Contrary to Popular Opinion, Health Care Does Follow Free-Market Mechanisms

On Sunday, one of my favorite economists, Greg Mankiw, used basic economic concepts to describe how the government reimbursement system distorts the health care market:

If a government policy increases the demand for a service, the price of that service tends to rise. If the government prevents prices from rising, shortages develop. The quantity provided is then determined by supply and not demand. In the presence of such excess demand, the result could be a two-tier market structure.

Mankiw’s point is that, by failing to reimburse providers for the full cost of providing services, the government is creating an artificial shortage. Some health care providers will stop seeing Medicare and Medicaid patients because they lose money on the services that they provide to them. The Mayo Clinic is already doing this. Unless the government starts to reimburse fully for the services performed, more providers will follow Mayo’s example.

Mankiw continues. Here, he describes the aforementioned two tiers of the market:

Consumers who can somehow pay more than the government mandated price will be able to purchase the service, while those paying the controlled price may be unable to find a willing supplier.

In other words, patients who rely on government reimbursements (i.e., Medicare and Medicaid patients) will have difficulty accessing services, but those who pay out of pocket will not.

I have seen this happen in my professional experience. Before I started working at the Show-Me Institute, I worked as an analyst in the business strategy department at a major health care system. In our expansion, we deliberately avoided populations with high proportions of Medicare and Medicaid patients. Instead, we targeted populations that were concentrated with fee-for-service patients, because they would pay for their services in full.

Parenthetically, this government reimbursement system raises health care prices. Providers charge more to fee-for-service patients then they would in a non-distorted market. In order to stay in business, they have to make up for those patients who cannot afford to pay more than the government mandated price. It’s just like how retail stores increase their prices in order to compensate for losses due to shoplifting.

I like Mankiw’s post because it illustrates how, contrary to popular opinion, health care does follow free-market mechanisms. Health care is subject to the same laws of supply and of demand as any other market. When the government intervenes, it creates a price floor or a price ceiling, and a shortage or a surplus.