What Is the Best Role For Government in Health Care?

The other day I had a post on an ingenious entrepreneurial solution to the problem of imperfect information in the market for physicians’ services. One of the commenters was Nobel Laureate Kenneth Arrow and I have republished his remarks below.

But first I want to focus on a broader set of issues. Most discussions of health policy in recent years have focused almost exclusively on getting people insured and (if they are sick) keeping them insured. Today I want to ask about everything else the government is doing:

  • Beyond some minimal level of catastrophic coverage, should the government encourage third-party insurance over individual self-insurance (say, through a Health Savings Account)?
  • Should it require coverage for specific services (such as chiropractic care or preventive medicine)?
  • Should it regulate every aspect of the health insurance contract, or should regulation of health insurance look more like regulation of life insurance?
  • Should it encourage employer-based coverage rather than individually-purchased insurance?
  • Should it encourage non-portable group insurance over individually-owned, personal and portable insurance?
  • Beyond certification of basic skills (consistent with the government’s duty to prevent fraud), should the government impose restrictions on what such non-doctors as nurses, paramedics and pharmacists can do?
  • Should it prevent practitioners licensed in any one state from practicing medicine in every other state — unless they are licensed there as well?
  • Should it prevent health insurance licensed in any one state from being sold in every other state unless licensed in those states as well?
  • Should it regulate every aspect of hospitals and nursing homes, or should regulation be no more intrusive than the rules that apply to a typical downtown office building?

Loyal readers of this blog know that government is deeply involved in all of these areas and in every case the decisions it makes are very, very bad. My solution: Get government out of the business of regulating health care. Government policy should be one of neutrality and laissez faire. It should not bias choices or restrict them — at least no more so than in markets for other professional services.

We frequently hear that health care is special. I don’t disagree. But that specialness does not prima facie warrant regulation. To the contrary, because of the specialness of health care it is extra important that politicians and special interests not be allowed to muck things up. As it turns out, almost all the special regulation in health care has left us worse off than if it had never been legislated in the first place.

On the other hand, here is Professor Arrow:

The statement that competition may mitigate the effects of asymmetric information is certainly true, and I don’t think I ever said anything to the contrary. I do maintain that usually, and certainly in the health industry, competition is at best a partial solution and does not obviate the need for public policy to add to market discipline…

Consider the purchase of a complex consumer good, say an automobile. Here, there may well be asymmetric information. The company can keep records of complaints about its products and may know fairly well the probability of a failure in some aspect. The buyer knows nothing at time of purchase and may acquire only a limited knowledge from experience. If there is a failure, our system relies on a non-market mechanism, namely, civil litigation. This could of course be countered by the seller’s announcing in advance the possibility of failure, as pharmaceutical manufacturers do regularly. The point is that competition is only a partial substitute for asymmetric information. The possible disutilities and the asymmetry of information are much greater in the case of medical services…

I have two responses to this. One is theoretical; the other is empirical. Let’s take the empirical evidence first.

There may be market failure in health care. But as I documented years ago, this sector is so completely dominated by government failure that market imperfections pale by comparison.

What is the primary result of government’s involvement in this sector? It is the overwhelming presence of third-party payment of medical bills — created directly through Medicare and Medicaid or encouraged indirectly through the tax exclusion for employer-provided insurance. And what is the result of that? It is a sector where there are no real prices and therefore where there is no real price competition. And, as I have shown elsewhere, when you don’t have price competition, you don’t have quality competition either.

All of this of course creates perverse incentives — for everyone. And when people act on those incentives they do things that make costs higher, quality lower and access more difficult than otherwise would have been the case. Virtually everything the government has been doing in health care in recent years is an attempt to ameliorate the bad effects of people acting on the perverse incentives created by previous government policies!

By contrast, Devon Herrick and I have shown that wherever third-party payers are absent (or at least unimportant) health care markets work really well. For example: cosmetic surgery, Lasik surgery, international medical tourism, domestic medical tourism, walk-in clinics, free standing emergency care clinics, telephone and email consultation services, concierge medical services, online mail order pharmacies, etc. (See The Market for Medical Care: Why You Don’t Know the Price; Why You Don’t Know about Quality; And What Can Be Done about It.)


