Arrow on markets for health care Notes for September 29

Main points

Arrow notes a number of ways that health care markets cannot reach optimum, efficient results in the economist’s technical definition of those terms. He argues that these are explained by “the nonmarketability of the bearing of suitable risks and the imperfect marketability of information” (p. 947).

He also proposed a sociological thesis, that many of the institutional features of health care address these problems. Thus doctors, for instance, do not act like profit-maximizing agents, their training is provided by non-profit institutions, and they are licensed. We insist that they behave this way in order to overcome the problems that impede efficient markets. Our efforts, in turn, make it more difficult to develop efficient markets. We insist that doctors not act like normal economic agents. One consequence is that it’s nearly impossible to compare prices for health services.

Is it really like that?

Daniel asked whether the informational problems that Arrow noted aren’t being solved. You can look up all sorts of stuff on WebMD, for instance, and drugs are being advertised just like other consumer goods. He might have added that the prices for medical services in some areas, like laser eye surgery and dentistry, are being advertised as well.

Generally speaking, it would be very interesting to compare the health services that are covered by insurance with those that are not, like laser eye surgery and dentistry. For the former, there is more consumer choice and more of it focuses on price: when you’re paying out of pocket, you pay attention to price in a way that you don’t when you’re paying through insurance. We could look at prices and the quality of care to see if competition forces improvements in these areas or not.

But I don’t think that most areas of medicine are as transparent as Daniel’s remarks might have suggested. WebMD and drug commercials are a start, but you really can’t diagnose even a simple condition by yourself: it’s too hard. And prices are completely opaque.

For example, here’s the experience of one critic of the US health system in buying medical services for his family.

Eight years ago, my wife needed an MRI, but we did not have health insurance. I called up several area hospitals, clinics, and doctors’ offices—all within about a one-mile radius—to find the best price. I was surprised to discover that prices quoted, for an identical service, varied widely, and that the lowest price was $1,200. But what was truly astonishing was that several providers refused to quote any price. Only if I came in and actually ordered the MRI could we discuss price.

Several years later, when we were preparing for the birth of our second child, I requested the total cost of the delivery and related procedures from our hospital. The answer: the hospital discussed price only with uninsured patients. What about my co-pay? They would discuss my potential co-pay only if I were applying for financial assistance.

Keeping prices opaque is one way medical institutions seek to avoid competition and thereby keep prices up. And they get away with it in part because so few consumers pay directly for their own care—insurers, Medicare, and Medicaid are basically the whole game. But without transparency on prices—and the related data on measurable outcomes—efforts to give the consumer more control over health care have failed, and always will.** David Goldhill, “How American Health Care Killed My Father,” The Atlantic Monthly (September 2009), web p. 4.

Uwe Reinhardt, an eminent health economist, describes our system for setting prices as “chaos behind a veil of secrecy.”

Readers may wonder how the many fees that hospitals receive under the fee-for-service method are negotiated separately with each hospital. Generally, the fees are not negotiated individually, but as across-the-board discounts off a giant schedule of list prices that each hospital maintains — like list prices at car dealers that no one actually pays. These schedules of list prices are known as the hospital’s “charge master.” … For uninsured patients the discount is negotiated by the hospital on a patient-by-patient basis, with appeal to the patient’s ability to pay.

Each hospital has its own charge master and updates it periodically by its own unique process. Consequently, across hospitals in a given state, the list price for a particular item – e.g., a normal chest X-ray — can vary tenfold or more. In most states — California being one exception — hospitals are not required to make these charge masters public.†† Uwe Reinhard, “How Do Hospitals Get Paid? A Primer,” New York Times, January 23, 2009.

Bear in mind that, according to Arrow, this sort of behavior is something that we insist on. We don’t want our health providers to act like economic agents and we don’t want to think about the price of health care: we just want to get the right treatment for our condition. The question is whether our resistance to economic thinking about health care serves us well. Arrow claims that it fills the gaps left by ineffective markets in health care. He’s probably right. But could we do better with some other way of accomplishing that goal?

This page was written by Michael Green for Freedom, Markets, and Well-being, PPE 160, Fall 2010. It was posted October 6, 2010.
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