The Medicare DRGs: Efficiency and Organizational Rationality

Abstract

In fiscal year 1984, the United States' Medicare program began reimbursing inpatient hospital services under a system known as the Prospective Payment System (PPS). This system is a per-case reimbursement scheme in which cases are divided into relatively homogeneous categories called diagnosis-related groups (DRGs), and each DRG is paid a unique price set in advance of treatment. The great promise of PPS was that it would merge, into a framework of unified organizational rationality, physicians' orientations toward individual patients and administrators' and regulators' orientation toward the common good. Processes of hospital care would thus be made efficient in that judgments regarding diagnosis and treatment would embody both the particularistic interests of patients and the social interest in the use of resources. In this Article, the author claims that this normatively attractive framework is conceptually and empirically flawed because it ignores the complex interactions that occur within hospitals and the distinctiveness of each organization. Because the framework is therefore not operating as conceived, there appears to be no linkage between the goal of efficiency and the use of the DRGs as a per-case payment system. The author concludes that PPS should be abandoned in favor of a system in which hospitals would be paid under locally administered prospective budgets.