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Understanding Health-Care Spending's Ugly Spike

Megan McArdle is a Bloomberg View columnist who writes on economics, business and public policy. She is the author of "The Up Side of Down."
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For years, we worried about the rapid rate of growth in health-care spending. A crude extrapolation of prior trends suggested that by the middle of the century, America would be spending 157 percent of gross domestic product on health care, leaving no money at all for food, shelter or Franklin Mint collectibles.

People usually talked about this as a problem of America's unusually high rate of health-care cost inflation. But, in fact, that wasn't the problem at all, as you can see from this chart:

Source: Organization for Economic Cooperation and Development

Compared with the growth rate in health-care spending of other members of the Organization for Economic Cooperation and Development, America's has been on the low side. Relatively speaking, our spending on Franklin Mint collectibles is probably more of an outlier.

The problem was the level of our spending: We were growing at a relatively slower rate, but from a much higher base -- the difference between a 10 percent raise on a $50,000 salary and a 5 percent raise on a $150,000 salary.

Source: Organization for Economic Cooperation and Development

Unfortunately, it's very hard to reduce the absolute level of spending on something -- and much easier to cut the growth rate, even if that growth rate isn't particularly fast. So during the debate over Obamacare, you heard a lot about "bending the cost curve." And, wonder of wonders, over the last few years people noticed that health-care inflation was slowing down.

A number of theories accounted for why this was happening. One held that the Affordable Care Act had bent the cost curve just as promised; even though most of its reforms hadn't taken effect, doctors and hospitals were preparing for them by holding down costs. This theory was very popular with officials in the Barack Obama administration and their advisers.

Another theory held that the health-care cost slowdown was mostly due to the recession. Some people lost their jobs, and their insurance; either they were paying out of pocket, or they were on Medicaid, with its famously stingy reimbursement rates, and either way, spending was falling. Even those who had insurance might have been scrimping on elective care in order to avoid deductibles and co-pays.

A third theory held that we were seeing a temporary lull in the rate of medical innovation. Spending growth tends to be driven by very expensive care on the frontiers of medicine: oncology, transplants, neonatal and so forth. With a lot of drugs losing patent protection, and fewer hot new machines and procedures being introduced, health-care spending was naturally slowing -- possibly with an assist from insurers, who had started to do things such as running their own clinical trials to determine which patients needed expensive new drugs, and which ones could safely be kept on boring old generics.

None of these theories is mutually exclusive, of course; we could be seeing a little bit of each. A lively debate goes on; I won't walk you through all the arguments here. Rather, I'll point you to a new piece of data that came in last week: In the fourth quarter of 2013, health-care spending seems to have grown at the fastest pace in a decade:

Source: Bureau of Economic Analysis

First, let's go through the obvious caveats: It's one quarter. Economic statistics jump around all the time. This could be revised downward substantially. It could also just be a fluke.

But let's say it isn't a fluke. What would that tell us?

Obviously, it counts against the idea that government regulation is responsible for the slowdown -- that the administration has successfully "bent the cost curve." If hospitals really are ratcheting back in anticipation of delivery system reforms, then I would not expect cost growth to be rising dramatically just now.

Note that this also isn't what I'd expect to see if the opposite is true -- if Obamacare is driving up the rate of health-care spending. It's not implausible that this might happen: We're increasing coverage, which tends to increase utilization. Moreover, many of the payment reforms tend to encourage consolidation of the hospital and medical practice sectors. Unless there are huge economies of scale, consolidation tends to raise supplier power, and thus prices, not reduce them.

But this trend has been happening since the middle of 2012. The timing doesn't jibe well with the theory that health-care spending is rising because of Obamacare. It's much more consistent with the theory that the slowdown was driven by the recession, or a temporary innovation hiatus, or a combination of both.

This is hardly the last word, of course. But as it stands, the data suggest two things: We need to revisit our theories of why cost growth has slowed over the last few years, and we need to prepare for what this trend might do to our budget if it continues.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

(Megan McArdle writes about economics, business and public policy for Bloomberg View. Follow her on Twitter at @asymmetricinfo.)

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