Economic Efficiency Right Now, We Are Seeing

Economic Efficiency

Right now, we are seeing the beginning of the rollout of Obamacare, the kludge solution to America's broken health care system. The Affordable Care Act is a suite of laws and regulations that are designed to improve access to health care services in the United States, and the rollout has been spaced out over the course of a few years. Right now, the rollout is intensifying but the most significant elements will not arrive until 2014. As with any major policy change, there are myriad criticisms, and in this case one of those criticisms is the impact that Obamacare will have on the economics of health care in the United States. This paper will examine the effect of the law from the perspective of allocative efficiency.

Background

The key concept here is allocative efficiency. When a market operates under the condition of allocative efficiency, "the value consumers place on a good or service (reflected in the price they are willing to pay) equals the cost of the resources used up in the production" (Tutor2U.net, 2013). Thus, the price equals the marginal cost. When that condition is satisfied, total economic welfare is maximized (Ibid). There are a number of preconditions to allocative efficiency, none of which are present in the current health care market, and none of which are likely to be present under the Affordable Care Act either.

The Affordable Care Act does a number of different things that draw away from allocative efficiency. It proposes mandatory buy-in of insurance wherein one's health care consumption is not matched by costs out of pocket at least in the short run (Fisher, 2012), places caps on insurance rates, negotiates lower drug payments, and establishes funds to help consumers pay for their insurance (HHS.gov, 2012). Pre-existing issues drawing away from allocative efficiency include differential bargaining power between buyers and suppliers, FDA monopoly protection on new drugs and government involvement in health care via Medicare, Medicaid and Veterans' Services.

Market Failure

There are so many market failures in health care both under the old system and under the Affordable Care Act it is actually difficult to know where to begin. Caps on prices under both scenarios artificially limit supply. Very low information on the part of consumers -- and this information is often controlled by the medical industry -- result in very low bargaining power on the part of consumers and leads to supplier-induced demand (Frakt, 2011). The nature of health care as often a life or death issue is similarly the source of market failure, because there is often inelastic demand for health care services, something providers are more than eager to take advantage of. So there is a surfeit of demand at times in health care, and excess profits for the industry. FDA-granted monopolies on new drugs are a massive market failure -- monopoly by definition is market failure, with a shortage of supply the natural consequence (Economics Online, 2013).

So in health care before the ACA we can see a lack of competition, poor information and negative externalities. The latter comes in the form of the cost to society of poor health. Sick employees represent lost productivity for businesses, and this costs the U.S. economy billions of dollars a year. Clearly, in an allocatively efficient market, such externalities would not exist, there would be no monopolies, and consumers would not lack for information (they would all be trained doctors, and have access to their own medical records and academic journals for the latest information).

Policy Recommendations

If the government wanted to seek allocative efficiency in health care, the ACA will not do that. Obviously, the Act is seeking to reduce the negative externalities associated with low information (by setting up information exchanges), poor bargaining power of buyers (by setting up insurance exchanges) and lost productivity at work (by insuring tens of millions of previously uninsured Americans). Whether any of these things comes to pass is not known yet, because the ACA is not fully implemented yet. It is doubtful that government can resolve these issues. However, no intelligent human being could make a case that the health care system is operating anywhere remotely close to economic efficiency at this point. The ACA might make it worse, might make it better, or might just make a different type of mess than the one we have now. Either way, the health care system is nowhere near efficiency, never was, and probably never will be.