Health care presents unique challenges to elected officials. Without some public regulation, market failures will lead to consequences many voters would find unacceptable, as Kenneth Arrow explained long ago in a seminal essay. Among the problems that inevitably arise is the collision of risk aversion among consumers, which leads them to seek insurance protection against expensive medical services, with the ability of insurers to steer clear of potential customers who can be identified as high risks because of their health conditions. Without governmental intervention, the market will drift toward restricted access to care for the very sick. Public regulation and subsidies are the tools all countries use, including the US, to address this unavoidable problem.

But these challenges in the market do not mean that the only viable system is one based on full governmental control, which itself carries risks owing to the predictable failings of regulations written and overseen by politically sensitive officials. Advanced economies have tended toward strong centralization but many are not monolithic. There is room in some of them, such as in Germany and Switzerland, for non-governmental institutions to play significant roles too.

The US occupies a unique position on this policy spectrum. None of its peer countries allow as much space as the US for private insurance and privately-owned systems of care provision to engage directly with consumers and patients beyond the reach of full public regulation. Even so, the US does not have a “free market” for medical services, as critics so often state incorrectly. There is substantial regulation, and hefty public subsidization too. The result is best seen as an unruly public-private non-system with requirements written based on changing historical conditions and no overall plan guiding their evolution.

At the center of this complex mix of federal and state programs and regulations is a vast network of hospitals, physician practices, nursing homes, and other institutions that are both highly skilled and technically competent and thus capable of world-class care. But its fragmentation and complexity also lead to excessively burdensome costs, paid through high premiums and expensive public programs. For years, the US has spent far more on health care than any other high-income country, as documented by data compiled by the Organization for Economic Cooperation and Development (OECD). In 2022, the US spent 56 percent more than the next highest-spending country—Switzerland.

The heavy burden these costs impose is the principal failing of the US system and the one that still needs to be addressed in a coordinated fashion. The challenge is to create new structures that inject durable cost discipline into the provision of medical services without eroding their quality and timeliness. That should be possible as studies show that much of the high-cost burden is associated with irrational pricing in some settings, frequent occasions when services are rendered to patients despite scant empirical evidence of their efficacy, and heavy administrative overhead and maddening levels of paperwork.

There is an opportunity here for proponents of a market-oriented solution to show they have a plan for attacking this problem, but they need to frame the debate properly in order to win it. What’s needed is not one-off ideas but a system change that incentivizes continuous productivity and quality improvement in the processes governing patient care. Market proponents must convince voters such a system change is more likely to occur with their ideas and not with more centralized government control. It is a tall challenge, but not an impossible one.

What’s at Stake?

The provision of medical services to patients in the US is conducted mostly by privately-run hospitals, physician practices, labs, clinics, and diagnostic centers. It is an uncoordinated system operating without the guidance of a coherent overarching plan. While its default setting is to deliver high-quality care, exorbitant bills are also the norm, as fees are set without any apparent connection to the marginal costs of providing the services, as would be the expectation in a functioning market. Patients are also on the receiving end of substandard care in far too many instances, owing to gaps in coordination among those providing services and the inaccessibility of care in some circumstances.

Despite a plethora of potential targets for cost-cutting, easing this burden has proved elusive. A major obstacle is the difficulty of separating what is wasteful and expendable from the essential. Without processes capable of making such careful distinctions, cost-cutting risks eroding the quality of care provided to patients.

An additional problem is the misidentification of the core challenge. Some opponents of a stronger governmental role believe the solution is the easing of rules that would allow healthier individuals to buy less expensive insurance. Lowering their premiums, however, often means higher costs for those with pre-existing conditions, not a lowering of the overall bill. While some steps in insurance deregulation might be helpful, the primary forces driving high costs are the expenses incurred by major health systems delivering services to patients. To put a real dent in costs, these mega-systems must become more efficient on a continuous basis. As in other markets, innovations that lead to new ways of providing services at less cost would deliver substantial societal benefits by lowering the total cost burden without harming the quality of care provided to patients.

The primary mission for policymakers is thus devising reforms that lead to a continuous search for more efficiency and higher productivity in the provision of services to patients. Market interventions that lead to such improvements are not the strong suit of government regulators. Consequently, there is an opportunity here for market advocates to make their case.

The Government’s Options

Over the past decade, the imperative to improve the efficiency of the nation’s entire network of medical care institutions has led the government to attempt a re-engineering of the system based on a vision the government itself developed.

Falling under the heading of “value-based” payment reforms, the federal government has encouraged hospitals and physician groups to form new entities dubbed “accountable care organizations,” or ACOs, which are said to have the potential to deliver better care at less cost by eliminating unnecessary expenses.

The exact channel for the efficiency improvements of ACOs has been harder to pinpoint but the idea is that the government can incentivize a transformation by using its regulatory powers to reward those ACOs capable of meeting the government’s cost and quality objectives. Successful ACOs get bonus payments. The government is also running a series of experiments to test other cost-cutting models.

After a decade of experimentation, the evidence is thin to non-existent that the government has found the right formula. As is often the case with regulatory initiatives, it is hard to write nationwide rules that work in all markets, or which are nimble and flexible enough to provide room for entrepreneurial initiative. Some ACOs show promise, but most exist to help hospitals and physician groups maximize their revenues without fundamentally changing their business plans. Further, the rules tend to cater to incumbents and the protection of their financial viability at the expense of truly innovative but also disruptive competitors.

