Economy cannot be all that’s slowing health costs

A new set of projections released last week by Medicare’s actuaries has drawn much attention, in part because it suggests the deceleration in the growth of health costs we’ve seen over the past few years is ephemeral. The actuaries attribute the slowdown to the “lingering effects of the economic downturn and sluggish recovery” and to increases in cost sharing.

Both of these explanations have serious shortcomings ― and that, in turn, suggests something larger is in fact at work.

The assertion that economic sluggishness is playing a dominant role is based on an econometric analysis that links past slow growth in gross domestic product to current aggregate health spending. However, such a macroeconomic explanation is difficult to reconcile with the slowdown in Medicare, because there is no reason to expect Medicare ― a subsidy that goes mainly to retired people ― to be much affected by the economy.

What’s more, the econometric methodology itself, which I have long disliked, was debunked in another paper released last week. Amitabh Chandra and Jonathan Holmes of Harvard University and Jonathan Skinner of Dartmouth College found that when they made even modest changes in this type of model, the results changed drastically. They concluded, “We are reluctant to make much of the time-series evidence between GDP growth and health care spending.”

A simple rule of thumb is that econometric results are untrustworthy if small specification changes ― such as shifting the time period by a couple of years ― substantially alter the results. (The same critique applies to an earlier analysis of this ilk, also much cited in the news media, from the Kaiser Family Foundation. The report is unfortunately less scientific than it pretended to be.)

The second reason for the spending deceleration cited by the Medicare actuaries ― increased cost sharing ― has a bit more force to it. As I noted in a column a couple of years ago and as has played out in recent decisions by Walgreen Co. and other companies, employers are shifting away from defined health care benefits and toward defined contributions. But as the actuaries’ report shows, total out-of-pocket spending has fallen from 11.7 percent of aggregate health care spending to an estimated 11.3 percent in 2013. So even though increased cost sharing may help explain the change in private spending on health care, it’s hard to see how this factor can explain the overall slowdown.

All things considered, I don’t put too much weight on last week’s report from the Medicare actuaries. And I’m willing to put some pride, if not money, on the table. The actuaries project that, in 2014, Medicare will grow by more than 5 percent. I bet it will be less than that. (Anyone who wants to take the over-under on that projection can email me at the address at the bottom of this column, and we will check back at the end of 2014.)

The Chandra paper raises another, more serious reason to worry that the recent trend might not last: The growth in health care employment has not slowed. And as they note, it seems unlikely that there will be “a permanent bending of the cost curve without a commensurate shift in employment rates.”

That’s a good point, and yet Chandra and colleagues may be a bit too pessimistic. Consider that labor compensation accounts for only about 60 percent of total health care spending. So it doesn’t move in lockstep with spending, and slower job growth doesn’t necessarily imply a sustainable decline in spending growth. Indeed, job growth declined markedly in the late 1990s, after a slowdown in health spending earlier in the decade, but neither of those changes were sustained. A noticeable decline in job growth is thus not sufficient for an ongoing deceleration in health spending. And it’s not clear it’s necessary either.

The recent experience is illuminating. As the Chandra paper points out, employment in the health sector is growing at about 2 percent a year, in line with historical rates. But we should expect some job growth as the population ages and demand for health care increases. It is therefore encouraging that the ratio of health care workers to Medicare beneficiaries has stabilized and even declined a bit.

It is also encouraging that the growth in total compensation in the health sector has fallen to between 2 percent to 4 percent annually over the past three years, from 5 percent to 8 percent a decade ago. (Compensation per full-time-equivalent worker is rising at only 1 percent to 2 percent a year, down from 4 percent to 5 percent.) If labor is 60 percent of health costs, and labor costs are rising at 3 percent a year instead of 6 percent, the effect is to reduce the underlying growth in health costs by about 2 percent a year.

Doug Elmendorf, the director of the Congressional Budget Office, summarized the situation trenchantly last week. In comments on the Chandra paper, he noted, “The slowdown in health care cost growth has been sufficiently broad and persistent to persuade us to make significant downward revisions to our projections of federal health care spending.”

At the same time, Elmendorf emphasized, “Growth in such spending remains the central challenge in putting the federal budget on a sustainable path.”

He is exactly right. The past several years have been encouraging. But we should push for further steps ― especially, moving Medicare away from fee-for-service payments ― to keep costs decelerating.

By Peter Orszag 

Peter Orszag is vice chairman of corporate and investment banking and chairman of the financial strategy and solutions group at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration. ― Ed.

(Bloomberg)