The following originally appeared as a Kaiser Health News column on 24 September 2010. It is co-authored by me [Austin Frakt] and Rexford Santerre, a professor of finance and health care management at the University of Connecticut. This post has also been cited in the 29 September 2010 edition of Health Wonk Review.
In late August, The Wall Street Journal reported that government-owned hospitals are “drowning in debt” due to high health care costs, high rates of uninsured patients and cuts in public payments. Some government facilities are closing while others are being sold to private-sector firms. These developments may result from normal market competition that tends to drive inefficiencies from the system. But something important could be lost when public facilities disappear from the marketplace: access.
Health facilities of different ownership types — private for-profit, private nonprofit or government — coexist in many markets. For example, St. Joseph Medical Center, the Harris County Hospital District and Methodist Willowbrook System are all acute-care hospitals operating in Houston. Palm-Gardens, Dr. Susan Smith McKinney and Rutland are nursing care facilities coexisting in Brooklyn, New York. Each is organized on a different legal basis. Specifically, the first within each group represents a for-profit organization; whereas, the other two are public and nonprofit entities, respectively. Other health care organizations, such as substance abuse centers, dialysis facilities and community health clinics, also sometimes take on different legal ownership forms.
Mixtures of ownership add competition along different dimensions. Economic scholars have considered how the various organization types pursue alternative goals and behave differently regarding choices such as setting prices, quality and mix of patients (i.e., uninsured, Medicaid, Medicare, private-pay). Welfare-enhancing competitive effects along these dimensions have been observed in markets in which mixes of ownership type exist for certain kinds of health care organizations.
One theory for why health care markets have evolved to include mixtures of firms with different ownership, advanced by Nobel-laureate economist Kenneth Arrow, is that medical care (like education) is a personal good for which quality is often hard to measure and judge.
If all medical care was provided by for-profit organizations, consumers might worry that providers would skimp on costs by compromising quality in the pursuit of higher profits.
Nonprofit providers, in contrast, are supposed to use any financial surplus for the express purpose for which the organization was formed. For example, a nonprofit hospital may use the surplus to install additional beds, provide uncompensated care or offer unpaid community benefits, but not to pay bonuses to decision-makers within the hospital, such as managers, employees or board members. Because of this “nondistribution constraint,” nonprofit hospitals supposedly face a softer incentive to compromise quality, but given the absence of any well-defined property rights, may produce with higher costs than truly necessary.
Taken together, Arrow’s view suggests that when operating in isolation the typical for-profit health care organization faces an incentive to mind the bottom line. In doing so, it may skimp on quality in the face of “asymmetry of information” or the inability of consumers to measure and judge quality at least as well as health care providers. Nonprofit health care organizations face the opposite incentive — to produce with higher costs and quality. This incentive is particularly strong when decision-makers in those organizations receive personal benefits or prestige from running or working in a business with higher levels of structural, process or outcome quality.
Some health care researchers have argued, and others have empirically found, that the mixture of ownership forms help to more efficiently balance costs and quality. That is, given the trade-off between the two, as previously described, in for-profit and nonprofit organizations, the mixture of ownership forms may lead to some beneficial “competitive spillovers.” In particular, because of the competition among the ownership types, for-profits may operate with higher quality and nonprofits may produce with lower costs than they would have otherwise. Thus the mixture of for-profit and nonprofit companies brings about a better balancing of costs and quality from a consumer perspective.
What do public or government health care institutions bring to the table under this competitive spillover theory? One possibility is that when it comes to human capital services like health care or education, consumers value costs and quality, but also access. Government, often as the provider of last resort, directly provides greater access or pressures for it, either by coexisting in the market or threatening to enter it. Notice the important role that community colleges and community hospitals provide in this regard. The competitive spillovers from the three legal types of organizations may help to bring about a more efficient balancing of costs, quality and access from a societal perspective.
The effects of the current economic climate on government health care facilities bears watching, as do the effects on access that result from their closure or takeover by private firms. If levels of access fall, consumers may suffer harm, particularly vulnerable or underserved populations that disproportionately depend on public institutions. Government is often viewed as the antithesis of the market. But when it comes to health care, it may be more appropriately viewed as a critical player in it, though in potential balance with facilities of other ownership types.
