US Healthcare Within a Mixed Economy

Short essay on the mix of state and private provision of healthcare

Introduction

Healthcare in the United States of America (US) exists within a mixed economy, but unlike national security which is undertaken strictly by the state, it functions, in part, with state provision that oversees private provision, such as regulations like anti-trust laws, while offering coverage; and private provision that provides the necessary products for consumers, such as insurance plans. The nature of this combination renders the institution rivalrous and exclusionary, and thus not a public good. In fact, the US is the only Organization for Economic Co-operation and Development (OECD) country that does not have universal healthcare as a system or right. Currently, 91.5% of eligible people have health insurance, among them, 67.3% have private insurance plans and 34.4.% have government-provided plans through Medicaid (people with low incomes) and Medicare (above 65 or under 65 with a disability) programmes; the most common type is employer-sponsored plans, covering 55.1% of the population (Census, 2019); and though the US has the largest per capita expenditure in the world (OECD, 2019), 8.4% of the population does not have coverage (Census, 2019). Healthcare, like most commodities, is scarce and demand is unlimited, and thus it requires allocation and necessary components to undertake its allocation. However, it consists of atypical markets where the fundamental aspects of supply and demand, such as two primary agents (the buyer and seller) are guided by prices that determine the allocation of resources, do not serve as adequate descriptions of the nature of healthcare in the US.

The interactions in this market are obfuscated by third parties (i.e. insurance companies) who can dictate the terms of transaction and, by extension, the allocation of resources; and by unintended beneficiaries (i.e. externalities); and patients and consumers do not always know what they need and cannot comprehensively evaluate the treatment they receive (i.e. asymmetric information), thus government intervention is commonplace in order to protect patients and attempt to stabilise the imbalanced structure (i.e. undesirable coverage or distribution) of the market. The reason for this being the belief that competition among private insurers is much more efficient (Enthoven, 1978), and complementary to provisions within the Constitution that emphasises public choice and promotion of general welfare over the right to access healthcare. Similarly, state provision is not without its imperfections. In attempts to look after everyone, the government implements intrusive regulations that, contradictorily, harm consumers and patients; either as a result of acting within the interests of the private sector or driven by ideological stubbornness, or both. These failures, therefore, also exacerbate market failures, such as market concentration that stifles competition, thus inflating exclusionary aspects of healthcare.

The private and state provision, respectively, of healthcare in the US will be discussed in this essay.

Identifying market failures

Kenneth Arrow’s (1963) descriptions of the norms of welfare economics – the concept of Pareto optimality (or efficiency) – provides a framework to understand the fundamental aberrations of healthcare that makes it unique. His conclusion states that healthcare is unique because there is an absence of markets for two inherent characteristics: the uncertainty of the incidence of illness and efficacy of treatment; and the asymmetric information between patients and medical care providers – together these, naturally, occurring features undermine the existence of an ideal market. Therefore, employing the first theorem of welfare economics which states that the ideal economy is one with perfect competition in all markets that have relative equilibrium positions which are socially efficient as a practical starting point will help to understand the deviations (i.e. market failures) that violate the conditions of a market (Butler, 1993), thus preventing an ideal economy from existing in this sector.

Externalities

A common prevalent healthcare market failure is the ‘free rider’ problem, or ‘externalities’: The result of unintended spill-over effects of consumption or distribution; or benefits indulged and consequences experienced by external parties beyond the transaction. There are two types of externalities: positive externalities, for example, an insured consumer receiving their annual flu-shot not only protects them from the seasonal flu by decreasing the likelihood of contraction, it also minimises the possibility of spreading, thus, by extension, protecting anyone they encounter; and negative externalities, for example, a stranger who comes in contact with the consumer benefits from the treatment without having contributed to the cost of the flu-shot. This demonstrates that market forces are not comprehensive enough to undertake the provision of healthcare efficiently because the market is inherently incapable of containing the benefits and consequences of a transaction to the necessary parties.

Asymmetric information

Typically, consumers know what they want and can comfortably judge a transaction after it is completed (e.g. grocery shopping). In a perfect economy, this would be a fundamental feature of all markets, however, healthcare does not allow such a relationship to exist because parties of a transaction are unequal in the knowledge of one another. This form of inefficiency is known as ‘asymmetric information’ – people do not always know what type of sickness they are suffering from and what the right type of treatment is; consequently, they will regularly have to rely on medical professionals to provide the necessary solution, which still cannot be properly assessed in hindsight. The government attempts to correct this imbalance by, pre-emptively, ensuring regulations are in place to protect consumers, such as distribution being undertaken by licensed physicians and the development of pharmaceutical drugs being overseen by the Food and Drug Administration (FDA).

