Healthcare is Not a Market

The Republican party seems to be pushing the perennial myth that the “Free Market” will make the healthcare system more efficient. This ignores a wealth of evidence by respected neoclassical economists (such as Kenneth Arrow), but also ignores plain Micro 101.

To clarify, a few things are needed for a efficient market:

1. Consumers have an indifference curve for consumption.
2. Suppliers are price-takers; they do not discriminate on price.
3. Consumers have full information about all products on the market.
4. There are no transaction costs and no barriers to entry/exit.
5. Homogenous products.
6. Constant returns to scale.

It’s possible to quibble with one or two (you can argue that one is redundant, and others add more requirements, etc) but that’s the general necessary assumptions.

Now, the free market only exerts its magic is all requirements are fulfilled. Obviously, it’s not a binary result, so if you violate an assumption to a greater or lesser degree, the market becomes less efficient – and thus less “magical.”

This is not controversial. I just want to repeat: this is taught in every Micro 101 post, and freely acknowledged by every neoclassical economist.

Let’s consider the healthcare market.

First of all, consumers do not have set indifference curves for healthcare consumption. Certainly, there are exceptions; and there are some healthcare providers where people do have such indifference curves (non-essential providers).

However, the important stuff is the unpredictable stuff. It’s worth nothing that medical expenses are involved in about half of bankruptcies.

But from a logical standpoint, suddenly discovering cancer changes your desire to consume healthcare. This is not by choice. It’s in response to changing events.

As a consequence, forcing everyone to pay out of pocket for medical expenses (taking it to the extreme) would do nothing but forced people who have unfortunate medical problems to suffer and die – through no fault of their own, and outside of their ability to control.

This is the “moral issue” that Kenneth Arrow pointed out: do we, as a society, want to let citizens of our democracy sicken and die simply because they have the bad luck to fall ill?

Not to mention the related issues – healthcare is not homogenous (every person requires different treatment), suppliers are not price-takers, consumers never have full information on treatment options and costs, and there are tremendous transaction costs to undergo a procedure.

Any of those would be enough to kill the possibility of an efficient healthcare market.

But the deeper problem is assuming that people can ration their healthcare consumption, according to how healthy they want to be, and that costs for each person will be roughly equivalent (varying only in the amount they choose to consume).

That’s a fantasy, and a piss poor one at that.

Of course, healthcare has a number of problems currently – one of the major ones it the lack of decent incentives. How many people die in hospitals for lack of basic hygiene? For medical mistakes, like hooking up a feeding tube to a blood vein? And how is it that a hospital that tries to reduce medical accidents actually ends up losing money – because the real profit is in treating more serious disorders, so it pays to make someone sicker before you make them better?

Those problems can be solved either through incentive alteration (changing the entire pay system of health insurance) or through regulation; for obvious reasons, changing and enforcing regulation is the easier (politically feasible, economically feasible, and successful) way to fix or at least alleviate those problems.

Making healthcare more of a free market will not.

However much people talk of “moral hazard” and “tort reform.”