Magazine | August 10, 2009, Issue


(Roman Genn)
In which the government's tentacles chock health-care consumers

A few years ago, while vacationing in New Hampshire, I stopped in one of its state-owned liquor stores to buy kosher wine for the upcoming Jewish holidays. I could not find any. But right across the state line, a privately owned Massachusetts liquor store that served the same communities had lots of choices.

Are the people who run the New Hampshire liquor stores prejudiced? No. They are bureaucrats. The difference between a bureaucrat and a retailer is profound: Retailers maximize profit by giving people better value for the money. A McKinsey Global Institute study credited retailing with 34 percent of the 1995–99 surge in U.S. labor productivity and for much of its growth through 2002. Consider the retailing innovations of convenient outlets such as eBay, Amazon, and Netflix, or the availability of inexpensive, stylish goods from the likes of Ikea and Target. U.S. retailers offer more than 170,000 book titles, 211 car models, and countless custom-designed PCs.

But maximizing consumers’ choices and lowering prices are not among the incentives of the government employees who run state-owned liquor stores. Despite the power of monopoly retailers to extract volume discounts from wholesalers, researchers found no difference in prices between state and private liquor stores. Consumers were also slighted by the state stores’ shorter operating hours, inconvenient locations, limited product availability, and restricted advertising. Some who wished to see lower rates of alcohol consumption had claimed that state ownership would achieve that, but it has not. Consumers instead adjusted their shopping habits, which meant they paid higher prices in the form of lost time and fewer alternatives.

In short, state-run stores don’t work very well. So why do almost all the current plans to reform health care include a monopoly health-insurance store operated by the federal or state governments?

The government-run health-insurance markets in Massachusetts and the Netherlands are cautionary examples. Both suffer from a failure to control costs, high levels of consumer dissatisfaction, a lack of competition, and the inhibition of entrepreneurial innovation. Just as the state-run liquor stores have limited inventory, the Massachusetts and Dutch government-run health-insurance markets offer a limited variety of plans called “standardized benefit packages” — insurance-speak for “You can have it in any color as long as it’s black.” But while Henry Ford’s Model T was stripped to its bare essentials, Massachusetts’s government-designed insurance policies come loaded with features, requiring enrollees to purchase 43 benefits, some of which consumers may not want or need. Some of those mandatory benefits are very costly: In vitro fertilization alone raises the price of insurance by up to 5 percent. One can sympathize with the families who need this benefit, but it is not the kind of life-or-death medical care for which efficient insurance is designed. And is it fair to raise everybody’s prices to subsidize those who do need it? 

The government-run exchanges are supposed to enable competition, but in fact they inhibit it by regimenting prices and benefits. With few choices and little price competition, it is no surprise that in 2007, one year after the Netherlands switched to a government-run market, only 1 percent of consumers changed their insurance plans.

Would people buy these expensive packages of benefits if they were not forced to do so? In state-run systems, costs are obscured through subsidies, cost-shifting, and third-party-payer mechanisms. But what about in competitive markets for other products? A recent J. D. Power survey found that preferences for automobile options shift markedly once consumers are informed about costs. For example: Absent price information, navigation systems were consumers’ No. 1 pick among car options — but when the $1,600 price was revealed, they slipped to No. 14 in the rankings. Swiss consumers are required to buy their own health insurance from private companies, and they exhibit moderate price elasticity in their purchases — in other words, they look at the price tag when they’re choosing the options. Researchers for the American Enterprise Institute discovered similar price elasticity in the United States and concluded that 12 million uninsured Americans would be able to find affordable coverage if they were permitted to shop in states that had fewer required benefits but better prices (current law forbids them). That cannot happen under a government-run market.

While piling on mandates, the Massachusetts government also prohibits some options that consumers want, such as high deductibles that reduce the cost of policies. Some 73,000 Massachusetts residents were excused from the state’s requirement to purchase health insurance for the simple reason that they could not afford it. Many of them would have been better off with lower-priced, high-deductible policies than with no insurance at all, if only because they at least would have had protection against catastrophic medical expenses. And high-deductible plans have another benefit: They control costs. A recent RAND Corporation study found that persons in the middle and upper income brackets with high-deductible policies spent less on health care than those with low-deductible policies without negatively affecting their health.

