The Market Process in Health Care

Jerrod Anderson

Consumer shopping is a key ingredient to encouraging market competition. Markets in which consumers can effectively shop incentivize producers to offer goods at lower prices, higher qualities, or both. Where consumers cannot effectively shop, competition is diminished. The health care market in the United States seems to be characterized by consumers that cannot effectively shop for health care. This could be for any number of reasons: consumers do not fully understand the product they are consuming, prices are hidden behind layers of bureaucracy, restrictions exist on the type of competition providers and insurers can engage in, and so on.

In this chapter I explore how private institutions can structure exchange to support a well-functioning market, even in the face of potential market imperfections. Since as early as Arrow (1963), economists have viewed the health care market as fundamentally dysfunctional, mainly due to asymmetric information issues. Asymmetric information is viewed as a problem in many other markets, such as auto mechanic, lawyer, and tax accountant services, but these markets tend to have only one relationship characterized by asymmetric information. Health care, on the other hand, because of the insurance component, has multiple relationships characterized by asymmetric information: adverse selection may affect who buys insurance and what insurance is offered, moral hazard can encourage insured individuals to overconsume health care, the doctor’s superior medical knowledge incentivizes overtreatment and over-diagnosis, and there is a potential moral component that is inevitably attached to the issue (Arrow 1963). I use the historical example of “lodge doctors” (those hired by mutual aid societies and other organizations beginning in the nineteenth century) to demonstrate how these groups supported a well-functioning health care market. I then use the characteristics of the lodge doctor arrangement to understand how modern insurance companies could serve as institutional cornerstones for a well-functioning health care market today.

Three general attributes characterize how the lodge doctor institution enhanced consumer shopping and strengthened competitive forces. First, information about provider quality must be truthfully and publicly revealed. Mutual aid societies that employed lodge doctors achieved this by choosing the lodge doctor through election. Medical tourism can achieve this through data collection on outcomes by insurers in the course of normal business activity.

Second, health care providers must have the incentive to provide the service at a low cost. Both mutual aid societies and insurers providing medical tourism policies do this by contracting a fixed salary with the provider determined annually via a bidding process (in the case of the lodge doctor) and a fixed fee for a procedure decided before the procedure begins (in the case of medical tourism). By offering alternative means of obtaining health care, these practices also have the added benefit of putting downward pressure on prices of providers that are not subject to those contracts.

Third, the payment arrangement must incentivize the provider to maintain quality. In the case of the lodge doctor, this was achieved through the fixed salary, which channeled the doctor’s efforts toward effective prevention and early treatment, and through the yearly election, which incentivized the doctor to provide high-quality care in order to keep his job. In the case of insured medical tourism, insurance companies have the incentive to contract with high-quality providers because those insurers bear the cost of complications of postoperative care upon the patients’ return home.

In the first section, I describe the role of the consumer in the market process and how we should view what are often termed market imperfections, which can potentially blunt market competition. This is followed by a review of the literature on consumer shopping in order to show that under most current arrangements, consumers cannot effectively shop for medical care. The next section describes lodge doctor practices and how they aided in increasing competition in the health care market. I discuss limitations of this model in the present day. I then describe medical tourism, how it can enhance competition in the health care market, and what the impediments to increasing its use are. The chapter concludes with a brief discussion of the findings.

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