"Health Care, Uncertainty and Morality"

Kenneth Arrow believes that market failure is an inherent feature of health care markets, and that society constructs institutions, adopts norms, imposes regulations, and uses other means to try to minimize the consequences of these failures. But some of those may be breaking down, "and that has led to some of the problems we have today." Uwe Reinhardt explains:

Health Care, Uncertainty and Morality, by Uwe E. Reinhardt: In last week’s post I discussed Kenneth Arrow’s exploration of whether special characteristics set health care apart from other commodities — whether it had a “moral dimension.” ...

Professor Arrow, a Nobel laureate, explored in the early 1960s what the characteristics would be of a perfectly competitive market for an ordinary commodity, how the medical care industry deviated from those characteristics, and what aspects of health care might explain these deviations.

He concluded that virtually all the special features of the medical care industry — the role of nonprofit institutions; the expectation that physicians ... would always put the interests of their patients above their own self-interest; professional licensing and many other forms of government regulation — could “be explained as social adaptations to the existence of uncertainty in the incidence of disease and in the efficacy of treatment.”

This uncertainty has several aspects. First, physicians may not agree on the medical condition causing the symptoms the patient presents. Second, even if physicians agree in their diagnoses, they often do not agree on the efficacy of alternative responses...

Third, information on both the diagnosis of and the likely consequences of treatment are asymmetrically allocated between the sell-side (providers) and the buy-side (patients) of the health care market. The very reason that patients seek advice and treatment from physicians ... is that they expect physicians to have vastly superior knowledge... That makes the market for medical care deviate significantly from the benchmark of perfect competition, in which buyers and sellers would be equally well informed. ...

Wherever asymmetry of information is present, there exists the potential for the better-informed market participants to exploit the ignorance of the less well informed. ... Professor Arrow explained many of the nonmarket social institutions and regulations characteristic of medical care that he had identified as “attempts to overcome the lack of optimality resulting from asymmetry of information and the inability of competitive markets to allocate efficiently all of the risks inherent in health care.”

Pointedly, he said, “It is the general social consensus, clearly, that the laissez-faire solution for medicine is intolerable.”

Professor Arrow touches on the moral aspects of health care only in passing... In formal economics, the moral dimension of health care manifests itself in an externality modeled by economists as “interdependent utility functions.” That fancy jargon covers cases in which person A is happy (altruism) or unhappy (social envy) from knowing that person B consumes a certain commodity. Economists do not prescribe such interdependencies; they take them as givens in prevailing cultural norms.

With respect to health care, Professor Arrow observed that people typically have “concern for the health of others”... These tastes, Professor Arrow concluded, help explain some unique characteristics of the medical care market, for example, the redistribution of purchasing power built into private and public health insurance and the peculiar form of price discrimination practiced in the industry at the time of his writing, which struck him as not aimed mainly at profit maximization but instead as an attempt to make health care affordable to the poor. ...

In a recent interview with Conor Clarke in The Atlantic, Professor Arrow was asked how much of his 1963 paper “is still an accurate representation of the problems the health market faces.” He responded:

I think the basic analysis hasn’t changed. There are wars over the details, but the basic analysis is accepted. Some specifics have changed. If you look closely at my argument there is a sociological structure. There is a kind of sociological thesis. The market won’t work – it doesn’t work well in the health context. But something else supplements the market, and the thing I put stress on in the paper are the elements that put a non-economic influence on the market: professional commitments to provide a service, to engage in services that aren’t self-serving. Standards of caring decided by non-economic actors. And one problem we have now is an erosion of professional standards. In a way there is more emphasis on markets and self-aggrandizement in the context of health care, and that has led to some of the problems we have today.

Coming from one of the most revered economists of our age, these are sobering thoughts. ...