Hospitals have been criticized, including by me, as wildly inefficient. Yet two new pieces of evidence suggest that the hospital market may be more efficient than conventional wisdom suggests.

Hospitals practice medicine in drastically different ways, and the higher-spending ones don’t seem to generate any better results than those that spend less. Because of third-party insurance and other distortions, though, the market doesn’t punish the inefficient hospitals. That has been the traditional critique.

A new study suggests, however, that hospitals actually do gain patients when they provide better value. Economists Amitabh Chandra of Harvard University, Amy Finkelstein and Adam Sacarny of the Massachusetts Institute of Technology, and Chad Syverson of the University of Chicago examined how 5,000 hospitals treated some 3.5 million patients who suffered heart attacks. About a third of the patients died within a year of their heart attack, and the researchers used the variation in survival rates across hospitals to approximate the quality of care provided. The average cost of treatment was $16,000, but that also varied from place to place.

The researchers found that hospitals with higher survival rates net of the cost of treatment were rewarded with more patients. More specifically, if in a given year hospital A had 10 percent higher productivity than hospital B, hospital A tended to have 25 percent higher market share that year and to experience 4 percent more growth over the subsequent five years.

The team also found that the variation in survival rates was more important in driving market share than the variation in cost was. In other words, patients seem to seek out hospitals with better survival rates but not ones with lower costs.

As the researchers note, “It could be that competitive market forces re-allocate market share to higher productivity hospitals, or it could be that higher productivity hospitals happen to have other features -- such as beautiful lobbies or good managers -- which separately increase demand. But whatever the driving force behind them, some force or forces in the healthcare sector lead it to evolve in a manner favorable to higher productivity producers.”

The second piece of new evidence comes from a recent Institute of Medicine report (discussed in a previous column), which reaffirmed earlier findings that the substantial variation in Medicare costs across the U.S. could not reliably be linked to variation in quality. Yet the report also suggested the principal driver of such variation is not hospitals but rather post-acute-care services -- such as skilled nursing facilities, rehabilitation facilities, home health services and hospices. Were it not for this regional variation in post-acute care, the overall Medicare spending variation would be 73 percent less.

Both of these studies were carefully done, but there are still reasons to be cautious about concluding that hospitals are really wondrous examples of productivity. For example, the Chandra paper examined only one condition, yet hospitals treat a lot more than just heart attacks.

In any case, the significant variation in productivity within each hospital -- how much practice norms differ from doctor to doctor -- presents a powerful challenge. I suspect that this internal variation may diminish over the decade ahead, as digital records are more widely used and as payment systems move away from the traditional fee-for-service model. Until it does, though, it is too soon to conclude that hospitals are actually efficient.


Peter Orszag is vice chairman of corporate and investment banking and chairman of the financial strategy and solutions group at Citigroup Inc. and a former director of the Office of Management and Budget in the Obama administration.

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