This imperfect information failure is most evident in the relationship between consumers and healthcare insurance companies, the variable of insider information (on both sides) dictates the transaction to benefit one side, thus exposing the uninformed party to exploitation. Naturally, consumers know more about their health than insurers, and so are less likely to purchase insurance if it’s costly and they are not at risk – one reason why young people are the largest uninsured group (Quinn, Schoen and Buatti, 2000; CMS, 2014; Census, 2020) – or if they know the costs will be too high because they have underlying conditions or dangerous habits, such as smoking or alcoholism. In this case, they will not disclose this information which leads to the insurance company charging them the same premium as someone who is healthy, thus losing potential profit. This results in adverse selection becoming a prominent feature, in response, insurance companies may raise premiums or reduce exposure to large claims. This response can lead to a ‘death spiral’ (Cutler and Zeckhauser, 1998), a condition that arises when premiums rise, causing a healthy group to opt-out if they perceive the cost unworthy, in turn, causing premiums to rise again given the insured group is smaller and less healthy which discourages the remaining healthy people into dropping their coverage and, once again, causing premiums to rise. As this process continues, the market becomes persistently exclusionary, people will continue to opt-out, the insured pool gets smaller, and prices will rise until it eventually disappears because more people will drop their coverage. Inversely, Akerlof’s (1970) “market for lemons” theory provides an understanding of the consequences of this inefficiency being exploited by sellers. For example, insurance companies will exploit the existence of asymmetric information to market products that coerce consumers to disregard their lack of knowledge regarding the uncertainty of their health condition and quality of products to sell them low-quality goods (i.e. a lemon). In this case, competition between insurers will take place in the form “rent-seeking” (Krueger, 1974) ‘in a “race to the bottom” which sees prices driven down at the expense of quality (Leonard et al., 2013).

Hospital and insurance market concentration

One reason for exceptional healthcare costs is the weak competition within the US system; in part, a result of heavily concentrated hospital (this is also an aberration of government price-setting regulation, which forces hospitals to compete on the quality provided) and insurance markets which decreases the intensity of competition. Beginning with a wave in the 1990s, concentration within hospital markets has persistently risen (Gaynor, Ho and Town, 2015) with consolidation being the primary reason, which also caused $42.2 billion consumer surplus loss between 1990 and 2001(Town et al., 2006). A Health Care Cost Institute (2019) report using the Department of Justice’s Herfindahl-Hirschman Index (HHI) determined that 81 of 112 (72%) metropolitan hospitals were “highly concentrated” by 2016, a 67% increase from 2012.

This clarifies the scale of this deviation from the ideal (i.e. perfect competition) which bears detrimental results, such as increasing hospital prices (Gaynor and Town, 2011; Robinson, 2004), a decline of quality (Gaynor and Town, 2012; Gaynor, Ho and Town, 2015), the burden of cost passed onto citizens who, consequently, pay substantially more per capita for healthcare than most countries (Tikkanen and Abrams, 2020), and results in young people being less likely to be insured because they are unable to afford it (CMS, 2014; IMCCU, 2019). And within the insurance market, this means exploitative behaviour exercised by companies in the form of higher premiums, such as price gouging during disasters, which makes coverage too expensive and making it the most common source for bankruptcies (Himmelstein et al. 2019), even for the heavily insured this means higher expenses and less consumer surplus. Specifically, those on employer-sponsored plans will see the associated costs passed onto them in the form of salary reductions or benefits, or the loss of their insurance plan altogether (Baicker and Chandra, 2006; Emanuel and Fuchs, 2008).

Moreover, comparative studies of the Medicare programme (Kessler and McCellan, 2000) and the United Kingdom’s state-provided, universal National Health Service (NHS) (Gaynor, Serra-Moreno and Propper, 2013) demonstrate that quality of patient care increased when concentration was not prevalent instead there were improvements in mortality and readmission rates in hospitals competition within regulated price-administered systems. However, there is evidence to suggest that the relationship between hospital and insurance markets is one-sided in that consolidation within the latter is “relatively more beneficial to patient experience” if the former’s market is more concentrated, and hospital market consolidation is “relatively more detrimental to patient experience” when the market is less concentrated (Hanson, Herring and Trish, 2019). This suggests that hospital markets are much more rigorous than their complementary counterparts because they do not succumb to insurance market concentration as easily as insurance markets do when the other is concentrated.

Identifying Government Failures

Proponents of government intervention typically reinforce the inherent inability of market forces to deliver the promise of optimal outcomes, and thus an ideal market, to meet the demands of healthcare. This position posits aberrations of free-marketism as key to justifying the need for intervention to rectify market failure via regulation, taxes, or bans, but this position intends to curb deviations by attempting to, paradoxically, perfect a system it deems inherently flawed. As a result, attempts to mimic an ideal market generate unideal outcomes either directly or indirectly.

Patent system

In an attempt to combat, for one, externalities, like the positive type of breakthrough research which will inevitably enter the medical field to be assessed before it is manufactured into the necessary form to be distributed and consumed, government intervention is undertaken through the use of price controls relating to research and development where the government is able to affect the supply side of healthcare. Such intervention, thus, affects competition by proliferating intellectual property right exploitation; trading competition for exclusive licenses for research (Heller and Eisenberg, 1998) and to innovate devices and drugs via the patent system.

