10/17/2008 05:12 am ET | Updated Nov 17, 2011

Market Mythology in Health Care: Why Markets Can Never Control Health Care Costs

Market theorists have been telling us for years that the competitive marketplace will keep prices under control, as well as fix problems of access and quality of health care. This statement by senior fellows of the Hoover Institution in 2006 reflects market ideology which has framed health care policy for three decades:

"Greater reliance on individual choice and free markets are the solutions to what ails our health care system . . . A handful of policy changes that harness the power of markets for health services have the potential to give patients and their physicians more control over health-care choices, create more health insurance options, lower health costs, reduce the number of uninsured persons--and give workers a pay increase to boot."

If competitive markets are so effective in controlling health care costs, how is it that these costs continue to soar at rates three or four times the rates of cost of living or median family incomes? Here are five reasons why markets fail, and can never succeed, to control health care costs.

There is little actual competition in health care markets. Instead, we find widespread consolidation, whether among hospitals, pharmaceutical companies, other suppliers, nursing homes, dialysis centers, or insurers. As examples, Tenet, the second largest hospital chain in the country, controls 80 percent of hospital beds in El Paso, Texas, while private insurers have near-monopolies in 95 percent of HMO/PPO metropolitan markets (raising antitrust concerns by the U. S. Department of Justice). One-half of Americans live in areas that are too sparsely populated to have any real competition. And of course, when people are seriously ill and require the most costly care, they find it difficult or impossible to comparison-shop for physicians or hospitals.

On the supply side, providers and suppliers have wide latitude to set prices.
Much of the health care industry is investor-owned, from insurers to hospital chains and drug companies. As such, they are obligated to their shareholders to maximize profits and have wide latitude to set prices independently. In California, for example, Tenet hospitals have set charges for drugs ten times higher than state averages, while Ovation Pharmaceuticals hiked its price for Cosmegen, a chemotherapy drug for a kidney cancer in children, by more than 3,400 percent (not a typo!) in 2006. So-called not-for-profits can also set their own prices, as illustrated by a recent Wall Street Journal report that the "nonprofit" Carillion Health System in southwestern Virginia charges $4,727 for a colonoscopy and $1,606 for a CT scan of the neck, levels three to ten times higher than charged by other local facilities.

Our fragmented system works against bulk purchasing.

In such a fragmented multi-payer system as we have, there is little opportunity to achieve sizable discounts through bulk purchasing. Indeed, bulk purchasing of drugs was specifically prohibited by the Medicare Prescription Drug, Improvement and Modernization Act of 2003. That legislation was crafted by conservative legislators and lobbyists to protect the pricing prerogatives of the drug and insurance industries and to avoid discounts on drugs of 40 percent or more as are achieved by the Veterans Administration.

Distorted reimbursement policies favor gaming of the system.

We have entrenched policies with a wide gap between physician reimbursement for procedures and cognitive services (ie., the face-to-face listening and talking part of medicine as is typical in primary care, geriatrics, and psychiatry). Procedures are over-reimbursed while time-intensive cognitive services, including coordination and continuity of comprehensive care, are under-reimbursed. It is well documented that higher-reimbursed areas of the country attract larger numbers of specialists with more specialist visits, more hospitalizations and ICU use, more inappropriate and unnecessary care, and worse outcomes than are seen in lower reimbursed parts of the country with fewer specialists and more generalist physicians. Other providers game the system as well. For example, HCA, the largest hospital chain in the country, has inflated its revenues by "upcoding" the severity of patients' diagnoses, falsifying billing ledgers, and bouncing patients among its hospitals, sub-acute facilities, and home care agencies in order to bill multiple times for each episode of illness.

Demand for health care is not very sensitive to prices.

Although conservative theorists tell us that patients overuse health care if they are insured (moral hazard), that premise has been discredited as a major cause of health care inflation. We don't see runs by patients to unnecessary care. Most medical care is ordered by physicians, who themselves are largely responsible for an estimated one-third of health care services that are either inappropriate or unnecessary. As for price sensitivity, a 2005 RAND report found that spending dropped by only 17 cents for every dollar increase in price.

What can we conclude from all this? Based on three decades' experience with our deregulated marketplace, we have to conclude that markets cannot control health care costs, and in fact are themselves a big contributor to health care inflation. Market ideology in other kinds of markets do not apply in health care. Managed care of the 1980s and 1990s not only failed to contain costs, but also brought further complexity and turmoil to the marketplace while disrupting relationships between patients and physicians. It has become obvious that reining in the costs of health care and at the same time increasing access and quality of care will require major reform, including a larger role for government. Joseph Stiglitz, Nobel laureate in economics and former chief economist of the World Bank, puts it this way:

"Markets do not lead to efficient outcomes, let alone outcomes that comport with social justice. As a result, there is often good reason for government intervention to improve the efficiency of the market. Just as the Great Depression should have made it evident that the market often does not work as well as its advocates claim, our recent Roaring Nineties should have made it self-evident that the pursuit of self-interest does not necessarily lead to overall economic efficiency."

In our next post, we will look at how inflating health care costs driven by market forces
cause financial insecurity and economic hardship for a large and growing part of our population.

Adapted from Do Not Resuscitate: Why the Health Insurance Industry is Dying, and How We Must Replace It, 2008 by John Geyman. With permission of the publisher, Common Courage Press.

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