Wednesday, June 13, 2012

Is FREE Market right for Health Sector?

The implosion of centrally-planned economies(Russia) has led to a widespread and uncritical belief that a free market is the best mechanism for structuring the economic and social sectors. Every nation contemplating reform of its health system faces a fundamental question: what is the best way to structure the health sector?

Two polar structures have emerged: central planning and the free market

Central planning relies on a belief in the ability of government to advance the welfare of its entire people and manage its public sector operations efficiently. Free market relies on the beliefs that the consumer can make informed and rational choices and that a laissez-faire market will best satisfy individual wants and optimize efficiency.

The free market approach is based on the principle of utilitarianism, which recognizes that people have different needs, wants, and preferences. According to the neoclassic economic theory, letting people choose the bundle of goods they wish to consume within their budget constraints maximizes social welfare and yields optimum allocation and use of resources. Each household would shop for the best-quality goods at the lowest price, producers would have to compete to produce goods in the most efficient way. Market competition would spur efficiency and innovation. The free market also has another superior feature: it provides a constant flow of information about consumers’ preferences, their judgment about the quality of products, and the production costs of individual firms.

The free market, however, is not a panacea. It alone cannot perform all economic and social functions. Government needs to guide, correct, and supplement the market in many realms. For example, the free market system is only concerned about efficiency and it assumes that income is reasonably equally distributed among citizens. In reality this is not the case; government has to subsidize those who are poor. Economic literature has also documented that a free market is not the best approach to producing and allocating resources for public and merit goods. More importantly, government has to intervene to correct market failures and to fill voids in which a private market cannot be established.

Using economic principles, we can subdivide health care into three major categories: public, merit and private. According to economic theory, it is socially optimal for government to finance and possibly to provide the first two types of services; while it may be more efficient for the free market to finance and provide the third.
  • Public goods are non-exclusive and/or non-rival in consumption. Non-rival means that consumption by one person of a public good does not lessen the quantity of that good available to others. Non-exclusive means that it is impossible or prohibitively costly to make consumption of public goods exclusive to those who would demand and pay to consume the goods. In the health sector, most of public health and preventive measures are public goods. Examples include programs to provide clean water, sanitation, vector control, road safety, air- and water-pollution control, fluoridation of water, and mass health education.
  • Merit goods consists of services whose consumption produces greater social benefit than private benefit, such as family planning and certain primary-care services. Another type produces externalities such as vaccination and control of sexually transmitted diseases. A third type of merit goods includes services possessing significant interpersonal utility values (e.g. altruism), such as emergency services for trauma patients and medical services to relieve acute pain and basic health services for vulnerable people. Every society has a vulnerable population such as children and possibly women and minorities, and minorities, who may be powerless to make consumption choices to pursue private benefit.
  • Private goods are those services that exclusively benefit the persons who consume them, and that if consumed by one person, can’t be consumed by another. Because of their exclusivity, the market can produce and distribute them efficiently. Most of the curative medical services and drugs fall into this category.

Health sector is complicated; it actually consists of several markets whose interactions are complex.

Health sector consists of 5 mains markets - financing, physician services, institutional services, input factors and professional services. We can trace the interconnections among these markets from theories of demand and supply as shown below.
Health Sector Market
Health Sector Market

A worldwide search is underway to design health systems that combine the best of central planning with market mechanisms. Developed nations have been moving away from both polar positions and converging toward the center. The central planning systems, such as the United Kingdom and Sweden, are introducing market forces and central planning with market mechanisms. Developed nations have been moving away from both polar positions and converging toward the center. The central planning systems, such as the United Kingdom and Sweden, are introducing market forces and developing an internal-market approach. It is too early to assess their successes and failures. Meanwhile, the United States is moving away from its free-market approach toward a scheme of managed competition. Again, there is little empirical evidence on how well this scheme will work. One thing is clear, though: market competition bring about much higher transaction and administrative costs. Furthermore, genuine competition requires excess supply. Thus, it is unclear whether the total cost of a health-care system will be lower when it operates under managed competition.

Empirical evidence has taught us about the abnormal economics of the health sector. While this knowledge can guide us in designing health-sector reform, it also shows that there is no simple free-market solution in the financing and provision of health services.

Excerpt from "Abnormal Economics In The Health Sector" by William C Hsiao

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