Lack of hospital competition is often blamed for increases in hospital prices and health care spending. A reader asked me if increasing competition among hospitals would also lead to higher health care spending because hospitals would compete on technology and amenities, a medical arms race. I took a quick look at the literature on this question, which I do not claim is necessarily thorough. Here’s one handy literature review from a 2006 paper by Laurie Bates, Kankana Mukherjee, and Rexford Santerre:
Research using data prior to the mid-1980s typically found that an increased number of hospitals in the same market area was associated with efficiency losses, because hospitals typically entered into a medical arms race when confronted with competitors (Robinson and Luft 1985). Hospitals engage in a medical arms race when they spend unnecessarily on items such as cosmetic quality improvements, cost-enhancing technologies, and duplicate facilities as a way of attracting more physicians and patients. However, recent empirical analyses find that payer-driven competition replaced patient-driven competition after the mid-1980s. Selective contracting with managed-care insurers and the Medicare prospective payment system put pressure on hospitals to deliver health care more efficiently. Indeed, most studies using data after 1990 find that increased competition among hospitals reduces excess capacity (Santerre and Adams 2002), lowers hospital prices (Town and Vistnes 2001) and hospital costs, and results in lower rates of adverse outcomes (Kessler and McClellan 2000). Thus, given recent empirical evidence, we expect that a greater number of hospitals should be associated with increased technical efficiency. Recall that Rosko’s (2001) study lends support for this expectation, whereas Brown (2003) finds that a greater number of hospitals relates to lower levels of technical efficiency in line with the medical-arms-race hypothesis.
Like many ideas in health policy, the medical arms race hypothesis finds its greatest support in a prior era, the 1980s health care market landscape (same with cost shifting). However, the forgoing quote suggests it depends, in part, on the nature of the insurance market. To the extent that insurers have the power to selectively contract, a medical arms race is less likely. That explains the experience of the 1990s, when plans had the ability to exercise considerable contracting and care management power. The health insurance market has become more concentrated, as has the hospital market (see me, PDF).
But where are we today? Is the current era more like the 1990s or the 1980s with respect to the medical arms race? The same question can be posed of cost shifting and, there, I am aware of a solid answer. We’re in a middle ground in which a bit of cost shifting is possible, but to large extent it is not (unless hospitals acquire greater market power, which they just may). With respect to the medical arms race hypothesis, Robert Berenson, Gloria Bazzoli, and Melanie Au found in 2006 that, at least for specialty hospitals, competition did seem to promote greater investment in technology and capacity expansion. This was a qualitative, not a quantitative finding, however. It does echo (and cite) similar, qualitative work that points to a resurgence of an arms race in the 2000s.
So, beyond saying we might expect less of an arms race now than in the 1980s and more than the 1990s and that the degree of it varies by market depending on the power of hospitals and insurers, I can’t say much more. If you’re aware of recent quantitative work on this subject, please share.
Brown, H. S. 2003. Managed care and technical efficiency. Health Economics 12: 149–58.
Kessler, D. P., and M. B. McClellan. 2000. Is hospital competition socially wasteful? The Quarterly Journal of Economics 115 (2): 577–615.
Robinson, J., and H. Luft. 1985. The impact of hospital market structure on patient volume, average length of stay, and the cost of care. Journal of Health Economics 4: 333–56.
Rosko, M. D. 2001. Impact of HMO penetration and other environmental factors on hospital X-inefficiency. Medical Care Research and Review 58 (December): 430–54.
Santerre, R. E., and A. S. Adams. 2002. The effect of competition on reserve capacity: The case of California hospitals in the late 1990s. International Journal of Health Care Finance and Economics 2 (September): 205–18.
Town, R. and G. Vistnes. 2001. Hospital competition in HMO networks. Journal of Health Economics 20 (3): 313–24.