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Cost EffectivenessRationing

Market failure and information problems in healthcare

By March 24, 2015 No Comments

Politicians love to talk about improving the efficiency of health services, but they almost never mention market failure. Market failure is the reason that many countries have a public healthcare system and the reason many policies aimed at reducing overall costs, fail to achieve their goals. A better understanding of why markets for healthcare inevitably fail should help us design policies that will improve the performance of health services.

What are markets and how do they function?

Put simply, markets are means through which prices and levels of supply and demand for particular goods/services are determined. To function efficiently, they rely on a number of assumptions.

On the supply side, producers do not have control over prices; they are disciplined into setting low prices by well-informed consumers and try to maximise profits accordingly.

On the demand side, consumers have perfect information and are able to seek out the lowest price and maximise their utility. (Utility is just economist-speak for the benefit or happiness a person gains from spending their money.)

So, consumers need to be able to distinguish between different available options and determine which represent good value for money, and suppliers can’t have control over prices.

When do markets fail?

Markets fail when one of the assumptions fails. In healthcare, the most important assumption is perfect information. Consumers of healthcare are not well-informed and cannot easily distinguish between options available to them or often even figure out whether they need healthcare. Patients rely on advice from healthcare professionals, acting as agents, to make decisions about their healthcare needs. It is ultimately this advice which drives patients’ consumption of healthcare goods/services.

In markets for food or electronics, consumers are easily able to make choices that suit them, based on readily available information about price and quality; they obtain an efficient outcome from the market transaction.

What about an example?

After suffering for 24 hours from a painful eye infection, hoping it might resolve, I went to the optometrist. Here’s where the first information problem arises: I didn’t know whether or not I needed healthcare. By this point I needed advice, but I still didn’t know whether I’d be told the infection would resolve on its own, or whether it needed treating.

The optometrist assured me that it was lucky I hadn’t left it any longer. He then gave me some drops to clear the infection and a script for more drops, to use for the next week. I was happy with this advice because I could open my eyes again and within 48 hours, everything was back to normal. The eye drops cost $50.

Here’s where the second information problem arises: I didn’t know whether this was good advice, whether there might have been a cheaper alternative with a similar result, or if the infection would have self-resolved. $50 to fix an eye may seem a manageable sum, but it’s not cheap either and I had no way of knowing if this was good value for money. I was glad the consultation was bulk-billed; I would have struggled to estimate the value of the consultation too, because as Ben Goldacre puts it, “most patients are poorly placed to spot the difference between Clinical Genius and Poncy Moron.” I also wonder whether I would have delayed seeking advice even longer. (More about co-payments here)

The $50 had nothing to do with my understanding of the value of what I was paying for. It wasn’t a choice. I had to trust that the advice I had received was good. If I’d been told it needed further attention, I would have followed that advice and probably spent more too.

If I had been in the market for apples or chocolates, however, I would have easily been able to tell what benefit I would gain from the purchase and how much I would be willing to pay to obtain it. Even if I was looking for something I didn’t know the true value of, say a new television, I would easily have been able to seek out the information I needed to make an informed decision about how to spend my money.

In summary…

There is a clear difference between choices about healthcare and other goods or services, even if both require me to seek out information. While there is some shared decision-making in healthcare, it would be very difficult and impractical for a patient to decide which tests to pay for and ultimately which treatment path to follow. This is entirely different from the decision to buy a television, which does not set me on a path to further spending over which I have little control. These vast information problems are what cause the market for healthcare to fail.

It is arguable that the best way to improve efficiency in the allocation of healthcare resources is for governments to own these resources, rather than leaving it up to the market. Good evidence for this can be found in comparing the UK’s socialised NHS with the US’s largely private, market-based system. The statistics tell us that Americans generate more than twice as much in healthcare costs (per capita) as the British, but have a lower life expectancy. Life expectancy is a crude measure, but demonstrates the point that markets in healthcare do not result in efficient allocation of resources.

Victoria McCreanor

AusHSI Health Economics Research Associate