Economics of Health Care
by John Goodman
Issue 100 - January 30, 2008
 In many ways, the RAND Health Insurance Experiment confirmed what
common sense would have predicted in any event. That doesn't
diminish its importance. Some of the most significant studies in
economics have confirmed common sense. And in health policy -
where common-sense thinking is such a rare commodity - these results
were surely needed. Other findings, however, are more
subtle. The study found:
- Patients are responsive to out-of-pocket costs; if people
face a high deductible, rather than first-dollar coverage,
they will reduce their health care spending by about 30%.
- This reduction in health care spending has no effect on the
patient's health care in most cases.
- Patients reduce their spending not by comparing the marginal
value of various medical services with other uses of money;
rather, they reduce their spending by deciding not to initiate
care in the first place.
- Once patients enter the health care system they tend to get
the same care, regardless of the size of their deductible.
(Reconfirmed in a more recent RAND study.)
- Unfortunately, once patients enter the system they receive
effective (appropriate) care only 62% of the time. (The more
recent estimate is 55%.)
- Partly as a result of the above, patients with high
deductibles reduce their spending on more effective care about
as much as the reduction in less effective care.
Results (1 and 2) are understandable, but how can we explain (3) -
(6)? The explanation seems to be that then, as now, the health
care system is a bureaucratic, institutionalized structure, in which
normal market processes have been systematically suppressed.
Since most people pay with time, not money, when they buy care,
providers are not competing on price or quality. Since price and
quality data are not available, patients find it impossible to trade
off money against health services, the way they would do in a normal
market. Hence, their only real choice is whether to enter the
system at all. And the higher the expected cost of entry, the
less likely they are to do so.
Contrary to the impression left by universal care advocates, once
people get into the health care system they tend to get the same care
regardless of the kind of health insurance they have and regardless of
whether they even have health insurance at all. Unfortunately,
the care they get is often not recommended care.
In their recently published "Selective Memories" RAND
researchers take the institutionalized, bureaucratized, highly
regulated nature of our health care system as given. They then
ask: Are high deductibles a good or bad thing? Unfortunately,
they are still not certain what the right answer is.
After they spent $50 million ($350 million at today's medical prices)
on this experiment, surely we deserve better than that. At a
minimum can we not conclude that there is much more room for the
economic model of resource allocation in health care? The fact
that people are willing to make tradeoffs between health care and
other uses of money means that those choices do not have to be made
for them by government, managed care bureaucracies or even doctors.
If we combined the willingness of patients to make tradeoffs with
price and quality competition on the provider side, the medical
marketplace might exemplify many of the efficiencies found in other
markets.
John Goodman is President of the National Center for Policy Analysis
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