lot of money into health care. So they go after it. This is a great incentive for innovation. Unfortunately it also wasteful, because companies come up with all kinds of medical technology that is superfluous but that doctors use just because it's there. In fact, doctors feel compelled to use any technology that exists because they feel the need to protect themselves from lawsuits, which, ironically, are also a product of too much money being in play.

Another cause of high costs is inflated physician compensation, particularly for specialists. The Center for Medicare and Medicaid Services, the government body which sets Medicare and Medicaid rates, pays much more to specialists than they are paid in peer countries. This is done, purportedly, to attract top people into specialization. But most likely, in a freer market, specialists would be paid less than they are. The physicians, knowing a good thing when they see it, take full advantage of this arrangement by demanding the wages the market will artificially bear. Are they greedy? You could say that. But they wouldn't have had the opportunity to fulfill that greed if government hadn't thrown so much money at them.

There are other reasons for high health care costs: pharmaceutical pricing, higher administrative costs due to single-payer model paperwork, and hyper-litigiousness and resulting defensive medicine. But all these things have their root in too much money being artificially channeled into health care.

It may seem strange that the more money you throw at a problem the more expensive it gets. But that's the way economics works sometimes.