Diagnosing Health Care

Author’s Note: This originally appeared on my old blog, which I made private because some of the posts were no longer appropriate for my professional context. A friend requested that I make the content available, and I have obviously done so. This was originally published on July 2nd, 2011. I have made light edits to the original.

One of the more vapid uses of the “privatize it” mantra is in health care. Only special markets work well with a primarily private structure; most require a hybrid and some even ought to be privatized entirely. How does health care stack up?

My old micro text has 4 assumptions about efficient competition. I will be presenting them as 5, the first two comprising one in the text.

  1. A large numbers of buyers
  2. A large number of sellers
  3. Free entry and exit
  4. product homogeneity
  5. perfect information

How do health care markets stack up against these assumptions? And what does that mean for the private health care market?

Large numbers of buyers are easy to come by for most routine activities. There are some rare illness that have only a few customers*. In other words, on the consumer end, most procedures are going to be competitive for purchase, but niche markets may require regulation.

Large numbers of sellers is not so clear. There are many doctors, but only a handful of pharmaceutical companies. Some regions may have only one hospital while some areas may have several. Insurance companies may have large market shares as well. And again the problem of niche markets must be raised. All in all, there is a serious problem just assuming that any particular health care market is competitive based on sellers. Consequently, it may not provide efficient outcomes.

Free entry and exit isn’t terribly lacking. Building new facilities and buying new equipment is relatively unblocked, though the market may adjust to new situations a little slowly. Training doctors will always take awhile, so the market will not absorb shocks terribly well. However, the market is fairly stable, so that’s rarely going to be an issue.

Product homogeneity is generally met. Most services are comparable from provider to provider. Sure, every now and again you get a better equipped hospital, or a more talented team of family doctors at a clinic, but in the grand scheme of things the services being offered match up or the provider who is lagging is booted from the market.

Perfect information is not even close to being met. Unless you’re reading this and have a relevant degree, you’re probably not in position to make informed health-care decisions on your own, ethics aside. Even a good, honest doctor can’t be expected to convey 7 years of schooling and years of on the job experience perfectly. What’s more, is that the doctor may not be best informed, given the presence of intentionally misleading studies published with the blessing of the FDA. Worse, your doctor has incentive to mislead you into buying more healthcare than you need. His or her profits are dependent on how much you consume. By overstating benefits or risks, they can persuade you to buy more than you actually would if you knew what you were doing. What’s interesting is that these create the exact same kinds of inefficiencies as subsidies and taxes, and hence provide the strongest theoretical suggestion for intervention.

The takeaway is that healthcare markets are generally textbook examples of a market that requires government intervention. (Whether or not a specific proposal is a good idea, well, that’s another post.) Information problems and a small number of buyers or sellers fail even the standards put forward in an intro textbook. While fixing these problems is harder, seeing that they exist is quite easy.

*Yeah, it’s weird to think of people with rare diseases as costumers, yet economics is all about thinking like that. Oh, the dismal science.