Health Care Needs Stronger Market Forces

[This post first appeared at on April 17, 2012.]

The U.S. Health Care industry is a huge industry that exhibits a remarkable lack of competition. There is huge concentration of market power on both the buy and the sell side.

Break Down of U.S. National Health Expenditure by Vendor and Payer; Data via

Health care is a regional market, mostly because service providers need to be close to customers, and also because the key players (doctors, insurance companies) are regulated mainly at the state level. At the regional level, the supply side of the market is very concentrated. Take Boston (the #10 U.S. metro area) as an example. Two large hospital groups (Partners and Beth Israel/Deaconess) dominate the hospital market in Boston. These organizations were created by mergers over the last 20 years, e.g., Partners Healthcare began with the 1994 merger of Mass General with Brigham and Boston Women’s hospitals; it has since added a series of community and specialized hospitals and clinics. Partners is perceived to have significant pricing power in Boston. And, there are regional professional bodies that help create a unified view on the supply side: state medical associations, hospital associations, and in Boston the Harvard Medical School, which works closely with most of the major hospitals. Add to this the inherent stickiness of provider/customer relationships (what seriously ill person wants to shop for a better-value doctor?) and the lack of pricing transparency (who can decode a hospital bill?) and you have a market that functions poorly, if at all. It’s not surprising that U.S. hospitals and doctors have been able to maintain both high price levels and high utilization volumes (1).

The other large vendor group is the pharmaceutical industry (“Rx” in the chart), most of which (on a dollar basis) is a legal monopoly based on patents.

The payer side of the industry is equally concentrated. Private insurance pays for nearly 40% of health care, and in Boston, three large insurance companies (Blue Cross, Harvard/Pilgrim, and Tufts) dominate the insurance market, which is typical. Insurance companies are legally exempt from anti-trust laws that promote competition. Government pays for nearly 50% of health care (not including tax subsidies). Direct payment by corporations is small (the second and third bands from the top).

U.S. Health Care Expenditure per Capita in Constant 2010 Dollars: Amount (blue) and Growth Rate (red).  Data via &

So the dynamic here is like Sumo wrestling: two big guys grappling with each other, lots of ritual stares and grunts, little movement. In the 1990s, when insurance changed from “indemnity” (insurance pays for everything) to “managed care” (requiring co-pays, preferred provider panels, and utilization review), the rate of growth of health care cost slowed: payers seemed to have the upper hand. That stopped working about 2000, however, and rapid cost growth resumed, suggesting that power shifted to the vendor side. Mergers forming large regional health care provider groups may be part of the cause. And insurance companies have the wrong economic incentive: within the policy year their incentive is to reduce expense, and this leads to various service denials. Long term, however, the insurers earn a mark-up on the national health care bill: the faster health care costs grow, the faster their revenue grows.

Some advocate “consumer-driven health care” as the answer to cost control. Looking at these numbers, I can’t believe it is the whole answer. The government and provider groups control too much. Structural changes are going to be needed (i.e., the government using its power more explicitly to control prices and capacity, as happens elsewhere in the world), and the debt crisis will force this to happen. However, I think “customer driven health care,” where “customer” includes private payers as well as consumers, can do a lot, and where it can work, it will often be preferable to bureaucratic/political decision-making.

Slower growth of health care spending per capita in 2008-2010 is evidence for this case. Most analysts attribute this flattening to the recession: consumers had less money to spend, and fewer people were covered by generous employer benefits. As a result, they spent less. Not all of this reduced spending was wise, most likely, but this data is evidence that, when customers have more skin in the game, they spend less.

My next post will look at the case for “customer driven” health care in more detail.

(1) Past posts on medical costs: “Why Are U.S. Health Care Costs So High?” and “More Evidence That Doctor Fees Are A Big Reason Medicine Costs More In The U.S.“.


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