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CAN THE FREE MARKET RESCUE THE AMERICAN HEALTH CARE SYSTEM?
10/31/2007
PART FOUR: WHY THE FREE MARKET CANNOT FIX THE HEALTH CARE SYSTEM
Eighteenth century economist and godfather of modern free market theory, Adam Smith, had a vision that everyone would win in a market system where self-interest motivates both sellers and buyers. In such a market sellers seek profits and compete with each other, while buyers demand both low prices and high value in products and choose the seller who best meets their demands. Buyers and sellers also engage in their transactions without government interference. Smith considered this model, which he called the "free market," the most efficient economic system humans could engage in, and one that worked by mysterious forces to satisfy everyone.
The free market is wonderful in theory, but it doesn't always work so well in practice. Additionally, it works better with some commodities than it does with others. It doesn't work well with health care.
In this essay I will answer two questions:
CAN the free market solve the American health care crisis, and SHOULD the free market be given the opportunity to solve the American health care crisis?
THE HEALTH CARE "FREE MARKET"
There really is no traditional free market in medicine, one in which prices are determined by doctors (sellers) and patients (buyers). For one thing, the costs of office visits, treatments, surgery, etc. are not determined by the laws of supply and demand. There are dozens of factors that enter into how much to charge for one procedure or treatment including the doctor's time, his specialty, the technology that must be used in the diagnosis and treatment, the supplies needed, the overhead of the facility, etc. Individual patients have little or no bargaining power to reduce the fees. Furthermore, when you're sick, you need help immediately and there is no time for comparison shopping. Enter the insurance company.
There was a time many decades ago when patients paid doctors directly, either with cash or bartered goods, but that system no longer exists. By the end of WW II health insurance, mostly provided by employers, became the standard way to access health care. Instead of paying doctors directly, patients or their employees purchased health insurance policies that would pay for a percentage of routine as well as catastrophic care most could not afford on their own. Over the next few decades, as medical discoveries in pharmaceuticals and technology made medicine incredibly expensive, and priced the average American out of a direct access health care market, it has become essential to have health insurance.
The market, therefore, that we must assess when we evaluate the efficiency and affordability of health care is the market of the middleman: the insurance industry. There is no free market in directly accessed medical care.
So the next question is: is there really a free market in the health insurance industry? For that we need to look more closely at the elements of the free market.
ELEMENTS AND ASSUMPTIONS OF THE FREE MARKET
While it may take an economist to lay out charts and graphs and speak the insider lingo regarding the economics of health care, it really isn't that difficult to assess whether or not the buying and selling of health insurance fits into the standard definition of the free market. It will be important to know this to determine whether there are free market solutions to the health care problems in this country.
Wikipedia provides this definition: "A free market is a market where prices of goods and services are arranged completely by the mutual non-coerced consent of sellers and buyers, determined generally by the supply and demand law with no government interference in the regulation of costs, supply and demand."
The basic elements and assumptions of the free market system can thus be listed as:
1. Freedom: Both seller and buyer are free to act, to buy and sell.
2. The laws of Supply and Demand: Price is determined by both the supply of the commodity and the demand for the commodity as well as by competition between sellers.
3. The Profit Motive and Consumer Choice: Sellers attempt to get the highest price possible for their commodity, but buyers ultimately determine what they will buy and what they will pay, and thus what commodities will be sold.
4. Government non-interference: The government does not determine prices nor regulate the industry in any way.
DO THE ELEMENTS AND ASSUMPTIONS APPLY WITH HEALTH INSURANCE?
Let's examine each of these elements and assumptions and see if the insurance market fits into the model.
1. Freedom: Both buyer and seller are free to act, to buy and sell.
Certainly the seller has the freedom to sell whatever insurance product it wants to sell, to whomever it wants to sell. But it doesn't take a detailed investigation to determine that some buyers have less freedom than others. Buyers who have certain health risks, who have pre-existing conditions, and who are unemployed cannot access reasonably priced health insurance. Some may not be able to access any health insurance. If insurance companies refuse to issue policies to some potential buyers, then those buyers are not free. In the insurance market, not all buyers are treated the same. Some have more freedom than others.
2. The laws of Supply and Demand: Price is determined by both the supply of the commodity and the demand for the commodity, as well as by competition between sellers.
