The United States devotes 16.9% of its economy to health care, more than any other nation in the Organization for Economic Cooperation and Development (OECD), yet has the lowest life expectancy among OECD nations, according to The Commonwealth Fund. What accounts for the high cost of health care here?

Health care costs defy the normal laws of supply and demand, for several reasons. Fundamentally, health care is not like other goods and services, in that you can’t easily consume less of it as the cost increases (you can buy a smaller house if housing costs increase, but good luck settling for half of an open heart surgery). This would be as true in Geneva, Switzerland as in Geneva, Illinois. But there are several features of American health care that make U.S. health care a uniquely bad bargain.

Historical anomalies: During World War II, wage and price controls prohibited employers from competing for scarce labor by raising wage rates. So employers competed by offering benefits, such as health insurance. Thus, the unique American practice of wedding insurance coverage to the job was born. As the practice became established, generous health insurance coverage became a primary goal of union bargaining. The employer-based system of health coverage distorted the market for health care in numerous ways: by advantaging large employers, which benefited from a labor pool large enough to diversify risk, over small employers; by insulating individuals from some of the costs of their own health care decisions; and (one of my favorite topics) by necessitating regulatory interventions to deal with the worst of these adverse side effects. For example, we think of HIPAA as the law protecting health privacy, but actually the name of the law is the Health Insurance Portability and Accountability Act. The lack of flexibility in the labor markets arising from individuals being locked into jobs with good health insurance introduced a whole new complex regulatory regime affecting not only employee benefits, but also privacy and health information technology. This theme of structural problems necessitating complex regulatory solutions that increase health care administrative costs is one we will see again and again as we look at the industry.

Maldistribution of health care resources: Some health care payers offer hospitals and doctors much more money than others. Specifically, benefit plans covering large employers pay better than government programs like Medicare and Medicaid, and of course many people in the U.S. have no health care coverage at all and have to depend on charity care. So if you are a health care executive trying to decide where to locate a new clinic or (especially) hospital, the payer mix in the service area is of primary importance. You end up with too many hospital beds in wealthy areas and too few in areas with large numbers of Medicaid beneficiaries and the uninsured. This invites a patchwork of regulatory fixes such as certificate of need laws and mandated charity care. Certificate of need laws require health care providers to get approval from a state regulatory board in order to construct a hospital, nursing home or other facility in an area, usually by demonstrating unmet need. Established providers in the area contest new entrants fiercely, and in some cases (like Illinois) the boards approving certificates of need have been subject to corruption.

Payment systems may not align with society’s health care needs: In spite of the health care system spending exorbitantly on high-tech procedures, most primary care physician practices have struggled to make ends meet for decades. This has caused consolidation in the industry, as physicians have had to leave independent practice to become employed by health systems, or to aggregate into large practices (sometimes with private equity funding). The most urgent health care need this past year has been for care of Covid patients, but the demands of the pandemic have devastated health system finances, due to cancellation of high revenue procedures. The current system doesn’t adequately serve consumer needs, or operate in a logical way for health care providers.