Bottom line: where patients are spending their own money and government is least involved, health markets work best. Where government-created or government-encouraged third-party payment dominates and where government is most involved in other ways, health markets perform very poorly.

Now for the theoretical point. It is not correct to say that government can in principle improve upon the market if you cannot produce a model of political decision-making that can plausibly produce those improvements. Phil Porter and I have shown that as long as public policies compete against each other for the political support of people affected by those polices, the conditions for optimality are so extreme they will never be met.

In other words, government failure is normal. And the expected distortions are not small. They are large.

Comments (43)

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  1. Ken says:

    Another great piece.

  2. Dewaine says:

    “There may be market failure in health care. But as I documented years ago, this sector is so completely dominated by government failure that market imperfections pale by comparison.”

    Advocates of public intervention in the market hold to the idea that, although the government is inefficient now, it is still worth pursuing because it could exceed the performance of the market if policies makers have the right experience, technology, etc. Goodman and Porter are right to point out that the conditions for optimality will never be met.

    • JD says:

      I think that their point that “government failure is normal” is correct, although I think it goes even deeper than they proved. People are imperfect and power corrupts them. Centralizing decision-making will always lead to corruption and perverse incentives.

      • Dewaine says:

        “All of this of course creates perverse incentives — for everyone. And when people act on those incentives they do things that make costs higher, quality lower and access more difficult than otherwise would have been the case.”

        This is the inevitable result of government intervention. It works the same way as price controls in a simple supply/demand graph.

        • Samuel says:

          Isn’t this assuming there is less corruption in the market? This may not always be case. There is plenty of corruption in any man-made entity.

          • Dewaine says:

            In the market people are free to choose where there money goes, that freedom is much more hampered in government. Less ability to choose = more corruption.

            • Samuel says:

              In a pure market perhaps, but there isn’t and won’t ever be a pure market or any other form of pure ideological system.

  3. JD says:

    “Virtually everything the government has been doing in health care in recent years is an attempt to ameliorate the bad effects of people acting on the perverse incentives created by previous government policies!”

    One of the most important things for people to learn. Everybody is always clamoring to “do something” about our problems. People need to know what that means.

    • Dewaine says:

      Right. Our nation has 300 million backseat drivers lobbying for different things or just action in general. No wonder the car is teetering over a cliff.

  4. Ralph says:

    “All of this of course creates perverse incentives”

    -This is what we need to stop!

  5. Ralph says:

    “In other words, government failure is normal.”

    – This is always to be expected

    • Tom says:

      No, doubt. The government manages to mess up even the most remedial tasks.

      • Dewaine says:

        Of course it does, but will it continue to do so forever? Do you think that there may come a point in human evolution, technology, etc. where government is capable enough to regulate activity?

        We need to settle this issue. Even staunch-government supporters realize that it is inefficient more often than not, but they think that it can become good with practice, so the temporary pain is worth it. What do you guys think?

        • Samuel says:

          Government won’t go away, like it or not. It does provide a sense of order, like or not. So, the key is to find balance where government doesn’t overreach it’s power and capabilities and work with the private sector on areas it is more effective in.

          • Dewaine says:

            I agree with you. Obviously we will always have some form of government, but I think that we should try to limit it’s influence. Many people think that government can become more efficient than the market in general and that government will eventually be able to make “more optimal” decisions for people, do you think that is true?

  6. Harry Cain says:

    John, this morning’s WSJ had a piece on a new WellPoint strategy — have employers provide their employees a fixed amount to buy various medical goods, then give them info on what various providers charge for those goods, then let the employees decide where to spend their money. Looks like the pain of years of unsuccessful health policy is finally forcing employers to do the obvious. Let’s hope it catches on.

  7. Nick says:

    It seems that Prof. Arrow is employing the academic technique of not addressing your point while phrasing his response in a way that implies he is addressing it.

    He seems to be speaking to people who would argue that the state has NO role in health care markets. Constructing a hypothetical instance in another industry where state intervention is helpful, of course, in no way proves his point, and it’s a little shocking that he’d think it would. But more to the point, his argument in no way speaks to the state-caused micro-regulations and distortions that we see today. You don’t appear to be arguing that the government should be entirely removed from medicine (I would, but reasonable people can disagree on this), but that it’s role should be radically re-evaluated. And Prof. Arrow completely misses that point.

