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Can Health Care and the Free Market Coexist?

Nov 27, 2017
Kip Beckman

Principal Economist
World Outlook

Renowned economist Friedrich Hayek pointed out in his book, The Road to Serfdom, that the competitive markets that determine the supply and demand of most goods was absent in the delivery of health care services. Consequently, other methods of guiding economic activity in this sector were required.

This is an important observation to keep in mind when watching the ongoing debate in the U.S. regarding health care. The Republicans vehemently opposed the Affordable Care Act (commonly referred to as Obamacare), because in their view it represented a massive intrusion of government into the lives of ordinary Americans. They believed what was required instead was a more efficient health care system—based more on free-market principles and less on government intervention. Even though the Republicans control the presidency and both houses of Congress, attempts to repeal and replace Obamacare have failed. A few key Republicans in the U.S. Senate balked at replacement plans that would have eliminated health care coverage for millions of Americans who are currently covered under Obamacare.

The crux of the problem for Republicans is, as Hayek pointed out many decades ago, the economic principles that are effective in most markets are largely absent in health care. The demand for health care is almost perfectly inelastic, meaning that rising prices have a negligible impact on demand for services. If a child is sick, parents will spend whatever it takes to ensure the child gets better. Inelastic demand makes it very difficult to control costs, and it is for this reason that insurance has played a key role in health care. Insurance is required because people don’t get sick at the same time. Consequently, if everyone is required to buy insurance the risk and costs are spread out over time, making the price of health care generally more affordable for everybody.

The Guardian notes the problem that arises is that many young, healthy people would choose to buy food, shelter, transportation, and clothing before purchasing health insurance. The chance of illness for most young people is likely worth the risk. However, the decision to forgo purchasing health insurance leads to what economists call the “free rider problem.” As the free riders age and inevitably develop health issues, society still looks after them, even though they haven’t contributed to funding the health care system. Emergency rooms in U.S. hospitals generally don’t turn sick people away, and the cost of their care eventually turns up in higher premiums for everyone.

Obamacare dealt with free riders by including an individual mandate that fined healthy individuals who refused to purchase health insurance and contribute to a fund they will inevitably need as they get older. Forcing people to purchase something they don’t want, in this case health insurance, violates free-market economic principles, and the Republicans’ health care alternatives to Obamacare eliminated the individual mandate. But, the lack of an individual mandate has left Republicans in a dilemma. To avoid driving the fiscal deficit even higher due to reduced revenues from the absence of an individual mandate, the Republican health care plans proposed sharp reductions in spending on Medicaid—the program providing health care for low-income Americans that was expanded under Obamacare. The steep reductions in spending on Medicaid has, to date, doomed Republican efforts to repeal and replace Obamacare.

There are other aspects of health care that differ from free-market principles. On the demand side, most people don’t have the medical knowledge or judgment to make the informed decisions required for a free-market system to operate efficiently. In fact, most of us don’t even know the costs of health care services. When we get sick we don’t have much choice in determining the health care we need. Going to the hospital isn’t like buying a new smartphone, where it is possible to do research and make an informed choice based on price and features of the various products. On the supply side, there are huge barriers to entry in terms of challenging educational requirements, strict federal and state exams, and licensing requirements. These barriers to entry are essential—people don’t want an incompetent doctor making potentially life-changing decisions concerning their health.

The unique characteristics of health care explain why Canada and many other countries have single-payer systems run by government, with varying degrees of private sector involvement. Even health care in Switzerland, which is regarded as one of the most market-oriented systems in the world, has provisions that free-market oriented Republicans would object to. Swiss citizens purchase their own insurance packages from the private sector, there aren’t any employer-sponsored or government-operated programs in place. Individuals are required by the government to pay health insurance premiums, but the system provides government subsidies to help low-income people buy health insurance.

The Republicans may still succeed in repealing and replacing Obamacare. But, without a provision to ensure that young, healthy individuals purchase health insurance, two outcomes are likely: either the fiscal deficit will surge to the $1-trillion mark; or people, mainly low-income Americans, will lose health care coverage.

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