In our national debate over health care and its rising cost, many
health care economists say that one of the reasons why health care costs keep
rising is that the free market does not work to control costs in health care. Why
should that be true? Why should the free market work to control costs well in
many areas of our economy, but not in health care? The reasons are complex, but we must
understand them if we are to create a health care system that does not bankrupt
us. So, this post attempts to explain why the free market not work to control
costs in health care when it works well in so many other areas of our economy. The
main reasons are:
- Health care suppliers have monopoly power to set prices.
- Market prices do not exist in health care.
- Buyers of health care services cannot evaluate the quality or necessity of what they buy.
- The decision to buy a health care service is separated from the responsibility to pay for it.
In Health Care Markets, Suppliers Have Monopoly Power to Set Prices
A free market controls costs through competition. Sellers of a product
in a free market are not free to raise its price above the market price because
if they do, they will lose sales to other sellers who provide the same product
at the market price. In this situation, sellers can maintain their profits only
by keeping their costs under control, and sellers work to reduce their costs in
order to increase their profits.
This process works only if there are many sellers and they cannot
collude to raise the price of a product or limit its supply. If there is only
one supplier of a product, he/she can easily control the price at which it is
sold and use that power to increase profits. If there are very few suppliers,
they can work together to keep the price of a product above what a free market
would establish.
Health care markets do not have many sellers of health care services.
Health care markets are local, and in each local market, there are very few
health care providers. In most
communities, there is one medical center or perhaps two. Even in big cities,
there are rarely more than half a dozen medical centers. Because there are so
few of them, health care providers do have the power to set the prices of their
products.[i]
This power to set prices is known in economics as “monopoly power.”
Market Prices Do Not Exist in Health Care
Competition in a free market controls cost by setting a market price
for each product, but in health care, there is no such thing as a market price
for any health care service. If you go to a medical center and ask the price of
– say – a gall bladder removal, you will be told (if you can get an answer at
all) that the price depends on the
insurance that you have. There is a different price for every insurance company
and still another price for those who are unlucky enough to be without
insurance. If you are covered by
Medicare, there will be a yet another price.
In fact, even among patients with the same health insurance, the
“price” for a gall bladder removal will be different for every patient because
the fee-for-service payment model allows a health care provider to charge for
each, separate element of the service. How many bandages are used? How much
blood is used? Was there a “facility charge?” And on and on.
In short, the cost control function of the market price does not exist
in health care because, in health care, there are no market prices.
The lack of clear, market prices has yet another bad effect, which is
that neither a patient nor a doctor can consider cost when deciding among
alternative treatments. For example, a blockage in an artery may be treated by
using stents or by using bypass surgery, and it is often difficult to know
which of the treatments would be best in a specific situation. In some cases,
it might be best to choose the least expensive procedure, but doctors are not
trained to think that way, and patients cannot obtain the information to
initiate the discussion. So, cost-effectiveness is rarely considered.
Health Care Providers Are Experts While Patients Lack Technical Knowledge
Most patients lack the technical knowledge to understand what they are
buying. They have to trust their doctors, who are also the sellers of the
services they are recommending. Even among health care providers, there are no
accepted standards for health care services. When should arterial bypass
surgery be recommended? When should a gall bladder be removed? These are
matters of medical judgment, and doctors can and do differ. In short, patients cannot judge the necessity
or the quality of what is being offered to them. If one procedure is more expensive that
another, is the more expensive procedure really better? How can a patient have
that discussion with a doctor?
The Decision to Buy is Separated from the Responsibility to Pay
A market can control costs only if the buyers of a product are
motivated to obtain it at the lowest cost. Their bargaining with the sellers
sets the market price, and if they do not bargain, the whole process breaks
down. In the health care market, most
buyers are not motivated to obtain care at the lowest cost because most people
have health insurance. They do not have to think about cost. Thus, the fact
that people have health insurance interferes with the cost-containment function
of the market. We cannot do away with health insurance because modern health
care is inherently so expensive that, without health insurance, most people
would be unable to afford it. So, we must live with the fact that the buyers of
a health care service are not motivated to seek it at the lowest cost.
In theory, patients would become cost-conscious if they had to pay a
part of the cost themselves. However, in
order for such “co-payments” to have the desired effect, they would have to be
large, and large co-payments would create a hardship for most people. Indeed,
if co-payments were large, most people would be unable to afford health care at
all, and our inequitable health care system would become even more inequitable.
For all of these reasons, we cannot expect the market to perform its
function of controlling the cost of health care. The market cannot control
costs because
- In each local market there are very few sellers of health care services, and they have monopoly power to set prices.
- The market price cannot serve a cost control function because in the health care system, market prices do not exist.
- Patients lack the technical knowledge to evaluate the cost-effectiveness of alternative treatments.
- Because most health care bills are paid by health insurance companies, the decision to buy a health care service is made by a patient who does not care about its cost.
Therefore, we will need non-market methods of controlling cost if we
want to avoid being bankrupted by our health care system.
[i]
This power might be offset by the countervailing power of the health insurance
companies, but they are prevented by the anti-trust laws from joining together
to bargain collectively. So, they are weak compared to the health care
providers, who are able to set their prices almost at will.[i]
