OP-ED

Why “free market competition” fails in health care

In trying to think about the future of health care, thoughtful, intelligent people often ask, “Why can’t we just let the free market operate in health care? That would drive down costs and drive up quality.” They point to the successes of competition in other industries. But their faith is misplaced, for economic reasons that are peculiar to health care.

More “free market” competition could definitely improve the future of health care in certain areas. But the problems of the sector as a whole will not yield to “free market” ideas – never will, never can – for reasons that are ineluctable, that derive from the core nature of the market. We might parse them out into three:

  1. True medical demand is wildly variable, random, and absolute. Some people get cancer, others don’t. Some keel over from a heart attack, get shot, or fall off a cliff, others are in and out of hospitals for years before they die. Aggregate risk varies by socioeconomic class and age – the older you are, the more likely you are to need medical attention; poor and uneducated people are more likely to get diabetes. Individual risk varies somewhat by lifestyle – people who eat better and exercise have lower risk of some diseases; people who sky dive, ski, or hang out in certain bars have higher risk of trauma. But crucially, risk has no relation to ability to pay. A poor person does not suddenly discover an absolute need to buy a new Jaguar, but may well suddenly discover an absolute need for the services of a neurosurgeon, an oncologist, a cancer center, and everything that goes with it. And the need is truly absolute. The demand is literally, “You obtain this or you die.”
  2. All demand apes this absolute demand. Medicine is a matter of high skill and enormous knowledge. So doctors, by necessity, act as sellers, and agents of other sellers (hospitals, labs, pharmaceutical companies). Buyers must depend on the judgment of sellers as to what is necessary, or even prudent. The phrase “Doctor’s orders” has a peremptory and absolute flavor. For the most part, people do not access health care for fun. Recreational colonoscopies are not big drivers of health care costs. In some cases, such as cosmetic surgery or laser eye corrections, the decision is clearly one the buyer can make. It’s a classic economic decision: “Do I like this enough to pay for it?” But for the most part, people only access health care because they feel they have to. And in most situations, it is difficult for the buyer to differentiate the truly absolute demand (“Do this or you die”) from the optional. Often it is difficult even for the doctor to tell the difference. The doctor may be able truthfully to say, “Get this mitral valve replaced or you will die. Soon.” More often, it’s a judgment call, a matter of probabilities, and a matter of quality of life: “You will likely live longer, and suffer less, if you get a new mitral valve, get a new hip, take this statin. At the same time the doctor, operating both as seller and effectively as agent for the buyer, is often rewarded for selling more (directly through fees and indirectly through ownership of labs and other services), and is not only not rewarded, but actually punished, for doing less (through the loss of business, the threat of malpractice suits, and punishment for insufficiently justifying coding). So the seller is agent for the buyer, the seller is rewarded for doing more and punished for doing less, and neither the buyer nor the seller can easily tell the difference between what is really necessary and what is optional. This is especially true because the consequences of the decision are so often separated from the decision. “Eat your broccoli” may actually be a life-or-death demand; maybe you need to eat more vegetables to avoid a heart attack. But you’re not going to die tonight because you pushed the broccoli around the plate and then hid it under the bread. So, because it is complex and difficult, and because its consequences are often not immediate and obvious, the buy decision is effectively transferred to the seller. We depend on the seller (the doctor) to tell us what we need. Whether we buy or not usually depends almost solely on whether we trust the doctor and believe what the doctor says.
  3. The benefit of medical capacity accrues even to those who do not use it. Imagine a society with no police. Having police benefits you even if you never are the victim of a crime. You benefit from that new bridge even if you never drive over it, because it eases the traffic jams on the roads you do travel, because your customers and employees and co-workers use it, and because development in the whole region benefits from the new bridge. This is the infrastructure argument. Every part of health care, from ambulances and emergency room capacity to public health education to mass vaccinations to cutting-edge medical research, benefits the society as a whole, even those who do not use that particular piece. This is true even of those who do not realize that they benefit from it, even of those who deny that they benefit from it. They benefit from having a healthier work force, from keeping epidemics in check, from the increased development that accrues to a region that has good medical capacity – even from the reduction in medical costs brought about by some medical spending, as when a good diabetes program keeps people from having to use the Emergency Room.

All three of these core factors show why health care is not responsive to classic economic supply-and-demand theory, and why the “free market” is not a satisfactory economic model for health care, even if you are otherwise a believer in it.

Answers for the future of health care?

