The Rise of Market-Oriented Health Policy and Healthcare


Historical Analysis of Health Insurance explored several frameworks for understanding the evolution of American thought about health insurance; examined the belief of traditional reformers that health insurance should serve as one of a cluster of measures designed to secure citizens from the risks posed by capitalistic markets; suggested that, in an environment of escalating healthcare costs, doubts about the value of healthcare had led some reformers to stress its significance less for its substantive benefits than for its utility as an expression of social solidarity; noted the factors that undermined the special status of medicine and medical care; and indicated that medical care, in the eyes of diverse analysts, increasingly resembled other commodities traded in conventional markets. This article opens by characterizing the two broad forms that American proposals for market-based health policy initially assumed: one resting on modern economic analysis of the demand side of healthcare markets and the other, initially depending far less heavily on formal economic analysis, but reflecting the conviction that public purposes could better be realized through supply-side reforms. The article reveals the extent to which some of the founding ideas and concerns of health economics arose through analysis of the health sector when national health insurance (NHI) seemed imminent; and it briefly explores the consequences of these developments for the history of ideas about health insurance and for the development of healthcare markets on the ground. It offers conclusions about both the kinds of reform measures that American health policy has generated and role of economists in health policy.

From Advocating Care To Reforming Health Insurance

More than changing cultural perceptions of medicine helped elicit market-based thinking in health policy. From the late 1960s, and especially in the light of cost escalation that followed the introduction of Medicare and Medicaid, American healthcare became the subject of scrutiny that began to reveal shortcomings that would have to be remedied under any system of NHI. Cost escalation, the most pressing, was in a sense only a symptom of increasingly nonfunctional features of American healthcare. The health sector appeared to be an uncoordinated profusion of chiefly solo or small-group physician practices; freestanding, independent hospitals; and a diversity of public and private insurance programs. The fragmentation of the health sector, its maldistribution of resources, and its inability to tailor resources to needs on a community level or services to individuals in and among local institutions constituted a set of problems that experts as well as the public hoped to remedy. Pressure for NHI, that is, had become transformed into pressure for broad reform of the health system.

Until the end of the 1970s, NHI had seemed imminent, although in retrospect the apparently close but still abortive effort to achieve it in 1974 brought its short-term prospects to an end. For many traditional reformers, planning and regulation that they expected to take root under NHI would provide the levers to rationalize the distribution and deployment of resources and rein in costs; the resultant efficiency gains would provide the resources to expand and improve entitlements to health services. In their view, system reform amounted to more extensive and more thorough-going application of traditional policy means. However, other analysts of cost escalation and fragmentation exploited the prevailing interest in NHI as a vehicle to introduce novel ideas about the utility of markets and competition to solve the problems of healthcare. Two clusters of proposals emerged from their efforts: Reform of the demand side of the market through the imposition of increased cost-sharing under insurance (that is, increased out-of-pocket expenditures for insured individuals and families), combined with subsidies, graduated inversely with income, to insure the poor; and reform of the supply side of the market by creation of health maintenance organizations (HMOs) or other health plans that combined the delivery of healthcare and the insurance mechanisms to finance it. The roles of economics (and some other social sciences) in early studies of health insurance can be examined by tracing the emergence of these two categories of proposals.

Income-Graduated Cost-Sharing

Within economics it was the application of formal doctrines that increasingly subsumed healthcare under the rubric ‘commodity.’ The implications of the change emerged in at least two stages, one in which traditional advocates of NHI began to apply to healthcare (among other areas of policy) formal rationales for governmental provision and a second, in which skepticism about governmental provision combined with economic analyses to undermine the case for the specialness of care and therefore suggest the propriety of its subordination to market arrangements.

The first stage is represented by the tradition of publicexpenditure analysis, which emerged in the 1960s as part of the effort to rationalize governmental financing or provision of public services. Whereas an economist like Seymour E. Harris (1897–1974), in his study of American medicine, exemplified traditional advocacy for increasing the quantity, improving the quality, and rationalizing the distribution of health services, Herbert Klarman (1917–99), in a major, early review of health economics, maintained that only those health programs that made better use of resources than alternative ones could find economic justification. However, this orientation did not deflect needs-based analyses. Animated by concern for the social costs of lack of care, analysts regarded care as an investment in human capital and exploited the cost-benefit principles previously developed in analyzing governmental investments in water projects. Needs-based thinking had supposed that the demand for care depended all but exclusively on epidemiological, scientific, and technological factors; but a more dispassionate economic analysis provided evidence that care resembles other commodities in that its demand also depended on the economic variables of income and price (i.e., demand for care exhibited income and price elasticities). Nevertheless, from a needs-based perspective, such evidence could be reinterpreted: to recognize that insurance (a price subsidy) improves access to care is less to acknowledge the price elasticity of demand than to welcome the shift brought by insurance of a deprived population into the ranks of those able to acquire one of the necessities of life. Similarly, income effects among the insured wealthy need not have been taken to imply the dependence of demand on price. The wealthy buy more services because they have more education and appreciate more the value of care. From a needs-based standpoint, evidence for the commodity-like behavior of care therefore carried little weight, and it authorized reliance not on novel markets but on planning. Indeed, one of the economically characteristic features of healthcare, informational asymmetries, and the consequent dependence of patients on experts, only reinforced the conviction that nonmarket arrangements were preferred, if not indeed necessary.

