Health Care: What Market?

One of the fallacies being thrown around in the health care debate, such as it is, concerns the damage that would be done to the free market by the introduction of a lumbering government plan as competition. The problem stems from the little known fact that there is practically no market to speak of amongst insurance companies. In most states one or two insurance companies dominate with very large shares of the market. As a result the fabled free market forces that are supposed to produce that magical blend of top quality at bottom prices simply don’t operate.

A report by an advocacy organization, Health Care for America Now [‘HCFAN’] is extremely revealing: it shows that there is an extraordinarily high level of industry concentration in health care insurance across the country. The situation is worst in rural areas.

The report uses American Medical Association data and then applies the government’s anti-trust standard for determining industry concentration. The findings undermine the notion that there is a thriving highly competitive private insurance industry. Instead it appears we have a series of local oligopolies, and in some cases near monopolies. The market has broken down.

InHawaii, Rhode Island, Alaska, Vermont, Alabama, Maine,Montana, Wyoming, Arkansas, and Iowa, the two leading insurers account for over 80% of the market. There is no effective market.

That the market is dysfunctional is no surprise.

For a ‘market’ to perform its magic in the way free market advocates argue is always the case there have to be a number of conditions present. These are the assumptions that economists have developed as those necessary for a market to function properly. As long ago as 1963 the Nobel Prize winning economist Kenneth Arrow pointed out that some of the most important of these conditions will never be found in a market for health care. Arrow is hardly a left wing ideologue: he is one of the developers of the central models of market driven economics – the famous Arrow-Debreu model of general equilibrium – so for him to argue that the market for health care insurance will never rise to the standards necessary for it to produce normal free market results is quite a damning statement.

Nonetheless we are being bombarded with endless tirades about the end of the world as we know it were a public option to be part of the ultimate legislation.

I have said before, these tirades smack an awful lot like a defense of insurance industry profits, rather than an argument about the facts or about health care for the citizenry of America.

The plain fact of the matter is this: our system as currently constructed is too expensive: it delivers average results at premium prices. It is on an unsustainable trajectory and there will be a collision between health care and our national wealth sometime down the road unless we rein in those costs. In particular the per person cost of care must be limited.

This necessarily will require cuts of some kind. But there are no incentives within the system to drive those costs down. On the contrary, and as the HCFAN study corroborates, the bias within the system is to increase costs. One way the system does this is through the elimination of competition: there have been no fewer than 400 mergers amongst insurance companies in recent years.

No wonder the insurance companies are squealing: the competitive pressure that the market fails to deliver might actually turn up via a government plan.

Heck they may even have to cut costs and get efficient in order to compete.

Now that’s capitalism we can believe in.

Let’s hope it works.

Addendum:

I learned about the Arrow paper via Krugman’s blog.