  8. Devon Herrick says:

    I liked Professor Arrow’s example of an automobile. Cars are indeed complex consumer goods. The automaker may know their own failure rates, but not necessarily publish them. However, there are third-parties who will track failures. Edmunds.com, Consumer Reports, and Road & Track, etc. Magazines especially may loath to criticize automakers since magazines rely on advertisers. But information still seeps out. For instance, most car buyers know that Japanese cars tend to be well made and reliable. With the exception of recall in the past couple years, Toyota is a case in point. Consumers tend to understand that American cars are less reliable but getting better (probably due to competition). German cars are prestigious and reliable, but not always as reliable as Japanese cars. However, expensive repairs are just part of the experience owning a BMW or a Mercedes. A few years ago the Korean automaker, Kia, tried to communicate the message that it was not a fly by night purveyor of low-quality cars by offering a 100,000 mile warranty. It undoubtedly knew what its cost would be for such a warranty. It also had an incentive to identify and fix design flaws. In health care malpractice liability may also provide an incentive. But competition also plays a role. Unfortunately, we have too little competition in health care because (I believe) of excessive third party payment.

    • Politics Debunked says:

      Yup, that is related to a point I was going to make. There is a market opportunity for people to address asymmetric information by providing informatin like Edmundset al do. Manufacturers have incentive to compete to find ways to bypass the asymmetric information problem by providing consumers with more information to get people to buy their products, and to find ways to have third party or other reasons for people to trust that information. Obviously markets take time to act, but the internet will speed such processes.

      The problem is that now as you point out government reduces competition which reduces the incentive for such tactics since monopolies don’t need it and even oligopolies tend to be more complacent about their market share and not rocking the boat. Nobel laureate Ronald Coase recently wrote in Harvard Business Review that there seems to be an unfortunate disconnect between the thinking of many economists and the real world thinking of entrepreneurs. In this case they may find ways to address problems that economists just assume can’t be addressed by the market merely since they haven’t thought of a way to do so themselves, whereas of course others might.

      The other problem with the auto comment he made was: “If there is a failure, our system relies on a non-market mechanism, namely, civil litigation”. Obviously people could create contracts, or insurance, which will reassure a purchaser that there is no hidden information that will bite them as a way of gaining customers over other companies that don’t. The fact that something isn’t currently done in a particular case doesn’t mean it couldn’t be if the idea is spread. In addition of course there is a place for civil litigation, in some cases the answer to deterring fraud isn’t prevention but punishment, just as we punish theft and murder to deter those.

  9. David Stockman says:


    I much enjoy and appreciate your work. On pages 696-699 and 710 of my book, “The Great Deformation: The Corruption of Capitalism in America”, I present a rendition of the Goodman gospel that may be even too pure for Goodman: “In truth, employer-provided health insurance is one of the great deformations of our times, and is no more an honest form of free market insurance than Social Security pensions. Instead, it is a form of tax-subsidized cost-pooling in which overutilization, overpricing and free riding is endemic.”

    • wanda j. Jones says:

      Mr Stockman: You are right and you are noble to have written your book. It needs to be popularized down to the HR director of each company that enjoys the tax deduction. The question to be posed is whether their employees would like to have more income, and to decide how to spend it on healthcare. Can you imagine the reverberations throughout the country if everyone chose, not first dollar coverage of everything, but last dollar coverage of terminal conditions? In the middle would be annual memberships paid to a healthcare system to manage one’s risks and continuing conditions, but in a cohort/group format.

      Fundamentally, we will not get cost containment until we get a genuine constraint on the amount of money that flows into the healthcare system.

      What do we need in the 21st Centur;y, not just the 20th?

      Wanda Jones
      New Century Healthcare Institute
      San Francisco

  10. Al says:

    There is information asymmetry even among the physician population who are the experts in the field so I don’t see how government bureaucrats can suddenly reduce asymmetry among the general population when it hasn’t been done in the physician population. In fact many of the rules and regulations of government have been a major factor in preventing unscrupulous physicians from being condemned and sanctioned by the expert population (the physician) and in the process reducing information asymmetry.