Although cultural changes noted in the previous article helped divest care of its special characteristics, developments within the social sciences fostered a reorientation among formal analysts of public policy. A novel and powerful approach to analyzing both politics and policy, known as ‘public choice,’ particularly as undertaken by one of its founders and leading lights, James M. Buchanan (1919–2013), suggested that the virtues of public provision had been overrated. In a study of public goods, Buchanan revised the case for special social arrangements, especially public provision and production of certain goods. Acknowledging the desire of some citizens to increase the consumption of particular goods by all citizens, he could treat the individual’s consumption as enhanced by an external benefit. His analysis suggested, moreover, that unlike cases such as national defense or fire and police protection, such ‘externalities in consumption’ need imply no monolithic supply, for example, governmental provision. Externalities in consumption could be provided in conventional markets by private producers so long as the community participates (through financing) in purchasing the goods or services. Buchanan’s position departed from that represented by Paul Samuelson (1915–2009), one of the major analysts of public goods, whose approach Buchanan regarded as excessively prescriptive (i.e., paternalistic). Buchanan thus provided a path for analyzing healthcare that opened the door to subsuming it under more conventional market arrangements.

It was Buchanan’s student, Mark V. Pauly (1941–), eventually to become one of the most distinguished of American health economists, who first took that path (1971), although Martin S. Feldstein (1939–), having undertaken an econometric analysis of the British National Health Service, was working along similar lines in the early 1970s; indeed, the two exerted a mutual influence. Although some others had in principle reduced calls for NHI to externalities in consumption, it was Pauly who first unequivocally translated notions about the specialness of care into support for a taxfinanced program of subsidies. Pauly’s question was how to optimize the subsidy. His analysis took the unequal distribution of income as given, assumed that demand for care responds to price and income – i.e., he accepted frankly that price and income elasticities suggested that care is an ordinary commodity – and anticipated that different consumers would have different levels of care. This last point also departed from traditional social justice rationales for care, which largely anticipated that NHI would provide a uniform standard of care. His analysis led him to propose ‘variable subsidy insurance’ (VSI). For the poorest it would prove comprehensive coverage at low or zero premium cost; for those with middle incomes, it would subsidize demand by paying part of the premium cost (perhaps to an extent that varies inversely with income) and impose deductibles and/or coinsurance that would increase with income; for the wealthy, it would supply a catastrophic policy, i.e., one that would pay only for the most expensive forms of care. The cost-sharing provisions would constrain utilization (and thus respond to growing concerns, intensified by talk of NHI, about cost escalation). Almost simultaneously, Feldstein offered a similar proposal for ‘major risk insurance’ (MRI).

These proposals carried important implications both for improving public policy and for exhibiting the value of economics – and some implications of its use – as a means for analyzing policy. In regard primarily to the substance of policy, several features stand out. In acknowledging the desire of some citizens to increase consumption of care by others, the proposals gave expression to social solidarity. They do so, moreover, by assuring taxpayer sovereignty: the taxpayers decide what services to subsidize, for whom, and to what extent. In recognizing that diverse consumers (because of differences in their ‘tastes’ for care and in their income) would exhibit diverse levels of demand for care and in according a minimal role to expert determination of need, the proposals expressed consumer sovereignty. In granting the poor, as traditional reformers had wanted, the same rights as those better-off to make choices from among the same providers in the same private markets, the proposals emphasized that aspect of social solidarity that focused on inclusiveness and mutual regard across income classes. However, in rejecting a universal standard of care, the proposals drew back from the distributive imperatives underlying older notions of solidarity. This result followed in part from the economic tools that underlay the proposals. The optimization procedures of welfare economics aimed to enhance allocative efficiency – the efficiency with which resources are distributed among consumers in that a system of graduated subsidies under cost-sharing would achieve a reasonably tight match between the income of consumers and the socially desired enhancement to their consumption of care. In addition, any market operating under these proposals would help constrain social costs by fostering productive efficiency: In competing for the business of patients with purchasing power, healthcare providers would have to show themselves frugal in using the funds brought to healthcare transactions by insured consumers who would have to foot a significant part of the bill. Providers would seek either to produce a given level of care more efficiently or offer services of perhaps reduced (but still positive) benefit but at lower cost. Physicians and hospitals, that is, would have to become the financial, as well as the medical fiduciaries of their patients. Finally, because the proposals left market mechanisms largely undisturbed (except to the extent the supply side would evolve on its own under such a system of subsidies and cost-sharing), they offered a means to resolve controversy among economists about separating efficiency in the allocation of health services (achieved through the exercise of consumer choice under cost-sharing) from distributional equity in access to health services (achieved through incomegraduated public subsidies).

