Economic Thinking About Health Care

For anyone seeking to affect or even evaluate public policy options, economic thinking is crucial. It helps us to avoid some of the worst, and yet most common, errors in the public policy arena. Economic thinking emphasizes the role of incentives and the importance of comparing each potentially favored option with other real and available options, not with perfection. Let’s look at health care as an example.

Government health policies have generated perverse incentives that have led to undesirable outcomes. In a normal market, consumers pay for the service and choose from whom to buy. Sellers in a true, more open market are compensated by their customers. Competition from rivals provides sellers with a strong incentive to keep costs and prices low. Sellers thus have a strong incentive to serve consumers’ interests: if they do not, consumers will buy from competitors who do that better.

Key relationships that make real markets work have been eroded by U.S. health care policies that evolved over the previous six decades and more. The structure of the health care market is now permeated with perverse incentives that encourage people to engage in actions using resources inefficiently and imposing those costs on others. These incentives underlie both the poor performance of the industry and the rising health care costs we all know about. Examining the incentives helps us see what can be done to improve outcomes.

We turn now to the four major reasons for the poor performance of the health care industry. First, the structure of today’s government programs relies on third-party payments that erode the incentive to economize. Very little health care is purchased directly by consumers. Most is paid for indirectly through taxes or insurance premiums. When someone else is paying the bill, the patient has little reason to conserve on the use of the resource and the provider has little incentive to keep costs low.

Second, the huge tax advantage providing for the purchase of health insurance through one’s employer undermines competition and makes it very costly for individuals or families themselves to purchase a health insurance policy that fits their preferences. Rather than allowing consumers to choose, government subsidies and regulations push them into standardized and controlled group plans provided through employers. Moreover, under this system, losing your job means also losing your health insurance. People do not generally buy auto, life, or homeowner insurance through their employers. Why do so many buy health insurance this way? Answer: The tax system subsidizes them to do so and punishes them with higher personal costs if they do not.

Third, state regulations that force insurers operating in the state to cover numerous services like in vitro fertilization, drug rehabilitation, marriage counseling, acupuncture, and massage therapy also drive up costs and make it still more difficult for consumers to purchase a pol icy that fits their preferences. Interestingly, the political pressure for this coverage does not come from consumers but rather from suppliers wanting taxpayers to subsidize their operation.

Fourth, regulations prevent consumers from purchasing a health insurance plan offered in another state.

Thus, if you would like to purchase insurance that would provide you with inexpensive basic coverage at a low cost, but you happen to live in a state that has adopted many of the expensive mandates, you are out of luck. Essentially, the government has organized the health insurance business into separate cartels that operate in each of the 50 states. You can buy nearly everything ranging from groceries and automobiles to life and auto insurance from providers in other states, but not health insurance.

Economic thinking allows policy professionals to ask the right questions, thus helping good thinking to overcome some tempting policy errors that are made every day.

James D. Gwartney holds the Gus A. Stavros Eminent Scholar Chair at Florida State University, where he directs the Stavros Center for the Advancement of Free Enterprise and Economic Education. This is an excerpt from the Institute for Humane Studies Policy Career Guide. It was written prior to recent federal legislation on health care, but the editors believe the principles still apply.