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If We Want Lower Health Care Spending, We Are Going to Have to Pay for It

Craig GarthwaiteUltimately, spending less on health care is a relatively easy task: We either need to consume fewer services, or spend less on the services that we consume. But much like we teach our Kellogg students about maximizing profits, the devil is in the details.

It’s certainly tempting to ask the government to swoop in on a white stallion and solve the all our problems by fiat. For example, we could have the government simply exploit its monopsony power and set prices, but an artificially low price will lead to an inefficiently low quantity of services and future innovation (stay tuned, we will have more to say about this next week).

Similarly, we could explicitly ration quantities (as opposed to implicitly doing it through a large uninsured population). But how could we hope to determine the right level of care? Ultimately, if we ask the government to unilaterally fix this problem, instead of a white stallion we could behold a pale horse and all that it entails.

The good part, perhaps the best part, about the Affordable Care Act is that it attempts to address this problem using market forces. The question is whether we are ready for what these market forces will entail.

We will focus today on the role of market forces in the insurance market to control prices in the newly established ACA exchanges.

This month the Obama administration announced that it would allow insurers to use “reference pricing” for insurance programs in the exchanges. Under a reference pricing system, insurers set the maximum price they will pay for a specific set of services and if patients go to a facility that costs more than that amount they are required to pay the difference.

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