Cut Health-Care Costs - But How?

IF President-elect Clinton has a mandate on any issue it is surely health-care reform. At times he appeared to place the onus of reducing federal budgetary deficits and restoring the competitiveness of American industry squarely on this policy initiative. Yet the thorny question of how to get wildly inflationary health-care costs under control while simultaneously expanding access to 37 million uninsured citizens largely went unaddressed during the campaign.

Having failed to articulate a concrete strategy for reducing health-care costs during his drive for the presidency, Clinton will enter a legislative quagmire without a popular consensus for specific action - the one weapon that might have enabled him to face down the formidable special interests arrayed on this issue.

Political factors explain the campaign's silence on the mechanics of reducing costs. While there is no shortage of blueprints for bringing about reductions, the unpleasant news they entail renders most reforms unsuitable for political discourse.

Consider a few side-effects of limiting health-care expenditures: lower incomes for physicians and other health professionals; diminished employment in health administration and insurance; less access to high-tech medicine and marginally useful procedures; lower returns for pharmaceutical, bio-tech and health-care corporations; reduced patient choice of providers; closures of local hospitals; and profound changes in how people use and regard the health-care system.

A second reason for obscuring the cost-control issue lies in the complexity and breadth of effective solutions. Containing costs entails a far more complex policy prescription than the conventional choice between competition and regulation. True, some health-care reforms emphasize markets, consumer choice (assisted by sophisticated agents such as employers), and provider competition, while others entail direct governmental controls such as caps on expenditures, fee schedules, and limits on new technology . The regulation-versus-competition choice, however, is something of a false dichotomy. In order to work, all reform plans require a mixture of sensible government interventions and incentives for competition.

Mr. Clinton's plan would create a National Health Board to set an annual "global" budget governing health expenditures. Unfortunately, such key details as whether this strategy will rely principally on administered pricing or provider competition to secure compliance with budget caps have been left obscure.

Although President Bush scarcely troubled to explain how he would contain costs (except to invoke competition and malpractice reform), the regulation-abhorring Reagan and Bush administrations have already put in place a Byzantine regulatory apparatus for rate-setting. These regulations governing Medicare physician and hospital fees, which can readily be adapted to set prices for all health insurers, are likely to constitute the "backup mechanism" Clinton has referred to in his reform proposals. Since the y offer a handy and fast-acting lever to slow inflation, they may ultimately prove to be the new administration's primary tool for cost control.

The ultimate success of cost containment depends on whether effective measures are found to deal with the peculiar economic relationships involved in the purchase of health-care services. Although the presidential campaign fostered the notion of a bipolar choice between governmental fiat and market forces, prospects for long-term success rest on achieving an appropriate balance of incentives and controls.

Paradoxical as it may seem, a firm governmental hand is often necessary if a transition to competition is to succeed. As we learned the hard way from airline deregulation, an infrastructure conducive to competition is needed for markets to work efficiently. This is especially important in health care because the economics of the industry are complicated by "market imperfections," such as inadequate information among buyers and sellers, that distinguish it from other sectors.

The mixed record of competition in controlling costs is attributable to the government's failure to develop such an infrastructure. For example, although the government purchases almost 50 percent of all health-care services, it has been reluctant to throw its enormous buying power behind competitive solutions such as obliging beneficiaries of government programs to participate in competitively delivered programs. Until managed-care systems reach a critical mass, the entrenched customs, hierarchies, and

practice styles of organized medicine are unlikely to change rapidly.

"Pro-competitive" regulatory intervention is particularly needed in the insurance industry. Historically, insurers have preferred to compete by selecting healthy customers rather than forcing down costs. Individuals, meanwhile, can anticipate their needs for services better than insurers and can upset insurers' ability to estimate expenses. Controls over the way in which insurers rate risks are therefore necessary, probably requiring open enrollment and community rating, allowing for certain actuarial di fferences.

Providers, particularly physicians, practice in highly fragmented and autonomous settings and are resistant to change. Scrutiny by antitrust regulators is essential to keep cartel practices and "professional ethics" from thwarting the cost-reducing benefits of competitive reform. Health professionals have proven especially adept at securing protection from competition through state legislative action.

Finally, the malpractice system may place limits on the savings that can be expected from competitive incentives, so adjustments to the liability system (such as recognizing variations in the standard of care in a competitive environment) may be needed.

On the buyer's side, individuals and even many employers are ill-equipped to negotiate conscientiously with providers. Establishing and regulating entities to assist in gathering information and in bargaining are central to market-based reforms. If it is to be retained at all, tax-free treatment of employer health-insurance contributions should be adjusted to reward plans that are efficient in controlling costs.

There has been one beneficial side-effect to the complex rate regulation of Medicare providers established by the Bush and Reagan administrations. We have learned how hard it is to control costs through regulation without causing expensive or harmful repercussions elsewhere in the system. The primary lesson has been that price controls do not necessarily limit costs. Freezes in physician fees under Medicare were followed by sharp increases in the aggregate number and complexity of services provided.

The key to cost regulation abroad has been pervasive governmental regulation limiting growth of costly technology and facilities and controlling the specialty mix of physicians and the availability of private insurance. Such pervasive regulation is unlikely in the United States. Moreover, questions exist about the effect of such controls on provider efficiency and quality. Purely regulatory solutions assume an omniscient governmental agency capable of taking into account a wide variety of consumer prefer ences. In health care, the "quality" of a service embraces a variety of patient concerns: outcomes, amenities, caring, relief of anxieties. Even the most self-confident regulators will acknowledge that they lack tools to price new technologies at optimal levels.

The crux of the regulatory dilemma - how to effectively control the system-wide volume of services and still preserve diversity and innovation - has yet to be resolved. "Dividing up the pie" under global budgeting requires some use of incentives and market interactions among doctors and hospitals. Health-care reform is preeminent in the Clinton mandate for change. Whether his ill-defined plan can be transformed into the comprehensive and subtle mix of policies needed remains an open and politically charg ed question.