Why do government-controlled markets require benefits that people may not want and prohibit those they do want? The reason is elementary politics: The politicians that run the markets respond to lobbyists, who are financed by providers and interest groups representing everybody from athletic trainers to acupuncturists and massage therapists. But nobody is paid to lobby for consumers.

There are additional dangers from a government-run market. The government’s regulatory power enables the state-backed market to crowd out employer-sponsored insurance because subsidies (available in Massachusetts for families of four who earn less than $66,000) help it to undercut the price of privately offered insurance. At the same time, while businesses do face penalties for not providing health insurance, those penalties are low relative to the cost of providing such coverage. So the incentives all are stacked toward the government option. The percentage of Massachusetts employees enrolled in employer-sponsored health insurance slipped from 85 percent in 2003, before the government-run market was instituted, to 78 percent in 2007; the national average is 82 percent. Similarly, Massachusetts employers’ contributions toward the cost of policies declined from 82 percent in 2001 to 75 percent in 2007; the national average is 85 percent. Future Massachusetts residents may have no choice but to buy health insurance from the state-run market.

Government monopolies tend to inhibit the emergence of new competitors, and can keep private-sector innovations that would make health care better and cheaper off the market entirely. Such innovations have achieved remarkable results. For example, one South African insurance company financially rewards its customers for joining gyms, undergoing screening for chronic diseases, and quitting smoking, and has achieved high rates of participation in those programs, up to 38 percent. Participating customers have achieved significant cost reductions, most notably in treatment for the chronic diseases that account for the bulk of health-care costs — e.g., a 7.2 percent reduction in expenses for cardiovascular disease, a 15.1 percent reduction for cancers, and a 21.4 percent reduction for endocrine and metabolic diseases.

Government-run plans also limit innovation through unilateral price-fixing. In the Netherlands, for example, the government controls the bulk of the prices paid to providers. When the government permitted hospitals and insurers to negotiate freely for a limited number of procedures, prices dropped and there were cost-saving innovations. In the case of total hip replacements, for instance, hospitals began to offer warranties on their services, while insurers began paying enrollees’ deductibles if they used lower-priced hospitals.

Entrepreneurs generally avoid markets controlled by a government buyer because one change in public policy could wipe out their entire investment. Their resources will be spent lobbying in Washington, not innovating. Because they discourage innovation and new market entrants, government-controlled markets encourage consolidation. Anticipating government domination, a small number of Dutch insurers consolidated to control 80 percent of the market. In response, health-care providers consolidated, too, so they could bargain effectively with the insurance cartel. 

Limited choice, little price differentiation, consolidated insurers, oligopolistic providers, lack of entrepreneurs — this is the deadly brew that causes higher prices and lower quality. The rate of increase in health-care costs was declining in the Netherlands before the national-market reform in 2006; costs rose 4.4 percent the year after it was initiated and 5.1 percent the second year. Individual health-insurance premiums rose 8–10 percent in 2006–07 and even more in 2008. Not surprisingly, the Dutch are now unhappy with their system.

Those who argue for a single, standardized system argue, in effect, that the American public is not capable of wending its way through a thicket of insurance options, and therefore needs a centralized market offering a limited choice of plans with standardized features. But in the rest of the U.S. economy, Americans have driven down prices and demanded higher quality across a range of complex purchases, such as personal computers and cars. Car prices have increased only 35 percent since 1984, while the Consumer Price Index has risen about 104 percent. Americans manage all sorts of complex transactions with lots of options, from banking to cell-phone plans.

Others justify the government market and the consolidation it would create with the observation that only large groups can achieve real administrative savings through economies of scale. But there is no evidence of economies of scale in insurance. And in any case, innovation and competition in the private marketplace are likely to overwhelm economies of scale in a government-run system. Thus, in Switzerland’s market, which has neither employer- nor government-based groups, health-care costs have declined since 1994.

The government’s proper role in health insurance is to help subsidize those who cannot afford it, to ensure transparency so that people can shop intelligently, and to prosecute fraud, abuse, and anti-competitive behavior. But the government should not create a state-run market that inevitably will limit competition, inflate costs, and prevent innovation. As in the rest of the economy, the American public should shop for itself.

– Regina E. Herzlinger, a professor of business administration at Harvard Business School and a senior fellow at the Manhattan Institute, is the author of Who Killed Health Care?


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