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The Many Market Failures of Health Care

There are obvious reasons from a noneconomic standpoint why we should have some sort of universal health care system in the U.S.  There are also good reasons from a broad economic standpoint, primarily that there are significant administrative cost savings from having a Medicare for all type of system.  These savings come about because the existence of a large number of insurance companies, each with multiple policy options, puts a huge burden on the providers of health care, as they seek payment for services in an ever increasingly complex system.

But still, politicians, “armchair economists”, politically driven “thinktanks” and others promote the mythical “free-market” as the best option for society, even though it is clearly not working, and is becoming more problematic over time. Those who support this idea are ignoring some basic concepts taught even in classes on neoclassical (mainstream) economics.  These concepts are known as market failures and are widely accepted among professionals, even if some of those professionals allow their personal biases to cloud their thinking on the health care issue.

Market failures happen when an industry has certain characteristics that prevent it from providing a sufficient quantity of goods and services or provides them at too high a price.  Even the staid standard bearer of Federal government economic regulatory analysis, the Office of Management and Budget (OMB), recognizes the sources of market failures, which are:

  • Externality—when a third party which is not part of a market transaction is impacted in some manner by that transaction.   It can be in a good way, such as when immunizations for some reduce the probability of others contracting an illness, or it can be in a bad way, such as when firms release contaminants into the environment, causing water or air pollution.  They are generally referred to as being positive or negative externalities, or as external benefits or external costs.
  • Market power—when an industry includes at least one entity that big enough to purposely affect the market.  This can either be as a seller, like Walmart or Amazon or as a buyer, such as a single employer in an isolated or rural community.  Market power generally means the price level and/or the quantity of output can to some degree be determined by the entity with the power.  Monopoly is the case of one seller, monopsony is the case of one buyer.  Oligopoly and oligopsony refer to small numbers of sellers and buyers.
  • Public goods and common property resources—some goods, and many services, are more effectively provided by the public sector.  Policing, military protection, emergency services, and transportation routes are some of them.  It is often difficult to exclude people from benefitting from public goods, such as defense, even if they have failed to meet the requirements of attaining them, such as paying taxes.  Public goods tend to be societal necessities, like public water facilities, that the private sector has insufficient incentives to provide on a large enough basis.  Therefore, federal, state or local governments provide them to the community at large.  Common property resources are also easily accessible, because they are either publicly owned (like a national park), or have no defined ownership (like the ocean).  Unregulated market systems provide no incentives to prevent exploitation to the point of destruction.  Governmental or similar institutions may be required to set and implement restrictions on their use.  Catch limits for wild harvested fish is a good example of this approach.
  • Asymmetric information—this is econo-speak for one side knows more than the other, and may take advantage of that fact.  Pharmaceutical manufacturers know what is in their products—you do not.  Medical professionals may have a lack of experience—you may never know their qualifications.  Even intangibles such as bed-side manner may be important to a patient, but will only be known by word of mouth, or through personal experience.  The medical profession and the healthcare industry as a whole are both highly complex, and medical services can be extremely personal.  Outcomes and even costs are frequently unknown to the patient ahead of time, and services may even be provided without the patients’ knowledge, as is likely in surgical and emergency medical treatments.

One would be hard-pressed to find an industry sector more rife with market failures than the healthcare industry.  The communicable nature of many diseases means there is more than adequate reasons immunizations should be widely available to the general public. 

There are very large positive externalities associated with accessible health care.  As described earlier, immunizations reduce the number of people infected by communicable diseases.  Preventative and ongoing health care also reduce the potential for illness, lowering the risk of disease or injury to others.  Chronic conditions can be kept in check to enable medical resources to be focused on acute treatments when needed, rather than letting conditions like diabetes go untreated until a crisis develops.

Patents, government-granted monopolies, are everywhere in use in medical care, and while they can make treatments expensive while the patent is in force, they also incentivize the development of treatments.  The high costs of entry to this industry ranging from the costs of medical training, the high level of scientific knowledge required across the industry, the cost of increasingly sophisticated technology, and the costs of acquiring patents, are but a few of the many reasons there is a high level of monopolization across the industry.

Many hospitals and other medical facilities are run as non-profits, and some are affiliated with universities or charitable organizations.  These facilities typically treat patients regardless of ability to pay.  As a result, there is a large public goods component to the healthcare industry.  Economists also see the effectiveness of treatments like antibiotics as a type of common property resource.  The more antibiotics are used, the faster we see bacterial resistance to antibiotics.

Finally, this is clearly a complex industry involving many types of skills, and most of them requiring high levels of training.  Patients are unlikely to ever have anywhere close to the amount of expertise healthcare providers have, even medical professionals may not have full information regarding the effects or costs of the treatments they provide, and the current system contains many opportunities and incentives to not make information, such as insurance reimbursement rates, easy to determine.  Patients often don’t know until months later, the full cost of a treatment like a surgical procedure.  Virtually every aspect of the industry creates a situation of asymmetric information.

For all these reasons are more, the market system does a poor job of meeting the needs of participants across the entire industry. Anyone, including politicians, and widely-respected economists, who say otherwise is sorely mistaken.  Public provision of universal health care has been shown time and again in other countries to offer the best solution to the healthcare problem.

Modern Monetary Theory, a concept drawn from the overall, or macroeconomy, tells us that we can afford to implement a universal healthcare program in the U.S.  While a far from perfect assessment tool, an honest and informed microeconomic analysis of this sector can tell us many reasons why we should have universal health care.

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