    I think Professor Arrow is looking to create a new set of experts that have neither the skills nor the political independence to make the ongoing decisions that are needed. The market may not be perfect in solving the asymmetry problem, but there is nothing else that comes as close to solving it. Government always exists to help fill the cracks that might be created as long as it distances itself from the marketplace.

  11. Joe Barnett says:

    There is also a problem of asymmetric information when it comes to regulations. For example, consumers could assume that what regulators allow (ie., what meets the regulatory standards) is safe/healthy/fair/etc because those whose job is to regulate are paying close attention to what is being done in the regulated market, and have much more information than the individual consumer. Thus, consumers defer to FDA judgments, e.g. A market solution to this problem is competing standards (regulators), as this NCPA study by economist Noel Campbell suggests: http://www.ncpa.org/pdfs/st208.pdf Competing standards-setting organizations, warranties and money-back guarantees, refund policies, BBB ratings, etc., are ways in which the marketplace, when allowed, can provide information that minimizes the relevance of technical asymmetric information.

  12. Floccina says:

    Employer-provided insurance could almost be called forth party payment! Government should really, really not encourage it.

  13. Politics Debunked says:

    re:”It should not bias choices or restrict them — at least no more so than in markets for other professional services.”

    I’d suggest you are giving them too much credit by assuming they are regulating those other areas appropriately, rather than mucking them up as well. The Institute for Justice among others is constantly battling in court the restrictions places on various professions to limit competition and benefit those already in the field.

    Private competing certifications can address the issue of qualification assessment without the need for a 1 size fits all monopolistic government approach.

    I suspect you are aware of this and it was a minor unintended glitch, rather than underestimating the extent of bogus regulation in other niches the way people outside of healthcare underestimate how much of an over-regulated mess it is.

  14. Hallman, William says:

    What is the best role for government in health care? To die peacefully.

  15. Uwe Reinhardt says:


    You write:

    “Beyond some minimal level of catastrophic coverage, should the government encourage third-party insurance over individual self-insurance (say, through a Health Savings Account)?”

    How do you define “catastrophic” here. Is it a function of the patient’s income or just a flat amount, say, $10,000 a year, regardless of income?

    Also, would the HSAs be tax preferred, that is, make after-tax health care costs for a procedure lower for you and me, wealthy men, than for a waitress or cab driver? Is that what government should do?


  16. John Goodman says:

    @ Uwe Reinhardt

    Actually I would allow anyone to have a health savings account as long as they also have whatever the IRS considers credible health insurance.

    The economics of HSAs are basically independent of income, although they vary a lot by location.
    Almost everywhere, a $100 deductible plan is a waste of money. By raising the deductible to $1,000 you will save more than $900 in reduced premiums and you can put the premium savings in an HSA and come out ahead.

    Of course low-income families need money to put into an HSA. But that is no different than their need for money to pay premiums.

    HSAs should be treated the same way as premium payments are treated under the tax law. If premiums are excluded from table income, HSA deposits should also be excluded. If people receive tax credits for premiums and HSA deposits, the HSA accounts should be Roth HSAs.

    • Uwe Reinhardt says:

      Thanks John. But you did not define for me what “catastrophic” means in this context.

      Clearly we are talking about annual health spending that exceeds some threshold and for which one should have insurance coverage.

      So should the annual maximum out of pocket spending to which families are exposed be the same for all families, in dollar terms, or should it be related to family income?

  17. John Goodman says:

    @ Politics Debunked

    I agree with you about the other professions. They all seem to want their own medieval guild.

    @ Harry Cain

    I saw the WellPoint article. Sounds like something right out of my book Priceless.

  18. Bob Hertz says:

    When poor people do not have enough money for food, we give them food stamps rather than try to regulate the thousands of prices in thousands of grocery stores.

    When John talks about funding HSA’s for poorer people, I think this is what he has in mind. Call it vouchers, even call it medical food stamps.

    I would add rather gently, however, that I sure have not seen any such subsidies for HSA’s in any budget of Paul Ryan’s. If we were to give each family with income under $40,000 a sum of $2000 for their HSA, this would be a total federal outlay in the neighborhood of $80-$100 billion. I am OK with this, but will the GOP back this up?

