CHAPTER 1
Introduction
There are three kinds of lies: lies, damn lies, and statistics.
-Popularized by Mark Twain (originated by Leonard H. Courtney, 1895)
Counter to what Mr. Twain might have advised, this study's going to do it again; that is, develop a hypothesis, and then—using statistics—test it with government data (and we all know they don't lie, don't we?).
This study updates 1995 and 1998 analyses of post-World War II (WWII) National Health Expenditure (NHE) data. The previous studies used a standard neoclassical model. The current study covers additional years through 2009, adds managed care and government regulatory effects, and uses an evolutionary economic model of a health care sector characterized by complexity and emergent properties. My central purpose here is to explore, from an evolutionary perspective, the drivers of the persistent growth in relative health spending. In particular, why do we all pay such a large and growing portion of our income for health care "and yet, in many cases, not receive the health services we need?
This study agrees with the two previous findings (by myself and Mark Freeland) that relative health spending growth has been induced by increasing insurance coverage levels. All three studies agree that the root of the growth in relative health spending was a single rule change, the post-war extension of the employer tax exclusion for employment-related health care insurance. However, the current model puts the results into a self-organizing historical evolutionary paradigm that allows for "the structural uncertainty inherent in [the] evolutionary process [of a complex autocatalytic feedback system]." This paradigm is structured around dynamic trajectories that that can be affected by various factors. In contrast the standard neoclassical model espouses a static view, using comparative statics to analyze the movement from one equilibrium to another.
This story is not a simple tale of rising costs; instead I must account for a multiplicity of factors. At the end of the study, I hope to present a better picture of the historical events that induced relative health spending to grow so precipitously. A note of caution is in order: with an evolutionary-economic approach, one would not expect to find or demonstrate some universal principle; instead one typically finds dynamic behaviors and tendencies that might be expected to recur under circumstances that mimic those of the past. The health care sector is a complex evolutionary system, much like a dynamic biological system; it changes over time and is irreversible. As Stuart Kauffman relates, "At levels of complexity above atoms, the universe is on a pathway, or trajectory, that will never repeat." This contrasts with time-reversible systems such as Newton's laws and neoclassical economics. But discovering lessons from what has occurred will enable the formulation of a few historical lessons that may be applicable in designing future policies.
Economics as an evolutionary science. Increasingly, economists are employing an evolutionary perspective to understand and predict economic phenomena. And that is what I do here. So what is it and how does it work? Eric Beinhocker tells us that:
Evolution is an algorithm: it is an all-purpose formula for innovation, a formula that, through its special brand of trial and error, creates new designs and solves difficult problems. Evolution can perform its tricks not just in the "substrate" of DNA, but in any system that has the right information-processing and information-storage characteristics ... In short, evolution's [recipe is simple,] "differentiate, select, and amplify ..."
From an economic perspective, evolution is the source of "novelty, knowledge, and growth."
Beinhocker goes on to say that "... both economic and biological systems are subclasses of a more general and universal class of evolutionary systems ..." that researchers believe follow "general laws of evolutionary systems." Thus "[i]f the economy is truly an evolutionary system ..." it will follow those general laws. Beinhocker also states that these laws of economics do not "imply that we will ever be able to make perfect predictions about the economy, but [they do] imply that we might someday have a far deeper understanding of economic phenomena than we do today."
To distinguish biological and social scientific evolution, I note that economics follows rules of operation found in the book The General Theory of Economic Evolution, by Kurt Dopfer and Jason Potts (D&P).
The evolutionary ontology of the social science `economics' is made up of ideas expressed as generic rules, which relate to operations on resources; D&P distinguish these from biological rules, which are genetic. Whereas "[g]enetic rules replicate biologically, generic rules 'are communicated' socially." In evolutionary economics the generic rules that evolve can be the cognitive and behavioral rules of the individual, the coordination of people with social rules, or the organization of matter and/or energy with technical rules. But all of these rules need to fit together; thus economic evolution—like biological evolution—includes not only changes in its generic rules, but also the ongoing process of their coordination.