The elements of supply and demand are not the main factors controlling this very complicated market, in that both are relatively stable. Demand doesn't change very much, except as the population grows. In other words, everyone would like to have health insurance. Supply, in theory, is unlimited. There is no limit to the number of policies a company will offer, provided their customers fit within their risk profile. Insurance companies are well aware that they are offering a commodity that is crucial to the well-being of buyers, thus they have enormous leverage and can charge extremely high prices, especially as their costs go up. When the price gets to a certain point, instead of some magical free market equilibrium being reached, with people refusing to buy and the insurance companies lowering their prices, the companies know most buyers will simply have to pay the higher price. They are content to allow others to be forced out of the market.
While there is some competition between companies that provide group policies, to keep the cost down for their large corporate clients, there is no similar competition for individual purchasers. In order to remain profitable, insurance companies must take into account their "losses," that is, how much they have paid out to doctors and hospitals in medical claims. The price of an individual policy is based to some degree on this statistic, as well as on the risk posed by the potential policy holder, and not necessarily on competition with other companies. Certainly, individual consumers who struggle to find an affordable policy do not feel as if insurance companies are competing for their business.
3. The Profit Motive and Consumer Choice: In a true free market, sellers attempt to get the highest price possible for their commodity, but buyers ultimately determine what they will buy and what they will pay, and thus what commodities will be sold.
Like all companies, insurance companies operate to make a profit. In an ideal world, where all buyers of health insurance were treated the same by insurance companies, there would be competition among companies, and buyers would choose the company that offered the best policy, balancing cost and services. But today's buyers, desperate for coverage, are really at the mercy of the insurance companies, who determine what type of policies they will offer, and how much they will charge. Buyers do not determine what is sold, by any means. Nor do they determine price. They have no ability to decide what they will pay; that is up to the insurance company.
4. Government non-interference. The government does not determine prices nor regulate the industry in any way.
While the states (which are responsible for laws pertaining to health insurance) set some general parameters regarding health insurance practices, and have created agencies to monitor complaints, for the most part government does not set prices or have a heavy hand in regulating health insurance companies.
In the health insurance market, therefore, we see that three out of four assumptions of the free market do not apply.
One has to ask then: why are conservatives so insistent on preserving the "free market" in health insurance when that industry does not conform to the free market model. When conservatives talk about the "free market" in health care, what they are really talking about is the fourth assumption. They are saying, for ideological and political reasons, that they want no government interference in or regulation of the insurance industry, and so far they have largely gotten their way. One might be tempted to ask them if ideology is really more important than the well-being of all the American people. It is, I believe, a fair question.
(For the remainder of this article, even though I have shown that health insurance does not operate according to fundamental free market principles, I will continue to use the term "free market" in quotation marks when I am referring to our current system.)
IS A FREE MARKET IN HEALTH INSURANCE DESIRABLE?
Recently, presidential candidate and prostate cancer survivor Rudy Giuliani repeated the free market mantra when he said in a campaign ad that he would not be alive today if this country had a single payer health care system. Rudy is saying what many well insured folks say and what everyone else knows: as long as you can afford a good policy, you have a good chance of accessing excellent health care. What he did not say is that if he was an unemployed auto worker, or a low paid, uninsured delivery man, just the opposite would be true: he may not be alive today UNLESS America had a single payer health care system.
Nevertheless, to conservatives the "free market" is the only route to take, even though we have just seen what a misnomer "free market" is as it pertains to the health insurance industry.
Beyond recognizing the failure of the "free market" in health insurance, we need to ask ourselves as a people whether or not there are some specific things about health insurance that make it an improper candidate for inclusion in the free market system. In other words, should health insurance simply be treated as any other commodity, or is there something different about it?
It isn't that difficult to see that access to health care is not the same thing as access to Gucci handbags, Chevy Suburbans, or Pottery Barn linens. Purses, cars and linens, no matter how coveted or convenient, are not essential to life. Health care, on the other hand, is.
While a few (usually those who have adequate health insurance) see good health insurance as a luxury, most people in this country consider it a necessity, like food, water, and shelter. This is why every other Western industrialized nation provides universal coverage to their citizens.
Something else to consider is that the free market, regardless of how well it works in providing goods to buyers and profits to sellers, does not always move in a direction that is in the best interests of society. This is especially true now, as technology creates problems for the survival of humanity and as the sophistication of advertising hides the negative effects of some products. Although buyers are supposed to be the ones that determine what products they will buy, the reality is that in this extremely complex market, buyers do not always have the facts that enable them to make physically and economically healthy choices for themselves and their fellow citizens.
