Market Failure
The other day, (former) House Whip Roy Blunt (R-Mo) said the following in a radio interview:
For some reason, though, conservatives and libertarians like to pretend that these basic rules don't exist when it comes to health care, that if we just did away with Medicare, Medicaid, and various regulations, the market would somehow magically produce affordable medical care and health insurance for everyone, including the elderly and those with pre-existing conditions. It is difficult to overstate how divorced from reality this fantasy is.
The free market had plenty of time to work its magic prior to the passage of Medicare, but for obvious reasons, it failed to provide the elderly with any affordable options. Because elderly people require much more in the way of medical services, on average, than younger people, it makes no economic sense to offer them health insurance, at least not at premium levels that most people can afford. The result was an epidemic of uninsured elderly Americans who were being bankrupted by medical bills. That's why Medicare was necessary. It was a response to a massive market failure.
There are plenty of legitimate criticisms that can be made about how Medicare is run and how its fee-for-service model creates unhealthy cost incentives. But make no mistake, something like Medicare is necessary. The market is simply incapable of providing the elderly with affordable access to medical care. So unless you want to live in a world where most old people can't afford to see doctors, the government has to play a major role.
And, of course, the problem is not limited to the elderly. When it comes to health care, market failures are pervasive. Unlike with auto or home insurance, where the risk of loss (getting in an accident, having a fire, etc.) is relatively even from person to person, health insurance companies have an enormous amount of risk-related information at their disposal. The short and long term costs associated with most medical conditions are relatively easy to estimate. Thus, someone with juvenile diabetes or a congenital heart condition provides a very different risk profile than someone without those conditions. Factors like race, gender, income-level, and lifestyle also significantly affect one's risk profile. As a result, there will always be a large percentage of people for whom it makes no economic sense for a profit-seeking company to insure, at least at affordable premium levels.
The bottom line is that, when it comes to health care, all the market is really capable of doing is providing reasonably affordable care to the young and healthy, people for whom the risk profile is essentially random and therefore the economic model more closely resembles that of other major types of insurance (car, home, life). But a system that only covers the young and the healthy is, by definition, a failure. That's why every other industrialized country has long since adopted some sort of government insurance system. Expecting the market to provide affordable health care to all is like expecting the market to provide everyone with an affordable personal chef. It's never gonna happen.
HOST MIKE FERGUSON: What is the proper role of government, and what are the potential impacts of the direction that we’re going right now?This is a sentiment commonly expressed by conservatives and libertarians. It's also totally ridiculous, an example of an almost childish kind of magical thinking. I am as big a believer in the power of the marketplace as anyone, but the market is not the Force. Its powers cannot be harnessed to achieve all policy goals. There are very obvious limits to what the free market is capable of producing. For instance, the market will NEVER lead to the provision of goods and services that are unprofitable. That's why you can't buy an Ipod for a dollar or be chauffeured across town in a limousine for 50 cents an hour. That's why you can't buy private flood insurance if you live in flood plain or buy auto insurance if you're legally blind. The market won't provide these goods and services to you because doing so makes no economic sense.
BLUNT: Well, you could certainly argue that government should have never have gotten in the health care business, and that might have been the best argument of all, to figure out how people could have had more access to a competitive marketplace.
Government did get into the health care business in a big way in 1965 with Medicare, and later with Medicaid, and government already distorts the marketplace.
For some reason, though, conservatives and libertarians like to pretend that these basic rules don't exist when it comes to health care, that if we just did away with Medicare, Medicaid, and various regulations, the market would somehow magically produce affordable medical care and health insurance for everyone, including the elderly and those with pre-existing conditions. It is difficult to overstate how divorced from reality this fantasy is.
The free market had plenty of time to work its magic prior to the passage of Medicare, but for obvious reasons, it failed to provide the elderly with any affordable options. Because elderly people require much more in the way of medical services, on average, than younger people, it makes no economic sense to offer them health insurance, at least not at premium levels that most people can afford. The result was an epidemic of uninsured elderly Americans who were being bankrupted by medical bills. That's why Medicare was necessary. It was a response to a massive market failure.
There are plenty of legitimate criticisms that can be made about how Medicare is run and how its fee-for-service model creates unhealthy cost incentives. But make no mistake, something like Medicare is necessary. The market is simply incapable of providing the elderly with affordable access to medical care. So unless you want to live in a world where most old people can't afford to see doctors, the government has to play a major role.