Two additional features of the work by Pauly and Feldstein merit attention. One is their discussion of ‘moral hazard,’ the tendency of insurance itself to foster the occurrence of the risks against which it provides protection, so named by the insurance industry to signal the ‘abuse’ of insurance by policy holders. In the case of healthcare, under an insurance scheme that, absent cost-sharing, affords a zero price at the point of service, the insured will purchase more care than otherwise. Pauly regarded the effect not as morally dubious but as rational. It implies that a taxation scheme that compels citizens to pay for insurance against certain risks is inefficient, because, under the scheme, some consumers would have to pay more than they would want to; some consumers, in a word, would benefit from purchasing a lower standard of care. Moreover, cost-sharing, by reducing demand and thus constraining utilization, would reduce the premium of insurance and therefore could make desirable a policy otherwise unattractive to some consumers. The effect of coinsurance, for example, depends on the elasticity of demand, which varies among consumers; an optimal policy would thus similarly vary. Hence, the utility of such schemes as VSI: Income-graduate subsidy would encourage socially desired utilization (i.e., the increased consumption by some consumers that others desired); and income-graduated cost-sharing would improve the efficiency of the resultant allocation.

Feldstein, responding to Pauly’s view of moral hazard, showed in the case of the hospital industry that the stimulation of demand that insurance occasions has a special characteristic: it results in increased prices, which in turn elicit more insurance, i.e., it produces a circular effect that, although not explosive, provided strong evidence in support of costsharing. Moreover, the government further stimulates demand via the tax treatment of health insurance (primarily, that the health benefits that employers provide employees are exempt from employees’ income tax), from which Feldstein drew two conclusions: (1) tax subsidies make the net cost of an insurance premium fall below the expected value of the benefits; and (2) they encourage employees to substitute for taxable wages more comprehensive (but shallow) insurance. Insurance then provides first-dollar coverage for modest expenses, but little coverage for catastrophic ones. It was in the light of these concerns that Feldstein devised MRI. Health insurance, previously seen as a solution to the problem of achieving access to health services, itself now became the source of two problems: intensive price inflation and inappropriate forms of coverage. Older advocates of health insurance had insisted on universal, comprehensive benefits as following from the high social valuation of healthcare; now, their approach seemed to be an artifact of faulty policies. In the newer view, allowing some consumers to purchase a lower standard of care would not only serve the cause of efficiency but it might also help overcome the political obstacles to NHI. As Pauly observed after over a decade of discussion about the virtues of NHI and of its possible forms, advocates of comprehensive NHI had kept the poor and those suffering from catastrophic illness from obtaining a standard of care that, if lower, was nevertheless, for them, more desirable.

These concerns lay in the background to the RAND health insurance experiment (HIE), one of the most ambitious social experiments ever undertaken. Conducted over the period from about 1974 to about 1982 by the RAND Corporation, a nonprofit organization that contracts with diverse organizations to carry out research and policy analysis, the experiment emerged from the War on Poverty amid discussions of how to arrange financing of care for the poor. The principal issue around which it took form was the lack of consensus about the effects of increased demand (through expanded entitlement and improvement of benefits) and about the effects of cost-sharing, on both utilization and health, in constraining demand. This is not the place to discuss either its origins and evolution or underlying economic concepts; for present purposes, only some of its conclusions merit attention. The experiment indicated a price elasticity of 0.1 to 0.3 for most kinds of health services (i.e., an increase in price of 1% would decrease quantity demanded from between 0.1% and 0.3%). Although the measured elasticities were modest, the experiment seemed to show that consumers do adjust usage to price; that excessive insurance does seem to result from moral hazard; that cost-sharing does constrain use, even for hospitalization; that these changes, for all but the sick poor, had little effect on health; and that therefore cost-sharing can serve as a sound instrument of public policy that aims to constrain costs. The implication seems to have been that much of the care provided to most consumers lay on what Alain C. Enthoven (1930–), a prominent advocate of healthcare markets, called the ‘flat-of-the-curve’ (i.e., where the initially upward graph of benefits of care as a function of their costs flattens, indicating that additional expenditures on care provide no health benefits).