The market is very good at creating products that appeal to emotions or to what pleases the senses, or that caters to human desires for status and luxury, regardless of how damaging it might be to human society. Two examples come to mind. One is with respect to the auto industry, the other the food industry. At a time when oil is becoming increasingly expensive because of potential shortages, and those shortages are a cause of instability in the world, and as carbon emissions from automobiles are affecting the health of the planet, the market continues to promote large gas-guzzling vehicles. And at a time when obesity is contributing to poor health and sky-rocketing the cost of health care, the market increasingly offers up sugar and fat laden foods as well as super-sized meals.
The free market may be profitable for businesses, but increasingly in many areas, as demonstrated above, the free market has hidden dangers for consumers. Adam Smith's belief that in a free market what was good for the entrepreneur would naturally be good for the consumer, is simply no longer true. And this is especially true in the health insurance industry where the goals of the industry (to make a profit no matter how many people are left out) and the goals of the people (to access affordable health care no matter your risk) are often in opposition to each other.
The insurance company is the middleman in the enormous health care industry, essentially the gatekeeper to medical care, and it keeps many consumers out by offering policies only to healthy individuals and to groups where the risk is lower. Having this kind of "free market" means, in effect, that you do not have a "fair" market. When all human beings need access to medical services, and some simply can't obtain that access - for any number of reasons - you have a fatally flawed and inherently unfair system.
The answer, then, has to be "no." Unless your "free market" is also fair and allows for universal coverage, which by definition it can't, a "free market" in health insurance is not desirable.
HEALTH CARE: PRIVILEGE OR RIGHT?
Ultimately, where you come down on the health care debate, in terms of whether or not you think health insurance should be allowed to operate in an unregulated "free market," is based on whether you think health care is a privilege or a right. If health care is a privilege, then health insurance is just another commodity, like a Lexus or a Rolex watch, neither of which most people can afford. If health care is a right, we will have to do more than leave health care access to the "free market," where many will be denied that right.
The United States is the only wealthy nation without a universal system of health care. That is because we cannot come to an agreement about whether or not health care is a right. Conservatives see health care as a privilege, and insurance to access that care just another commodity you are entitled to if you can afford it. To liberals, health care is a right and individuals must be treated equally in terms of access to the medicine they need. Hence, we have evolved a hybrid system.
For most people of working age, health care is something that must be purchased, either directly or indirectly through one's employer. For the very poor and the elderly, there are government systems of health insurance that are not purchased, but are provided largely because of the understanding that the most vulnerable citizens have a right to be cared for when they are ill. And finally, we have a system of government provided medical care in the military and the veterans administration.
Unfortunately, that hybrid system leaves many middle and working class people out, unable to afford increasingly expensive individual health insurance policies.
EFFICIENCY, HEALTH CARE, AND THE FREE MARKET
Another argument that can be made against our current "free market" system of health care is with respect to efficiency. The free market is often thought to be the most efficient way to distribute goods in a society. When there is no government middleman, there is no complex bureaucracy to slow things down, conservatives claim. The possibility of establishing a large, expensive bureaucracy is one of the arguments against universal health insurance. Yet we find that the administration of the Medicare and Medicaid systems is actually much more efficient than the administration of the private insurance system, which has grown its own huge bureaucracy.
According to the World Health Organization, our public systems of Medicare and Medicaid spend about 4 percent of their budgets on administrative costs, while private health insurance companies spend about 15 percent of their premiums on such costs, which inevitably raises the price of policies. The difference can largely be attributed to the adversarial relationship between customer and insurance company in the private sector. Those administrative costs are high because they include underwriting expenses that determine price of policies based on medical risk, and pre-approval of medical procedures, as well as assessment of claims for payment or non-payment.
Excessive administrative costs aren't the only added expense in a private system. The necessity of generating profit, paid to stockholders in dividends, adds another layer of expense to the "free market" system.
The current system is inefficient in another way. Although there are government systems for those least able to pay, and private systems for the rest, there are still many (47 million) who are left out of the insurance system. A substantial number of these 47 million cost the country a great deal. When they do not seek treatment for their illnesses because they cannot afford it, they miss more days at work, and pass on communicable diseases to co-workers who also miss work, thus costing businesses money. Sometimes the lack of early treatment leads to serious complications that can result in more costly treatment down the road, or even in death.
