What's So Bad About the Public Option?

Lately, I’ve noticed that many public discussions about health reform have two underlying assumptions. The first is that anything done by the private sector is efficient and good and anything done by the public sector (i.e., by government) is inefficient (high-cost production and misallocated resources) and bad. Underlying these assumptions is the unspoken premise that the private sector always and everywhere has all the good characteristics that the private sector would have if markets were competitive (i.e., many small firms, no side-effects (externalities), fully-informed rational consumers, no scale effects, and no public goods or public good-like qualities). The corollary to this is that the public sector has all the negative characteristics one would expect of an entity isolated from market forces and controlled by political forces.

Framed in this way, it is then taken for granted that the (bad) public option will result in “crowding out” of (good, efficient) private health insurers. Originally, crowding out pertained to government borrowing and its effects on interest rates. All else held constant, such borrowing tends to increase interest rates, thus raising the price of private borrowing and reducing private investment. Over time, this would tend to shrink the private sector, which (when it has all the good qualities of competitive markets and fully informed consumers) would be a bad thing for us all.

The problem is that for a variety of well-documented reasons private health insurance markets and private medical care markets do not have the characteristics of perfectly competitive markets. Consequently, they are not efficient. We know that US healthcare costs twice as much per capita as any other developed country and delivers lower population health outcomes. We know that underwriting costs for private health insurance exceed those of public health insurance (Medicare) by a factor of at least 3 to 4. We know that the financial incentives created by private (and to some extent public) health insurance reimbursement policies distort resource allocation away from prevention and chronic disease management and toward complex, high-tech (and in many cases marginally beneficial) care. The misallocation of resources has important ethical dimension as do the higher costs of privately provided insurance and services. Aside from excluding 47 million Americans from regular access to healthcare or relegating them to after-the-fact emergency care, both higher costs and misallocation of resources tend to reinforce and increase the existing inequities between those who have health insurance and those who do not.

So one assumption I want to question is the assumption that the private sector can deliver healthcare and manage risk better than the public sector. (If you doubt this, allow you mind to dwell on how well the private sector managed risk in financial markets. If you think it's not the same, then I want you to think about the uninsured as a sub-prime health insurance market and then imagine the heyday the private sector could have with it.)  And I want to expand “better” to include not only efficiency, but also ethics or fairness: characteristics of allocations and trade that tend to be reinforced or at least not undermined by truly competitive markets when rational fully-informed consumers trade in them.

Kenneth Arrow suggested in his paper on Uncertainty and the Market for Medical Care that the non-competitive behaviors observed in medical care were “social adjustments” adopted to correct for market failures of information asymmetry and uncertainty.

 ....the special structural characteristics of the medical care market are largely attempts to overcome the lack of optimality due to the nonmarketability of the bearing of suitable risks and the imperfect marketability of information. These compensatory institutional changes, with some reinforcement from usual profit motives, largely explain the noncompetitive behavior of the medical-care market, behavior which, in itself, interferes with optimality. The social adjustment towards optimality thus puts obstacles in its own path.

Implicit in this is a normative judgment about medical care and health insurance markets and what they should be doing: preventing and treating disease among all who demand it and insuring against financial loss for all who desire it. Moreover, he suggests that the usual profit motives cannot be relied upon to bring us to a competitive equilibrium. Instead they reinforce the non-competitive aspects of these markets, which are neither efficient nor are they ethical. Arrow wrote the above in 1963. Since then, medical care and health insurance markets haven't changed much. They are still  failed markets despite repeated “compensatory institutional changes” aimed at correcting for both the allocation failures and the ethical failure of 47 million uninsured US residents.

The public option would be an important first step toward correcting these permanently flawed, distorted, unfair and unethical markets. It would provide both an ethical and an efficient option to those without insurance and to those with inadequate insurance. If it crowds out an inefficient, unethical private sector, I fail to see the loss.

Comments

[miguelitoh2o]

What I would like to know based on BHO's description as the PO as a catchall for the uninsured, and expecting it to only cover about 5% of the population, how do we attain the so called 'economy of scale' to negotiate lower rates from providers? Also, there has been no evidence to suggest that the PO will be allowed to pay at or near Medicare rates, so the primary mechanism envisioned in the PO to lower overall healthcare costs is beginning to look as if it will be stillborn when the bill finally emerges from Congress. My only positive take on that is that at some time the costs will become so excessive that reigning in costs will be mandatory,and hence that meaningful reform will be mandatory, which in the end looks about the same as it does right now.

[Maxine Udall (girl economist)]

I agree with all you say, Miguelito. The economics are much more straightforward than the politics. I think once the PO is in place (which is the big hurdle) it will be only a matter of time until the govt is negotiating rates no matter what the original law says. And it will negotiate them for all public programs at once, not piecemeal, so whatever they negotiate will be for Medicare, Medicaid and the PO. You are right that in time the meaningful reform will occur whether we want it or not. And you are right that price negotiation is essential to cost control. I know of a firm that was able to obtain Medicaid drugs pricing for its employees health plan and slowed the rate of increase in their health care costs to roughly 3% per year.