Whether it’s the sovereign debt crisis unfolding in Europe or the Super Committee charged with finding $1.5 trillion in savings from the U.S. budget over the coming decade, public sector austerity is de rigueur in most developed nations. Canada is no different, and while the federal situation is reasonably healthy, some provinces are facing major challenges.

The politically-sensitive healthcare file constitutes the largest single expenditure for every province in Canada. Even before the recession hit, it was abundantly clear that healthcare spending wasn’t on a sustainable pace. It consumes 42% of Ontario provincial spending (other provinces have similar ratios), and the debt piled on during the recession only made finding a sustainable spending path even more pressing.

Last week The Mowat Centre, at the University of Toronto, published a study advocating that the Ontario government look towards productivity gains, restructuring provisions and making more effective use of technology in tackling the healthcare file. Getting more healthcare services out of each dollar spent would certainly be akin to a silver bullet, but there has been a long running debate with respect to how technology impacts healthcare spending.

While technological progress has made items like electronics less costly and reduced costs for industries dependent on technology (banking, telecommunications, etc.) the evidence shows this hasn’t occurred in healthcare. In fact, the U.S. Congressional Budget Office (CBO) published a study in 2008 entitled ‘Technological Change and the Growth in Healthcare Costs’ concluding that about half of all the growth in healthcare costs over the past couple decades is attributable to technological progress.

Why has the healthcare industry been the exception and not the rule? It’s largely because technological progress has allowed for treatment of previously untreatable health ailments. The result has been spending that otherwise would not have occurred. This is naturally viewed positively, but a peculiarity of the market for healthcare services (whether in Canada or the United States) is the way in which it is priced, making it very hard to ever capitalize on cost efficiencies even when they are present.

Competition ensures that the benefits of technological change are widely dispersed, allowing consumers to benefit from the lower unit costs and better products. The key difference in the market for healthcare services is that as technology advances (lowering the cost of treating a patient) there is no competitive pressure to pass on the unit-cost savings because of the fee-for-service pay schedule.

Adding to the problem with the fee-for-service model is how it induces excessive treatment.

There’s a blurring of lines between what is strictly necessary and what might be considered overkill. There’s a basic asymmetry of knowledge, similar to what occurs when you get your car fixed, but if the bill is paid by a third party (the government) it is rarely questioned. Most physicians won’t engage in unethical practices, but there’s no denying a similar situation exists (studies in the U.S. have also shown it not a trivial issue). The authors of the Mowat study were aware of these shortcomings, but believe that they can be overcome with some structural changes.

Getting any of the disparate groups involved with the provision of healthcare (even within professions) to agree on anything other than funnelling more money into the system will be like herding cats – especially if it means one group will see a reduction in its take.

In Europe, some member states have very good public finances, others terrible; Canada is not so different, only the fiscal transfer system is far better. Healthcare costs are the elephant in the room, pushing spending ever higher. And it’s a beast that will have to be tamed before bond markets determine that the youth and unborn simply can’t pay the bill.

Will Van’t Veld is an economist with ATB Financial