Improving Health Care
A Dose of Competition
About This Event

What is the proper role of competition in health care markets? On July 23, 2004, the Federal Trade Commission and Department of Justice jointly issued a major report, Improving Health Care: A Dose of Competition. The report, which followed nine months of hearings held during February–October 2003, systematically surveys the performance of the health care marketplace and identifies a number of barriers to more effective competition. Many of the recommendations are aimed at federal and state government agencies. They encourage increased antitrust scrutiny of the activities of provider networks, hospitals, group-purchasing organizations, and insurance and pharmaceutical companies. David A. Hyman, a professor at the University of Illinois, was the project leader and principal author of the report. At this AEI event, he will discuss "lessons learned" in assessing the role of competition in U.S. health care.

9:45 a.m.


10:00 Speaker: David A. Hyman, University of Illinois
Discussants: Joseph Antos, AEI
John E. Calfee, AEI
Stephen Foreman, Robert Morris University
Tom Miller, Joint Economic Committee
Moderator: Robert B. Helms, AEI
Noon Luncheon
Health Care Monopolies: A New Look
Speaker: Clark Havighurst, Duke University
1:30 p.m.


Event Summary

November 2004

Improving Health Care: A Dose of Competition

What is the proper role of competition in health care markets? On July 23, 2004, the Federal Trade Commission and Department of Justice jointly issued a major report, Improving Health Care: A Dose of Competition. The report, which followed nine months of hearings held between February and October 2003, systematically surveys the performance of the health care marketplace and identifies a number of barriers to more effective competition. Many of the recommendations are aimed at federal and state government agencies. They encourage increased antitrust scrutiny of the activities of provider networks, hospitals, group-purchasing organizations, and insurance and pharmaceutical companies. David A. Hyman, a professor at the University of Illinois, was the project leader and principal author of the report. At this AEI event, he discussed "lessons learned" in assessing the role of competition in U.S. health care.

David A. Hyman
University of Illinois

The Federal Trade Commission (FTC) and Department of Justice (DOJ) joint report on health care is centered on competition law, which encompasses both antitrust enforcement and consumer protection. The two agencies act against anticompetitive behavior among private entities, but they have no jurisdiction over states or federal agencies. State attorneys general also can police violations in their states, and private plaintiffs can bring suits as well.

Between February and October of 2003, the FTC and DOJ held twenty-seven days of hearings to better understand the nature of competition in health care. Two hundred fifty witnesses appeared, and 4,900 pages of transcripts were recorded. The resulting report discusses the role of competition in health care markets and how that competition could be bolstered. The report is available at

The report begins with the role of competition in health care financing and delivery. A chapter on physicians discusses alleged antitrust violations among independent practice associations, various compensation schemes, and tools of antitrust enforcement. Similarly, the report devotes a section to hospital market dynamics and controversies, including certain payment practices and recent hospital mergers. Another focus is the insurance industry. While insurance is regulated by the states--and not the FTC--the report investigates the role of private insurers in the individual market, public programs, and the uninsured population. Some potential challenges facing insurance markets are insurance company mergers, government monopsony power, and state benefit mandates. The report also investigates the extent of competition among pharmaceutical manufacturers, and its impact on innovation. It discusses the regulation of Pharmacy Benefit Managers (PBMs) and direct-to-consumer (DTC) advertising. A final chapter addresses issues outside the four health sectors, including Certificate of Need programs, long-term care institutions, international comparisons, and potential side effects of proposed solutions.

The FTC-DOJ report made six recommendations and eleven antitrust observations. Many of the recommendations were directed to other government agencies; others targeted providers and payors. The FTC and DOJ recommend:

  • Providers and payors should continue experiments to improve the incentives for lower costs and better quality.
  • States should decrease barriers to entry in provider markets.
  • Governments should reconsider subsidies, aiming to make them direct and transparent.
  • Governments should not allow collective bargaining among physicians.
  • States should weigh the benefits and costs of regulating PBM transparency.
  • Governments should reconsider the value of benefit mandates.