This added cost of late treatment will probably have to be absorbed by an emergency room, where costs are much higher than those associated with traditional office visits, but where patients legally cannot be turned away regardless of ability to pay. When this happens often enough, it may force some emergency rooms and/or hospitals to close their doors, causing shortages in available hospital beds.
Eventually the lost revenue for hospitals that remain open must be made up by charging higher prices for medical procedures, which causes more "losses" to the insurance companies, which in turn leads to insurance companies raising their rates on everyone else. No one can claim this is an efficient way to run a health care system.
SUMMARY:
QUESTION #1: CAN THE FREE MARKET PROVIDE THE SOLUTION TO THE AMERICAN HEALTH CARE CRISIS?
Conservatives love to turn to the "free market" for the solution to all of our economic and social woes. So it should not be surprising that they believe the free market and competition will also fix the health care system. If only there is enough competition between insurance companies and health care plans, the rates will go down, they say. If only pharmaceutical companies are forced to compete with each other, drug prices will go down.
While in theory this makes sense, it has never worked out in practice. In fact, the realities of making a profit in the insurance industry, and the protections afforded the pharmaceutical companies, make effective competition and consumer bargaining power non-existent. Insurance companies don't compete with each other in any way that helps individuals. Instead they keep their costs low by only covering those individuals who have a very low risk of using medical services or spreading the risk by covering large pools of employees. In the health insurance industry, the companies have all the power and the consumer must take whatever he or she can get.
As for drugs, there is a built-in barrier to competition in the patent protection that is given to pharmaceutical companies for the new drugs they develop. Pharmaceutical companies have protection for many years from rival companies marketing a copy cat drug. However, once the patent expires, pharmaceutical companies are often involved in attempts to extend the patent with lawsuits and other strategies to prevent generic versions of their drug from coming onto the market and competing with them. While pharmaceutical companies deserve to have their research protected and to recoup their costs for developing the drug, the patent guarantees that the drug cost will be high in the United States, where drug price caps are not favored.
There are two major changes that must be made if we are to fix the health care system. One is to lower costs or at least slow the rate of price increases. The other is to cover everyone with some form of health insurance. As I have demonstrated above, since the health care industry does not operate according to conventional rules of the free market, since the incentives to lower costs are simply not there, and since the way insurance companies make profits is to exclude high risk buyers from the market, it seems foolish to believe the current "free market" can fix the health care system.
QUESTION #2: SHOULD THE FREE MARKET BE GIVEN A CHANCE TO SOLVE THE HEALTH CARE CRISIS?
Since it has already been demonstrated that the current "free market" in the insurance and pharmaceutical industries is incapable of fixing the health care system, the answer to this question must also be "no." In addition, the insurance and pharmaceutical industries have had many years in which they could have attempted to improve the system, but that is not what they have done. Instead they have paid lobbyists enormous amounts of money to protect their interests no matter what that does to the consumer. The industries involved in the "free market" in health care seem uninterested in reforming the system. In other words, the "free market" in health care has failed.
There is another reason, however, why health insurance should not be left to the "free market" and that is that health insurance is not just any commodity. Like food, water, and shelter, health care is a necessity, and access to it ought to be considered part of the "right to life" spoken of in the Declaration of Independence. In this country, the only way to access medical care is by buying health insurance.
It is immoral to treat health insurance the same way other commodities are treated, as products in a free market that excludes many people from the ability to purchase them. It is simply too much of a gamble to expect the "free market" to somehow address the medical needs of every citizen in this country, rich and poor alike, especially when it has failed in the past. In fact, as a nation we have already decided that the "free market" cannot meet the health care needs of its elderly citizens, which is why Medicare was instituted, and its poorest citizens, which is why we have Medicaid. However, the "free market" has now produced a situation where many middle class citizens cannot afford health insurance, and that is only going to get worse.
In conclusion, for reasons of efficiency, practicality, and morality, the "free market" should not be the means by which we change the health care system.
There may be a way to keep some elements of the current private market in health insurance and still reform the system, but that will require government involvement and regulation of the insurance and pharmaceutical industries. In the next and final installment of this series I will discuss that possibility and other ideas for fixing the broken health care system in the United States.
-Ellen Terich
All content © 2005 outragedcitizen.com
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