Organizations, Markets, and Health Care Reform

30 July 2009 at 10:54 pm 7 comments

| Russ Coff |

Amidst the fierce debate about the U.S. health care system is a raving lack of clarity. At the core, is whether organizations and markets fail to produce an optimal solution. Even the most neoclassical of economists these days acknowledge that market externalities exist and that these should be the focus of government intervention. Unfortunately, I don’t feel that the debate has been rigorous or well-informed in defining the market failure or why a government run system would be superior.

Liberal Economist Paul Krugman explains why markets fail summarizing Kenneth Arrow’s arguments (here). Basically, the third-party payee system and the information asymmetries render comparison shopping ineffective (and hence competition fails to yield an optimal solution).

Indeed, there is a good bit of inefficiency in the current U.S. system. A recent NY Times article notes that health care costs the average U.S. household $6,500 more each year than other comparable wealthy nations. Unfortunately, looking at many of the important outcomes, it appears that consumers are not getting much for their money on many dimensions (e.g., chronic disease outcomes). So it should be possible to lower costs and improve outcomes. Of course, this ignores the question of whether costs are higher to subsidize R&D that ultimately spills over into other countries.

Unfortunately, the article continues to point out how the reform efforts seem to ignore this low-hanging fruit. For example, the Mayo Clinic achieves much lower costs and exceptional outcomes, at least in part, by compensating physicians with low-powered incentives (salary instead of fee-for-service). Ironically, this is something most good students of organizations could have suggested (Holmstrom & Milgram demonstrated how weak incentives are preferred over perverse incentives — of course, any OB scholar could have confirmed that 40 years ago).

The focus has been on implementing a government-run system. There may be reasons to do this. However, is it not obvious (to me) how this would allocate resources more efficiently. Along these lines, it is ironic that Krugman was stunned on camera by a group of Canadians who would not argue in favor of their own government-run health care system: Oops!

So, I ask, how would a government run health care system really allocate resources more efficiently? Clearly the system needs a kick start. . . .

Entry filed under: Bailout / Financial Crisis, Former Guest Bloggers, Innovation, Institutions, Law and Economics, Management Theory, Public Policy / Political Economy, Strategic Management. Tags: .

Introducing Guest Blogger Russ Coff Special Issue of HRM on “HRM and Knowledge Processes”

7 Comments Add your own

  • 1. Steve Phelan  |  31 July 2009 at 12:09 am

    Welcome to O&M Russ! As an Australian I have been exposed to a couple of hybrid systems, one which is more public (Australia) and one more private (USA). I prefer the Australian system.

    An obvious area of economic benefit is transaction costs. I seem to recall that medicare system overhead (in the US) is 6% while 20% of costs are administrative costs for private funds. Combined with the bargaining power of the federal government to lower drug costs and physician wages, the % of GDP spent on health care is considerably lower in Australia, provides greater security, is less of an administrative hassle (private insurers in the US seem compete on denying claims), and leads to superior outcomes (such as life expectancy).

    The really tough part of the whole equation is rationing health care. If a treatment can prolong life should it be given at any cost? And for any life expectancy? Government and private systems both implicitly ration health care. In the government system, certain procedures (and drugs) are not covered, while the private system rations via the cost of premiums, co-pays, and deductibles.

    We need to separate the rationing debate from the bargaining, transaction costs, and spillover debates.

    Just my $0.02 worth.

  • 2. Karl  |  31 July 2009 at 3:49 am

    Great post, and interesting comment by Steve. I have experience from a dozen of health care systems, all with their pros and cons, but fortunately have never been seriously ill so I will try to keep the comment research oriented rather than personal.

    In addition to the questions of bargaining, transaction costs, and externalities, I am puzzled that so few are discussing the role of innovation in health care both as a reason for the explosion in costs and as a potential solution to cost problems.

    Innovation (funded downstream by government-financed primary research and upstream by pharma companies) is a primary reason for the increase in cost: health care can save lives today that would have lost 10 years ago (e.g. neonatal care and emergency surgery). Obviously, that often comes with a cost, the above examples both increase the reate of long-term disabilities in a population.

    Innovation in health care also offers potential solution to cost problems (e.g. telemedicine in remote areas). I don’t have the knowledge what such cost saving could amount to on an aggregate scale but it is unlikely that they would offsett the costs incurred by other innovations. Saving lives will always be more important for physicians than reducing costs.

