Recall a basic lesson of economics: A market participant with a dominant position can influence prices in a way that a small, competitive player cannot. . . .
If the government has a dominant role in buying the services of doctors and other health care providers, it can force prices down. Once the government is virtually the only game in town, health care providers will have little choice but to take whatever they can get. . . .
To be sure, squeezing suppliers would have unpleasant side effects. Over time, society would end up with fewer doctors and other health care workers. The reduced quantity of services would somehow need to be rationed among competing demands. Such rationing is unlikely to work well. . . .
A competitive system of private insurers, lightly regulated to ensure that the market works well, would offer Americans the best health care at the best prices.
Whenever someone uses the phrase “basic lesson of economics” when discussing the U.S. health care system, you should be suspicious. As Paul Krugman says, “the standard competitive market model just doesn’t work for health care: adverse selection and moral hazard are so central to the enterprise that nobody, nobody expects free-market principles to be enough.”
I earlier tried to make this point in more detail: “lightly regulated” private health insurance is a fantasy, because the whole point of a for-profit insurer is to charge premiums that expect the expected payout under the policy; as a result, no sick person would be able to afford insurance. You don’t need adverse selection or moral hazard to explain this: if I know someone has an expensive form of cancer, I’m going to charge him $100,000 for health insurance, and he won’t be able to pay. The free market for health care is one in which sick people die, and smart people who ignore that point are being less than honest. (Or maybe they are hiding behind the phrase “lightly regulated” – if they consider the prohibition of medical underwriting “light regulation.”)
And if dominant market participants are the problem, then we already have that problem. Check out page 6 of this report (hat tip Krugman). In the median state in the U.S., the top two insurers have a combined market share of 69%.
Finally, it’s clear that the current system isn’t working – we have both 50 million uninsured people (plus many millions more who are not sufficiently insured against a major medical problem), and we have rising health care costs that will destroy the federal budget over the next several decades. So when Mankiw says we need “a competitive system of private insurers, lightly regulated to ensure that the market works well,” what is he saying? That we need less regulation than we have now? Or is he just talking about abstract principles?
Update: Once again, you may be better off reading Brad DeLong’s response to Mankiw.
By James Kwak