Health care spending in the US vs UK: The roles of medical education costs, malpractice risk and defensive medicine

We analyze how two key factors contribute to the high cost of healthcare in the US relative to the UK: (i) the higher private cost of medical education, and (ii) the higher risk of malpractice litigation. To assess the role of these factors we formulate, calibrate and simulate an equilibrium model of physician wages and the supply of medical graduates, work hours and treatment decisions of practicing physicians, and malpractice risk and malpractice insurance pricing. Consistent with prior work, we find direct costs of malpractice fines and insurance explain little of the high cost of healthcare in the US. However, the high private cost of medical education interacts with high malpractice risk in an interesting way: It leads doctors to (i) demand high wages and (ii) use excessive diagnostics to mitigate risk (“defensive medicine”). The agency problem that arises because patients cannot judge the efficacy of tests allows them to be over-prescribed. Together, these factors increase costs far more than direct malpractice costs. Specifically, physician salaries plus diagnostic tests comprise 4.04% of GDP in the US, compared to only 2.3% in the UK. The mechanisms emphasized in our model can largely explain the difference. Our policy simulations imply that more generous medical education subsidies would lead to both improved patient welfare and reduced overall health care costs in the US system (a Pareto improvement). We also find policies to (i) reduce malpractice risk, or (ii) induce doctors to internalize a small part of diagnostic costs, would have similar efficacious effects.