And, of course, the problem is not limited to the elderly. When it comes to health care, market failures are pervasive. Unlike with auto or home insurance, where the risk of loss (getting in an accident, having a fire, etc.) is relatively even from person to person, health insurance companies have an enormous amount of risk-related information at their disposal. The short and long term costs associated with most medical conditions are relatively easy to estimate. Thus, someone with juvenile diabetes or a congenital heart condition provides a very different risk profile than someone without those conditions. Factors like race, gender, income-level, and lifestyle also significantly affect one's risk profile. As a result, there will always be a large percentage of people for whom it makes no economic sense for a profit-seeking company to insure, at least at affordable premium levels.
The bottom line is that, when it comes to health care, all the market is really capable of doing is providing reasonably affordable care to the young and healthy, people for whom the risk profile is essentially random and therefore the economic model more closely resembles that of other major types of insurance (car, home, life). But a system that only covers the young and the healthy is, by definition, a failure. That's why every other industrialized country has long since adopted some sort of government insurance system. Expecting the market to provide affordable health care to all is like expecting the market to provide everyone with an affordable personal chef. It's never gonna happen.
posted by A.L. at 10:27 PM
18 Comments:
This is a very well written piece and it is impossible to overstate the fundamental thesis behind it... the 'market' that is trumpeted as a God-like force by Friedmaniacs, Randroids, and the Austrian school is nothing more than a collection of interactions between people trying to make money and people trying to get things they need or want. There may be a plethora of reasons why capitalism is the best basic system on which to base an economy, but it is equally important to remember that a true free market (like any anarchy) leads to the dictatorship of brute force. Those with the most money will use it to take over the market. This has happened several times in American history. It can be strongly argued it has been happening again at least since the Reagan years, even since the Carter years.
The problem is that economists see the market as a medium for meeting society's needs while business sees the market as a medium for making money. It doesn't matter how sound an economic argument is, if someone can't make money on that premise then the economic 'truth' of the argument doesn't matter.
When it comes to health care, the simple fact is this: one cannot make a profit providing health care unless one caters exclusively to those who can afford it or one charges those who cannot afford it a smaller fee in hopes they will not need care and then denies at least some of them service when they do need care.
So the argument can be made that economic arguments have no place in the health care discussion, at least not when addressing the direct question of how it should be provided. Economic principles may have a great deal of effect on how the government should go about intervening, but none at all in the question of whether or not the government should intervene.
I totally agree with the sentiment of this post. However, I am not sure this effect is 'market failure'. At least not how an economist would use that term. Unless you want to label the markets failure to provide everyone with a personal chef a 'market failure'.
People with pre-existing conditions and old people cost a lot. They need Business Class health care, while young and healthy people can do with Coach. So the problem is with who pays for the business class tickets, as most people who need them can not afford them. This is where a government transfer is needed.
So I would call it a desirable redistribution from healthy people to less healthy people, and not a market failure as such.
The medical insurance market is, essentially, a market failure. The cost of health care means that the only way one can make a profit providing health care is by providing health care directly to those who can afford to pay for it and by selling health insurance (not at all the same as health CARE) to healthy people on the premise they will not need to use it.
Unfortunately, the insurance model is based on the idea that under normal circumstances the customer will not need the policy. Everyone is going to need to see a doctor sometime, so you can't cross your fingers and hope no one does, and check-ups, tests, and preventative care to keep people healthy can actually cost more than the treatment for people already diagnosed as sick.
So really, market failure is a legitimate claim to make in this area. Because the market is about profits and health care is not a service that can be efficiently provided to most of the public at a profit, and health insurance depends on people not needing health care.
Those last two paragraphs regarding risk and how it varies (or doesn't) should be communicated to as many people as possible.
On market failures and the preferably unspoken truth that market absolutists must endure.
http://www.crisispapers.org/essays7p/invisible.htm
The back of the invisible hand.
A most excellent post.
Thank you for writing it.
Excellent post and good comments.
Blunt makes a salient point when he says that government distorts the market. But, as is always the case with the crooks, fools, and liars who call themselves conservatives these days, he totally misses the point. Which is that there is no free market, has never been a free market, and will never be a free market. In the real world there is always government action, or a monopoly, or price-fixing, or bribery, or something going on that distorts the market.
In physical science we have the idea gas law, but no scientist believes it describes anything in the real world. OTOH, Conservative politicians grasp some abstract ideology, then pretend that it's myths represent the reality.
