Liberals Are Wrong: Free Market Health Care Is Possible

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Avik S. A. Roy - Avik Roy is a Senior Fellow at the Manhattan Institute for Policy Research, and author of The Apothecary, a Forbes blog on health-care and entitlement reform.

One of the big divides between liberals and conservatives, of course, is on the value and utility of the free market. Most Americans appreciate that market-based economies, broadly speaking, outperform state-based ones. But most, if not all, progressives make the argument that health care is different: that markets may work for computers and soda pop, but they don't work in health care.

The most famous exponent of the theory that markets can't work in health care comes from Stanford economist Ken Arrow. In 1963, the Ford Foundation approached Arrow--an up-and-coming economist, albeit one without prior health care experience--about applying his theories to the practical problems of health, education, and welfare. With Ford's support, in December of that year, Arrow published a paper in the American Economic Review entitled "Uncertainty and the Welfare Economics of Medical Care."

In it, Arrow endorsed the view that "the laissez-faire solution for medicine is intolerable," that the delivery of health care deviates in fundamental ways from a classical free market, and therefore, that government must intervene to correct these deviations.

Arrow's paper energized those who were already predisposed to skepticism about free markets. Indeed, many people credit Arrow with inventing the field of health economics. Arrow went on to share the Nobel Memorial Prize in Economics in 1972, becoming the youngest person to ever garner that honor, albeit for his work outside of health care.

With characteristic understatement, Paul Krugman wrote in 2009, "Economists have known for 45 years -- ever since Kenneth Arrow's seminal paper -- that the standard competitive market model just doesn't work for health care...To act all wide-eyed and innocent about these problems at this late date is either remarkably ignorant or simply disingenuous."

Ken Arrow's critique of health care markets

Arrow identified five principal distortions in the market for health care services and products:

  1. Unpredictability. Arrow points out that people's needs for health care are unpredictable, unlike other basic expenses like food and clothing. But while we can skip the occasional meal or sale at Old Navy, our need for health care can be far more urgently necessary.
  2. Barriers to entry. Arrow notes that you can't just set up shop on the side of a road and practice medicine: you must have a license to be a physician, and gaining that license requires years of expensive schooling and training. As a result of this constraint on the supply of physicians, there is a constraint on the supply of medical services.
  3. The importance of trust. Trust is a key component of the doctor-patient relationship; if a surgeon makes a serious mistake during an operation, for example, the patient may die or become permanently disabled. The patient must trust that the surgeon knows what he's doing and can't test-drive the surgery beforehand.
  4. Asymmetrical information. Doctors usually know far more about medicine than do their patients. Therefore, the consumer of medical services (the patient) is at a serious disadvantage relative to the seller (the doctor). Patients are therefore vulnerable to exploitation. In addition, third-party payors of medical bills, such as insurers or the government, are that much more removed from the particulars of a given case and unable to effectively supervise medical practice.
  5. Idiosyncrasies of payment. Unusually, patients pay for health care after, not before, it is received (that is, if they pay for health care at all). Because patients don't see the bill until after the non-refundable service has been consumed, and because patients are given little information about price and cost, patients and payors are rarely able to shop around for a medical service based on price and value. Compounding this problem is the fact that patients rarely pay for their care directly.

Arrow wasn't wrong to point out these distortions. Where Arrow goes wrong is in contending that these distortions are unusual, or unique to health care. Indeed, Arrow's prescriptions for addressing health care's distorted market involve...further distortion.

Arrow's antique critique

From today's perspective, Arrow's commentary comes across as a bit antique. Let's go through his objections.

Unpredictability is hardly unique to health care. Indeed, in the five decades since 1963, an entire industry has emerged to address the problem of unpredictability. Think of the extended warranties you're offered when you buy a new television, in case the product stops working. If you worry about being suddenly short of money, or accidentally making a mistake with your checking account, you can buy overdraft protection. If you're afraid of flying, you can buy traveler's insurance. And I haven't even brought up the classical forms of insurance, such as homeowner's insurance, auto insurance, and life insurance.

It's true that we have instituted barriers to entry in the delivery of medical care. It's a problem that Paul Starr documents well in his definitive history of the subject, The Social Transformation of American Medicine. But again, this is hardly a problem that is unique to health care. It's a lot easier to get a medical degree than it is to start an airline or a bank from scratch. We require licensure of lawyers, but Ken Arrow never managed to write a paper advocating for the nationalization of the legal industry. And it's not just doctors and lawyers: in many parts of America, you need a license to become a cat groomer, tattoo artist, or a tree trimmer.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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