The answer to the first problem, the variability and absolute nature of risk, is clearly to spread the risk over all who share it, even if it is invisible to them. If you drive a car, you must have car insurance, and your gas taxes contribute to maintaining the infrastructure of roads and bridges; if you own a home, you must have fire insurance, and your property taxes pay for the fire department. Because of your ownership and use of these things, you not only must insure yourself against loss, you also must pay part of the infrastructure costs that your use of them occasions. Similarly, all owners and operators of human bodies need to insure against problems that may accrue to their own body, and pay some of the infrastructure costs that their use of that body occasions. However the insurance is structured and paid for, somehow everyone who has a body needs to be insured for it – the cost of the risk must be spread across the population.

Skipping to the third problem, the infrastructure argument, its answer is somewhat similar: To the extent to which health care capacity is infrastructure, like police, fire, ports, highways, and public education, the costs are properly assigned to the society as a whole; they are the type of costs that we normally assign to government, and pay for through taxes, rather than per transaction. In every developed country, including the United States, health care gets large subsidies from government, because it is seen as an infrastructure capacity.

That leaves the second problem, the way in which all demand apes the absolute nature of true demand in health care (“Get this or die”). The answer to this problem is more nuanced, because it is not possible to stop depending on the judgment of physicians. Medical judgment is, in the end, why we have doctors at all. But we can demand that doctors apply not just their own judgment in the moment, but the research and judgment of their profession. This is the argument for evidence-based medicine and comparative effectiveness research. If a knee surgeon wishes to argue that you should have your arthritic knee replaced when, according to the judgment of the profession as a whole, the better answer in your situation is a cortisone shot and gentle daily yoga, the surgeon should have to justify somehow, even if just for the record, why your case is different and special. The physician’s capacity to make a buy decision on your behalf must be restrained at least by the profession’s medical judgment. If the best minds in the profession, publishing in the peer-reviewed literature, have come to the conclusion that a particular procedure is ineffective, unwarranted, or even dangerous, it is reasonable for insurers, public or private, to follow that best medical judgment and stop paying for it.

These three core factors – the absolute and variable nature of health care demand, the complexity of medicine, and the infrastructure-like nature of health care capacity – are all endemic to health care and cannot be separated from it. And all three dictate that health care cannot work as a classic economic response to market demands. Failure to acknowledge these three core factors and structure health care payments around them account for much of the current market’s inability to deliver value. Paying “fee for service,” when the doctor is both the seller and acting as agent for the buyer, and when the doctor is punished for doing less, is a prescription for always doing more, whether “more” delivers more value or not. Paying “fee for service,” unrestrained by any way to make classic value judgments, means that hospitals and medical centers respond to competition by adding capacity and offering more services, whether or not those services are really needed or add value.

For all these reasons, it is vastly more complex to structure a health care market rationally, in a way that delivers real value, than it is to structure any other sector, and simply fostering “free market” competition will not solve the problem.

With nearly 30 years’ experience, Joe Flower has emerged as a premier observer on the deep forces changing healthcare in the United States and around the world. As a healthcare speaker, writer, and consultant, he has explored the future of healthcare with clients ranging from the World Health Organization, the Global Business Network, and the U.K. National Health Service, to the majority of state hospital associations in the U.S.  He has written for a number of healthcare publications including, the Healthcare Forum Journal, Physician Executive, and Wired Magazine.  You can find more of Joe’s work at his website, www.imaginewhatif.com, where this post first appeared.

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ThronCheJohn R. GrahampilesMargalit Gur-Arie Recent comment authors
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Thron
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Thron

Joe, your post misses reality by a solar system, so let me try to bring you back from outer space. President Obama’s economic council in July reported that goverment health care programs do not pay for quality or value, but do pay for poor quality. For many health care providers, government represents 50-70 percent of their revenue meaning the majority of health care provider services are underpaid for excellence and overpaid for failure perverting free market principles. Plus, all discounts government mandates on payments for both failure and excellence are transferred to private insurers artificially inflating premiums perverting the health… Read more »

Che
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Che

JRG, very well stated.

John R. Graham
Guest

I hope to be as courteous as possible here: 1. “True medical demand is wildly variable, random, and absolute.” It certainly is: just like death, car crashes, or house fires, but insurance markets have developed to deal with those risks. As for the need being “absolute”, that is not a meaningful adjective. While nobody needs a Jaguar, most people would argue that an adult “needs” a car if he’s going to live a middle-class life. One hundred years ago, only very rich people could afford cars, and it would have been unimaginable to most people that the masses would every… Read more »

Jim
Guest

Piles,
In your opinion is US healthcare an example of free market healthcare? If so, why do you think it isn’t successful and if not what are your examples of failed attempts?

piles
Guest

There are, however, no examples of successful health care based on the principles of the free market, for one simple reason: in health care, the free market just doesn’t work. And people who say that the market is the answer are flying in the face of both theory and overwhelming evidence.