Second point: to the extent that market choice works, it is because buyers and sellers have choices, and can make judgments about the marginal utility of a dollar vs some good or service. Buyer has the option of not buying. Health care necessity offers no choices. Only the circumstantial event of serious need or its absence.
Third, insurance is not going to follow free market paradigms. Insurance is neither a good nor a service, it is a pooling of risk.
Insurance CAN follow a free market paradigm IF several factors are met.
1.) It has to make financial sense for a broad customer base to purchase insurance. This means that the risk has to be real and their share of the shared risk has to be smaller than the cost should the insured against happen.
2.) The providers of insurance must be able to provide a significant service worth paying for incrementally should the insured against happen. They must deliver when the chips or down or their product is worthless.
Factors one and two also both require that the pool of consumers sharing the risk must be large enough to support more than their /fair/ share of the costs, to make their /purchased/ share worth buying.
3.) Finally, the insured against must happen rarely enough that the provider collects more than they pay out.
This works very well for homeowner's insurance and life insurance, and used to work well for auto insurance before the increased risk required government intervention in the form of unfunded mandates to attempt to force universal coverage to keep the auto insurance market running.
It doesn't work for health insurance because everyone is going to need a doctor and none of the pools of shared risk are large enough to support the costs of their members. So the providers are forced to refuse to pay out while taking in as much money as possible.
What we are seeing in both parties right now is some attempt to institute a mandate system to keep the health insurance market running. The Democrats' current plans are partially funded, though not sufficiently, while the Republicans plans are effectively entirely unfunded and indeed depend on cutting current government health care services to force seniors onto private insurance rolls. Neither system will work.
What is needed is one shared pool, either by an efficient system of cost sharing between all the private insurers (and a mandate for CARE instead of merely COVERAGE) combined with government subsidy programs for everyone who cannot afford insurance or by creating a single shared pool among the tax base.
E.R.
Good points re: an insurance/market paradigm. But - in a free market, buyers and sellers set the price though supply and demand interactions. With any of the kinds of insurance you mentioned, the seller sets the rates, based largely on actuarial tables.
For instance, the market will NEVER lead to the provision of goods and services that are unprofitable.
To a doctrinaire libertarian, anything that is not profitable is, by definition, not worth having. That is the underlying assumption that has to be met.
For some reason, though, conservatives and libertarians like to pretend that these basic rules don't exist when it comes to health care, that if we just did away with Medicare, Medicaid, and various regulations, the market would somehow magically produce affordable medical care and health insurance for everyone, including the elderly and those with pre-existing conditions. It is difficult to overstate how divorced from reality this fantasy is.
I'm not at all convinced this is true, but it may very well be what conservatives would prefer people believe. When Reagan used the term "compassionate conservatism", Republicans were happy to have people believe this implied a form of conservatism that wasn't as ruthless, greedy and cruel as 'normal' conservatism. In reality it was just code along the lines of "tough love". It was an old rationalization of social darwinism, that the best way to help people was to toss them out in the street and let them live or die by their own means. The strong would learn to thrive, the weak would die off and we'd be rid of them. I don't think anything has really changed, and their expectations for private healthcare are very similar.
As long as a private healthcare system provides first class care to those with means, and is profitable, it will be a successful system in the eyes of conservatives. That it excludes a significant portion of the population whose care would not be profitable is not a bug, it's a matter of unreasonable expectations, and that's what needs to be adjusted.
The comments so far have treated the failure as if it were static, but it's not. This is an ongoing failure, and it's just going to get worse if nothing is done, until even people of means will find that they cannot pay for health care.
Badtux explains it with admirable simplicity. I think even some of our conservatives here might grasp the nub of the argument.
While I agree with your overall thesis on government intervention, I don't think that the concept that "anything that is not profitable is not worth having" can be a useful one. In your particular examples, I think we can all agree that government shouldn't be providing a personal chef to individuals who cannot afford one. In fact, I think it's fairly reasonable to demand the government not engage in processes that are guaranteed money losers.
I would amend your argument with the point that government is useful in situations that are not profitable in the direct short term. There are a myriad of examples with the most apt being the Human Genome Project - a risk too great to be taken on by private entities lead to one of the most important medical developments of our time. Likewise, broad health-care is a short-term money loser, but a long-term profit in preventive care, administrative costs, more able working citizens, and other externalities that matter to the government but not to a company. I think this kind of argument may be challenging but is one that bridges the gap between the party outlooks. Of course, this requires to Republicans to admit that government does have a role in at least some collective action - which they seem keen on rejecting.