The patent system allows companies to exercise monopoly rights to increase market exclusivity. Companies will invest to meet the marginal cost between the expected revenue of a new discovery and the cost of the discovery, and while they have patent protection, in order to make a profit, they will charge a price higher than the marginal cost of production. However, they will also lobby for lax regulatory oversight that allows them to exploit their monopoly power to further concentrate the market by price or “evergreening,” or both, for example, purchasing existing drug products and then inflating the price, like in the case of an EpiPen being inflated by 500% by Mylan (Pflanzer, 2016), and then making incremental changes to the drug that does not significantly improve standards of care (Beall et al., 2016). Their success demonstrates the susceptibility of the government-operated patent system.

As a result of this government-administered monopolisation, consumers face enormous barriers to access because the drug market becomes artificially exclusionary rendering necessary medication unaffordable (I-MAK, 2018), even for generic versions (Greene and Riggs, 2015). In fact, diabetic patients have been forced to turn to the ‘Black market’ for insulin (Crist, 2019) because the drug has been, persistently, patented. Given this reality, and the lack of empirical evidence (Boldrin and Levine, 2013), it is fair to suggest that this system does not serve its intended purpose, thus bringing into question its existence or at least its current state.

Partisanship

An extreme and persistent source of government failure in healthcare is partisanship, which produces several detrimental outcomes for Americans, especially for working-class non-white people, such as restrictive access and disparities in health outcomes. The state, either on a federal or state level, is fuelled by partisanship which translates into a divided, ideologically-driven provision of healthcare, take for example the expansion of Medicaid which, despite its public health benefits, has been opposed by conservative politicians for market-oriented reforms (Baker and Hunt, 2016). The guiding belief being neo-liberal oriented individual responsibility is in-line with the Constitution, thus better suited for delivering what people want than expansive, mandatory state provision and the aim of opposition being, as Olson (2015) states, to “dismantle social programs and replace them with privatized alternatives and social benefits that conform to the demands and logic of the market.”

Such partisanship extends to geographical manipulation, i.e. gerrymandering and the legacy of redlining to a lesser degree (both, also, prevalent in Republican-led states), which impedes the delivery of healthcare. There is evidence demonstrating a correlation between voter turnout and social service provision (Kenworthy and Pontusson, 2005), and so it can be argued that hindrance of the former stifles access to the latter. Since 2010, with the aid of the US Supreme Court, state legislatures have exacerbated disenfranchisement and skewed power relations between political parties by exploiting districting plans (Bentele and O’Brien 2013; McGann et al., 2016, pp. 56–96) giving ‘the Republican Party a considerable advantage when aggregated over the entire nation’ (McGann et al., 2016, pp.99–145). Consequently, this has negatively impacted the provision of healthcare in these places; Latner (2019) found that residents in gerrymandered states facing voter suppression have damaging relationships with healthcare, especially worse health outcomes, and have recently experienced a shift in partisan support for the Republican Party.

Whereas, ‘gains in health care insurance coverage are associated with vote shifts toward the Democratic Party.’ Evidently, this reality is at odds with popular arguments (Wittman, 1995) that claim ordinary forces of political competition, inherently, serve as mechanisms to hold politicians to account, and thus can sufficiently deliver efficiency.

Affordable Care Act and Moral Hazard

Although, moral hazard is a typical insurance market failure, in an attempt to make coverage affordable within the remits of the established system, Barack Obama’s Patient Protection and Affordable Care Act (commonly referred to as the Affordable Care Act or Obamacare) in 2010 inflated pre-existing deviations. ‘Moral hazard’ in healthcare refers to the result of an insured person changing their behaviour, typically riskier, upon gaining coverage because they are now protected; for example, making health decisions, like purchasing extra medication or staying in hospital longer than needs be, that they would not have done so if they were not insured.

The government argument for subsidising insurance is that it encourages more people to buy insurance, this is supported by conventional theory that claims consumers are hurt when they voluntarily purchase full coverage (Manning and Marquis, 1996). However, the Act exacerbated underlying market failures by, primarily, mandating community ratings (uniform pricing that disregards individual risk prospects (Pauly, 1970)), a price control provision that decreases consumer surplus because the insurers charge everyone the same; in turn, disincentivising healthy people from purchasing insurance, thus increasing the risk of declining average health of an insured population, and reducing profit-making for companies. Insurance companies attempt to combat this moral hazard by encouraging responsible behaviour, such as charging a co-pay for unnecessary visits to physicians; and in-line with economic theory, premiums have consequently risen since the Act passed (NCSL, 2018). Consequently, demonstrating how the bureaucratisation of healthcare hinders the ability of the markets within it to operate. Restrictive regulations that attempt to achieve near-universal coverage without overhauling the system.

Conclusion

In conclusion, it is clear that the mixed provision of healthcare, and all that pertains to it, cannot function as the ideal economic market. Given that healthcare has properties of a merit good, it is, therefore, incompatible with market forces because private provision cannot consistently deliver necessary results, such as efficiency (coverage, distribution, etc.), so government intervention is required. This intervention attempts to remedy the adverse effects that arise, like externalities, because consumption of such goods is always ideal, given the social benefits outweigh their private counterparts. However, it is evident that government provision also hinders the provision of healthcare overall. Government intervention attempts to mimic an ideal market, but such a response does not efficiently allocate this good; instead, it can exacerbate inefficiencies that harm consumers or patients through exclusionary regulations and extreme partisanship.