One observation made in the report was that institutional form is not necessarily a determinant of antitrust behavior. Non-profit hospitals, for example, could operate anticompetitively. The report also finds community commitments to be "an ineffective, short-term regulatory approach to what is ultimately a problem of competition." It also observes that allowing providers to exercise countervailing power against health plans is unlikely to benefit consumers.

Improving Health Care suggests that barriers to competition are not market failures, and that such barriers can be overcome. One barrier is excessive regulation of insurers and providers. Misaligned incentives represent another barrier that results when the payor is not the patient. Informational deficiencies and societal attitudes are further hindrances to effective competition.

A few lessons have emerged from the series of hearings and production of the report:

  • Health care is complex.
  • The government can be both a source of and a solution to the problems of our health care system.
  • Every sector believes it deserves special consideration due to some unique circumstance it faces.

Despite its vast complexities, health care is like other industries and stands to learn from them--embracing transparency, for example. Perhaps most importantly, competition does not need to be perfect for it to be a viable alternative for our health care system.

Stephen Foreman
Robert Morris University

The recommendations that I testified to at the FTC-DOJ hearings last year regrettably are absent from this report. The classic conditions for market competition are many buyers and sellers, a homogenous product, perfect information, and free entry and exit of firms. The theory also rests on constant or diminishing returns to scale and instantaneous dynamic adjustment. In fact, health care markets take ten years to adjust to market entrants. Functioning markets also align the incentives for preference and payment, but third-party payors in health care dissociate the two. Competitive models also boast consumer sovereignty, prices that signal quantity imbalances, and no externalities. These characteristics are largely absent from health care markets.

Can competition work in health care? Theoretically, health insurance markets can function competitively. Hospital markets are hindered by the problem of dynamic adjustment, and physician service markets are handicapped by asymmetrical information.

The most important current trend in the health care sector is massive insurer consolidation. We are also experiencing a wave of hospital mergers and mounting frustration and fragmentation among physicians. Health insurance companies are getting away with big, unlawful mergers, but physicians cannot band together even in small groups. Ironically, antitrust enforcement has come to the defense of multi-billion dollar insurers facing small physician groups.

Health insurance premiums have been increasing at double-digit rates, and the rise cannot be attributed to physicians. While wages of all professional workers increased overall by 90 percent between 1993 and 2000, physicians' wages grew by only 10 percent. Instead, insurance companies are raking in unprecedented profits and paying their executives enormous salaries. Payments to hospitals are also growing rapidly. Remarkably, insurers' administrative cost percentages are increasing as the firms grow, suggesting monopolist behavior. These same firms have also become involved with bid-rigging, Medicaid kickbacks, and physician payment lawsuit settlements.

Health insurer consolidation has not occurred through skill, foresight, and industry. UnitedHealthcare, for example, enjoys billions of dollars in profits and executive salaries. United owns the only two physician payment databases used to calculate physician payment rates. The company has 100 percent of physician payment information, while individual doctors have none. Even United CEO Bill McGuire admitted in their 2002 annual report that the system is broken and needs to be fixed. Can competition do it?

Monthly health insurance payments are beginning to surpass house payments, even while insurers are paring back coverage and threatening to ration new technology. As a result, more physicians are becoming employees instead of independent contractors. Like nurses, they will form unions and inevitably mount a powerful countervailing response. Perhaps most disturbingly, a market evolution that transforms the role of physicians could cause sharp declines in physician productivity.

In the long run, insurance may not be available at any cost, and the government may be forced to roll out national health insurance. Insurers may come to function as railway express agents or Western Union, and we may see military medicine for all. Of great concern would be public medical care following the trajectory of public education in this country.

Tom Miller
Joint Economic Committee

The FTC-DOJ report underscores a few critically important points: First, competition in health care is hard work, and it is made harder by government. In public programs, governments function not only as regulators but also as buyers. Forty-five percent of health care dollars are spent through Medicare and Medicaid, but the programs' impacts are even greater. Government purchasing distorts prices, skews allocation, and generally shapes the health care business environment.

Over-regulation and mis-regulation are extremely costly, imposing a net burden of $174 billion in 2002, according to Duke economist Chris Conover. Misguided regulation pits all sectors of the health care industry against each other, but the consumer is always the loser.

