Who’s Afraid of Competition?

For opponents of President Obama’s health care reform efforts, there’s no greater rallying cry than “Competition!” Invariably, government is presumed to be competition’s sworn enemy. Senator Tom Coburn, M.D. (R, OK) provides a nice summary of this point of view [1]:

“We are either going to have a government-run health care system or we are going to have a private, vigorous, healthy, consumer-oriented system where we actually allow market forces to allocate these scarce resources.”

Unfortunately for Sen. Coburn’s line of reasoning – as Monica Sanchez recently noted (here [2] and here [3]) – when it comes to health insurance, “vigorous, healthy” competitive markets are a pipedream. They do not exist anywhere in the country, and it is highly unlikely that they could. Instead, in nearly every local market in the country a very small number of insurers exercise what economists call “oligopoly” power (the ability to charge prices higher than their costs, because of the absence of robust competition). And as long as private firms remain the dominant insurers (and weakly regulated ones at that), it’s very hard to imagine how more competitive health insurance markets could come into existence.

Strong government action – the antithesis of “vigorous, healthy, consumer-oriented” markets, in Sen. Coburn’s worldview – is desperately needed to bring some competition over price and quality into the health insurance industry.

The government action required includes the kinds of efficiency-enhancing measures [4] President Obama kick-started through the stimulus package – investments in better information-technology systems in health care, in preventive care, and in studying whether “comparative effectiveness” measures can improve quality and control costs. His Office of Management and Budget director Peter Orszag is a leading authority on these tools for “bending the curve” of health care cost growth, and there may be bipartisan support for extending some of these measures further as part of a comprehensive health care reform package.

The government action required also includes more aggressive regulation of private health insurers, especially by prohibiting them from competing through exclusion of the most sick or likely-to-become-sick from coverage. (Seems like a no-brainer, huh?) There may even be some Republican support available for such regulatory strengthening, at this time of rapid shifts in public sentiments about government. “Regulation” was a dirty word in American politics for three decades, reliably drawing a groan of dismay. (“There they go again – those bungling, greedy bureaucrats messing with The Market.”) But when President Obama, in his speech before Congress last week, mentioned regulating the financial industry, there was a standing ovation before he could even finish his sentence. And it was a bipartisan cheer – I couldn’t spot a single legislator, of either party, still in their seat [5].

As important as these kinds of reforms are, there is a third and absolutely critical form of government action required, if we want to provide quality coverage to everyone and rein in the runaway cost inflation in health care: creation of a new public insurance plan that is open to everyone, to operate alongside private insurance plans. This is what President Obama proposed on the campaign trail, but it has not appeared in his speeches this week [6] on health care reform; apparently, he wants to leave this policy design question open for legislators to weigh in on.

Unsurprisingly, a group of Republican senators threw down the gauntlet this week [7], saying that they’re willing to talk about all the other components of health care reform but not this one last, critical piece. A public insurance plan would mean Big Government messing with the superior wisdom of markets once again, they said – “another Washington bureaucracy” stepping on our freedoms. But there was a curious twist to their argument, this time around: instead of suggesting that fumbling, wasteful government would make health care more costly and inefficient, their concern was that private insurers would be forced out of business through competition from the public plan. That’s right: the competition introduced by creation of a public plan is what they’re so scared of.

While the Republican senators contend that a public plan would drive private insurers out of business, careful analyses (such as this [8], this [9] and this [10]) of the kind of “hybrid” health-insurance system (with public and private plans operating side-by-side) proposed by President Obama predict a mix of public and private plans operating long into the future. What they also predict, though – and this may give us a better understanding of the Republican senators’ gauntlet-tossing – is that the public plan will force private insurers to slow down the rate of price inflation. In other words, they will actually have to compete for customers based on price and quality (that is to say, the mechanism through which markets work), thanks to the public plan. And there’s no reason to think they can’t do so, if this competitive pressure is introduced into the system.

At the same time, there’s no good reason to expect them to ever rein in health care price inflation as long as we fail to introduce more competitive pressure through creation of a public plan. Oligopolistic insurers and oligopolistic health care providers (the small number of consolidated hospital and clinic groups that dominate most local health care markets, as will be described in my next blog post) can pass on price increases to health care consumers (that is, all of us). In some instances, they do this through explicit anti-competitive price-raising agreements [11], but simple economic reasoning should lead us to expect that in a great many more cases a similar effect (prices raised, to the mutual benefit of insurers and providers, at the expense of the rest of us) is achieved with no need for direct collusion. This anti-competitive dynamic appears to be [12] exactly what has happened in Massachusetts [13], where health care reform required everyone to get coverage from private insurers without creating a public plan or introducing any other means of “bending the curve” of price growth.

What’s needed, in short, to provide quality coverage for everyone and at the same time stop prices from breaking both our private and public budgets, is countervailing bargaining power for health care consumers. This bargaining power would balance out the price-setting power of oligopolistic insurers and oligopolistic providers, introducing more competition on price and quality into health insurance markets. A public plan open to everyone would provide that countervailing bargaining power, because of the large number of people covered (on whose behalf the government would have an incentive to bargain for better rates from providers) and the administrative efficiencies of public insurance programs compared to private ones.

Most importantly – for making sense of the political fight now fully joined on whether to include a public plan in health care reform – a public plan would generate, not impede, competition in health insurance markets. And that, in fact, is why the self-proclaimed defenders of the “Free Market” – who just happen to have some longtime friends in the health insurance and pharmaceuticals industries – fear and oppose it.

Phillip Cryan is a graduate student in the Goldman School of Public Policy, at the University of California, Berkeley. For his Masters thesis, he is analyzing the impact of an employer play-or-pay mandate for health care on employment.