(FORTUNE Magazine) – MOST CURES for America's ruinous, $800-billion-a-year medical bill focus on changing our profligate insurance system, which encourages patients to consume -- and doctors to provide -- too much health care. But inflated demand is only one jaw in the giant vise squeezing U.S. businesses and taxpayers. The other is a severe limitation on supply. Misguided policies have frozen the number of American medical schools and barred foreign doctors from practicing here. The number of physicians has risen much more slowly than the rapid growth in demand for tests and operations. The result: While most doctors are richer and busier than ever, large parts of the country are struggling to cope with chronic staff shortages. This is not the conventional wisdom. Quite the opposite. While America's medical establishment admits there's a shortage of most types of doctors in inner-city and rural areas -- and primary-care physicians virtually everywhere -- it continues to insist that the main problem is too many doctors, not too few. ''We have a more than adequate supply,'' says Dr. Edward J. Stemmler, executive vice president of the Association of American Medical Colleges. ''There is no compelling reason for medical schools to increase their size.'' In a report to Congress on Medicare reform, a commission of prominent health care experts echoes Stemmler's views: ''The number of physicians exceeds, or will soon exceed, that required to meet national health care needs.'' How can that be? Because, the argument goes, the law of supply and demand does not work when it comes to medicine. Under the prevailing system of fee- for-service health insurance, doctors get paid no matter how many tests and procedures they perform, and in many cases, no matter what they cost. In addition, constant advances in technology, notes Princeton University economist Uwe Reinhardt, give doctors ''considerable power to create what they view as justifiable demand for their services.'' Nor do consumers (patients) complain overmuch, since they pick up only a small fraction of the bill. So in this unnatural market, any increase in supply (the number of doctors) wouldn't necessarily reduce prices and might even increase overall demand (total health care spending). IN FACT, the physicians' power to create demand is waning. The reason: Traditional fee-for-service health insurance is steadily giving way to a system in which big health care purchasers -- HMOs, managed-care networks, and similar groups -- attempt to reduce unnecessary tests and operations by putting doctors on salaries and fixed monthly payments and by screening and approving procedures in advance. Already 38% of insured Americans are covered by HMOs and other managed-care programs. And with both President George Bush and Bill Clinton pledging to rely on managed care and managed competition as the foundations of their proposals to reform health care, that percentage will likely soar in the years ahead. How would increasing the supply of doctors dovetail with a more rapid shift to managed care? Beautifully. In a national system of managed competition, health care providers competing to win the business of big buyers would be under tremendous pressure to offer the best-quality service at the lowest cost. A plentiful supply of doctors would help them do just that. As high- priced clinics and practices lose business, some doctors, particularly those primarily serving the shrinking fee-for-service sector, would find their now busy schedules partly empty. It's reasonable to expect that their reaction would be the same as in any industry with excess capacity: Reduce prices to lure more customers. Even if the shift to managed care proceeds less rapidly than promised, there's plenty of other data -- largely ignored -- to suggest that those who maintain that the U.S. is suffering from a doctor glut are wrong. By international standards, the country is hardly oversupplied. America has 2.3 doctors for every 1,000 people -- vs. 2.9 in Germany and 2.6 in France -- even though the U.S. spends almost twice as much per capita on health care. The most striking evidence of a doctor shortage is the extraordinary labor market for physicians, a Shangri-La far removed from the tumultuous, competitive arena for the average lawyer, architect, and engineer. While white-collar America grapples with layoffs and pay cuts, doctors in some specialties choose from dozens of job offers and go on to earn as much as the chief executive of a $100-million-a-year company -- around $200,000 annually. The chance of joining the jobless is about as likely as contracting scurvy. ''For physicians, a job search is like dining at a gourmet buffet,'' says Roy Huntsman, a management consultant to 200 doctors in central Florida. ''The choices, and the incomes, are fantastic.'' Since the late 1970s, the number of doctor recruiters in the U.S. has jumped from about 25 to more than 1,000 -- one for every 20 annual graduates of residency programs. Most, not surprisingly, find the notion of a physician surplus