Health care as a complex adaptive system. Economics in the traditional neoclassical framework is essentially static, characterized by equilibrium in all markets and across all markets in what is known as general equilibrium. When there are shocks from changes in technology, public policy, consumer preferences, or any of the myriad other factors affecting markets, market changes will occur over time, but from one static equilibrium to another. By contrast, following Stuart Kauffman, "... a complex system is a system of many dynamically interacting parts or particles. In such systems the micro-level interactions of the parts or particles lead to the emergence of macro-level patterns of behavior." As an example, he tells us that a single isolated water molecule is a rather humdrum phenomenon, but if one puts "a few billion water molecules together and adds some energy in the right way, one gets the complex macro pattern of a whirlpool ..., [which] is the result of the dynamic interactions between the individual molecules." The whirlpool is an 'emergent' property of these interactions. In the same way, economies are groups of people who collectively interact to develop and adapt their behaviors in complex emergent patterns that process information and systematized the economy as a whole.
Although a formal definition of "complexity" has proved elusive, Scott E. Page tells us that a "system can be considered complex if its agents meet four qualifications: diversity, connection, interdependence, and adaptation." I would add that a complex system will have "strong interactions among its elements," and that what happens in the system now can strongly influence the probabilities of many kinds of later occurrences.
Clearly, something other than the standard neoclassical approach is required. As Mark Blaug says, "health economics is a field which must make the average neoclassical [economist] squirm because it challenges his or her standard assumptions at every turn." Given the multiplicity of reasons to steer away from a neoclassical framework, including my own inclinations, I proceed to analyze health care as a complex adaptive system with emergent properties.
My intention is to treat the health care market as an evolutionary complex system with emergent properties that can be analyzed using post-WWII data. In doing this, however, it is also necessary to incorporate the unique features of the health care sector. Hodgson tells us that "while health itself is a universal need, needs for health care are largely involuntary, varied, and idiosyncratic." He adds that "[t]hese issues have important consequences for the planning of health care systems...." Combining the inherent dynamism of complex adaptive systems generally, with these unique properties of modern health care, as well as its needs and capabilities, results in "an opening for alternative approaches to health care economics ... [whose systems he concludes] ... are non-linear, complex, and have strong interactive effects."
Micro-meso-macro. Until recently, neoclassical economists have been used to thinking of economic analysis as taking place at either the micro or macro, the former referring to the individual and interactive behavior of consumers and firms, and the latter to—economy-wide economic behavior—a sum-total of the former. However, Dopfer, Foster, and Potts (DFP) tell us that "From the evolutionary perspective, one cannot directly sum micro into macro." In this study, the health care sub-sector analyzed—and where given rules and norms apply within this subsector—is only part of the macro economy; thus the proper reference for the sub-sector is "meso." This is apparent in context as follows.
* Micro structure refers to individual rule carriers, as well as the systems they organize. Their inter-relationships and behaviors are complex. Micro structure occurs within the elements of the meso and macro structures, and includes their rules for both individual agents and the systems they organize. Together, these factors provide the basis for an ontologically coherent framework for an analysis of economic evolution as changes in the micro domain, and thus within the meso and macro domains as well.
* Meso structure consists of a rule and its population of actualizations, which can be thought of as a macro-economic sub-sector and is thus subject to macro-level rules. For the health care meso-sector, emergent properties from macro-level rules and the interacting micro behaviors of the consuming and service units (carrying their own health care rules) result in the emergent aggregate behaviors that constitute the meso market. Within this scenario, DFP posit a "meso trajectory," as a way of understanding the micro-processes, as well as the meso, and ultimately the macro consequences involved.
* Macro structure is the emergent behavior of interacting meso sub-sectors.
While emergent micro behavior results in meso and macro behavior, this does not mean that either is predictable from micro behavior or that macro behavior is predictable from meso behavior. As Stuart Kauffman tells us in his book, Reinventing the Sacred, "... [while] the economy is ceaselessly creative, [it is] beyond the reach of reductionism ..." By contrast, reductionism is a key feature of the neoclassical economic model.
Health care as a meso-macro system with emergent properties. The health care sector is a diverse, agent-connected, interdependent, and adaptive. But in addition, it is also a meso market within the macro-economy. In particular, health care spending is a subset of consumption, and this study examines the portion of consumption going toward health care, which is thus meso-macro, and is defined as relative health care spending. Its trajectory is the subject of the following analysis. Emergent properties of relative health care spending may or may not follow from the micro behaviors of the agents, but often, what occurs at the higher levels of analysis, differs from the micro level, not just in scale, but in kind. In sum, I analyze emergent relative health care spending historically as a complex adaptive system in an evolutionary framework.
