Up until now, we devoted much of the course to the behaviors of patients, payers, and providers. These players interact with one another in the marketplace, but who is tasked with governing these interactions? In this segment, we will introduce a new player, the government. Government intervention in health care market is quite extensive, and can be summarized into three broad categories; provision, financing, and regulation. In the provision category, we find mainly government owned hospitals. Which as you may recall are considered safety net hospitals, and are responsible for a disproportionate share of care provided to low income, and uninsured patients. The second category is financing. The government finances patient care through Medicare, Medicaid, and other government programs. This means that the government provides payment for the treatment, and services received by patients enrolled in these programs. The government also funds research, and training of both scientific, and medical staff through the National Institute of Health, and other agencies. The third category is regulation. In a free market or an unregulated market, the forces of supply and demand regulates prices, wages, quality, entry and other outcomes. But health care markets are regulated. That is, the government sets a series of regulatory restrictions that define what the various entities in the market are allowed to do, and what they are not allowed to do. Regulatory restrictions can take the form of simple rules, like prohibiting the sale of alcoholic beverages to minors, or can take the form of very complex rules. Like those that govern the treatment of mergers and acquisitions. Broadly speaking, government regulation has been justified on two grounds; efficiency, and equity. Efficiency means that regulation exists to prevent market failures, such as asymmetric information or externalities. Equity or fairness means that regulation exists to prevent disparities in quality, and access to care. There is an active debate among scholars about the extent of government interventions in markets. Some believe that government should intervene more, and some believe that government should intervene less. The evidence shows that many government interventions, those designed to improve efficiency, and those designed to advance equity, rarely achieve their intended goals. So, here is a concrete example of entry regulation that failed to achieve its intended goal. This regulation is known as Certificate of Need, or CON. The 1974 health blending Resources Development Act require all states to have structures involving the submission of proposals in obtaining approval from a state health planning agency before opening a new hospital, expanding an existing hospital, or purchasing expensive technology. Most states model their CON program after the one instituted in the state of New York back in 1964. A potential entrant, or an existing entity looking to expand or purchase expensive technology, must appear before a CON review board, and convince its members that there is a need for additional capacity in the market. CON review boards are a classic example of regulatory capture. The case where a government sets up a regulatory apparatus to police a particular market, and they need expert advice. Now, who has expertise in the hospital industry? That's right. The hospitality industry. So, CON review boards are almost always made up of representatives of incumbent hospitals. That is the incumbent hospitals in the market capture the regulatory body, and guess what, they don't want to allow more competition in their market. So, not surprisingly, there is little entrepreneur activity in states that use CONs. What did the government try to achieve here? Essentially, CONs have been set up across the country under the assumption that rationing hospital construction, and expansion would limit increases in healthcare costs. Building and equipment are capital inputs. So the logic was, limiting inputs would translate into a reduction in healthcare utilization and cost. In 1987, when the federal government realized that CONs were not achieving their intended goals, the mandate was repealed along with the associated funding. It turns out it is easier to form a committee than to dismantle it. So, only 14 states discontinued their CON programs. All other states still regulate entry and expansions using CONs today. The failure of Certificate of Need legislation was that it did not account for the substitutability of inputs. Let's see what that means. Consider the amount of regulated inputs, like those capital inputs regulated under CONs on the X-axis, and the amount of unregulated inputs like labor, and other capital inputs on the Y-axis. To produce a level of service A, the hospital uses a combination of regulated and unregulated inputs. Of course, to produce more services represented by points B and C, the hospital needs greater amounts of regulated, and unregulated inputs. Connecting the optimal choice of input mix for each level of service provision, provide what is known as the expansion path. The path represents the optimal combinations of inputs as output is expanded. Now, the government interested in blocking utilization beyond Service Level B puts in place a CON program that limits the amount of regulated inputs and makes the optimal input combination that produces Service Level C unattainable. Without getting too much into production theory, know that while movement along the optimal expansion path is now blocked, the hospital can still attain Service Level C by choosing a different mix of inputs at point C*. This input mix is clearly not optimal. Not only that CONs failed to prevent increased utilization, it led to a costly sub-optimal allocation of resources in producing services. For example, if a hospital was not allowed to build a new ward, it could still cram patients into an existing one. If a hospital was not allowed to purchase expensive imaging technology, it could still use older, less effective or advanced technology. The point is that while CONs are common, hospitals can still admit and treat more patients. In addition, CONs create a barrier to entry for new health care facilities, and limits competition in health care markets. In the CON case, the government who is entrusted with protecting competition ended up being a major anti-competitive force. CON legislation also applies to other parts of the healthcare industry. For example, CONs are quite common in home healthcare, where they really make no sense. Home health care is a labor intensive industry with little capital investment. So, CONs laws for home help simply serve to decrease the number of competitors. We found that the number of home health agencies per 100,000 Medicare beneficiaries, in non-CON state was nearly double the number in CON states. In the next segment, we will discuss anti-trust regulations, and its application to health care markets.
