Uncertainty and Technological Change in Medicine

At the heart of Kenneth Arrow's landmark article on the economics of medical care is the pervasive influence of uncertainty, both in regard to the occurrence of disease and to the efficacy of treatment. These uncertainties, as Arrow contends, have led to the following distortions in the operation of health care: (1) health insurance schemes that have insulated patients and physicians from the financial implications of their medical decisions (i.e., the moral hazard argument), and (2) delegation of medical care decisions from patients to physicians because of the extreme information asymmetry between the two parties (the principal agent theory). These arguments are made with little reference to technology or technological change, issues that Arrow explores in numerous other works (1962, 1969). Yet these issues of moral hazard and agency provide a significant thrust behind technological development in medicine. In the past forty years, physicians have faced strong clinical, economic, and social incentives to adopt and use new technologies in management of disease. The insulation of patients from true medical costs through insurance has compounded these effects. The growth of insurance has led to strong, positive feedback to the R&D sector, which fueled such rapid technological change that both the quality and costs of U.S. health care bear little resemblance to those prevailing at the time of Arrow's writing.

This essay explores the dynamics of technological change in medicine and is divided into three parts. ¹ First, we briefly sketch the complex institutional interplay through which medical innovation emerges. Second, we propose that innovation must be understood as a process of "cultural" learning or evolution. That cultural evolutionary process, in turn, involves the coevolution of technique and knowledge. Third, we discuss several special features of the nature and process of technological change in medicine that set it apart from other sectors of the economy. In this respect, we highlight the persistence of uncertainty and expand on Arrow's (1963: 951) observations that "uncertainty as to the quality of the product is perhaps more intense here than in any other important commodity. Recovery from disease is as unpredictable as its incidence." We then draw some concluding observations.

Institutional Interplay in Medical Innovation

Since the 1960s, the technological contours of clinical practice have undergone considerable change. One useful index of the high degree of technological change is the plethora of new drugs and devices that have been introduced: Burton Weisbrod (1991), for example, reported that approximately 35 percent of the 200 largest-selling prescription drugs are new each year. Furthermore, in 1999, the Food and Drug Administration (FDA) approved some 5,000 new and modified devices. Over the same time period, physician-innovators were pioneering new clinical procedures, whose development did not necessarily center on a particular health care product. These procedures ranged from high-tech coronary artery bypass grafting to preventive measures for changing lifestyles of high-risk population groups.

This virtual explosion in medical technology raises a central question: How did all this innovation come about? Since World War II, powerful demand- and supply-side forces have encouraged medical innovation in most industrialized nations. On the demand side, we have witnessed an ongoing expansion of health insurance, and the existence of generous insurance schemes. Recall that the creation of large federal insurance plans, that is, Medicare and Medicaid, occurred after the writing of Arrow's seminal work on medical care. On the supply side, government funds for medical research and education increased significantly during these years. This expansion, in part, arose out of the wartime successes of government-sponsored research and development efforts and the resulting report entitled, "Science the Endless Frontier," which called for federal investment in basic biomedical research. In the United States, expenditures for medical research increased fortyfold in real terms between 1940 and 1987; the budget of the...