• Health care market failures (and what can be done about them)

    This post complements one yesterday that focused on market failures in health insurance (read it first). It’s loosely based on the content of Economics of the Public Sector, by Joe Stiglitz. Here’s a run down of market failures pertaining to the provision of health care. Please alert me to anything I’ve missed or relevant papers.

    Failure of competition. The hospital industry is highly concentrated in many areas, though greater competition exist more broadly for physician services. Antitrust enforcement can play a role. Government also affects competition by trading it for incentives to innovate through the patent system (pharmaceuticals, devices).

    As is the case for health insurance, competition can never be perfect in health care. The products, treatments, are not identical due to both provider and patient factors (your doctor does it differently than mine, I respond differently than you). Thus, health care services don’t really compete with one another as equal goods. Each is a unique product with its own degree of monopoly power. This is a source of market power that cannot be fully purged from a market-based health system, no matter what government does or does not do.

    Public goods. Some aspects of health are public goods, meaning it costs nothing for an additional individual to enjoy the benefit and it is not possible to exclude an individual from enjoying it. An example is herd immunity. As evidence that a free market might under-supply herd immunity, public school systems (governments) require documentation of childhood vaccinations (or evidence of a qualifying exemption). Public assistance (Medicaid, public clinics and hospitals) also increase access to care, facilitating the provision of the public goods aspects of health care, among others.

    Externalities. Herd immunity is a positive externality of health care. So might be increased educational attainment and work force participation associated with good health. Both can reduce demands on public programs and buoy economic growth that benefits society in ways not captured by the participants in health care transactions. Therefore, the market might under-provide health care. (A related phenomenon is when a health insurer rationally does not “invest” in preventative care for its policyholders because it is not likely to capture the long-term benefits as policyholders switch to other insurers.) Government mandates and subsidies are among the possible responses.

    Information asymmetries. Physicians generally know more about how health services will affect patients than patients do. This can foster supplier-induced demand, contributing to an inefficiently high level of utilization. In general, private-sector solutions can be as or more effective than public ones. They included various means of contracting, monitoring, fraud detection, and care management.

    What else? About that, a few correspondents — all good economists — have suggested I discuss equity (income transfers) and the view of health as a merit good (one we should be compelled to consume for our own best interest, i.e., paternalism). The former strikes me as outside the realm of market failures, but still important. Perhaps the latter can be folded into market failure as a special case of an information failure (people don’t know what is good for them due to lack of information (?)).

    Comments closed
    • I think the health care market is functioning perfectly. The problem is that the market is producing profits, not health.
      In US health care, the free market has given us a situation where we spend twice as much as other developed countries but end up at the low end of health status. Some would call this market failure. On the other hand, the market has been a success for some people. Profits for all sectors of the health care industry (insurance, doctors, hospitals, pharma, device makers, etc.) are spectacularly high. Cynically, one could say that the market is a success and doing what it is intended (producing profits) and that we shouldn’t expect better health as an outcome from this market. Any health benefit (or adverse health impact) is merely an unintended consequence of the market.
      And this brings us to the primary dilemma of the free market and health. The primary goal for the free market is profit. Any diversion from this goal is inefficient and against the interests of the holders of capital. However, the primary goal of the population is better health. It might seem that you could organize a market to reward ‘better health’ but all that we have been successful in organizing is markets that deliver health products and services. Some of these improve health, others are just a waste of time and money, some can be detrimental to health.
      What market failure?

      • @Mark Spohr – Wow! As an economist (not a businessman), I 100% disagree with you on the goal of a market. It seems I’ve failed completely (in your case) in explaining anything about economics. Sadly, the language and concepts of economics are misused and misapplied to promote business interests, which is not what I’m talking about. Don’t be fooled!

        In economics terms (as well as health terms), the health care market is not functioning perfectly. In a perfect market profits are zero, by the way. In any case, as I’ve pointed out, a perfect market cannot exist for health care. I’ll say it again, it cannot exist. It’s a fiction. Welfare economics shows us why. That’s the point of the post.

        Now, is the concern of welfare economics health per se? No. It’s utility, which is different. This is critical to keep in mind but does not in any way condemn an economics point of view. It merely illustrates that it is an incomplete one. About that, I’ll return next week.

    • Austin, you have not failed as an economist or a blogger. I posted my cynical screed as a parody of the arguments which circulate among the less informed chattering classes.

      However, I do think that we need to be reminded that the goal of the “medical industry” should be “health”, and not profit.

      Thank you for all that you do.

      • @Mark Spohr – Phew! Sorry to misinterpret. We need an emoticon for “cynical screed.” (There’s gotta be one.)

        How best to motivate entities and people to maximize health and/or economic welfare is not so clear to me as it is to you. It is certainly not worth arguing about though. We’d not get very far.

    • Dr. Frakt,

      I have a concept to run by you/ question.

      I was pondering and reading way day on the revolution in Finance with micro finance lending, projects such as Kiva.

      I started thinking of why this sort of innovation has been limited (UCCs would probably be the main innovation) in healthcare. Could it be that we assume that everyone in the system should be treated the same? Now our normative sensibilities make us feel queasy about treating people differently in healthcare based on income but I think there are two facts: it is already bifurcated and it is a unsustainable cost path.