However, in constraining use, cost-sharing did not, as its advocates hoped, limit chiefly ineffective care. Cost-sharing was therefore a blunt instrument, but its impact, at least on the nonpoor, seemed positive, for the reduction of utilization it achieved did not have an adverse effect on health. Pauly and Feldstein had justified consumer sovereignty with References: to lack of knowledge about the outcomes of care. The RAND group, which had classified forms of care into the categories of ‘effective’ and ‘ineffective,’ now argued that the failure, even of care it classified as effective, to affect health under a variety of insurance schemes that fostered reduced utilization authorized the same conclusion.

Cost-Sharing, The Poor, And The Value Of Services

However, the message issuing from the experiment was not univocal. The HIE revealed that, in regard to the poor, especially the ill poor, cost-sharing could entrain adverse effects on health; that is, the failure of the poor, under costsharing, to obtain some effective services led to reductions in their health status. Diverse policy responses could be devised to bring such services to the poor. One would establish targeted programs to supply specific services to the poor, although not all services are amenable to this approach. Others might exploit screening programs, but in large populations their costs exceed their benefits. Moreover, as critics of market based care have argued, the likely confinement of this measure to public programs risks offense to standards of equity and the dignity of the poor. Yet another would supply insurance but exempt the poor from cost-sharing, as Pauly had suggested and as, under Medicaid, they largely had been, although maintaining a separate Medicaid program rather than the imposition of a general income-graduated cost-sharing would continue to stigmatize the poor, which is indeed the approach taken by the Obama reforms under the Affordable Care Act (ACA, i.e., the Patient Protection and ACA, PL 111–148; as amended by the Health Care and Education Reconciliation Act, P.L. 111–152, passed in March 2010). Another approach, also taken under the ACA, would impose on individuals and families a modest level of income-graduated cost-sharing and provide income-graduated subsidies, as the likes of Pauly, Feldstein, and the RAND group had been discussing. Yet another measure would be to structure coinsurance so as to foster coverage of effective services, an approach that draws strength from recent research on the effectiveness of care, although the still small proportion of services that have been evaluated limits the usefulness of this practice.

Other policy responses might be devised; however, more important than the prospect of modest cost-sharing in any version of NHI, the experimenters acknowledged, was the difference between some insurance and none. Nevertheless, in regard to the poor, the RAND group was reticent, leaving to policymakers to decide whether the experimental results should authorize public provision of care to the sick poor. The normative case for cost-sharing for the nonpoor, in other words, was for the researchers overwhelming; but for the poor they aimed only to narrow public debate by providing concrete experimental results, not to propose whether and if so how to expand entitlement to services. For the poor, if not for the better-off, relativism, not reform, is what characterized analysts of health policy.

The experiment has exerted an enduring influence in American health policy, particularly in its emphasis on the utility of demand-side measures – which have received far greater application in America than in other advanced countries – to constrain utilization. However, subsequent developments have changed the context for assessing its implications. A growing body of more recent research has suggested much more strongly than the HIE that uninsurance and underinsurance, especially for the poor, entrains poor health outcomes and that improving Medicaid and other kinds of coverage entails positive health benefits. By strengthening previously attenuated convictions about the effectiveness of care, these results have enhanced the case for redistribution to cover effective services, whether routine and inexpensive (such as blood pressure monitoring and in general management of chronic diseases) or less frequent but much more costly (such as organ transplants or care for heart disease or cancer), especially but not only for the sick poor.

Indeed, Nyman argues that advocates of cost-sharing have failed to understand a point that reformers have been making since early in the past century: insurance is needed to secure access to forms of care that are not affordable even by the middle class and that are medically valuable, even life-saving; insurance, that is, possesses what Nyman dubs its ‘access value.’ In these cases, the exercise of moral hazard, that is, the purchase of more care than would be purchased without insurance, is precisely the point, for it gives access to valuable services that would otherwise be inaccessible. Because the payoff from insurance amounts to an increment to income, Nyman argues, the purchasing decisions of a seriously ill person with insurance reflect not a shift along the demand curve, as most economists assume, but a shift of the curve outward. Discouraging consumption through cost-sharing of services that are valuable and expensive is therefore welfare reducing, because it limits the access value; at the same time, excessive consumption of less urgently needed or less valuable care may be a relatively minor effect of insurance. Pauly, a major architect of the moral-hazard argument, eventually recognized that its applicability to the seriously ill and the services they need had not been adequately studied. The HIE therefore provides little assistance for policymakers in deciding the extent to which especially expensive services should become available to Americans, both poor and better-off.

