Why Is Innovation the Main Driver of Healthcare Spending Increases?

I have this demand: Every weekday, I want to get from home to school and back again with as little travel time as possible. I could fulfill this desire in various ways: drive a car, ride a bike, walk, fly a helicopter. Let’s pretend my demand is currently being fulfilled by a helicopter because that’s the fastest way available. So, you could say that my demand to get to school as quickly as possible is being fulfilled to some extent, but it’s not being completely fulfilled, which would entail getting to school and back with zero total travel time. Technology is limiting my demand from being completely fulfilled.

I will call my fulfilled demand active, because I’m actively spending money to fulfill it, and my unfulfilled demand latent, because it exists but is not currently being fulfilled.

What does this have to do with innovation? Well, not much, except that it lays the background for understanding my next sentence. Innovation (which I will define as finding a new way to fulfill demand) comes in two varieties: (1) the variety that creates cheaper ways to fulfill active demand and (2) innovation that activates latent demand.

Let’s make this concrete. If a new helicopter company comes up with a cheaper way to sell a similar-quality helicopter as the one I have, then I could have gotten that one instead. This would be an example of fulfilling active demand in a cheaper way. And if a teleportation company comes along, then I could get one of those and all of my latent demand would be activated.

All of this assumes money is no object, which, when we’re talking about healthcare, it often isn’t. But this post isn’t about that.

So now you should understand that when innovation has the net effect of increasing total spending in an industry (like healthcare), it’s probably because a lot of latent demand is getting activated (i.e., we’re spending money to fulfill demands that weren’t previously being fulfilled). This is great! . . . Except when it bankrupts us. So we probably need to somehow ration (especially the high-cost-yet-marginally-better-outcome stuff) and encourage innovation of the cost-lowering kind.

Ignoring (for now) the rationing suggestion, here are my thoughts about who we can expect/encourage to provide the cost-lowering innovation.

Providers (doctors and hospitals). I don’t see providers as activating much latent demand in healthcare. They kind of have to just use what treatment techniques they’re provided and find the most cost-effective way to administer them to the right patients. So, provider innovation should be a major source of the cost-lowering variety (think about IHC or Mayo Clinic).

Suppliers (device manufacturers and pharmaceutical companies). When thinking about supplier innovation, they do both kinds. Often they are coming up with miracle drugs and devices that activate latent demand (think about insulin, which prolonged the life expectancy for diabetics from months to decades), and sometimes they are also coming up with devices that make it cheaper to fulfill already active demand (think about at-home dialysis machines).