When economic theory begins to diverge from observed behavior, a new theory usually is just ahead. This situation seems to be occurring in healthcare economics now. If so, we will soon see some new ideas addressed in the next microeconomics textbook.


Past Theoretical Structures

Arguably, economic theory in health care is entering its fourth generation. To understand what lies ahead, it helps to understand the past three generations of theory as they have applied to health care

The volunteer generation. Many describe early healthcare finance as the “volunteer” era. People paid cash, or produce, or bartered services for care. Much care was delivered without payment. Standards of care varied more, as did access to care. In some cases, communities raised funds for individuals to undergo a procedure they could not pay for. Hospitals and health systems often were sponsored by religious organizations, and sometimes by cities or states.

By World War II, the nation seemed ready for a more organized approach. We were primed for change by communications, a new sense of national purpose, the development of management science (for example, Alfred Sloan was refining automobile processes for product lines and distribution networks), a national sense of power and optimism, and other developments.

The Great Society generation. Healthcare economics changed radically from World War II up until the late 1980s. Medicare, Medicaid, and commercial insurance were introduced. Standards were set for at least minimal access for all. Medical societies and many others sought a consistent level of care regardless of payment. The 1986 Emergency Medical Treatment and Labor Act (EMTALA) required some forms of treatment regardless of whether patients could pay.

The most common form of payment was “cost plus” (with the costs based on fixed amount for specific types of care). For hospitals, half of patients were treated under federally prescribed Medicare schedules. It became commonplace to charge commercial patients more to recoup the lower receipts and time lags of Medicare, Medicaid, and no-pay patients.

Many governments outside of the United States moved to develop publicly funded, “universal access” concepts. Within the United States, many healthcare economists focused on cost-shifting (the dollars to shift more burden to commercial patients) and access (the numbers who had minimal payment options and often received more limited care).

The market-driven generation. Beginning in the late 1980s, health systems began to think of themselves more like businesses, and less like charities. Leaders and consultants often were engaged from other market-driven sectors. For-profit healthcare companies gained market share.

Why Expect a Fourth Generation?

In the past, economic theory in health care seems to have undergone change when three conditions were present:
  • There was a national sense that we could do better
  • Our results using current models were seen as increasingly diverging from actual behavior
  • Economists in other fields were developing new approaches that could be applied to health care

It stands to reason that the presence of any one of these conditions today would similarly be a harbinger of something new. Consider, then, that not just one but all these conditions appear to be present today.

There is a national sense that we could do better. At best, it seems, our current efforts to control healthcare costs are only keeping the rate of increase down, to single digits. Meanwhile, the nation continues to spend far more than other countries, to the dissatisfaction of most Americans.

The goal of one standard level of care is out of reach in most regions of the United States. In some geographic areas, healthcare provider organizations are receiving double-digit surpluses; in others, providers are close to going out of business. Common sense suggests that the rewards range between primary care and specialty care will lead to more shortages at the bottom of the pyramid.

Current economic approaches are diverging from reality. Classic competition theory says that markets with many suppliers have the lowest cost. However, among the nation’s healthcare markets, the lowest total healthcare costs are in markets with two to three major health systems. Markets with many health systems actually have the highest costs.

When health system competitors are added to a market, costs should theoretically go down. But in our nation’s healthcare system, they don’t.

In theory, higher deductibles should lead to patients shopping for lower costs. But the reality is different.

Economists in other fields are evolving new approaches. The line between financial and non-financial analyses is going away. The role of nonfinancial variables in financial decisions is receiving significant attention, as is the role of market analyses on nonfinancial issues. Examples of nonfinancial inputs into financial decisions include:
  • The strength of networks(e.g., the communication and trust) of decision makers who need to collaborate on some issues, even as they compete on others
  • Decision makers who value prestige and influence more than they value current dollars
  • The differences in the way decisions are approached when they are made locally versus remotely

What Do We Need From Next Generation Economic Models?

To be helpful, the fourth-generation healthcare microeconomics handbook will need to explain current realities, and do a reasonable job in predicting future behavior. For example, the next generation economic model will be helpful if it answers questions like the following:
  • Will a proposed consolidation lead to lower costs in providing care, and will it lead to lower costs for the payer and consumer?
  • How can an organization estimate and aggregate enough consumers/patients to make a new product work?
Impact of consolidation on cost. It is clear from recent interviews with health systems and others in several markets that there is no consistent pattern in how costs are affected by a consolidation, even among health systems with similar organizational profiles and similar market profiles. More information is needed to understand the impacts. To assess a proposed consolidation’s likelihood of producing positive financial results, inputs considered probably should include the following:
  • The image/prestige value of the potential transaction
  • The strength of leaders’ relationships with each other
  • Whether leaders overall feeling about the future reflect optimism or defensiveness
  • Leaders’ belief about the future of value-based payments
  • The degree to which the two organizational cultures are compatible
  • Local circumstances (e.g., payer and provider market shares, employers’ focus on keeping costs low, and the degree to which providers are cooperating as well as competing)
  • Whether decisions are made locally or remotely
Consumer engagement. When analyzing decision-making patterns among segments of patients, consumers, and households in the market, the following questions should be considered:
  • How big is the tech-savvy segment?
  • How big is the time-starved segment?
  • What sources of information do the different consumer segments tend to use?
  • How sick and how old are individuals in the segments, and what are their cultures. ethnicities, and socioeconomic groupings?
  • How strong are the local healthcare brands?

Looking Ahead

During a previous era, investigative reporters seeking answers learned to “follow the money.” In health care today, if they want to find out what will happen next, it’s becoming apparent they need to “follow more than just the money.” Fortunately, some economists and modelers are on the way with help.


Keith D. Moore, MCP, is CEO, McManis Consulting, Denver, and a member of HFMA’s Colorado Chapter.

Dean C. Coddington is a senior consultant, McManis Consulting, Denver.

Publication Date: Thursday, February 01, 2018