A Great Recession Story? A Stochastic Frontier Analysis of Washington State Hospitals

Objective: The objective of the article is to contribute to the policy debate over the drivers of the recent slowdown in the growth of health care cost by estimating a stochastic frontier cost function for hospitals in Washington State. Using a Feasible Generalized Least Squares (FGLS) procedure to estimate a time-varying inefficiency model, the article tests whether cost efficiency or productive efficiency was significantly different before and after the great recession. 

Motivation: An important ongoing policy debate in health care is whether the bending of the health care cost curve has been driven by current economic conditions, increase in efficiency, and/or other factors, such as changes in the technological landscape. For the first time since the managed care era of the 1990s, real per capita health care spending grew at the rate of real per capita Gross Domestic Product (GDP) growth, which was 1.4% in 2010 and 0.3% in 2011. This represents an important trend change, given that, on average, growth rate was 2.5 percentage points above GDP growth rate during 1960-2011. Those who hold the view that the current slowdown is primarily the result of the Great Recession expect that health care spending growth will return to historical trends shortly after 2018. In a recent study, Cutler and Sahni (2013) estimate that combination of the recent recession, changes in insurance mix, and Medicare payment rate changes explained 45 percent of the slowdown in health care spending growth. This finding suggests the need to investigate others factors to explain the slowdown in health care cost growth.

Additionally, it is relevant to measure productive efficiency in light of the productivity adjustment provision included in the Patient Protection Affordable Care Act (PPACA). The PPACA calls for annual cuts in Medicare payments to hospitals of 1.1 percent per year based on the so-called productivity adjustment and will force hospitals to offset this cut by increasing productivity by at least 1.1 percent. Since for many hospitals in the State of Washington Medicare represents between 45 to 49 percent of their total revenue, increasing productive efficiency could potentially improve its productivity.

Data: Washington State Department of Health: year-end financial report per hospital during 2003-2011.