These reflections, which result from new research that occasioned reevaluation of the RAND HIE, clearly implicate both sides of the market, although the HIE itself had focused on the demand side. The figures such as Pauly and Feldstein who had suggested demand-side reforms at first actively opposed reconstruction of the supply side of the market. Reconstruction would require a major role for government, but the newer approaches to public policy took inspiration precisely from what their advocates regarded as governmental failures, especially under traditional regulatory regimes (which had been under attack since the Carter administration). By contrast, incentive-based reforms, to which Charles L. Schultze (1924–) later gave systematic articulation, sidestepped any meddlesome and likely counterproductive governmental intrusion into the economy, and it reduced the risk of antagonizing the major interests, especially the providers of healthcare. Instead of what Schultze called the ‘command-and-control’ characteristic of regulatory regimes and the ‘perverse incentives’ operating under them – terms that helped put much wind in the sails of Schultze’s ideas – incentives that aligned the interests of actors with public purposes could serve public policy more efficiently in both economic and political senses. Moreover, economists believed that demand-side reforms that responded to concerns for the inflationary effects of insurance (e.g., reducing the tax subsidies of health insurance), could achieve with reasonable promptness and certainty the savings anticipated by theorists, whereas ambitious structural reforms might not work and entail severe unintended consequences. Supply-side innovations, nevertheless, had their advocates, and the evolution of markets on the ground has taken place in a context defined by their concerns and their vocabulary.

Healthcare Plans

Indeed, it was roughly simultaneously with demand-side analyses that an alternative, supply-side approach emerged. It called for combining insurance with the provision of care through competing large, bureaucratic institutions (healthcare plans, initially, chiefly the HMO). The early proponents of this approach shared some views with advocates of cost-sharing, especially that healthcare is a commodity suitable for sale to consumers in markets, and a commitment to an incentivesoriented approach to public policy as preferable to regulation; but they departed from advocates of cost-sharing by calling for government to assist in reorganizing the supply side of the market and then to withdraw and let it evolve. Moreover, unlike advocacy of cost-sharing, the call for reform of the supply side did not at first result chiefly from applications of economic theory.

Reforming The Market

Instead, their views arose from at least three convictions: (1) although under cost-sharing physicians would have to compete on economic as well as medical grounds, aiming to serve as fiduciaries of patients’ money as well as their health, incentives toward economy could become truly effective only if they were made to bear more directly on physicians; (2) large bureaucratic organizations could accomplish this task in ways not possible under market conditions characterized by solo practice and freestanding hospitals; and (3) traditional healthcare policy, which relied on professional self-regulation, planning, and regulation of institutions, especially hospitals – the very features of healthcare markets that, for older theorists, distinguished them from conventional markets and reflected the unusual characteristics and fundamental importance of healthcare – if carried out effectively, would either lock-in the causes of dysfunction in healthcare or, because draconian, erode in the face of opposition from patients and providers. In a period when cost escalation elicited characterizations of complex problems facing the health sector, when calls for NHI grew coupled with calls for the reform of health system itself, and when traditional forms of governmental regulation were in decline, the market solution, based on new organizations, seemed to cut through the Gordian knot that advocates of traditional NHI then still hoped to unravel by strengthening established practices.

Hence Paul M. Ellwood, Jr. (1926–) and his colleagues, in their classic summary of the ‘health maintenance strategy’ Ellwood et al. (1971), held that the ‘‘health system is performing poorly because its structure and incentives do not encourage [systemic] self-regulation’’ and that ‘‘[m]arket mechanisms, such as competition and informed consumer demand, which might provide a check on the provision of unnecessary services, inflation, and inequitable distribution, do not exist in the health industry.’’ Their conclusion (p. 298) was as simple as it was bold:

—–The emergence of a free-market economy could stimulate a course of change in the health industry that would have some of the classical aspects of the industrial revolution conversion to larger units of production, technological innovation, division of labor, substitution of capital for labor, vigorous competition, and profitability as the mandatory condition of survival. Under these conditions, HMOs would have a vested interest in regulating output, performance, and costs in the public interest, with minimal intervention by the federal government.

To sharpen the contrast between prevailing arrangements and the market-based system, Ellwood, from 1972, invoked a locution that until then had been little exploited in discussions of healthcare, ‘cottage industry.’ In the early 1970s, it allowed him, together with his colleagues and allies, to epitomize the inadequacy of what they perceived to be a still preindustrial health sector; and it has remained a handy resource that has enabled them and their successors to deprecate subtly traditional healthcare policy and practice, while enhancing the legitimacy of the novel, market-based ones and buoying their prospects.