Margalit Gur-Arie
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Margalit Gur-Arie

It’s not only that health care is not a free market, it is immoral for it to be so. It is immoral for people to be able to buy health and years of life, according to their financial means and station in life. The only other “industry” where “buy or die” is the modus operandi is the mostly defunct “protection” industry. Once a free society reaches the conclusion that a market, or trade practice, is immoral, it will eventually eradicate it, regardless of financial considerations. Most other free societies have made that discovery years ago. I guess it is taking… Read more »

Jim
Guest

Peter, Please re-articulate your last post, it makes no sense. You just said that every-time a single-pay system uses the “free market” it gets more expensive. How could a singe-pay system use the free market? It’s a non-sequitur. Seriously, every time you respond to one of my posts you base your rebuttal on a factual error or misunderstanding of the argument. Your claim about elective surgery is so wrong. Hospital’s don’t “accept” reimbursement rates, the live with them as dictated by CMS and every private payor. I’m guessing that the cost of elective surgery has gone down while the quality… Read more »

Peter
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Peter

“elective surgery that is not covered by insurance, for example”
Yes, at 3 to 4 times the rate that a hospital would accept from an insurance carrier. If I paid in chickens would I get a better rate?
“Someone else is dictating the services you can purchase
Someone else is dictating price and allowable profit margin…”
Jim, if you look at single-pay systems in the industrialized world you will find that the more they use the “free market” the more expensive the system.

Jim
Guest

Peter, There is no claim that there aren’t parts of healthcare that operate in a free market way — elective surgery that is not covered by insurance, for example. But, fundamentally, US healthcare is not a free market system. That is a fact. One can argue about whether that is a good thing or a bad thing, but arguing that US healthcare is an example of a free market system is like arguing the world is flat because parts of it are flat. A root cause of the problems with healthcare is the way in which free market forces are… Read more »

Peter
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Peter

“Let me say that again, WE DO NOT HAVE A FREE MARKET HEALTHCARE SYSTEM.” As in we don’t have a free market anything because government is involved to some extent in everything we do? I guess the FDA trying the ensure we have safe drugs makes healthcare not a free market system because in a true free market system people dying from dangerous drugs would be handled by free market forces that would punish drug makers in the market if they killed people selling un/under tested drugs to make a profit. Isn’t medical malpractice the free market in action –… Read more »

Nate
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Nate

Peter I see you shoveling your stupidity again, if you didn’t say so many ignorant things my post wouldn’t be so long. Starters BS most consumers, roughly 80%, can pay 100% of their HC out of pocket. Unless you now define 20% as most you are wrong. Next I can’t sell insurance without a license, the state and federal government tell me what type of insurance I can sell and what it will cover. In some cases they tell me how much i can charge, how I can market it, and to whom I can market it. They even go… Read more »

Jim
Guest

Peter, You are confused on a number of points 1) I was not defending free market healthcare, I was criticizing Joe’s argument that a free market healthcare system won’t work because of intrinsic healthcare characteristics. I systematically went through the 3 claims Joe makes and showed how, in each case, they do not substantiate his claim that free market forces won’t work “ for reasons that are ineluctable, that derive from the core nature of the market.“ Joe made a claim and presented an argument in an attempt to substantiate his claim. I demonstrated that the argument does not support… Read more »

Phillip
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Phillip

should read “quality surveys” above.
Islands of excellence in a sea of mediocrity.

Phillip
Guest
Phillip

Healthcare in America will never be competitive and never efficient. There are too many variables and therefore too easy for doctors, hospitals, testing companies, pharma, and insurance companies to game the system. Plus you are dealing with a highly emotional service, where efficient decision making is often neglected. It needs to be dramatically simplified. Single-payer has proven to be the most efficient system in the world. It cuts out an entire bureaucracy and keeps the doctor closer to the patient. There is no real market economics involved in the U.S. system. Customers are disconnected from what they buy. There is… Read more »

Peter
Guest
Peter

Jim, first the rebuttal was not too long for posting, especially given the length of our longest winded poster, Nate. I think you just wanted to draw eyeballs to your web site. Second it is you that failed to argue any point that says Joe Flower’s conclusion is unsubstantiated. In fact you make no specific arguments as to why the so called “free market” hasn’t already driven down costs and prices – certainly it has time to do so if it had any incentive. You simply state general free market principles and ideology to make “a point” but fail to… Read more »