ludicrous. ''This isn't just a regional or specialty problem, but a plain shortage,'' says Susan Cejka, president of the largest recruiting firm, Cejka & Co. in St. Louis. ''If there weren't a shortage, our industry wouldn't be thriving.'' A study by Merritt Hawkins & Associates, a Texas recruiting firm, found that 87% of America's 5,000 hospitals are urgently seeking doctors, and that 86% of all physicians in their last year of residency received 50 or more job , inquiries, many of which led to offers. Says the firm's chief executive, Joe Hawkins: ''The reality is that there's no such thing as an unemployed doctor in America. But the myth of too many doctors dies hard.'' One reason may be that doctors prefer not to acknowledge the extent to which an imbalance in demand and supply accounts, at least in part, for their high incomes. Between 1982 and 1992, spending on doctors' services, adjusted for inflation, jumped from $75.3 billion to an estimated $165.5 billion. The principal motors of that increase were spectacular advances in technology and a rapid rise in the ranks of elderly Americans, which fueled demand for everything from cataract operations to electrocardiograms. From his campus- like clinic in Fort Myers, Florida, for example, Dr. David Brown sends around town a bus to conduct free eye examinations. Using a new surgical technique -- fine incisions that don't require stitches -- he can perform in about 15 minutes cataract operations that in the 1970s could take several hours. In addition to such demand-boosting advances in productivity, doctors' incomes in the 1980s soared because new restrictions were imposed on the supply side. Since 1982, the number of physicians who care for patients has grown 34% to 520,000, less than one-third as fast as the 119% increase in real (inflation-adjusted) spending. The dearth of doctors is mainly a legacy of two glaring public policy errors: freezing medical school places and shutting out foreign doctors. Medical schools expanded in the 1960s and 1970s. The turning point came in 1980, when an influential study commissioned by the Department of Health and Human Services predicted a huge surplus of doctors by 2000. Urged on by state medical societies, state governments stopped building new medical schools. Worse still, almost all America's 126 medical colleges cut back enrollment. Ohio encouraged the cuts by providing the same level of funding for fewer students. Between 1982 and 1991, the number of medical school graduates declined 3% to around 16,000 a year. As medical schools contracted, the only other source of new doctors -- foreign-trained physicians -- was also restricted. In 1976 the U.S. passed a law that required foreign doctors who had finished a residency program in America to return to their home countries for two years before they could reapply to live in the U.S. As a result, most foreign doctors stopped practicing here after finishing their residencies. Instead, they stayed home or found lucrative work in the Persian Gulf. Until the 1976 law was passed, Canadian doctors were treated virtually like U.S. doctors. They could cross the border to practice on easy-to-obtain five- year permits. The arrangement made sense: Canada's residency programs are fully accredited in the U.S., and 42 states accept Canada's licensing exam. But then the 1976 law slammed the door on many Canadian doctors by requiring them to obtain a full-time resident's green card before practicing in America. That's tremendously cumbersome. A candidate must secure a job offer in the U.S. that the employer is willing to keep open for the year or two it takes to get a green card. With supply constrained and demand soaring, doctors' incomes exploded. In 1982 the average physician collected $194,000 in gross revenues, measured in 1992 dollars. This year the figure is $318,000. According to a telephone survey by the American Medical Association, doctors on average earned $164,000 after expenses and before taxes in 1990, compared with $112,000 in 1985. THE MOST HANDSOME gains went to the medical royalty, specialists. They consist of two groups: surgeons and nonsurgical specialists, who focus on ailments such as heart disease and cancer. In 1990 surgeons earned an average of $236,000 a year. The typical generalist, or primary-care doctor -- family doctor, pediatrician, or internist -- makes much less, just over $100,000. American doctors are much better paid than foreign physicians. As compared with the $164,000 average in the U.S., the world's best-paid doctors are the Germans, at $120,000 a year. British physicians earn an average of about $65,000, and the Japanese $78,000. The pay gap between specialists and primary-care physicians has put the tightest squeeze on the doctors America needs most -- the generalists, who are the foundation of the managed-care system and a bulwark of small-town America. These doctors are mainly paid by the visit rather than by procedures; hence, their productivity, and income, rose far more slowly in the 1980s than the specialists' did.

