Chapter 3.G: Economic and Regulatory Theory

The Federal Trade Commission has periodic events relating to health care competition.

U.C. Hastings Law School maintains this blog on Healthcare Price and Competition.

The following is an excerpt from a decision enjoining the merger of two hospital companies in the Chattanooga area because the merger would tend to create a substantial reduction in competition. This is the Commission's preliminary discussion of the economic forces that operate within the health care industry.

In re Hospital Corporation of America
106 F.T.C. 455 (1984), aff'd, 807 F.2d 1381 (7th Cir. 1986)

 [I]t is important to have a fundamental understanding of the role of physicians and third-party payors in the health care transaction.

The role of the physician is a market response to the extremely high cost to consumers of health care information and expertise. As a result of the patient's grossly imperfect information concerning proper diagnosis and treatment, and the doctor's much greater knowledge, the doctor decides what diagnoses, treatments, and so forth the patient will have. The physician orders tests, prescribes drugs and courses of treatment, and so forth, and most important for our analysis, decides whether and when a patient will be admitted to and discharged from a hospital, along with the battery of tests and procedures he receives while there. The patient simply cannot decide these things for himself; the doctor is his repository of information and expertise and thus plays the critical role in determining the nature and extent of hospital and other health services the patient will receive.

In addition to a lack of information about how to diagnose and treat himself, the patient has perhaps even less perfect information about the occurrence and extent of future illness and injury. For the most part, neither the doctor nor the patient can control frequency or intensity of disease or injury. For example, the typical patient cannot anticipate or prevent being in an automobile accident or developing cancer. Likewise, the doctor cannot determine the type or intensity of diagnosis and treatment until a problem develops, to the extent that he can determine the severity of a problem within a short period of time at all. The uncertainty associated with the nature and extent of potential health problems is thus enormous, and the uncertainty about the cost associated with diagnosis and treatment of such contingent events is equally high. As a result, the patient cannot plan financially for the treatment of his health problems; he may be healthy for the rest of his life and have to spend no money on health care whatsoever, or he may receive an injury so serious that he could not possibly hope to pay for his treatment with his annual salary. What is the logical market response to this dilemma? Health insurance.

Insurance is a response to uncertainty, and spreads the risk of financial loss occasioned by treatment of disease or injury over both the people who turn out to have little need for health care and those who turn out to have a great need. By paying an insurance premium in a world where the future need for health care is uncertain, a potential patient eliminates the risk of not having the money he needs to pay for diagnosis and treatment, particularly of serious illnesses or injuries, should health care and of particular interest to us, hospital care, be needed....

With respect to our analysis, there is one extremely important effect on the hospital services market of third-party payment: The extent to which a patient is insured determines the extent to which he is sensitive to the price of hospital care. If he is fully insured, once he becomes ill his interest lies in receiving the best quality care possible, including the highest quality comforts and surroundings if he is in the hospital, no matter what the costs. Who, then, is concerned about price? We would expect third-party payors and their customers, the world of potential patients and employers who pay insurance premiums, to be interested in minimizing the costs of insurance. Of course, the government and taxpayers, who insure many of the elderly and under-privileged through the Medicare and Medicaid programs, should be interested as well. There is one wrinkle, however. When hospital prices rise, the increased payments made by an insurance company are spread over all its subscribers, both patients and non-patients (i.e., prospective patients); premiums rise less than proportionally to the increase in hospital prices. Thus, not every significant increase in hospital prices will bring a significant market reaction from insurance consumers....

We are thus confronted in this care with a very peculiar market indeed. Because of the uncertainty of illness and injury and the grossly imperfect information available to consumers of hospital services, patients generally rely on physicians to determine the nature and extent of the medical care they receive and on third-party payors to provide the financial assurances that such care will be paid for.

For a powerful argument that "health policy elites" are out of step with most of the rest of America in embracing market-based approaches to health policy, see Mark Schlesinger, On Values and Democratic Policy making: The Deceptively Fragile Consensus around Market-Oriented Medical Care, 27 J. Health Pol. Pol'y L. 889 (2002):

"The influence of market thinking among health policy elites in this country is . . . dominant. Its persistent appeal, in the face of the remarkably uneven  performance of market-oriented reforms, reflects the persuasive power of simple economic answers to complex policy problems, a pattern replicated at other times in other policy contexts. However, despite the apparently bipartisan consensus in favor of markets that has been forged among  the Washington elite, this dominance is neither well recognized nor broadly supported outside of the Beltway. For example, although the [Clinton] Health Security  Act was based on a model of managed competition, its market-based origins remained obscure for most of the American public. And the results discussed earlier suggest that the public thinks about markets in medical care in very different ethical terms than do elites based in Washington. . . . In my experience, policy makers in Washington have not idea how strongly divergent their interpretations have become from those endorsed by the American public."

According to eminent sociologist Eliot Freidson:

The ideology of the free market permeates our thought today, providing our assumptions about what is reasonable and what is not. . . . This utopian image dominates the way we think about health care in the United States, even though little resembling the free market is to be found in reality.  Something like it may have existed in the United States until the early twentieth century, when licensing was weak, payment was out-of-pocket, practice was entrepreneurial, and medical knowledge and technology were well within the ken of consumers.  But today, the market in which health care takes place is organized by massive public and private insuring and health care organizations, and consumer choice is heavily constrained by government regulation, insurance contracts, and the complex, esoteric character of the information bearing on those choices, not to speak of massive advertising campaigns designed less to inform consumers than to manipulate and direct their decisions.  It is simply grotesque to think of health care today as even potentially truly free market “subject to ordinary rules of free enterprise.”

28 J. Health Politics Policy & L. 169-70 (2003).

For additional notes on economic and regulatory theory, see the update page for Chapter 1.C.