Business Journal

The Other $700 Billion Question

by Jennifer Robison

Can behavioral economics bail out the problems with healthcare spending?

Say "$700 billion" to U.S. taxpayers, and they'll know exactly what you're talking about. That's the price tag of the rescue package passed by Congress to shore up the ailing U.S. financial system. And with a population of 300 million, that price tag amounts to about $2,300 for every man, woman, and child in the United States.

But there's another $700 billion problem facing the U.S. government, though it's not garnering the same public awareness as the financial bailout. It's hidden in the U.S. healthcare system, and it presents either a problem -- or an opportunity -- for taxpayers.

Where's the problem?

It's no secret that healthcare costs are on the rise in the United States -- or that they take a substantial chunk out of the government's coffers every year. The Congressional Budget Office (CBO) reports that "Over the past 30 years, total national spending on healthcare has more than doubled as a share of GDP. . . . [A]ccording to CBO projections, that share will double again by 2035, to 31% of GDP. Thereafter, healthcare costs will continue to account for a steadily growing share of GDP, reaching 41% by 2060 and 49% by the end of the 75-year projection period." A good chunk of that spending will be on Medicare and Medicaid, which currently "accounts for about 4% of GDP, or 26% of total spending on healthcare. By 2035, those figures grow to 9% of GDP, or 30% of total spending on healthcare, and by 2082, to 19% of GDP, or 38% of total spending." (See graphic "An Unhealthy Trend.")


What's less readily apparent is that a significant portion of healthcare spending doesn't necessarily improve health. "A tremendous amount of what we pay is spent on things that don't actually do any good," says Princeton University's Angus Deaton, one of the world's foremost economists and a leader in healthcare economics. Peter Orszag, director of the CBO, agrees: If healthcare spending is currently at 16% of GDP, his analysis suggests that almost 5% of GDP -- or about $700 billion annually -- goes to healthcare spending that can't be shown to improve health outcomes.

And $700 billion might just be a portion of the problem. A recent report from PricewaterhouseCoopers estimated the wasteful spending in the entire healthcare system -- not just the portion funded by taxpayers -- to be up to $1.2 trillion of the $2.2 trillion annually spent on healthcare in the United States. This wasteful spending can be categorized into three waste "baskets": behavioral, clinical, and operational.

But where is that money going? That depends on whom you ask. Worry about rising healthcare costs is nothing new; government and business, not to mention taxpayers, have been fretting about the issue for decades. Meanwhile, solutions have come and gone without making any noticeable dent in the healthcare bill. But lately, the CBO has been taking a different tack at examining the $700 billion problem: It's using the principles of behavioral economics.

Behavioral economics

"We're aggressively monitoring developments in behavioral economics, both for our work in putting forward options to policymakers and in terms of evaluating the impact of proposals that are actually moving through the Congress," says Orszag. "Spending ten percent of GDP on healthcare services that don't improve health outcomes is nuts."

The CBO became so intently and rapidly interested in behavioral economics -- which blends insights from psychology with more traditional, neoclassical economics -- because it has the potential to reduce healthcare costs in ways that neoclassical economics simply can't. As most Economics 101 students could tell you, the underlying premise of neoclassical economics is that when most people are asked to make financial choices, they weigh the options rationally; emotions aren't a factor in their decisions. Economists call getting your money's worth, whether in dollar value or in general happiness from the purchase, utility.

Where neoclassical economics falls short is in explaining irrational financial decisions that appear to have little or no utility, at least in neoclassical economic terms. Take cosmetic surgery, for instance. A nose is a nose is a nose, but many people have happily spent between $3,000 and $8,000 for cosmetic rhinoplasty though the original nose smelled as sweet. Neoclassical economics would say the utility from the nose job comes from the feeling of being more attractive.

tx5sl_mawksqlsThe CBO believes that behavioral economics can not only help explain those unnecessary costs but point toward ways of reducing or eliminating them. Unlike neoclassical economics, behavioral economics assumes that human emotions play a role in influencing a consumer's spending decisions on anything from toothpaste to automobiles to rhinoplasty. And though the government doesn't care in particular how much utility a consumer gets from a prettier nose, it cares very much about the ever-increasing cost of tax-funded healthcare in general.

What this economic approach also can't explain entirely is the $3,000 to $8,000 price range for the cost of the surgery. In a neoclassical economic model, all hospitals would use the least expensive and most efficacious methods to create nicer looking noses. But clearly, though healthcare facilities have a financial incentive to keep costs down, some do, while others don't.

Of course, one of the costs involved is the surgeon's fee. Though plastic surgeons make more money in Manhattan than they do in Missoula, that explains only a portion of the price difference. "No one can find any explanation for why costs are so different across hospitals or regions of the country," says Deaton.

"The single most important determinant of our fiscal future is the rate at which healthcare cost per beneficiary will grow in the future," says Orszag. He notes that he "can't think of anything that's more important for the federal budget" than getting healthcare costs in line. And behavioral economics might be the answer to the $700 billion problem.

Overemphasizing personal experience

For example, the CBO's behavioral economic team is operating under the assumption that, as Orszag says, "Doctors are human beings. They're influenced by psychology, as is everyone." Emotion naturally affects the decisions that physicians and healthcare consumers make, and behavioral economics can help explain the degree to which emotions influence their decision making. The CBO's research indicates that a few behavioral economic findings, such as the importance of salience and social norms on decision making, may have the greatest impact on cutting waste.

