The most famous exposition of this 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: the youngest person to ever garner that honor, although it was 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:
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.
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.
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.
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.
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.
Yes, Virginia, There Can Be a Free Market for Health Care - Forbes
