Under Norway's prospective payment system, which was in existence from 1972 to 1980, hospital costs increased 15.8 percent annually, compared with 15.3 percent in the United States. In 1980 the Norwegian national government started paying for all institutional services according to a population-based, morbidity-adjusted formula. Norway's prospective payment system provides important insights into problems of controlling hospital costs despite significant differences, including ownership of medical facilities and payment and spending as a percent of GNP. Yet striking similarities exist. Annual real growth in health expenditures from 1972 to 1980 in Norway was 2.2 percent, compared with 2.4 percent in the United States. In both countries, public demands for cost control were accompanied by demands for more services. And problems of geographic dispersion of new technology and distribution of resources were similar. Norway's experience in the 1970s demonstrates that prospective payment is no panacea. The annual budget process created disincentives to hospitals to control costs. But Norway's changes in 1980 to a population-based methodology suggest a useful approach to achieve a more equitable distribution of resources. This method of payment provides incentives to control variations in both admissions and cost per case. In contrast, the Medicare approach based on Diagnostic Related Groups (DRGs) is limited, and it does not affect variations in admissions and capital costs. Population-based methodologies can be used in adjusting DRG rates to control both problems. In addition, the DRG system only applies to Medicare payments; the Norwegian experience demonstrates that this system may result in significant shifting of costs onto other payors.