Rule changes can have a large impact on emergent properties, which themselves can have subsequent effects on the further evolution of a system. It is this study's purpose to examine the historical evolution of the health care sector from an initial rule change (and later reactive modifications) that resulted in its historical and current path. Emergent behaviors often take place over a long period of time and, as found in Aziz-Alaoui and Bertelle, "cause and effect need not be close in time."
Relative health care spending: A brief historical overview. In 1942 the US government began granting employers tax exclusions for employee health care insurance purchases to allow wage increases without violating war-related wage controls. The controls ended with the war, but the tax exclusions were explicitly continued after 1945. Subsequently, employer sponsored health care insurance started to spread, though not all companies purchased it. Relative health care spending began to rise, as did relative medical prices—i.e. the medical price index divided by price index of total consumption. The differential financial advantage of selling medical services over other consumption induced by added coverage resulted in demand by both employers and employees to add to or expand coverage still more. Thus the financial advantage was seen in both the growth of relative health care spending and the growth in relative medical prices. For firms, the addition or expansion of coverage became a way to compete for employees. A feedback mechanism arose, whereby greater coverage increased the relative demand for health care which then resulted in higher relative medical prices and greater relative health care spending, which, in turn, further increased the demand for coverage. Over time, society came to see higher relative medical prices as unfair and punitive to those who didn't—or weren't able to—receive the subsidies inherent in the employer tax exclusion.
To ease the effects of this perceived unfairness, the elderly and poor were provided with Medicare and Medicaid, respectively, starting in 1966. The creation of these programs was followed by the creation of numerous similar public programs (e.g., the disabled were added to Medicare in 1973). But the more additional subsidies became available, the more health care demand rose vis-à-vis overall consumption demand,—and the stronger the stimulus became,—both to relative medical prices and relative health care spending.
As seen above, continuing coverage increases (inherent in the tax exclusion and the new government insurance programs) brought about an increased demand for medical services seen in the higher relative medical prices and additional funding. But on a positive note, it also resulted in a continuously rising derived demand for both existing and new services of medical providers, medical firms, insurance companies and research institutions; and many of these services included technical innovations and organizational improvements. At the same time, the products of medical firms were similarly improved. Because innovations are constantly occurring across all sectors of the economy, many probably would have come about in any case, but others occurred because of the increased stimulus. In yet other cases, the increases in demand—seen in both the market for products and services and for those producing them—simply raised relative medical prices and input costs, as will be seen below in the case of tonsillectomies. In spite of these complications, there is no doubt that medical services and products have been greatly enhanced in both their quantity and quality because of the demand-induced medical innovations.
Managed Care. As insurance companies became aware of the effects of rising coverage, a number of other countervailing emergent properties manifested themselves. In particular, with the passage of 'The Health Maintenance Organization [HMO] Act' passed by Congress in 1973, managed care became available for the management of an individual's health care in exchange for an overall payment. In addition, fee-for-service insurance companies started adopting many of the managed care innovations by providing a designated comprehensive market basket of medical services under various payment options and copay arrangements. An emergent property of managed care, whether HMOs or fee-for-service packages, has been the advent of managed care insurers hiring or contracting with providers to provide care at prices lower than those typically found on a strictly fee-for-service basis—often with fewer or curtailed services—in exchange for guaranteeing them clientele. Packages of medical services also brought—in addition to the tax incentive to purchase insurance—broader coverage (e.g., dental, vision, and hearing defect coverage). Added also was the often contentious process of having to justify individual and provider claims to both private and public insurers, with sometimes tedious legal steps involved. Patient claims became subject to review and, in many cases, have been denied. Provider practices were monitored and subject to stringent regulation by the federal government. In any case, what had been a rather straightforward market involving patients and providers before the end of WW II, evolved to include large insurance companies, lawyers, practice managers, numerous claims representatives, and lobbyists (for vested interests) as well as an enlarged bureaucracy to handle claims, enforce rules, and process the paper work supporting these increased activities. As a result, receiving and giving health care services has become one of the most complicated and arduous fiscal activities facing many Americans and their health care providers. Today, buying health care is not as easy or straightforward as buying other goods and services.
