With health expenditures rising relative to GDP, most
pundits and health economists believe that the U.S. health care system
needs to be reformed. Those who favor reform can be separated into two
groups. The first group believes that due to the insulation from
premiums and the medical expenses themselves, individuals consume more
health care than they would if they paid for these services
out-of-pocket. Economists refer to this phenomenon as moral hazard. The
second group believes that without more government intervention, those
who are poor and/or sick will not be able to afford insurance. While
the former is certainly important, there is little evidence to support
the latter. Additionally, effective reform must also address the
There is certainly
reason to believe that moral hazard exists. While individuals may not
go to the doctor simply because they have insurance, they will likely
consume excess care on the margin. For example, suppose an individual
goes to the emergency room for severe stomach pain. The doctor suspects
that the patient may have appendicitis and administers a series of
tests. After inconclusive results, the doctor tells the patient that it
is unlikely that they have appendicitis, but that a CAT scan could
completely rule it out. If the patient is insulated from the cost, they
will surely agree to the scan regardless of the fact that it is not
likely to change their diagnosis.
problem with spending on the margin is that it often involves spending
on expensive procedures that offer the patient little benefit. Arnold
Kling refers to this as premium medicine.
second group believes that the biggest problem facing the U.S. health
care system is that the sick and the poor cannot afford insurance.
These individuals argue that more government intervention (and possibly
a single-payer system) is necessary to provide the poor and the sick
insurance. However, this is simply not true. Lisa Dubay, John Holahan,
and Allison Cook found
that 25% of the uninsured were eligible for public coverage, but were
not enrolled. They also found that an additional 20% of the uninsured
live in households that could afford insurance. Similarly, Kate Bundorf
and Mark Pauly estimated that, depending on the definition of affordability, 25% to 75% of the uninsured could afford insurance.
these findings are certainly important when designing effective reform,
what is missing from the debate is a discussion of supply-side reforms.
In The American Economic Review in 1963, Noble Prize
winning economist Kenneth Arrow tackled the idea of uncertainty and
medical care. Included in the paper was a section on the unique aspect
of the market for medical services. Especially prescient were Arrow's
thoughts on the supply-side.
supply-side is riddled with inefficiencies. For example, the supply of
doctors is restricted by licensing and medical school enrollments.
Physicians also often act to exclude substitutes such as physician
assistants and nurse practitioners. What's more, doctors effectively
act as a collective monopoly because of the lack of price competition
within their ranks. These restrictions on supply lead to higher prices
for patients and higher incomes for doctors. This is especially
inefficient considering that patients often lack price information
until they receive their statement of benefits in the mail. Although
the insurance system was quite different in 1963, many of the
inefficiencies of the market are consistent with what is seen today.
article also studied insurance and, using a mathematical model, stated
that the ideal form was full coverage above some deductible. He also
stated that if insurers were risk averse, which undoubtedly they are,
they would also require a co-payment above the deductible.
some may condemn Arrow's theory as outdated, they would be erroneous to
do so. Requiring consumers to pay a deductible would give individuals
the incentive to obtain pricing information and would thus cause
doctors to be more forthright with their billing methods. Additionally,
a market with consumers who no longer lack price information will begin
switching to physicians that they perceive as offering better quality
service and thus may induce some level of price competition among
doctors. This type of policy is consistent with that advocated by
Unfortunately, the battle for price competition will also require additional reform. On the supply-side, economist Robin Hanson suggests
"replacing doctors with cheaper alternatives." This is quite possibly
the best way to induce price competition without reducing the patients'
quality of treatment. Hanson justifies this by highlighting a study in the Journal of the American Medical Association
that finds that there is no difference in health status among patients
receiving care from a nurse practitioner and a physician. Along the
same lines, it may also be prudent to re-examine the licensing
restrictions on physicians and the medical school admissions policies.
as policymakers take a step back and design some type of reform, they
should keep in mind the lessons learned from Arnold Kling, Kenneth
Arrow, and Robin Hanson. The United States health care system does not
need a major overhaul. The system merely needs to reduce inefficiencies
and realign incentives on the demand-side and the supply-side.
Josh Hendrickson teaches economics at Wayne State University. He also maintains the blog entitled, "The Everyday Economist".