      My question is why has there not been a revolution in low-cost care for Medicaid or uninsured? Is it because our system treats every patient as the same value proposition? The market powers are driven as if all 300 million Americans need the same exact needs. What I am really driving at as why there is no micro finance in healthcare?

      I am not sure if I communicated my point effectively.

      Just thoughts.


    • Can you have a vital and successful market if people do not have a good sense of what the product costs? Most people in America have subsidized health insurance, subsidized either by the employer (who gets a tax break for the investment) or by the government through Medicaid/Medicare.

      Thus, most people in American have no idea how much their health insurance costs, let alone what healthcare services and medical products cost. When the EOB arrives, there is often a gasp of astonishment at the price. Imagine that happening as a result of a car purchase – not knowing the price until after you purchased your Mercedes!

      Is something a commodity if you die when you don’t get it? I may want an iPad, but if I can’t afford it, I don’t have to buy it. If I get seriously ill or break a bone, I can choose not to treat it, but the effects of that choice could be crippling or deadly. Healthcare as “market” is messy for many reasons, not the least being that lives are sustained or lost due to the delivery (or failure to deliver) healthcare. Always difficult to price the value of an individual’s life….

    • Mark Spore’s “cynical screed” is economically correct–notwithstanding Frakt’s “economist” comments–as is Main Street Muse. My recent book “The Managed Healthcare Industry–A Market Failure; how healthcare turned into wealthcare for big insurers and managed-care companies” (Create Space-Amazon, etc., July 2011, 495 pp) was written precisely to offer a multi-disciplinary end-run around the pundits whose narrowed acuity limits their access to the externalities of the problem.

    • This is a good discussion.

      However, @ Austin Frakt’s comment

      “As is the case for health insurance, competition can never be perfect in health care. The products, treatments, are not identical due to both provider and patient factors (your doctor does it differently than mine, I respond differently than you). Thus, health care services don’t really compete with one another as equal goods. Each is a unique product with its own degree of monopoly power. This is a source of market power that cannot be fully purged from a market-based health system, no matter what government does or does not do.”

      The comment is oversimplified. The “products,” “treatments,” are actuarially identical (except for experimental drugs and surgical technologies).

      The primary purpose of indemnity insurance is the assumption actuaries implement into a model for underwriters to price a specific insurance policy. A secondary purpose, risk management, hedges on the chance that the actuaries’ assumptions may turn out wrong or somewhat inaccurate. The function of actuarial analysis is to help underwriters form the basis for a premium paid by an insured for the coverage as stated in a policy; it is not to protect insurers from the risk of ineffectual actuaries. When such a secondary rationale as risk management is merged with indemnity insurance, it turns its insurance risk into a business or speculative risk and reduces the value to the purchaser of a premium based originally on indemnifying, or promising to reimburse for a predicted loss.
      The Supreme Court in 1982 declared in Union Labor Life Insurance Co. v. A. Alexander Pireno that the insurance risk is “completely” transferred to the insurer at the time the policy is sold, not when the claim is made. The Court held that “the use of [the insurer’s peer-review company] as an aid in its decision-making process is a matter of indifference to the policyholder, whose only concern is ‘whether’ his claim is paid, not ‘why’ it is paid.” (Emphasis made by the Court.)

      Before managed-care involvement, indemnity insurers had to estimate their risk more closely, because they were state regulated and forbidden to influence it further than the policy language permitted. Moreover, they could not sustain their competition with each other by withholding payments, only by broker-mediated “services.” After managed care entered, its pseudo-insurance got a second bite at the apple. They now could control payouts by denying the medical necessity of quantities of care actuarially accounted for by the premium by “suggesting” that the insurers should withhold payment for medical and hospital services these third-party “experts” deemed not medically necessary.

      Frakt says: “Please alert me to anything I’ve missed or relevant papers.” So read my new, comprehensive book on “The Managed Healthcare Industry-A Market Failure; how healthcare turned into wealthcare for big insurers and managed-care companies” (Create Space/Amazon, July 2011, 495 pp). Some complimentary review copies are available: Click on my name (above) and contact me at the hospital website. — JCS

    • BTW, I disagree with Austin’s definition of a “perfect market” as one that is without profit “In a perfect market profits are zero.” That’s only in the long run. As Areeda and Turner pointed out in 1975: “market price reflects what consumers are willing to pay for the last unit of output [and] marginal cost reflects the full current cost of resources needed to produce it [while] a higher price would result in a reduction in output and thus deprive some buyers of a commodity for which they were willing to pay the cost of production.”

      Because the monopolist can affect market price by varying its output, it faces a downward-sloping curve. An increase in output will tend over time to reduce the market price. This does not seem to occur in healthcare. It is concealed because healthcare has a rising cost curve, where offering more healthcare cannot reduce unit cost. However, lowering providers’ capitation costs and manipulating output by directly managing patient care allows the monopolist to succeed in the short term. Ultimately, when MCO healthcare prices end up above “what consumers are willing to pay for the last unit of output,” especially when supported by government contracts or subsidies, the monopolists have proffered a deadweight loss to society. This is commonly seen when people cut back on seeing doctors or cutting pills in half.

      Although Areeda-Turner’s explanations use the term “commodity,” which has been held to be distinct from “services,” the similarities between efficient production of commodities and efficient use of healthcare resources under government and commercial insurers’ concepts of managed care can no longer escape notice and the Affordable Care and Dodd-Frank Acts are now hovering over the healthcare pseudo-system.