Medicare is trying to reduce the disparity in fees by increasing reimbursements to generalists and cutting payments to specialists. But the gulf is still immense. For example, orthopedic surgeons in Sarasota, Florida, receive $2,500 in Medicare reimbursements for a one-hour hip replacement operation, including brief follow-up visits. By contrast, Sarasota internist ( Gary Ivins collects about $100 an hour from Medicare for seeing an average of three elderly patients. With fewer and fewer new doctors choosing primary care -- and established generalists either rapidly graying or retiring -- the outlook is scary. If the picture doesn't change, the AMA reckons, by 2000 an aging, health-care-hungry U.S. population will have to make do with 219,500 generalists, some 10% more than exist today. This drought is particularly hard on the 67 million Americans who live in rural areas. According to the Department of Health and Human Services, more than 100 U.S. counties are without a single physician. Over 200 rural hospitals have closed in the past five years, many for lack of physicians. Unable to find family doctors, the poor of Appalachia travel long distances for medical care. These hardships are mirrored in the inner cities, where poor patients must often wait hours in emergency rooms to receive basic care from a harried, overworked physician. The strain is a way of life for Mary McKenna, 48, a housewife in Nesquehoning, Pennsylvania, a town of 3,400 in the foothills of the Pocono Mountains. McKenna, who is married and has three children, suffers from a heart condition. The only doctor in Nesquehoning recently closed his office. Once a month, McKenna drives her 1980 Mercury 45 minutes along a winding mountain road to visit a doctor 27 miles away in Albrightsville. Says she: ''Sometimes the trip will take all morning, for a 15-minute appointment. And with my condition, it's scary to live so far from my doctor.'' America has so few generalists that even big paychecks can't lure enough of them from cities and wealthy suburbs into small towns. The few who do settle in the country are terribly overworked. Their punishing lifestyle, in turn, discourages other doctors from choosing small-town practices. Lawrence Callie Varner, a family physician in Farmville, Virginia, faces the classic burdens. Besides him and his partner, there's just one general practitioner in Farmville, a picturesque town of 6,000 near the Blue Ridge Mountains. Varner starts his day at 7 A.M. with rounds at a local hospital, and ends between 8 and 10 P.M. taking calls at home. In between he sees about 45 patients. Varner works every other weekend and takes just eight or nine days of vacation a year. Even so, he can barely handle the flood of patients. For routine physical exams, patients have to wait three to four months for an appointment. Still, Varner cherishes his job. ''I see patients from the time they're born until the time they die,'' he says with satisfaction. Varner and his partner are seeking a third doctor to ease their workload and help meet Farmville's desperate need for more primary care. The pay is attractive: a starting salary of $80,000 plus bonus, rising to more than $90,000 in the second year. Nevertheless, Varner has found only two or three serious candidates in three years of recruiting. Hospitals, state governments, and communities help rural practices recruit by holding out a trove of inducements. Rural hospitals are offering income guarantees to doctors who join local practices. Sterling Regional MedCenter in northern Colorado is trying to attract a family doctor by guaranteeing a minimum income of $120,000 a year for the first two years. If the doctor earns just $100,000 from the practice, the hospital will make up the $20,000 shortfall. This year a pilot program will provide a loan of up to $200,000 at 5% to any new graduate of the Southern Illinois University School of Medicine who works for one year in an Illinois town of 25,000 or less. Oklahoma is offering lavish signing bonuses. Any doctor willing to practice for three years in a country town can receive a cash payment of $40,000, half from the state government and half from the local community. Small towns are competing with tremendous demand from managed-care networks in cities and suburbs, for whom the generalist is the key to the savings they typically realize. In an HMO or managed network, any patient's first visit is with a family doctor, internist, or pediatrician. To diagnose an ailment, the generalist runs tests and studies the patient's lifestyle, diet, and anxieties. A family doctor can often treat such problems as heart murmurs and skin lesions with advice or simple office procedures. Only if the patient needs finely tuned treatment does the generalist send him to a specialist. MANAGED-CARE networks are hiring voraciously. This year America's largest HMO, Kaiser Permanente, plans to absorb 160 primary-care doctors, 3% of all the generalists graduating from America's residency programs. Competition is bidding up salaries. The Health Plan of Nevada, an HMO based in Las Vegas, has lifted its average starting pay from $55,000 in 1987 to $102,000 this year. Many doctors like the HMOs' agreeable lifestyle. Says Edward Ellison, 37, a family doctor with Kaiser Permanente in Orange County, California: ''It's appealing to practice medicine without worrying about the business side or being tied to a beeper 24 hours a day.'' So far, managed-care networks have flourished mainly in the big cities, where they can find enough doctors to feed their growth, either by hiring them directly or by contracting at a discount with local practitioners. In rural areas and small cities -- places like Macon, Georgia (pop. 107,000), and Tyler, Texas (pop. 75,000) -- the shortage of generalists is blocking the growth of managed care. ''The scarcity of doctors makes it very difficult to penetrate rural areas and small cities,'' says Dr. Robert Rosenberg, vice president of health care operations at Prudential Insurance Co. ''The