Chapter 9.F.2 (or 3.F.2) -- Economic and Regulatory Theory

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This excerpt nicely frames the nature of the debate between advocates of market-based versus regulatory reforms.Health Care Into The Next Century
Mark A. Peterson
22 J. Health Pol. Pol'y & L. 291 (1997)

What are we to make of the market transformation of health care in the United States, the core legacy of the current decade? Should we favor the dynamics of markets, standing alone, as a vehicle for reform? What are the limitations? What has motivated the restructuring of the private insurance system? What happens when the market transformation extends from private insurance to the publicly financed programs for the elderly and poor? These questions motivate the next section of this [book].

Before launching into that analysis, however, it is imperative to recognize the slippery character of the term market. What do we mean when we speak of markets in the health care setting? One might have in mind a general consonance with the conventional American preference--among elites and the public--for private markets as opposed to government intervention. Taken to the extreme, however, relatively few people, beyond some libertarian and right-wing politicians, believe that all matters pertaining to the delivery of medical care services should be left to the marketplace, however conceived. Some individuals may believe that health care is no different from toothpaste, but that view is shared by few analysts and citizens. Most market advocates, such as health economists Alain Enthoven and Mark Pauly, support major interventions by the government to subsidize insurance coverage and promote improved rules of the game for an otherwise inefficient market. Analysts across the spectrum of opinion reject the simplistic dichotomies of government versus the market, or regulation versus competition. More pertinent are questions about where, when, in what form, and under what conditions both markets and government have a role.

In the health care setting, the market is more typically a reference to a set of market-like instruments or arrangements. These include privately owned or managed institutions, which can range from stockholder-owned insurance companies to nonprofit sickness funds in the German tradition. They often refer to the use of incentives embedded within institutions of whatever sort (private or public) that are designed to promote more efficient individual-level behavior. Fully capitated payments to physicians by corporate HMOs, which shift risk to the doctor and reward the utilization of fewer services, would certainly be included. But one would also have to consider the hospital payment methodology of diagnosis-related groupings (DRGs) used by a public program like Medicare. The market frequently is taken to refer to a process of decision making; for example, using competition among substitutable entities to identify and select the best choice according to some measure of utility. That competition, however, can be among private firms, nonprofit institutions, or even public agencies or employees. It can occur within an unregulated marketplace or within the bowels of the public sector. The same can be said of another market-like arrangement: contracting between relevant parties.

Even agreement on the meanings of these market-like instruments and arrangements in the abstract does not necessarily yield a consistent understanding of their meaning or impact in practice. How they are used and to what effect is highly contingent. Because various health care systems around the world have experimented with or implemented design features that look similar to some of these instruments or mechanisms, it is all too easy to accept the claim that market forces, and the "American model," are diffusing around the world. To do so, however, ignores the distinct effects that are generated when similar looking instruments--for example, contracts, competition among providers for patients, and capitated payments--are introduced in quite different historical, institutional, and cultural settings.

For our purposes, the market concept has developed a fairly distinct set of features specific to the contemporary American context (they need not go together as a matter of principle or in other contexts). First, although payers may be either private or public, private institutions regulate the flow of funds between payers and providers of care. Second, those private institutions are moving toward payment mechanisms that use incentives to promote cost- effectiveness. Those payment mechanisms generally fall under the rubric of managed care, itself a highly inclusive term for everything from staff-model HMOs with salaried physicians and their own hospitals to capitated payments to panels of physicians and other providers to discounted fee-for-service payments and bonuses paid to otherwise independent providers. Saying that everyone is in managed care is somewhat akin to suggesting that everyone has a mode of transportation: some fly airplanes, some drive cars, some use public buses, some ride bicycles, and some walk. It is easier to identify what is not included in managed care than what is, but that nonetheless remains a meaningful distinction, because all forms of managed care, no matter how weak, create behavioral incentives opposite those promoted by open-ended fee-for- service arrangements. Third, contracting is a dominant mode of establishing formal relationships between purchasers of coverage and insurers, between insurers and providers, among providers, and sometimes directly between purchasers and providers. Fourth, although private institutions, whether insurers or providers, need not be profit-seeking entities in order to perform in the market, for-profit firms are acceptable participants. Fifth, although the federal and state governments have enacted a number of policies that affect individual and institutional behavior in the market--such as financing Medicare and Medicaid, shielding employee health benefits from taxation, imposing some regulation of insurance practices, and isolating from state regulation self- insured companies with the federal Employee Retirement Income Security Act (ERISA)--decisions about insurance products and the delivery of medical care services are predominantly made by private actors.

The following is an excerpt from a decision enjoining the merger of two hospital companies in the Chattanooga area because the merger would tend to create a substantial reduction in competition. This is the Commission's preliminary discussion of the economic forces that operate within the health care industry.In re Hospital Corporation of America
106 F.T.C. 455 (1984), aff'd, 807 F.2d 1381 (7th Cir. 1986)

 [I]t is important to have a fundamental understanding of the role of physicians and third-party payors in the health care transaction.

The role of the physician is a market response to the extremely high cost to consumers of health care information and expertise. As a result of the patient's grossly imperfect information concerning proper diagnosis and treatment, and the doctor's much greater knowledge, the doctor decides what diagnoses, treatments, and so forth the patient will have. The physician orders tests, prescribes drugs and courses of treatment, and so forth, and most important for our analysis, decides whether and when a patient will be admitted to and discharged from a hospital, along with the battery of tests and procedures he receives while there. The patient simply cannot decide these things for himself; the doctor is his repository of information and expertise and thus plays the critical role in determining the nature and extent of hospital and other health services the patient will receive.

