The U.S. Healthcare System Might be Better than You Think (Part II)

Last time we outlined the challenges posed by the single-payer model of health insurance adopted by Canada, the UK and several other countries. The gist of that posting was that single-payer systems rely entirely on tax revenues to compensate providers for the costs they incur and therefore the aggregate cost of healthcare is under-reported in these countries.

The U.S. has not adopted the single-payer model. We instead use a complex combination of taxes, premiums, and unfunded mandates. By exploiting the market power of providers, we shift a large share of the costs of healthcare onto private insurance customers, thus reducing the burden on taxpayers, the sick and the elderly.

Many find the U.S. healthcare system wanting when compared to single-payer systems and have proposed our own single-payer system, i.e. Medicare For All. However, the U.S. system is so complex that facile comparisons with the relatively simple single-payer systems of other countries can be misleading. As we did with single-payer systems in the previous posting, we need to examine how well (or poorly) the U.S. system handles moral hazard, adverse selection, cost redistribution and quality. We kickoff that discussion with today’s topic.

The Market Power of U.S. Healthcare Providers

Market power is the ability a supplier possesses to choose the price it charges to buyers. Without it, the supplier can only charge the price collectively dictated by its buyers. Typically, the more market power a supplier has, the higher price it will charge its customers.

The market power of healthcare providers is plain to see. Most hospitals enjoy a local monopoly in the geographic area surrounding their location, especially for emergency services. Few people suffering a heart-attack will haggle over the price of emergency care. They generally go to the nearest emergency department regardless of price and quality. The fact that many states restrict the services offered by hospitals by requiring them to obtain “certificates of need” only magnifies the market power of the ones who manage to obtain them. And when you consider that physicians choose the hospitals where they treat their patients, rather than the patients and insurers who actually pay the hospital bills, it is easy to see how hospitals have so much market power. Pharmaceutical companies derive their market power from patent protections. Physicians tend to have less market power than hospitals and pharmaceutical companies, but they have organized into physician groups to counteract this disadvantage.

The more market power a supplier has over its customers, the more it can markup its price above the costs it incurs. So, do healthcare providers charge large markups to patients? The answer is a resounding “yes”, depending on who is paying of course. For example, Figure 2. shows the percentage markup charged by short-term hospitals by type of ownership in 2017. On average the percentage price markup for all hospitals was 360%. Not surprisingly, for-profit hospitals markup their prices the most (656% mean, 517% median), but even private not-for-profit and government-owned hospitals have very high markup percentages.

Data source: Medicare Cost Reports, 2017. The number of short-term hospitals for each hospital type are shown in parentheses.

To put these figures in context, grocery stores typically charge markups of 15% or less and clothing stores charge markups of 55% to 62%. So, markups of several hundred percent are astronomical. The fact that the mean markup percentages are greater than the median percentages indicates that the distribution is skewed to the right. In other words, large hospitals tend to charge higher markups than small hospitals. Which is further evidence that market power is the cause of these markup percentages.

One cautionary note, these are accounting figures and so the “costs” reported do not account for all economic costs incurred. Unlike not-for-profit and government-owned hospitals, for-profit hospitals must pay for all the capital they use to care for patients out of net revenues. Despite the ubiquitous use of the word “capital” in business and finance, its exact meaning in the context of economics is often poorly understood. In general, the under-measured cost of capital is the minimum amount of net revenues (as a percentage of capital invested) necessary to keep investors from transferring their capital to some other enterprise. Its value varies over time and depends on the reliability of expected future net revenues but will normally be in the 5%-15% range. Consequently, the under-measured cost of capital alone does not explain the difference in price markups between for-profit and not-for-profit hospitals.

Published by TheLoneEconomist

I am a PhD economist who studies just about anything and proudly specializes in nothing.

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