Disappointment with existing results is leading to renewed interest in policy levers that are more clearly within the government’s competence—price controls. Beginning in the 1980s, the federal agency running the Medicare program developed regulations for various categories of services that set payments based on numerous sources of data, such as historical costs and other measures of expected expenses for the inputs of patient care. Providers of covered services are required to accept these payments in full when agreeing to be participants in the Medicare program.

For those who might be concerned about the US adopting a health system under full federal control, they must coalesce around a viable alternative.

Proponents of a strong federal role in cost control want to extend the reach of these payment rules to the commercial setting, and thereby dramatically lower the cost burden in private insurance. It is well documented that many commercial insurance plans pay rates for services are far above what Medicare pays for its enrollees. For instance, several recent studies have shown that commercial insurance plans pay, on average, more than double what Medicare does for inpatient hospital care.

What’s more, price setting by the government polls extremely well, with large bipartisan majorities expressing support for aggressive action by Congress. If the federal government were to step in and cap what hospitals can charge, it would meet with little resistance among the patients needing these services.

The allure of public price-setting beyond Medicare is what animates the drive to set up a new “public option” health insurance plan to compete with private offerings. Several states—including Washington and Colorado—are experimenting with tying certain private plans with publicly-determined rates for services and calling it a public option.

Of course, hospitals fiercely object to having all of their rates capped by government rules, as do physicians who would face cutbacks similar to those that would occur for hospitals if Medicare’s fees were extended to all commercial insurance. Further, the regulations required to make public option plans viable risk driving away private insurers that are attentive to their bottom lines. Opposition from these industries and other providers of services is the principal reason public option plans are still not approved in most states and have not been approved by Congress either.

While government-determined price caps are guaranteed to lower costs for consumers, it does not necessarily follow that they will lead to the more efficient provision of care. For instance, providers of services might respond to price caps by simply reducing their expenses on an indiscriminate basis so as to not offend their internal constituencies. Rethinking their workflows to cut unnecessary outlays is harder work than across-the-board cuts and the added effort does not necessarily lead to better market outcomes because total revenue for these entities will be determined more by government rules than by consumer preferences.

Further, once in place, government price caps become tempting targets for further budgetary savings. In Medicare, physician fees have been cut repeatedly for three decades in response to budget pressures, to the point that they are now 40 percent below the average fees paid by commercial plans. It is easier politically to cut fees for providers of medical services than it is to raise taxes or ask patients to pay more for the care they receive.

The cumulative effects of such cuts in fees can lead to access problems for patients, as has been observed in many other countries with fully nationalized systems. The wait lists in the UK are a direct consequence of running the entire budget for the health system through a political process. The same problem manifests itself in Canada too even though the providers of services are not owned and staffed by the central government. It is an unavoidable reality of price setting that the supply of the affected services tends to fall when the revenue for the industry comes under the full control of the government.

A Structured Market

The alternative to stricter payment controls enforced by the government is a market with rules designed to incentivize the reengineering of care processes to eliminate unnecessary expenses. The providers most successful at improving their productivity would be able to offer lower prices to customers, which, with the right rules, could lead to growth in their market shares.

There are two key considerations when structuring these markets: standardization of the products and services, and strong financial incentives for consumers to select lower-priced options. Neither condition exists in the US today.

Standardization is critical because health care is so complex that variation obscures pricing differences. For instance, a consumer will find it nearly impossible to identify the lowest-priced option for a surgical procedure if the prices cited by the competing surgeons vary by whether or not the anesthesia and radiological services are included or excluded from them. With standardized bundles set by government rules, providers would have to disclose what they would charge for their services in a market that would allow consumers to compare the offerings on an apples-to-apples basis. The highest-priced providers would have trouble explaining why they are outliers.

The other crucial ingredient is an incentive for the consumer to want to use lower-priced providers of services. For instance, if a surgeon charges $1000 less than a competitor in the same market, patients must share in the savings when they opt for the lower-priced provider. Otherwise, there would be no incentive for the affected surgeons to offer competitive prices as doing so may or may not lead to higher volume and more revenue.

The benefits of writing such rules for the market are not mysterious or unknown, as they have been revealed by various targeted experiments over the years. When a large California-based purchasing system imposed standardized pricing requirements on surgeons offering joint replacement procedures, and then also built strong consumer incentives into the model to encourage migration to lower-priced options, the savings were immediate and dramatic, with patient volume dropping at high-priced providers by more than a third and rising at lower-priced alternatives by more than 20 percent.

These same principles also work when consumers are selecting insurance plans. With standard offerings, and incentives to migrate to lower-premium plans, insurers would have strong incentives to build provider networks that offer high-quality services with the lowest possible prices.

Making the Case

The provision of medical care to patients now accounts for about 20 percent of the US economy. One way or another, the financial burdens this sector imposes on consumers need to be disciplined so that scarce resources that could be used for other purposes, such as housing or educational advancement, are not wasted on over-priced and low-value health care.

The only question is what intervention will be chosen to bring about this discipline.

For many decades, there has been a steady movement toward federal control of the US health system. Public subsidies have grown, as have the rules restricting what is and is not allowable among those providing services to patients. It is not hard to imagine Congress taking the final steps toward full price regulation of the entire system, by extending the rules already embedded in Medicare to the commercial market. Once Congress makes such a choice, it will not be reversed quickly or easily or perhaps ever.

For those who might be concerned about the US adopting a health system under full federal control, they must coalesce around a viable alternative. Market discipline is possible but only with rules that make it clear to all concerned who is offering the best value to patients, and who is not, and then rewarding those providers who have done the hard work to become more productive and efficient over time.

Without the presentation of such an alternative, the endpoint for US health care is clear. The only uncertainty is how long it will take to get there.