Monday, 4 April 2011

Dr Evan Harris is wrong about price competition - without it we'll have worse and more expensive healthcare

Source: Professor Mark J. Perry's Blog for Economics and Finance

Dear old Dr Evan Harris, former Liberal Democrat MP believes that competition in the provision of NHS services is fine just so long as it isn’t price competition:

The government seems to be unclear as to whether there will be price competition (an invention of the Labour government, it should be noted). It has said it will amend the bill to remove the word "maximum" before the word "tariff" that will be set by Monitor, the regulator of the new system-cum-market (a maximum implying the tariffs can be undercut). But the head of Monitor says he expects to see such competition as an essential part of the market. That is why I am calling on our conference to completely rule out price competition in the NHS, so that providers compete only on quality.

Now I’m pretty sure that Dr Harris is a clever bloke – after all he’s always banging on about decisions being “evidence-based” and linked to sound theory. The problem is that his grasp of some essential economic theory and evidence is sadly missing. So I thought I’d help him out a little – firstly by pointing out that cheap doesn’t mean low quality and that, without price competition, suppliers have no incentive to be efficient or for that matter to address issues of quality.

And Dr Harris there’s evidence too!

“The results indicated that while competition reduced price significantly, quality of service was maintained or even enhanced. The effect of competition turned out to be greater on prices than on quality, and the influence of ownership appeared to be negligible on both.” Domberger, Hall & Lee, The Economic Journal, 1995


Theory is clear that competition increases quality and improves consumer welfare when prices are regulated (for prices above marginal cost), although the impacts on social welfare are ambiguous. When firms set both price and quality, both the positive and normative impacts of competition are ambiguous. The body of empirical work in this area is growing rapidly. At present it consists entirely of work on hospital markets. The bulk of the empirical evidence for Medicare patients shows that quality is higher in more competitive markets. The empirical results for privately insured patients are mixed across studies. Gaynor, NBER, 2006

And there’s:

The paper has two important findings: First, higher managed care penetration increases the quality, when inappropriate utilization, wound infections and adverse/iatrogenic complications are used as quality indicators. For other complication categories, coefficient estimates are statistically insignificant. These findings do not support the straightforward view that increases in managed care penetration are associated with decreases in quality. Second, both higher hospital market share and market concentration are associated with lower quality of care. Hospital mergers have undesirable quality consequences.  Sari, Health Economics, 2002

There is nothing at all suggesting that intensive price competition reduces the quality of care – there are some valid questions about regulation of pricing but these should apply to the internal costing of procedures as much as they do to the external commissioning of services. In a piece – very critical of the US system – Michael Porter and Elizabeth Olmsted Teisberg said this:

In healthy competition, relentless improvements in processes and methods drive down costs. Product and service quality rise steadily. Innovation leads to new and better approaches, which diffuse widely and rapidly. Uncompetitive providers and restructured or go out of business. Value-adjusted prices fall, and the market expands. This is a trajectory common to all well-functioning industries – computers, mobile communications, banking, and many others.

Health care could not be more different. Costs are high and rising, despite efforts to reduce them, and these rising costs cannot be explained by improvements in quality. Quite the opposite: medical services are restricted or rationed, many patients receive care that lags currently accepted procedures or standards, and high rates of preventable medical error persist. There are wide and inexplicable differences in costs and quality among providers and across geographic areas.

Now we might take issue with banking as a well-functioning industry these days but the point made is valid – it is a failure of competition that creates the problems in our healthcare systems. And, as Porter & Teisberg point out, costs (and prices) are essential drivers of efficiency, innovation and quality. To remove “price competition” as Dr Harris wants is, in effect, to say that medical procedures can never get cheaper, that there are no benefits to wider society from being able, say, to conduct hernia operations to the same standard at half the price?

Dr Harris wants a system without an effective price mechanism – and the result of this will be that medicine (unlike most other technology-driven aspects of our life - as you can see from the image at the top of the page) will get ever more expensive resulting in more rationing, richer doctors and further frustration at the system's bureaucratic inability to respond to customer needs.


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