The confidence evident in the preceding quotation rested far less on economic theory than on enthusiasm for a textbook notion of competition and from the knowledge that the archetype of the HMO, the prepaid group practice (PPG) – of which a few then existed, several having emerged especially from the 1930s – had successfully provided high-quality care more cheaply. Their principal tools were capitation payments (per head or per family) from plan members and either the staff or group model of provider organizations – in the former, the plan itself employs physicians, whom it pays a salary; in the latter, the plan pays the physician group, which pays its physicians a salary. In both kinds of plans the incentive structure of fee-for-service medicine had been reversed – for example, as Enthoven saw it, of Schultze’s call for reform of perverse incentives – as neither plans nor physicians benefited from increased utilization. Moreover, by owning or contracting with hospitals paid on a global budget, the plans had incentives to provide hospital care efficiently. Yet the numbers and market penetration of such organizations was small and, in areas in which patients did have choice of insurers, the success of health plans may well have reflected their case mix and the tastes of their clienteles. Moreover, early analysis of their performance suggested that their economies resulted primarily from limiting hospitalization rather than from constraining the other aspects of practice that exposure to a fully competitive market might have led plans to target. In other words, as a model for a competitive health system, the HMO was suggestive but hardly compelling. To call for expanding these modest precedents to dominate the entire health system and create a novel, competitive market was thus to pose an enormous gamble (as advocates of cost-sharing under fee-for-service had believed). Proponents found it appealing because, in the face of the complex problems of the health sector, competing health plans seemed a conceptually simple approach, one as yet little encumbered with a body of experience and a long history in the policy sphere. In comparison with what market advocates saw an apparently exhausted tradition of regulation and planning, markets populated on the supply side by competing, large, capitalintensive organizations looked fresh and promising.

However, there was some pertinent history in the policy sphere. The modest degree of market penetration that bureaucratic practices had attained by the end of the 1960s reflected in part the successes of the organized medical profession in controlling not only the narrow dimensions of medical practice and training but also the organization and financing of healthcare. PPGs had long been a target of the profession, which had generally succeeded in constraining their growth and proliferation. To assist him in taking on this legacy of professional control, Ellwood coined the term, ‘HMO.’ It expressed not only the hope that he, as a rehabilitation physician, entertained about the importance of prevention (especially regarding chronic disease) and its utility in an anticipated cost-control regime but also his expectation that additional organizational forms beyond the traditional PPGs could serve the purposes that advocates of plans envisioned. However, the new term recommended itself chiefly as a way to appeal to physicians without eliciting memories of the history of conflict over the organization of medical care. Like earlier reformers, who saw that social and economic developments presaged transformations of healthcare and called on the medical profession both to lead and, by so doing, protect its interests, Ellwood hoped to engage physicians and enroll them in his project of reform. However, another advocate of market-based reforms, the law professor Clark C. Havighurst (1933–), took a more adversarial stance toward the profession, holding that professional self-regulation underlay the profession’s anticompetitive practices. The cottage industry was the profession’s creature; it existed to serve the interests of the profession, not those of patients or polity. From the standpoint of his concern for antitrust, he believed that reorganizing the supply side would break the back of medical dominance over the market for healthcare, permit the evolution of large provider organizations that the profession had long succeeded in inhibiting, and expose physicians to market discipline. Even more important, he took on the role of policy entrepreneur who disseminated his views among those able to make decisions and act in practical circumstances. A major goal for his activity was to establish the market as a realm for the exercise of choice by consumers.

The Evolution Of Healthcare Markets

From the mid-1980s, the reduction of constraints on supplyside innovation resulting from antitrust activity; the diminished threat, after the failure of the Clinton health-reform plan, of increased federal regulation; and the restraints on state regulation resulting from federal preemption, under the federal Employee Retirement Income Security Act of 1974 (P.L. 93–406), of state regulatory powers in healthcare, helped open the door to the rapid evolution of healthcare markets on the ground. A new coinage, ‘managed care,’ emerged in the late 1970s and became commonplace from about the mid-1980s to encompass the early emergence of diverse and novel supply-side arrangements in addition to HMOs as originally conceived. Under that term, analysts included organizations and practices that supposedly generated efficiency gains (and thus cost-controls and quality improvements) through corporate control over the practice of medicine and that supposedly fostered competition among managed care entities and between them and conventional fee-for-service practice. From the late 1990s, with the ‘managed care backlash,’ the apparent consensus on the virtues of managed care had dissolved, but dynamic evolution continues.

That dynamism is one of several themes that emerges from the growth of markets. In both extent and degree, the dynamism of healthcare markets has surely exceeded the expectations of most of their early advocates. An industry formerly heavily sheltered from market forces now, under the profit motive – and the resultant imperative for nonprofit entities to emulate for-profit ones – has become subject to chaotic impulses that have created, reconstructed, and destroyed novel organizations and managerial and professional practices, as well as built and upended institutions and relationships among employers, insurers, providers, and patients. Indeed, so rapid have markets evolved that scholars have been in continuous struggle to keep up with events, characterize changes, and assess their implications. Such changes arouse concern not only with the services that healthcare markets provide but also likely more so the economic advantages and the profits that issue from them. A focus on market share and profit making is surely what anyone expects of markets; but roiling market dynamics seems incompatible with the stability that patients and consumers would hope for in a system intended to provide services of an often intimate nature and existential import.