That brings us to the topic of salience. We all recall things that are salient -- thoughts or ideas that are memorable because they're prominent or recent -- because they're top of mind. That applies to healthcare professionals as much as anybody else. "Doctors may overemphasize personal experience, especially recent events, in providing diagnoses and prescribing care because it is memorable and easily retrieved," says Orszag.

Studies indicate that this is accurate. In a recent presentation to the National Academy of Health Insurance, Orszag mentioned the results of a computer-based study that asked experienced vascular surgeons to monitor an expanding balloon, which simulated an asymptomatic abdominal aortic aneurysm. Some of the physicians were randomly assigned a bad outcome, while others were assigned a good one. The doctors then were given the same statistical information about future risk.

How did their experience affect the decisions these doctors later made? In Orszag's words, "Those who had experienced the bad outcome tended to choose to operate more quickly than those who had experienced the good outcome. Other evidence suggests that many doctors' imperfect knowledge of biostatistics makes it difficult for them to interpret clinical research, and that when they are presented with a positive screening test, they tend to overestimate the probability that a patient actually has a disease."

Overreliance on salience can be both expensive and dangerous because it short-circuits critical thinking. The CBO doesn't recommend that physicians stop relying on salience, however, because it's an ingrained human tendency. Instead, Orszag and his team believe that evidence-based practices could help overcome the effects of salience.

Replacing diagnoses and practices derived from short-term memory and experience with statistically verified or evidence-based standards solves two problems: Doctors have a standard to follow when evaluating each patient, and that would help eliminate variations in diagnostic and treatment practices.

Maggie Ozan-Rafferty, a healthcare expert, suspects that evidence-based standards would also help the medicine go down with doctors. "The more evidence-based the standards are, the easier it is for doctors to embrace them," she says. "It's a lot like airline standardization in the 1970s -- seasoned pilots resisted it, but it improved operational efficiency and safety for everyone." These are the same goals shared by the healthcare industry today.

Normalizing norms

cirlnbeys0simeeczaw1hqThe CBO, however, believes that evidence-based recommendations should not come from economists or the government or even hospitals, because that's a sure way to create backlash among physicians and healthcare consumers. That's why the CBO believes that evidence-based mandates should come from medical associations. Deaton concurs. "Reorganizing a system from the way that people have always done it will meet resistance, for sure," he says.

Many times, however, healthcare workers dismiss such measures as "cookbook medicine," believing that their experience, knowledge, and skill are better guides to diagnosing individual cases than a checklist of medical processes. If that were true, however, there would currently be much less variance in treatment and in costs.

Nor are evidence-based standards the same thing as "HMO committee medicine," which healthcare providers as well as patients view with suspicion. Instead, it's the careful replacement of assumptions with well-researched standards that could eliminate unnecessary procedures and their attendant costs. "We do very little testing of what works and what doesn't in healthcare," says Orszag. "A shockingly large share of the healthcare services delivered is not backed by specific evidence that they work any better than anything else."

In Orszag's presentation to the National Academy of Social Insurance, he noted, "In the mid-1980s, the American Society of Anesthesiologists promulgated standards of optimal practice (both in procedures and equipment) after analyzing the most common sources of errors. Providers had an incentive to follow the standards because deviations from them made the imposition of malpractice liability more likely. After the standards were adopted, mortality rates fell to about 5 per million encounters, as compared with averages of over 100 per million during earlier periods. This experience thus provides a case study showing that aggressively promulgated standards backed by some incentives can alter a long-standing and suboptimal status quo."

This too falls in the province of behavioral economics: social norming. Mandates created by professional associations, for example, set norm patterns -- if an association urges doctors to use a particular method because it achieves the best results, the doctor who doesn't use it is thus aberrant.

"Providing physician-level data on usage patterns and performance does seem to have some effect," says Orszag. "It's more effective when you tie it in with financial incentives, but simply providing information to physicians about their practice patterns relative to their peers does seem to affect their behavior. People don't want to be out of the norm."

Who's really paying the bill?

When making recommendations for reducing healthcare spending, it's easy to blame everything on healthcare providers. After all, they're the ones sending the bills. But that's short-sighted. For every healthcare decision, there's a patient granting approval. And it might be easier to grant that approval if medical treatment costs feel like they're someone else's expense.

The CBO suspects that as long as patients perceive that most healthcare spending comes from employers, insurers, or government rather than out of their wallet, they won't question the amount of money that is spent on healthcare. "Most of us don't realize how much we're actually paying for healthcare, and therefore we perpetuate this relatively inefficient system," says Orszag. "[But] if you told me that if we wrung some inefficiency out of the health system, my take-home pay would be three thousand dollars a year higher, that might generate more action than esoteric arguments about the long-term fiscal path we're on -- and the fact that [the system is] a train wreck waiting to happen."

Looking through a behavioral economics lens suggests that healthcare costs should be more salient to the people paying them. This would require patients -- as well as doctors -- to know what procedures have been proven to produce the best outcomes, rather than relying on the social norms of whatever hospital they're in.

Figuring out where and how healthcare spending is being wasted could cause healthcare professionals and patients to speak out against useless practices. The collective response might even spur some action. But the crucial player in effecting change could well be business.

Businesses are uniquely positioned to understand the economic realities underlying the healthcare system. Businesses have communication outlets in place that can encourage employees to adopt health-conscious -- and cost-conscious -- behaviors. Business has political muscle. And businesses could well be spending their healthcare dollars on care that doesn't make anyone healthier.

So, though the research on applying behavioral economics to healthcare is preliminary, it's pointing in a compelling direction. When the evidence-based results are in, it might be up to business to start demanding more accountability regarding healthcare dollars. After all, the P in GDP comes from business -- and many of the dollars in healthcare spending do too.

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