More Institutional Health Economics, Please!

Filed in Health Care Economics, Hospitals, Physicians by on October 12, 2009 0 Comments

pasquale_frank_lg11Today’s Nobel Prize award for institutional economists Oliver Williamson and Elinor Ostrom is a welcome step toward methodological pluralism in the profession. Both have looked outside markets to understand the organization of economic life. Ostrom is not even an economist–she is a political scientist by profession. As Bob Shiller observes:

This award is part of the merging of the social sciences. Economics has been too isolated and too stuck on the view that markets are efficient and self-regulating. It has derailed our thinking.

According to the NYT, “The Nobel judges, in their description of Mr. Williamson’s and Ms. Ostrom’s achievement, said that ‘economic science’ should extend beyond market theory and into actual behavior, and the two award winners, in their empirical work, had done this.”

There is a great need for more of this type of work in health economics. Joe White’s Markets and Medical Care: The United States, 1993–2005 is one good exemplar of needed work here; he eschews “discussions of how economic theory can be applied to medical care production and delivery” and instead “focuses on ‘the market’ in its actual, not theoretical, form, as it existed in the United States.” White describes case after case where consolidation, not medical need, drove industry structure. He leaves the reader with a clear and convincing image of a space where varying levels of provider and insurer power, not productivity, is the key to understanding changes in the profitability of services. I’ve seen few better brief explanations of rising medical costs than the following:

By 2003, one participant in the [Center for Studying Health System Change’s] Wall Street to Washington gathering could say that “the last few years in the hospital industry are probably the best we’ve seen in 20 years.” Beds had been closed (through mergers, failures, etc.) to the point that the sellers had power over the buyers (HSChange 2003c, p. 2). . . .

As a result of these developments, a new story had come to dominate—and in essence coordinate—market behavior. Remembering the pain of the late 1990s, managers of health care providers and insurance companies were determined to keep prices up through “pricing discipline.” “I’ve never seen discipline in the industry from a pricing standpoint like I’ve seen now” (HSChange 2004, p. 2), said one insurance industry consultant, providing part of the answer to why the underwriting cycle had yet to turn back toward lower margins. After a period of contract showdowns between health plans and providers, conflict had declined largely because, in most markets, “plans have recognized and accepted their weaker position relative to providers” (White, Hurley, and Strunk 2004, p. 1).

One might wonder why consolidation among insurers did not allow them to resist the providers’ demand for increased payments. The simple answer is that there were two concentrated parts of the market and one fragmented part. The insurers had to choose between fighting a full-pitched battle with the providers or exploiting their own market power vis-à-vis the employers. Raising premiums to employers was a lot easier. In theory, employers could have demanded restrictive networks (at lower prices). But since everyone had agreed that employees did not like restrictive networks, and providers (especially hospitals) were not willing to discount much to get into such networks, there were not many available for purchase. Individual employers could not invent such a product; they could only shop around and find the relatively best deal by customizing other contract terms, such as cost sharing.

After reading White’s work on the bargaining position of providers and insurers, it’s hard to dispute Alexander Rosenberg’s dismissal of the the “idea[] that the marginal productivity of labor or capital measures its causal role, and therefore its moral right to a proportional slice of the profits” as a “slip from Laissez-faire ‘science’ to ‘trickle down’ political philosophy.” Richard Posner was not exaggerating when he recently stated “the present generation of economists has not figured out how the economy works.” Five years ago Brian Leiter observed that “Philosophers . . . have . . . launched a devastating attack on the scientific and cognitive credentials of economics,” and the repeated failure of health care “markets” shows the troubling consequences of the disconnect between economic models of rationality and equilibrium and a reality dominated by worried consumers, herd mentalities among investors, and self-reinforcing pricing power.*

White concludes that “in order for any kind of ‘market-oriented’ reform of American health care to have significantly positive effects on cost, access, and quality, it would have to include such substantial restrictions on the normal ways of doing business in U.S. markets that it would be barely recognizable as ‘market oriented’ in the American context.” We can have universal coverage and cost control, or more laissez-faire in a health care system that is already an outlier among developed economies, but we cannot have both. Even a more “consumer-directed” system would rely heavily on regulation of contractual terms.

As Neil Buchanan has stated in a broader context, “our job is not to increase or decrease government’s role in the economy, but to improve it.” Institutional economists understand that many complex sets of institutions, roles, norms, and hierarchies give order to our daily efforts to make do under conditions of scarcity. When we hear about more “markets” in health care, we might do well to recall Robert G. Evans’s observations on the alliances they betoken:

Thus there is, and always has been, a natural alliance of economic interest between service providers and upper-income citizens to support shifting health financing from public to private sources. Analytic arguments for the potential superiority of hypothetical competitive markets are simply one of the rhetorical forms through which this permanent conflict of economic interest is expressed in political debate.

Institutional economists help us see beyond the theoretical purity of leading economic models to the muddy, grubby politics and power that ultimately lie behind much advocacy based on them.

*To be clear on what self-reinforcing pricing power means: On a conventional economic model, the more, say, a surgeon earns, the more that surgeon will be incentivized to work. But once income goes above a certain level, the surgeon can start walking away from negotiations with lower-paying insurers and concentrate on higher-paying ones. Shifting from labor to leisure becomes easier as one portion of one’s labor is more handsomely remunerated. Worried about that possibility, lower-paying insurers may desperately scrape together premiums to pay for the surgeon’s services. That bidding makes the surgeon’s threat to depart from serving some portion of the high-paying market more credible–and the cycle continues. The reductio ad absurdum is a flight to courtier-style medical care for an elite–a possibility adumbrated in the continuing appeal of concierge medicine.

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