In addition to a lack of information about how to diagnose and treat himself, the patient has perhaps even less perfect information about the occurrence and extent of future illness and injury. For the most part, neither the doctor nor the patient can control frequency or intensity of disease or injury. For example, the typical patient cannot anticipate or prevent being in an automobile accident or developing cancer. Likewise, the doctor cannot determine the type or intensity of diagnosis and treatment until a problem develops, to the extent that he can determine the severity of a problem within a short period of time at all. The uncertainty associated with the nature and extent of potential health problems is thus enormous, and the uncertainty about the cost associated with diagnosis and treatment of such contingent events is equally high. As a result, the patient cannot plan financially for the treatment of his health problems; he may be healthy for the rest of his life and have to spend no money on health care whatsoever, or he may receive an injury so serious that he could not possibly hope to pay for his treatment with his annual salary. What is the logical market response to this dilemma? Health insurance.

Insurance is a response to uncertainty, and spreads the risk of financial loss occasioned by treatment of disease or injury over both the people who turn out to have little need for health care and those who turn out to have a great need. By paying an insurance premium in a world where the future need for health care is uncertain, a potential patient eliminates the risk of not having the money he needs to pay for diagnosis and treatment, particularly of serious illnesses or injuries, should health care and of particular interest to us, hospital care, be needed....

With respect to our analysis, there is one extremely important effect on the hospital services market of third-party payment: The extent to which a patient is insured determines the extent to which he is sensitive to the price of hospital care. If he is fully insured, once he becomes ill his interest lies in receiving the best quality care possible, including the highest quality comforts and surroundings if he is in the hospital, no matter what the costs. Who, then, is concerned about price? We would expect third-party payors and their customers, the world of potential patients and employers who pay insurance premiums, to be interested in minimizing the costs of insurance. Of course, the government and taxpayers, who insure many of the elderly and under-privileged through the Medicare and Medicaid programs, should be interested as well. There is one wrinkle, however. When hospital prices rise, the increased payments made by an insurance company are spread over all its subscribers, both patients and non-patients (i.e., prospective patients); premiums rise less than proportionally to the increase in hospital prices. Thus, not every significant increase in hospital prices will bring a significant market reaction from insurance consumers....

We are thus confronted in this care with a very peculiar market indeed. Because of the uncertainty of illness and injury and the grossly imperfect information available to consumers of hospital services, patients generally rely on physicians to determine the nature and extent of the medical care they receive and on third-party payors to provide the financial assurances that such care will be paid for.

For further development of Rand Rosenblatt's perspective, see Rand E. Rosenblatt, The Four Ages of Health Law, 14 Health Matrix 155 (2004).

The Federal Trade Commission held an extensive set of hearings in 2003-2004 on Health Care Competition Law and Policy, resulting in a comprehensive report,
Improving Health Care: A Dose of Competition (July 2004).

Gregg Bloche’s article, The Invention of Health Law, was published in 91 Cal. L. Rev. 247 (2003).

Discussing regulatory issues generally, see Timothy S. Jost, Health Law and Administrative Law: A Marriage Most Convenient, 49 St. Louis U. L. J. 1 (2004).

Recent research documents that, over the past 30 years, Medicare has been more effective in controlling spending growth than have private insurers.  Cristina Boccuti & Marilyn Moon, Comparing Medicare and Private Insurers:  Growth Rates in Spending over Three Decades, 22(2) Health Aff. 230 (March 2003).  See also Len M. Nichols, Are Market Foreces Strong Enough to Deliver Efficient Health Care Systems? Confidence is Waning, 23(2) Health Aff. 8 (April 2004) ("There is broad consensus among market participants that without major change in our health system, health care costs and premiums . . . will continue to rise much faster than wages or incomes.").

For a powerful argument that "health policy elites" are out of step with most of the rest of America in embracing market-based approaches to health policy, see Mark Schlesinger, On Values and Democratic Policy making: The Deceptively Fragile Consensus around Market-Oriented Medical Care, 27 J. Health Pol. Pol'y L. 889 (2002):

"The influence of market thinking among health policy elites in this country is . . . dominant. Its persistent appeal, in the face of the remarkably uneven  performance of market-oriented reforms, reflects the persuasive power of simple economic answers to complex policy problems, a pattern replicated at other times in other policy contexts. However, despite the apparently bipartisan consensus in favor of markets that has been forged among  the Washington elite, this dominance is neither well recognized nor broadly supported outside of the Beltway. For example, although the [Clinton] Health Security  Act was based on a model of managed competition, its market-based origins remained obscure for most of the American public. And the results discussed earlier suggest that the public thinks about markets in medical care in very different ethical terms than do elites based in Washington. . . . In my experience, policy makers in Washington have not idea how strongly divergent their interpretations have become from those endorsed by the American public."
According to eminent sociologist Eliot Freidson:
The ideology of the free market permeates our thought today, providing our assumptions about what is reasonable and what is not. . . . This utopian image dominates the way we think about health care in the United States, even though little resembling the free market is to be found in reality.  Something like it may have existed in the United States until the early twentieth century, when licensing was weak, payment was out-of-pocket, practice was entrepreneurial, and medical knowledge and technology were well within the ken of consumers.  But today, the market in which health care takes place is organized by massive public and private insuring and health care organizations, and consumer choice is heavily constrained by government regulation, insurance contracts, and the complex, esoteric character of the information bearing on those choices, not to speak of massive advertising campaigns designed less to inform consumers than to manipulate and direct their decisions.  It is simply grotesque to think of health care today as even potentially truly free market “subject to ordinary rules of free enterprise.”
28 J. Health Politics Policy & L. 169-70 (2003).

For additional notes on economic and regulatory theory, see the update page for Chapter 1.D.

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