Government subsidies thwart competition in health care, and public programs very often behave anticompetitively. Price controls in Medicare and Medicaid, and Medicaid "best price" rules, for example, seriously distort health care markets.

The tax treatment of employer-sponsored health care has created a substantial bias toward third-party insurance. Third-party payment and decision-making have driven up health spending as individuals become less cost-conscious as their out-of-pocket shares decline. At the same time, providers willingly spend any extra money put before them.

Consumers are definitively last in the health care food chain. Less than 15 percent of national health dollars are spent out-of-pocket. Third-party payors wield all power to decide what to cover and how much to pay for it. Most employees are not offered a choice among health plans, and even those that are given a choice face only slight variants of the same plan held by the same company. Payors, providers, and politicians influence the design of the system; patient preferences are absent. This creates temporal disconnects between investments and their rewards, as patients are not expected to stay with a single plan throughout their lifetimes.

Even consumer advocates believe that health care decisions are too important to be left to consumers, making dubious the banner of "pro-consumer."

The vision of greater competition in health care has, in many respects, adopted the wrong focus. It measures competition among provider inputs where it should be targeting health outcomes. It aims to satisfy payors, instead of patients. It focuses on health plans and hospitals, not patients and their conditions. It looks for competition at the point of network contracting and plan enrollment, instead of at the point of service.

Health care information is vital to fostering competition in health care. Price transparency is just the beginning. Once consumers know what services cost, they will begin to consider their value and make informed decisions. Public disclosure will drive behavioral change, particularly as informed consumers at the margin signal others.

Finally, antitrust violations may not be the most obvious defect of our health care markets. There may be more powerful forces of market distortion that deserve our attention instead.

John E. Calfee

The FTC-DOJ series of hearings on health care markets is remarkable for its scale, comprehensiveness, and quality. The published summary and analysis of these hearings represent a substantial contribution to the literature on health care policy.

The report gives substantial and appropriate emphasis to the dominant role of third-party payments. Over and over again, the authors highlight the subtle and important ways in which third-party payments alter the usual economics of competition in general, and antitrust in particular.

Improving Health Care also gives considerable emphasis to the role of information. This perspective reflects the in-house expertise of the FTC, whose Bureau of Economics has for some three decades devoted substantial resources to the analysis of information as both a barrier to and an essential component of competition.

The report reflects one of the enduring features of most (but by no means all) FTC and DOJ antitrust and consumer protection operations. This feature is to minimize the use of detailed regulations in favor of case-by-case enforcement of very simple rules, such as the FTC Act's prohibition on deceptive, anticompetitive, and unfair practices. Although the FTC, in particular, vigorously pursued the rule-making approach some three decades ago, it soon learned that the attempt to make markets efficient by setting complex rules would do more harm than good. One of the more useful and less obvious insights to emerge from the FTC-DOJ hearings and the published volume is what amounts to a series of case studies in which enforcement of general rules for competition is found to be capable of dealing efficiently with an extraordinary variety of activities in exceptionally dynamic markets.

Joseph R. Antos

The report highlights an important point: competition actually does matter in health care. Debate over this fact was particularly evident in the recent presidential campaign. A competitive market's primary objective is efficiency, which means minimizing the resources needed to purchase goods and services that consumers actually want. Those who take risks and find a better way to produce health services are rewarded with profit. There is no guarantee that you get "equitable" solutions. Equitable solutions mean redistributing income through the tax system.

Consumer protection can harm consumers. There are numerous individuals and agencies besides the FTC and DOJ who have taken on this role. For example, New York attorney general Elliot Spitzer and other state officials are uncovering circumstances that are claimed to be anticompetitive. Are these cases truly anticompetitive, or are they legal business models that an official might not like? Another example is Medicare, which was set up to protect seniors and the disabled. How much consumer protection is there in a rule that prohibits seniors from paying more to get the health services they want?

The FTC is swimming upstream in trying to promote competition in health care. It has no jurisdiction over the actions of state and federal government agencies that would be anticompetitive if taken by private entities. Governments have a higher standard, but that does not mean they have better judgment. The Centers for Medicare and Medicaid Services does more to set the rules of the road for health care than anyone else, and everyone else is nibbling around the edges. We need to focus more on Medicare's actions that shape the climate of competition in the health system.