    Another tenious variable that researchers might or might not want to throw in but politicians have to adress is morals/ideology. To what extent we accept health care as an inaliable human right just as access to food and water (UN HR charter#25)?

  • 3. Glenn MacDonaLD  |  31 July 2009 at 3:44 pm

    Krugman is right on one count and wrong on another. First, disease is largely (not wholly) random and expensive to fix, so it tends to be insured. Of course. Where Krugman misses the mark is that he fails to notice that the big problem, unlike car or life insurance, is that it is not clear what the insurer ought to do and pay for when you are sick. The insured would like every conceivable test, procedure, etc., whereas the insurer feels the obligation to provide service quality/quantity consistent with its promises and premiums. This is a genuine tension, but there is exactly nothing about having the government run this market that helps to address it. Indeed, fostering active competition among insurers to retain and satisfy customers is much more likely to do the job. At Washington University we have access to a wide variety of insurance plans, ranging from very basic ($39/month for purely catastrophic care) to quite fancy ($300/month). When it is time for renewing annual contracts, there is a great deal of discussion about favorable and unfavorable experiences, and the providers reap what they sow.

  • 4. russcoff  |  31 July 2009 at 9:35 pm

    Steve: I misspoke above. Politicians have promised that everyone would be able to keep their insurance. If they keep their promises, a single payer system is of the table. Do you still get the bargaining power effects? Currently many providers choose not to accept Medicare because the rates are too low.

    Karl: I’m with you, the right to healthcare is at the core. You guessed what my next blog is ;-). I also agree about the innovation issue.

    Glenn:You make some excellent points as well. We also have some discussion about the plans when we have to re-enroll.

    Thanks for chiming in.

  • 5. Steve Phelan  |  1 August 2009 at 11:03 am

    Glenn, arguably the price system has not done a good job of allocating health resources because people who get chronic illnesses, for instance, are much more likely to be dropped by private insurers or have their claims denied. In other words, if you lose the health care lottery of life you are screwed.

    If health care is some fundamental human right as Karl suggest then everybody should be entitled to some minimum level of care. By providing basic universal care you eliminate adverse selection costs. This leaves room for private insurance to cover the gap between basic care and higher levels of care.

    For instance, in Australia, you often have to wait several months for elective surgery but those who elect to pay private insurance can have their surgery faster (often immediately). Similarly, experimental drugs are not covered by the government scheme but you are free to seek out your own treatment. (This explains why you sometimes see Canadians coming south to the US for specialized treatment.)

    Russ: If a government scheme gets large enough then you will see a network effect emerge that will potentially create a single payer system (i.e. their premiums will be so much lower than other schemes that they will crowd them out).

  • 6. srp  |  1 August 2009 at 8:26 pm

    There’s been a whole bunch of Internet discussion recently suggesting that Medicare does not have lower administrative costs than private insurers. The reported percentages of admin costs/total expenditure are distorted because

    1) Medicare patients are old and get more diseases treated so the denominator (total spending per patient) is higher for Medicare,
    2) Medicare is riddled with tens of billions of dollars of fraud because its utilization review is not as strict as private insurers’
    3) Much of Medicare’s SG&A is subsidized by the private sector as Medicare’s reimbursement rates are below provider cost for many procedures and so private payers make up the difference by getting overcharged.

    The international comparisons are likewise severely skewed by factors like Americans’ much greater obesity, more liberal definitions of infant mortality, huge illegal immigrant population, etc.

    Finally, very, very few medical innovations are first brought to market anywhere but the US due to the unwillingness of government systems to pay for new stuff. Anyone ever teach the EMI CT scanner case? Even though the company had no presence in the US it never considered launching the product anywhere else, certainly not at home in the UK, because the only market where such an innovation could be marketed was the US. If we shift to a centralized agency in the US deciding what to pay for, the world-wide rate of medical innovation will plummet, unless the Chinese market matures a lot faster and is relatively unregulated.

  • 7. Steve Phelan  |  3 August 2009 at 9:01 pm

    srp, you come very close to assuming the conclusion that single payer systems cannot be more efficient than a competitive market.

    How would you make an apples and apples comparison – how do the overheads look then? Let’s see the numbers instead of avoiding a heads-up comparison. For instance, a comment on a later Coff post suggests that immigrant effects are not large.

    You cite the costs of a single payer system (including possible diminished incentives for innovation) but single payer systems also save on marketing and adverse selection costs while extracting gains through bargaining power for lower provider costs. What is the net gain/loss?

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