Identifying Sources of Inefficiency in Healthcare*

Abstract In medicine, the reasons for variation in treatment rates across hospitals serving similar patients are not well understood. Some interpret this variation as unwarranted and push standardization of care as a way of reducing allocative inefficiency. An alternative interpretation is that hospitals with greater expertise in a treatment use it more because of their comparative advantage, suggesting that standardization is misguided. A simple economic model provides an empirical framework to separate these explanations. Estimating this model with data for heart attack patients, we find evidence of substantial variation across hospitals in allocative inefficiency and comparative advantage, with most hospitals overusing treatment in part because of incorrect beliefs about their comparative advantage. A stylized welfare calculation suggests that eliminating allocative inefficiency would increase the total benefits from the treatment that we study by 44%.