Nevertheless, the concern of market-oriented analysts and policymakers to widen the scope of consumer choice is a second theme in the evolution of markets. The managed care backlash seemed to suggest that consumers were disillusioned with paternalism, whether of employers or providers, and that they wanted to exercise choice in an environment that made the relationship of costs, benefits, and accessibility more evident than the combination of community rating and sub-rosa utilization controls that managed care had created. Private insurers backed off trying to influence physicians (the fundamental goal of managed care), aimed instead to influence patients in an environment of diverse choice, and tried to appeal to employers who sought to offer employees a menu of options rather than to select plans for them. Under such arrangements, the consumer would have greater room for making choices and greater responsibility for exercising them.

‘Consumer-driven healthcare,’ a particular set of financial and insurance arrangements, is perhaps the fullest expression thus far of this trend. It reflects the appearance of the middle-class shopper given to evaluating professional services, a phenomenon that market advocates had favorably anticipated. However, studies have shown that the extent to which consumers enjoy clear choices and, where they do, the extent to which they take advantage of them, have been highly limited.

A third theme has been the tendency of market advocacy and attention to market evolution to eclipse the public-interest goals of traditional reformers. After policymakers grew convinced that not only NHI but system reform was also necessary, after Senator Edward M. Kennedy (1932–2009) altered his thinking about healthcare reform to accommodate private markets, and after the failed Clinton plan marked a new check in the work of reformers to achieve NHI and opened the floodgates to dynamic market change, conceptions of the purposes of healthcare markets that depart from traditional collective thinking gained increasing prominence. Indeed, many have argued that the growth and growing familiarity of markets and the continual rehearsal of their anticipated virtues have entailed consequences many of which were foreseen with apprehension by the earliest critics of markets: Diminished interest in entitlement, access to care, continuity of care; waning of patients’ trust in providers; and loss of interest in fragmentation of the health system. What advocates of markets have deemed most important is enhancing efficiency, constraining cost escalation, avoiding paternalism, fostering choice, all without ‘rationing care,’ long demonized as paternalistic, unaccountable, and simply dangerous. This approach comports with recent cultural developments that have rendered ‘the market’ an idealization that lacks historical or social content or context. In the minds of their advocates, healthcare markets have not yet reflected or achieved an ideal state, but confident that such a state can be attained, they persist in searching for it.

Accordingly and here is a fourth theme in the evolution of markets policymakers’ focus on efficiency and consumer choice has compelled reformers oriented to traditional publicinterest goals to continually rehearse them and insist on their pertinence and viability. Even early advocates of markets like Pauly and Enthoven, for all their emphasis on care as a set of commodities and markets as the best way to distribute them, held to Schultze’s notion that markets existed (or should be created where they did not) to serve articulated public purposes, in the case of healthcare, not only efficiency and cost control but also improved entitlement; and they stuck with the conviction that the same markets that served the better-off should also accommodate the poor, albeit to buy a lesser standard of care. Moreover, Enthoven originally proposed that governmental regulation was needed to organize a market so as to meet public goals, and therefore he called early for ‘procompetitive regulation’. Later he substituted ‘managed competition’ – not to be confused with ‘managed care,’ i.e., provision of care by cost-efficiency-oriented bureaucratic organizations – as a means to avoid such problems as riskselection (e.g., selling insurance to the well and avoiding the ill) and product differentiation that hinders consumers from making comparisons and circumnavigates price competition. He and others held, in brief, that markets required regulation or management to keep their evolution in conformity with public purposes. That such concerns have managed to persist in the face of enthusiasts who reject governmental intervention in markets find testimony in the ACA, which both expands entitlement and organizes markets. The controversy that this legislation has aroused, however, shows that the struggle between market enthusiasts and advocates of traditional public-interest goals has scarcely ended.

These last two themes contrast sharply with experience in most other advanced countries. There, the traditional focus of policymakers lay on regulating or constraining the supply side of the market. Cost-constraining measures in advanced countries have included lower levels of funding; upstream limits on capital; planning; limits on the exploitation of technology; constraints on the size of the medical profession, its composition by specialty, and its geographic distribution; limits on professional fees; global budgets; bargaining among ‘peak associations’ (i.e., national-level interest groups); gatekeeper systems; explicit rationing and waiting lists; price controls (e.g., on pharmaceuticals); and simpler administrative and payment mechanisms, all of them practices to which the American polity has thus far been vastly less hospitable. Moreover, even the recent experiments that other advanced countries have undertaken with competitive measures – on both demand and supply sides – to foster choice and with it improve efficiency often have been accompanied by regulatory measures to keep their healthcare systems in conformity with underlying solidaristic values. In America, pressure in support of efficiency and choice pose a constant threat to traditional public-interest goals. However, regulation, which market advocates had seen as impediments to the achievement of efficiency and securing of choice, constantly returns through the back door. As diverse market arrangements provoke dissatisfaction from consumerscum-voters, they demand and get piecemeal protective regulation from the sequelae of market operations. However, few policymakers draw the conclusion that their focus on the efficiency of markets may fail to serve the public and thus require something resembling the practice in other advanced economies of subordinating market arrangements to other social values; rather, they suppose that the ultimate in market arrangements remains to be found.