Tangentially, this brings up an interesting point about caring for the elderly, from the perspective of profit. Given that we have a limited amount of resources to spend on social programs, I think it makes much more sense to support the millions of youth that are dying due to poverty rather than the elderly. In no small part because those youth are capable of producing more profit than the elderly, and thereby increasing quality of life for everyone. This may sound callous but it is indeed a choice we make, oftentimes through inaction.
Of course, this all changes if you believe that high GDP does not correlate with happiness and is not our governments goal; this seems to be your assumption but I don't believe it is the reality.
Let us not forget the whole reason why we have a government at all; to secure life, liberty, and pursuit of happiness. Capitalism is a means to that end, not an end in and of itself. In those cases capitalism contradicts that overall goal, it is capitalism, not that goal of government, which is wrong. And in the case of health care, clearly capitalism isn't working -- current treatments are far too expensive to work w/o pooling of costs, and private pools w/o government regulation a) cherry pick so they cover only well people (kicking sick people out) which defeats the whole purpose and b) are subject to an ever-escalating cost due to the disconnect between payment and cost imposed by pooling. Only serious government regulation has *ever* been proven to fix this situation... and is exactly what is sending the tighty righties into paroxysms of paranoid dementia.
- Badtux the Healthcare Penguin
I think that a significantly overlooked issue in the "market" paradigm for health care is that the market assumes a two-way transaciton. I (as buyer) purchase a service from a provider (a doctor/clinic/pharmacy/hospital). Insurance is a third-party to this transaction. The goal of an insurance provider is to make money as the third-party to this transaction; that is, to take more from me that they pay the provider. Further complicating these transactions are such factors as employer-provided insurance. The system we are dealing with is far from the free-market model, not because of the government, I submit, but because of insurance.
To Republicans alarming the public about the imminent rationing of health care, I submit that any health care system rations care. The U.S. just does it indiscriminately and insufficiently. It’s irrefutable that we prescribe and pay for too much unnecessary health care. Let’s move beyond the debate about whether we need a public insurance option. We do. Let’s debate the most relevant and most difficult question: how should we pay for comprehensive health reform?
http://axisofreason.com/2009/07/13/us-private-health-insurance-classic-market-failure/
"Good points re: an insurance/market paradigm. But - in a free market, buyers and sellers set the price though supply and demand interactions. With any of the kinds of insurance you mentioned, the seller sets the rates, based largely on actuarial tables."
By this excellent argument, however, one can exclude the entire American retail economy (saving perhaps gun shows and comics conventions)from 'the free market.' This is a pesky fact many conservatives won't particularly care for, but in our market system prices are set by corporations rather than negotiated by entrepreneurs or craftsmen and consumers. The only input the consumer has into most prices is the right to 'vote with their feet' and buy from someone else.
This right is also retained in the current insurance market, making it as 'free' as any other portion of the US market. It is under that definition of 'free market' that I made my argument.
My views on the American economy as a whole are, naturally, much more lengthy. :)
"I think that a significantly overlooked issue in the "market" paradigm for health care is that the market assumes a two-way transaciton. I (as buyer) purchase a service from a provider (a doctor/clinic/pharmacy/hospital). Insurance is a third-party to this transaction. The goal of an insurance provider is to make money as the third-party to this transaction; that is, to take more from me that they pay the provider."
This is very true, but as I noted about the free market process of price negotiation, this covers a very large portion of the American retail economy which is not free at all. Nearly every good or service we buy involves a middle-man making an extra profit for himself for being the middle man. Insurance isn't unique in this area, what does make it unique is that the costs for the services being rendered are themselves frequently high enough that the provider of insurance cannot afford to pay them and still make a profit.
This is what leads to HMOs finding ways to nickel and dime their customers on the bill, refusing to pay for given procedures or expenses for a wide variety of technicalities and exceptions that may or may not actually be in the policy the customer purchased. It also leads to the denial of coverage to already sick, handicapped, elderly, or 'at risk' individuals.
Successful for-profit systems are dependent entirely on relatively healthy customers being able to pay top dollar for their coverage at large enough premiums that the shared cost of all the premiums covers the expenses and the most expensive procedures can be paid for out of the customer's pocket. There are operating models including for-profit components (such as Sweden), but those include subsidies and/or 'socialized medicine' for those who cannot afford the full price version.
But, while you are correct about the lack of 'freedom' in the insurance market, it is no LESS 'free' than much of the rest of the US economy. Which is a much longer rant. :)
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