The Power of Markets... and Hospitals

05/06/2017 12:58 am ET

After reaching what many thought was an impenetrable impasse, the U.S. House of Representatives has passed a healthcare reform bill. It remains unclear whether this bill (or some version of it) will ever become law given the political dynamics of the Senate, but Republicans have now cleared the first hurdle in their healthcare reform effort. How did the bill’s proponents finally win over the House Freedom Caucus (a key group of Republican holdouts)? With an amendment allowing states to tell insurance companies they can cover fewer procedures and charge higher prices for patients with pre-existing conditions. Supporters of these measures say they will allow insurers to offer cheaper plans.

The House Freedom Caucus is right to be concerned about consumer healthcare costs. But Republicans’ embrace of the familiar argument that cutting government regulations in the healthcare sector will lower costs by fostering greater competition may be too simplistic an approach and risks setting them up for policy failure.

Competitive markets are a remarkable force, and we can thank them for keeping down prices at grocery stores, hair salons, and car dealerships. Economic theory indicates, though, that there are limits to the realms in which markets can function effectively. For healthcare, one particularly relevant factor that affects how well markets will perform is the availability of information.

Consider the example of tourists shopping in a foreign country. If they buy from a street vendor, they will probably overpay. The tourists don’t know what the local prices for goods are, and the street vendor takes advantage of their ignorance. If, on the other hand, the tourists go to a local grocery store with fixed prices, they are less likely to get ripped off. As long as enough of the patrons are informed consumers, the store’s managers know they will lose business if they overcharge. In a particularly touristy area, prices may be too high and quality not ideal, since almost all of the patrons will be ignorant of both the goods and their proper cost.

In healthcare, we—the patients—are tourists in a shop full of tourists. We don’t know which procedures or medicines we need, and we don’t know how much they should cost. We pay doctors to help us decide, but these doctors are often the very people who stand to profit if we decide to have a procedure done. Furthermore, our healthcare professionals rarely give us detailed information about the financial implications of choosing among available procedures, medicines, or providers. In some cases, the doctors are deciding themselves what we should prefer—which can include performing a test so that we feel like something is being done, even if the test is medically unnecessary.

Then there is the issue of billing. Like the street vendor, hospitals do not typically post prices publicly. Billing procedures at hospitals are often extremely complex, and it can be a struggle just to find out ahead of time how expensive a set of procedures will be. In some cases, we are left struggling to decipher the multiple medical bills we later receive to determine whether we were charged correctly.

For those of us who have health coverage, insurance companies are something like a local guide who helps us tourists navigate the street vendors. Insurers typically negotiate prices with hospitals that are lower than what the hospital charges those without health insurance. They employ armies of lawyers and healthcare experts to determine which procedures are necessary and what a fair price is. This helps to guard against overcharging, but it is an imperfect system since the lawyers and healthcare experts only can observe things from afar. They can’t always tell whether we actually need the test that a doctor recommends to us.

Given this complex healthcare system, there are limits to what market forces and deregulation can accomplish. For some simple procedures, individuals may learn to shop around and find the lowest prices. When prices are severely obscured or emergency care is required, shopping around becomes impractical. Those without insurance have no guide to make sure that they are not overcharged, while those who have it end up paying for the salaries of armies of lawyers and billing experts at insurance companies and hospitals.

There is no silver bullet for controlling costs, but several sensible proposals exist. For example, some states have started requiring greater price transparency, which may help consumers to become better informed and avoid being overcharged. Providers and insurers can change pay structures so that doctors are not paid more when they recommend and perform a greater number of procedures. We could also do more to limit the prices charged by pharmaceutical companies while increasing public funding of drug research in order to promote the continued discovery of new drugs. Everyone agrees that we are spending too much on healthcare. While the Obamacare greatly expanded access to health insurance, it has not addressed the rising costs of healthcare itself. But in order to identify smart approaches to controlling costs, we need to be mindful of market incentives and how they can be leveraged to improve efficiency without adopting the simplistic view that slashing regulations will lower prices.

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