Clark Havighurst
Duke University

Economists have recently shown that unit prices for health care in the United States substantially exceed those in other countries. In addition, the U.S. private sector pays higher prices for health services than Medicare and Medicaid. Although government's monopsony power might explain both circumstances, there are reasons to believe that high private-sector costs in the United States are a consequence of monopoly and weak competition. Indeed, hospitals appear to exercise monopoly power in many lines of business, and some pharmaceutical patents confer valuable monopolies.

Although high monopoly prices normally tend to misallocate resources by discouraging consumption of the monopolized good or service, health insurance minimizes this effect in the health sector by enabling patients to pay inflated prices. It also, however, enables monopolists to charge higher prices than they could charge in its absence. The problem lies not with health insurance as such but with the kind currently found in U.S. markets.
As a practical matter, American health insurers simply cannot refuse to pay for a desired service or product for which there is no close substitute on the ground that the price is too high. Monopolists are thus invited to charge health plans even higher prices, with only limited consumer cost sharing acting as a constraint on effective demand. With insurers competing only to provide easy access to all "medically necessary" services (and not optimal value for the premium dollar), monopolists in health care markets can expect to earn more than normal monopoly profits at premium payers' expense.

Some people are comforted because non-profit monopolies use their profits to cross-subsidize other health-related activities. Indeed, to qualify for tax exemption, non-profits must channel their profits to uses within the health sector even though those funds may have better uses elsewhere in the economy. These circumstances enable non-profit firms to grow very large and to operate with little accountability to consumers or to government. Over time, vast resources, first earned as monopoly profits, become permanently trapped in the health sector.

In addition, because U.S.-style health insurance may enable a monopolist to reap more than the marginal social value of the goods or services it sells, health care firms may be induced to overinvest in gaining and defending monopoly positions--by obtaining and exploiting biotechnology patents, for example. Although monopolies normally tend to cause underproduction, in health care they tend to have the opposite effect, funding or inducing activities that may be relatively low-priority in the context of the economy as a whole.
As serious as these misallocative effects seem to be, the redistributive effects of health care monopolies should be of even greater concern. The burden of the excess spending that U.S.-style health insurance permits or induces by facilitating the exercise of supplier/provider monopoly power is ultimately borne by working Americans in the health insurance premiums their employers largely pay on their behalf. Distributed more or less equally across premium payers (and not in proportion to their incomes), this burden falls as a hidden, regressive head tax on all workers having health coverage. In a time of legitimate concern about widening income disparities, this unfairness deserves to be rectified.

If the problem identified is to be remedied, American workers need to be given new market opportunities both to economize on their own health care and to stop contributing the excess resources on which the health care industry so freely feeds. Better choices in the marketplace would be more likely to materialize if something were done about the tax exclusion of employer-paid insurance premiums. Perhaps President Bush's second-term tax agenda will include a rollback of the tax exclusion with the express purpose of giving lower- and middle-income workers better control over how their limited incomes are spent.

AEI research assistant Ximena Pinell prepared this summary.

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AEI Participants




John E.
  • Economist John E. Calfee (1941-2011) studied the pharmaceutical industry and the Food and Drug Administration (FDA), along with the economics of tobacco, tort liability, and patents. He previously worked at the Federal Trade Commission's Bureau of Economics. He had also taught marketing and consumer behavior at the business schools of the University of Maryland at College Park and Boston University. While Mr. Calfee's writings are mostly on pharmaceutical markets and FDA regulation, his academic articles and opinion pieces covered a variety of topics, from patent law and tort liability to advertising and consumer information. His books include Prices, Markets, and the Pharmaceutical Revolution (AEI Press, 2000) and Biotechnology and the Patent System (AEI Press, 2007). Mr. Calfee wrote regularly for AEI's Health Policy Outlook series. He testified before Congress and federal agencies on various topics, including alcohol advertising; biodefense vaccine research; international drug prices; and FDA oversight of drug safety.


Robert B.
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