The big cost of big medicine – calculating the rent in private healthcare

ABSTRACT

As a country, the United States spends significantly more on healthcare than other advanced industrialized countries, and Americans have comparably worse health outcomes. Both are developments of the last four decades. In this paper, we look at how change in antitrust and patent law and thus change in market power in the largest four subsectors of healthcare, hospitals, physician groups, prescription drugs, and net medical insurance, have contributed to the increasing cost of medical care in the United States. We show that the annual rent – the degree to which health care is overpriced as a result of market power – was between 2.47 and 4.30 percent of GDP in 2016 – truly a big cost for big medicine.

KEYWORDS:

• Healthcare
• antitrust
• patents
• market power

JEL CODES:

• I11
• I18

Acknowledgements

Thanks to Gerald Friedman, Dean Baker, Gerald Epstein, Andrew Lopez and the two blind reviewers from the Review of Social Economy for help and comments on the paper.

Disclosure statement

No potential conflict of interest was reported by the author(s).

Data availability statement

The data used in this paper is all publicly available and can be found using the in-text references.

Notes

1 Data on total healthcare spending as a percentage of GDP and life expectancy at birth is taken from the OECD database (https://data.oecd.org/).

2 The idea of freedom to wield market power was developed by Galbraith (1952). He argued that where competition was missing on the same side of the market, the negatives from monopolistic or monopsonistic activities could be stymied through countervailing power – i.e. market power on the other side of the market.

3 These can be seen in the Horizontal Merger Guidelines (HMGs) issued by the DOJ in 1982 and 2010 compared to that issued in 1968. For discussion changing definition of horizontal merger law, see Stelzner and Chaturvedi (2020). For actual HMGs, see the DOJ website: https://www.justice.gov/atr/merger-enforcement.

4 64 Stat. 1125 (1950), 15 U.S.C. § 18 (1958), amending 38 Stat. 731 (1914).

5 A vivid example of this system is given by Roy and King (2016) in the price outcomes of Sofosbuvir medication for hepatitis C infection.

6 A global-budget system, which exists in Canada and not the United States, is where hospitals and the government negotiate annual expenditures for hospitals.

7 $HHI={\sum }_{i=1}^N{\theta }_i^2$.${\theta }_i$ is the market share of the $i$th firm in the industry. N is the total number of firms in the industry. Market shares always sum to 100 percent: ${\sum }_{i=1}^N{\theta }_i=100.$ Thus if $N=1$, i.e. there is a pure monopoly, the HHI of the industry is 10,000. In perfect competition, where it is assumed that each firm has an infinitesimally small market share, the HHI for any industry is zero.

8 Gaynor (2011) leaves out MSAs with a population of more than three million because large cities may have multiple hospital markets for their constituents inside the same MSA.

9 The 2010 report by the Office of the Attorney General of Massachusetts find similar variation in prices paid to health care providers by medical insurance companies.

10 This is the case where increased concentration leads to insurance companies passing on some of the benefits from decreased cost via exercising monopsony power. However, given trends in the cost of net medical insurance, premiums minus costs, and given other studies on the subject, it doesn’t seem that this case is common in the United States.

11 To some degree recent changes in law have put an upper limit on medical insurers’ ability to increase premiums even in the face of decreasing cost of medical care. Under the Affordable Care Act of 2010, insurers are required to spend at least 80 percent of their premiums on medical care. However, both Obama and Trump granted some waivers allowing for certain insurers to spend less than the required 80 percent.

12 https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/index.html.

13 Scaling the results on price found in micro studies to calculate the aggregate effect over the last 40 years has some problems. For example, in each of our three counterfactual estimates, the price effect from a given change in concentration is constant across levels of concentration. However, a basic Cournot N-firm model or a multiperiod limited capacity and price competition Bertrand model of concentration and pricing yield a price effect from concentration that grows as concentration grows. At the same time, scaling using growth accounting provides a good estimate for a number of reasons. First, as mentioned above, our counterfactuals for a given subsector stem from estimates of the change in price from a change in concentration in the same subsector. Second, most of the studies we survey are nationally representative. Third, as also mentioned above, we provide three counterfactuals based on different price effects to give a broad view of the aggregate effect from increased market power in healthcare.

Additional information

Notes on contributors

Mark Joseph Stelzner

Mark Joseph Stelzner is an economics professor at Connecticut College. He works on an array of topics from documenting changes in labor laws, to analyzing the connections between slavery and capitalism, to modeling wage discrimination and collective action.

Daniel Taekmin Nam

Daniel Taekmin Nam is a senior undergraduate student at Connecticut College. He an Economics major and an Applied Statistics minor. His research interests are in inequality and developmental economics.