Summer Rerun: Market Failure I: “Money-Driven Medicine”

This post first appeared on April 16, 2007

I always take note when a writer takes a position that is contrary to his usual stance. Tyler Cowen of Marginal Revolution is an intelligent and thoughtful commentator, but hews too closely to free market orthodoxy for my taste. But his review of Maggie Mahar’s Money- Driven Medicine, a hard-hitting critique of health care, American style, is positive, insightful, and implicitly acknowledges that health care reformers have a point.

The reason that Cowen supports Mahar’s assessment is that she explains why health care has failed in terms an economist can appreciate: she shows why the market has failed. One big culprit is information asymmetry. One of the conditions for a market to function well is that buyers and sellers have perfect information. In the medical arena, there is often a lack of good data as to what constitutes optimal practice. Among the many examples are the backing and forthing on hormone replacement therapy and mammograms. Now condiser: these treatments have been the subject of multiple large scale studies. Most protocols haven’t been investigated this intensely. And even when there is good information, the patient is at the mercy of his medical providers, the drug companies, and device makers. He can’t challenge their views; his best hope is to shop for a better practitioner, which is a costly, time consuming, and deeply flawed process (how can he judge whether a doctor is making sound recommendations?).

The other major element of market failure is the considerable disparity in buyer and seller power. If you are very sick, you will do anything to get better, which includes spending a lot of money. And our can-do, technology-loving culture favors doing more, whether beneficial or not.

From Cowen:

The book has the most coherent, supportable, and fleshed out anti-market story I’ve seen. It both tries to explain why the current system works as it does, and historically how it evolved from more modest and less expensive ways of doing business. It’s not just a rehash of the usual stories about the VA system or France. The discussions of the growth of for-profit hospitals, the increasing specialization of medicine, the problems with pay for performance, and markets for medical devices are all full of interesting tales.

I interpret the basic story as this: the American health care cost spiral comes from suppliers and their entrepreneurial abilities to market expensive and highly specialized services of dubious medical efficacy. Medical care starts off as ambiguous in value and hard to measure in quality. Customers are cowed by doctors and other family members into accepting or even demanding what is offered to them. Third-party payments make the problem worse, and government intervention has stoked rather than checked the basic dynamic. You end up with massive expenses, lots of stupidity, and – because of its expense — radically incomplete coverage. Every now and then the extra services do pay off, but not frequently enough to boost American stats on health care quality.

Ezra Klein also has an excellent review in Washington Monthly. He gives more of a feel of the book itself (and makes clear it’s a bit too heavy on anecdote for his taste). He concludes with an urgent plea:

It is up to us to decide if the ultimate goal of care should be cash, if our system of insurance should incentivize identifying those most in need of care so they can be denied access to it, if our hospitals should fret over the bottom line or the flat line, if our physicians should practice in a context that leaves them desperate to confide in the unknown reporter who leaves an unexpected message on their voicemail.

Finally, an article by Mahar, “The State of the Nation’s Health,” in Dartmouth Medicine, discusses inefficiency and variations in regional practice (which reflects a lack of consensus on what “good practice” is).

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  1. michel

    Health provision is a two by two matrix leading to four possible scenarios:

    1) Government provides insurance, govt runs provision

    2) Govt provides insurance, provision is private sector

    3) Insurance is private, provision is private

    4) Insurance is private, provision is Government

    The only serious alternatives are the first three, though I am told (it seems incredible) that New Zealand does the fourth.

    The correct system, the one that has been proven to work best, is #2. In Northern Europe you have affordable, predictable, universal coverage with well defined benefits, choice of provision, no waiting or rationing.

    In the UK you have waiting lists, high hospital infection rates, rationing, no workforce discipline because provision is a union dominated state sector monopoly. In the US you have unaffordable insurance subject to arbitrary termination, and health care is the leading cause of personal bankruptcy. The sector incurs huge costs owing to the frantic efforts to screen out bad risks. In both the UK and the US the effect is to move budgetary risk away from the insurance sector (in the UK this is the state), and onto the unfortunate patient.

    The solution is to recognize, as the Northern Europeans do, that the state should provide insurance, which is what it can do better and more cheaply than the private sector, but should not run all provision, which it will do more expensively and less well than the private sector.

    But to get there, you have to take on the public sector unions or the financial services industry. Good luck in either case.

  2. jumping

    One of the biggest problems with medicine and being left to the private sector is companies going after self interest. Profits instead of cures and effective treatments.

    Example: A lot of research is left up to big pharma. Pharma wants to sell you a drug that cost $300 a month for the rest of your life. Pharma advertises to doctors, advertises t patients, doctors make good money by prescribing a pill in 5 minutes, and having you come back in two weeks. So a perfect situation, we have an immeidate gratification society that sees this expensive pill as a quick solution to our problems. DOens’t matter, covered by insurance.

    So the patient ends up with side effects, or another problem. guess what the solution is? another pill…so the vicious cycle continues.

    1. Costard

      There are two sides to every transaction. You appear to be saying that the expensive drugs coming out of pharmaceutical research companies are not worth the high price tags.

      Alright. So why are consumers buying them? Why is this a successful business model if not for the fact that the cost of purchasing these pills is shifted onto everyone BUT the person purchasing them? And this at the behest of government?

      Are you saying that, rather than devising medicines that people actually want and are (hypothetically) willing to pay for, pharmaceutical companies should instead develop the medicines that uncle sam thinks they should use? And are you alleging that a federal bureaucracy will be able to do this 1) intelligently and 2) honestly? Without giving favors, or pursuing ideology?

  3. jb mcmunn md

    Insurance disconnects the buyer of the services and products from the true cost. If you want to cut health care costs ban all insurance and watch the cost of everything drop.

    It’ll never happen though. You would be paring down a huge slice of the economy and no one wants to endure that pain.

    It’s absolutely true that the lack of standardization of care makes “shopping” for care tough, but the simple fact of the matter is that for the vast majority of medical conditions we don’t have enough information. All a doctor can do is apply judgment using incomplete information. We would love to have better guidance but it isn’t there.

  4. Costard

    “One of the conditions for a market to function well is that buyers and sellers have perfect information. In the medical arena, there is often a lack of good data as to what constitutes optimal practice.”

    You miss the basic point, Yves, that the consumer of medical services and goods in this country does not require good data. In an insurance-based system, there is absolutely no incentive for the consumer to pick and choose, and therefore his discretion is irrelevant. With a given health problem, he will exhaust all alternatives available to him under his insurance program, so long as there is any chance of success. Additionally, you assume that there is such a thing as “perfect” information in a field that is continually in debate over even the most basic treatments — a fact which raises the question, how does one define “need” in such a field, and how can any entity other than the consumer decide what is best for him? The government will, looking forward, become liable for the decisions it makes regarding personal healthcare, for the precise reason that there is no “perfect” information in ANY market, much less this particular one.

    Such a system is unsustainable in a free market; the healthy and the responsible would opt out of an insurance system that is disadvantageous to them. However regulations at every conceivable level of the medical industry, from the state MA’s to medicare and corporate law encourage inflated prices and a reliance upon the bargaining power of the medicare and the large insurers. The average american cannot afford to risk major injury without insurance; and yet it is the focus on insurance that makes medical care so overtaxed and prohibitively expensive in the first place.

  5. michel

    You’re all missing the point. There is not one thing that may be subject to market forces or not, but two. One is insurance, the other is provision. The state can and should do insurance. Provision should be done by the private sector in the main, with no state monopoly.

    If you do not separate these two things, you cannot even begin to think clearly about public policy on health care.

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