Incomplete Vertical Integration in the Health Care Industry: Pseudomarkets and Pseudopolicies

Abstract

Most economic relationships are either arm's-length exchange transactions, each party seeking his or her own interest, or command structures, such as a firm or public agency, integrating joint efforts toward a common goal. The health care industry, however, displays a pattern of incomplete vertical integration—relationships which are neither truly arm's-length nor completely hierarchical. The doctor-patient relationship is archetypical. Physicians appear to sell services in private markets; yet they reach through the exchange process to direct the consumer-patient's utilization decisions, implicity undertaking to act in the patient's interest, and thus integrate forward. But they also integrate backward to control the public regulatory process—self-government—and some forms of insurance. The health care systems of different countries—Canada, the United Kingdom, and the United States—can be interpreted as different patterns of incomplete integration among five basic classes of transactors: consumer-patients, first-line providers, second-line providers, insurers, and governments. Each system of linkage has characteristic strengths and weaknesses. Nowhere, however, do we find a predominance of arm's-length market relationships. Where they exist, markets in health care are usually pseudomarkets dominated by one side of the transaction. The rhetoric of market relationships serves principally to obscure political struggles over shifting patterns of integration.

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References

1. This concept of agency must not be confused with the agent in the literature on principalagent problems—for example, sharecropping, or defense contracting. In the principal-agent problem selfish transactors with independent utility functions participate in a non-zero-sum game in which the principal's payoff depends on the agent's action, but the principal can define the payoff framework. In the professional relationship, by contrast, the professional agent's objective function includes the client-patient's health, welfare, or other characteristics. The test question is, If an action that is totally undetectable and that transfers wealth from principal to agent is available to the agent, will it be taken? In the principal-agent literature, yes. In the professional agency concept, no, or at least not always. Otherwise the concept of a professional has no meaning, and its special regulatory status has no justification.

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The importance of the agency concept was clearly brought out by Kenneth J. Arrow , “Uncertainty and the Welfare Economics of Medical Care,” American Economic Review, 53(5):941-973 (Dec. 1963); but it has dropped out of much subsequent work. The application of the label “uncertainty” both to unforeseeable future risks—insurable—and to incomplete present information—requiring agency—was unfortunate. Efforts have been made to support conventional demand analysis by assuming perfect agency—the consumer as physician-patient pair, and thus fully informed—or generalized agency. Perfect agency, apart from the direct evidence against it, undercuts all economic theories of professionals qua principals. Generalized agency is a concept that havers between perfect agency and nonagency without committing to the critical notion of incomplete agency. Operationally, it seems indistinguishable from perfect agency.

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10. Alain C. Enthoven , “The Behavior of Health Care Agents: Provider Behavior,” in Health, Economics, and Health Economics, ed. van der Gaag and Perlman , pp. 173-188.

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11. Theodore R. Marmor , Donald A. Wittman , and Thomas C. Heagy , “Politics, Public Policy, and Medical Inflation,” in Health: A Victim or a Cause of Inflation? ed. Michael Zubkoff (New York: Prodist, 1976), pp. 299-316.

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12. Stigler has pointed out, with apparent approval, the conservative bias of economic theory; see George J. Stigler , “The Politics of Political Economists,” Quarterly Journal of Economics, 73:522-533 (1959). If one starts from normative assumptions of consumer sovereignty and positive assumptions of complete information, zero transaction costs, and dynamic stability, one moves quickly to the position that whatever is, is right, and the market, like Pangloss's Providence, yields the best of all possible worlds. Some technological questions must be finessed to get to competitive market structure, but if information really is perfect, and transaction costs are zero, then these problems disappear. The only villain in the piece is government. Such analysis is, of course, marketable.