doctors tend to be so busy they have no incentive to join a managed-care network and offer discounts.'' As for specialists, if there were too many of them, why are the ones we have working so hard? And why are they making so much money? ''I don't see lots of specialists whose schedules are half-full,'' says John M. Ludden, medical director of the Harvard Community Health Plan, an HMO in Boston. ''There's very little excess capacity.'' In 1992, Jackson & Coker of Atlanta placed a dozen radiologists, one of the least recruited specialties, at $177,000 a year. As with generalists, the shortage threatens to get worse. Demand for specialists should climb in the 1990s as an aging population and advances in technology open new markets as varied as vision-correcting laser surgery and shoulder joint replacements. Rural hospitals are just as desperate for specialists as they are for family doctors. To serve its broad market in southwestern Virginia, Twin County Community Hospital has added ten specialists to its staff of 40 doctors since 1990, and plans to recruit ten more specialists by 1995. Sterling MedCenter in Colorado pays headhunters about $25,000 per search to recruit several specialists a year. Even in the big cities, some specialties -- among them, orthopedists, obstetrician/gynecologists, and emergency room doctors -- are in extremely short supply. Of the 30 positions Kaiser Permanente is recruiting to fill in Ohio, half are for specialists. It takes Kaiser as long as a year to attract a doctor in half a dozen fields. Still, the savings from putting specialists on salary are enormous. One Kaiser clinic in Cleveland used to refer all orthopedic surgery to outside specialists, at heavy expense. Now a staff of four Kaiser surgeons perform all the operations in-house, saving Kaiser over $500,000 a year. TO RELIEVE its doctor shortage, the U.S. needs to import more foreign physicians and expand its medical schools, with a special emphasis on steering far more doctors into primary care. Happily, the basic condition for accomplishing this -- a willing supply of would-be physicians -- already exists. Applications to medical school are climbing after a fall in the mid- 1980s. This year the Southern Illinois University School of Medicine had a near record 1,375 applicants for 72 places, a ratio of 19 to 1. Nor is there any lack of qualified foreigners eager to practice medicine here. To do so, foreign medical school graduates, as well as Americans educated at medical schools abroad, must complete a three- to four-year residency program run by a U.S. teaching hospital. Currently about 17,500 Indians, Filipinos, and other foreign medical graduates have passed the special qualifying exam and are enrolled in residency programs, mostly at hospitals in inner cities and impoverished rural areas. What's scandalous is that another 10,000 or so foreign-trained doctors have passed the U.S. entrance exam but are still waiting for a resident position -- even though several thousand more openings exist. No one seems able to explain why these slots aren't being filled, but the consequences are obvious. ''Keeping vacancies in residency programs creates man-made shortages of physicians,'' complains Dr. Navin Shah, an Indian-born urologist now practicing in Maryland, who is championing the cause of foreign physicians. Until that changes, many graduates of excellent foreign medical schools will continue to labor merely as low-paid technicians in hospital laboratories. Fortunately, the rural clinics and inner-city hospitals that rely on foreign-trained doctors and desperately want more are increasingly turning up the political heat on Congress. Worried by the shortage of care in rural areas, Senator Paul Simon of Illinois has proposed a bill that would prevent the nation's roughly 6,600 residency programs -- most of which are subsidized with taxpayer money -- from discriminating against foreign-trained doctors. That should force the residency programs to fill most of the now empty slots with foreign-trained physicians. Another new law passed in 1991 is reopening the gate to Canadian doctors. Once again they can practice in the U.S. on residency permits that now run for ^ six years. But there's still a catch. They must first complete an arduous examination that takes months of preparation. Hospitals from rural districts have been pressing the Department of Health and Human Services to accept the Canadian licensing exam in place of the U.S. exam. But in September, HHS Secretary Dr. Louis Sullivan, refused to lift this highly restrictive requirement. ''We have no control over another country's licensing exam,'' explains an HHS official. ''Accepting the Canadian exam could open the floodgates for other countries to insist that their licensing procedures also be accepted by the U.S.'' HHS should eliminate the examination requirement for Canadian doctors. The U.S. should also amend immigration laws so that foreign graduates of U.S. residency programs can practice in America without having to disrupt their lives and go home for two years. So far Congress and state legislatures aren't even talking about the best long-term solution: expanding state medical schools, or granting licenses for private schools. The issue is highly sensitive. Politicians remember the saga of the East Carolina University School of Medicine in North Carolina, one of the last medical colleges built in America. Before it opened in 1977, East Carolina barely survived vigorous opposition from the state's doctors. But as the political pressure created by America's doctor shortage grows -- and the national move toward managed care picks up steam -- even that barrier may fall. If it does, the biggest beneficiaries will be America's shortchanged medical consumers.

CHART: NOT AVAILABLE CREDIT: FORTUNE CHART/SOURCES: AMA AND HCFA CAPTION: THE GAP BETWEEN SUPPLY AND DEMAND Since 1982, growth in spending on physician services has jumped 119% after inflation to $165.5 billion, while the number of doctors has increased just 34%.