Concluding Reflections

The themes that this and Health Insurance in Historical Perspective I develop suggest that the ACA is a profoundly American product, tempering as it does the traditional goals of social policy with support for markets and consumer choice. It aims to cover most of the hitherto uninsured, and it preserves and reforms existing market arrangements and adds new ones; but it does not transform the healthcare system into a version of uniform entitlement to comprehensive benefits that traditional reformers long desired. Given the persistence under the ACA of employer-based insurance, of the diversity across employers in costs and levels of coverage, of regressive tax subsidies for private insurance, of Medicare, of Medicaid and its variations across states, of safety-net institutions devised for the poor; and the appearance of new provisions for incomegraduated subsidy and cost-sharing, the US has clearly decided to persist in subsidizing care according (primarily) to income, and thereby also (by proxy) according to race, and (secondarily) according to age. Proponents of reducing health disparities (i.e., different levels of health status prevalent among different ethnic and income groups) have recently come to apply the term ‘fragmentation’ – formerly employed with regard to such things as the ‘cottage-industry’ structure of the health sector, its lack of focus on the patient, and its inability to coordinate care – to the distinctions drawn in our health system by race, class, gender, and income. These distinctions find expression in the differentials that persist across social groups in access to care, extent and depth of coverage, magnitude of reimbursement, and the kinds and numbers of accessible insurers and providers. Although other health systems in advanced countries also took form with References: to such social categories, they persist in the American system to a far greater extent. The ACA offers not a uniform system of NHI, no ‘Medicare for all’ that some have advocated – HR 646, first introduced into the 111th Congress – no reckoning of care as a prerogative or right attached to citizenship to be equitably assured, but a system that expresses differential degrees of social success and approval, that affords differential degrees of freedom and responsibility in seeking and gaining access to care, and that provides differential access to care according to socioeconomic status and ethnic and gender identity. Americans have not utterly eschewed a sense of collective responsibility and social solidarity; but their choice of a market based system seems entirely consonant with their persistence in classifying and discriminating citizens from one another, their privileging the goals of choice and efficiency over social protection, and their seeking in the market an exalted path to realizing and expressing personal autonomy and responsibility.

What role has economics played in the evolution of American health insurance? In no sense has it been determinative of policy choices, in part because economists came to see themselves much more as servants of their masters, public and private, than as reformers or decision makers. Yet economists have scarcely been strictly neutral analysts, for like those for whom they work, they reflect (and in turn have reinforced) the broader cultural and social changes that have helped give rise since the end of the 1960s to a polity and to a population of policymakers more attuned to the values associated with the market – the home turf of economists – and more hostile to government, professional expertise, and paternalism (whether public or private) – than the concerns that traditional policymakers still strive to uphold. If economists have been more influential than in the past, it is the result, in great measure, of this convergence of values. However, their influence also reflected developments in the capacity to analyze public programs that economics as a discipline had begun to show in the late 1950s and 1960s. In a context marked by the problems emergent in the health sector under traditional policy, by the growing concern about cost escalation, and by the fear that expanding access to health services through NHI by extrapolating previous approaches to policy would be too expensive, economists applied to public policy their increasingly mathematized and powerful intellectual tools that had matured in the postwar era. From there flowed the influence of their fundamental individualism, of their arguments about the failures of traditional health insurance, about moral hazard, and about cost-sharing. Moreover, through efforts of this kind, they gave rise to the subdiscipline of health economics and heavily informed the emergent, interdisciplinary field of health services research.

As for analysis of the supply side, the push for competing health plans, rather than only for competition inside a traditional cottage industry, was less an argument of economists than the harnessing of modest institutional precedents by a new set of analysts to remedy the problems in healthcare that cost escalation had rendered acute. Yet as markets involving novel organizations and practices emerged and grew, their development provided grist for the economists’ mill. The efficiency of integrated insurers-cum-providers, their incentive structures, their marketing methods and market shares, their access to capital, their likelihood of serving goals increasingly defined by market-oriented sensibilities (and decreasingly defined by collective sentiments), all this and much more proved amenable to economic study and analysis. Even if the pace of events has often outrun the ability of economists and other health services researchers to keep up, the dynamism of markets and their capacity to serve the preferences of payers, of individuals, and the goals of mostly market-oriented policymakers have opened a vast field for economic analysis. There, too, economists will not and cannot make the value-based decisions that drive policy; but their powerful tools, their professional argot, and the market orientation they share with their employers and many policymakers assure that their will remain influential voices.


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Historical Analysis of Health Insurance
History of Health Insurance in The United States