    Let me add one quick technical correction to Dr Goodman’s comments (and I have brought this up before):

    The older one gets, the less premium difference there is between a low deductible and a high deductible. I speak as a former insurance salesman.
    Also, the longer you stay with one company, the higher your premiums get even for a high deductible contract. Health insurance companies offer a lot of “loss leaders” in first year premiums, and if this is the free market I think it stinks.

    • Vince says:

      The reason for your last remarks are because it is really not the free market. Most insurances are chosen by the employer and not the actual customer. If insurance was more portable and the consumer making those choices, you would see long standing and healthier customers benefitting such as you see with auto coverage – vanishing deductibles, rewards back etc.

  19. M. H. Wilson says:

    “Beyond certification of basic skills (consistent with the government’s duty to prevent fraud), should the government impose restrictions on what such non-doctors as nurses, paramedics and pharmacists can do?”

    Earlier this year I testified at a Washington State House Health Care Committee hearing and suggested that the state needed to reduce the barriers of entry for midwives and that over the next 20 years the state should have a goal of having 50% of births attended by midwives. That would result in a significant savings both in lives and in dollars.

    Just as one state cannot tax the products of another occupational licensing laws and other laws such as the McCarran-Ferguson Act and Certificates of Need are barriers to trade and need to be repealed.

  20. John Fembup says:

    “What Is the Best Role For Government in Health Care?”

    Whenever I make an appointment to see my doctor, I always remind myself that all medical care is local. So I invite my local town councilwoman to my appointment.

    She is then able to offer her suggestions, help my doctor with the really difficult decisions, and advise him how much he’s going to be paid for seeing me that day. There is no intrusive third-party payer in the exam room with us, intervening between me and my duly-elected local representative.

    To me, that is the best role for government in my medical care.

  21. John Seater says:

    It seems to me that Arrow’s argument is entirely abstract with no hint of whether the problem is large or small. It also seems to me that government intervention should not take place until some kind of empirical assessment of the magnitude of the problem that the intervention is supposed to correct and also some empirical assessment of any harm that the intervention itself will do. Then we can weigh costs and benefits. Arrow apparently has provided no empirical assessment of anything, leaving us hardly any better informed about what to do than before he pointed out the information asymmetry problem.

    In many cases, empirical assessment of costs and benefits will be difficult, but that does not mean we can just rush in with a government fix without trying to come up with some kind of honest assessment of costs and benefits.

  22. David Hogberg says:

    I’ve made this point before on asymmetrical information: It MAY be a problem in health care market, but as “compared to what”? Does the involvement of the government in anyway alleviate that problem? Rather, it exacerbates it with its thousands of pages of regulations that impact patient care. Doctors are far more familiar with those regulations since they deal with them on a daily basis–far more familiar than patients. So now patients are at an information disadvantage not only on medical knowledge but also on regulatory knowledge.

    Asymmetrical information may be a problem we just have to tolerate in medicine, since there may not be a remedy, and any government attempted solution only makes the problem worse.

  23. Nick Pandelidis says:

    I disagree with Kenneth Arrow. I would say civil litigation in fact is a free market force process. It is part of the rule of law enforcing contracts

    • Uwe Reinhardt says:

      I disagree with Nick.

      The way the Mafia settles contract disputes is a free market approach. It really works.

      Civil litigation uses a government agency.

      • Al says:

        The Mafia settles things through coercion and the Mafia chief is the one that has the most guns and power. If one wishes to make an analogy then the appropriate analogy to the Mafia is the government since it has the most guns and power and as we have recently seen with the IRS and other scandals can be the most coercive. On the other side of the coin is the market place that functions based upon rule of law. In this country rule of law is set and contract disputes are settled in independent courts of law.

  24. John Goodman says:

    Uwe: Free markets are consistent with anarchy? I don’t think so. One thing that is becoming clearer and clearer is that free exchange is not enough. In the informal economy of Peru there is freedom of exchange. But they are still poor because they lack the institutions of capitalism.

    An independent judiciary is one of those institutions. The common law is another.

  25. Celina says:

    Definitely we can’t deny with the fact that government plays an important role in health care system through which we are able to get beneficial health care support at regular intervals. Government interfere might be help to repair the current health care status and eligible to provide a quality health care service to the people. So we must welcome the role of government in every health care system.