A series of observations about healthcare has given rise to a public policy — mandatory price transparency — that in many markets may be ineffective or even counterproductive.
The policy perception is that transparent prices will increase competition and drive prices down. But under certain conditions — common in healthcare markets — the opposite may be true. Mandatory price transparency may reduce competition and drive prices up.
Let’s start with some generally true observations: Healthcare is expensive. It’s difficult for patients to know in advance how much a medical service will cost. Often, even doctors and hospitals don’t know costs in advance. Competition in healthcare doesn’t seem to drive costs down as it does in other sectors.
All these things are linked, but correlation is not causality, and causality may not run in the direction you think it does. Transparent, knowable prices are a good thing. Competition is a good thing. But it doesn’t necessarily follow that legally imposed transparency will lead to competition and to the benefits we expect from competition.
Public policy initiatives mandating transparency are widespread.
In June 2019, President Trump issued an Executive Order on “Improving Price and Quality Transparency in American Healthcare to Put Patients First.” In conjunction with this release, Centers for Medicare and Medicaid Services Administrator Seema Verma said — correctly — “Under the status quo, health care prices are about as clear as mud to patients.” No argument from me on that count. Nor do I downplay the negatives of that situation.
Most states — red and blue — have mandated some version of healthcare price transparency. The National Conference of State Legislatures tracks such laws.
My colleague, Jessie McBirney, and I just published a research paper on “Price Transparency in Healthcare: Apply with Caution.”
In a Twitter discussion about this paper, a good friend and health economist, Devon Herrick, said: “Transparency does not result in competition. It’s the other way around. Price competition results in transparency. The key is finding a way to boost competition.” There’s considerable merit to his argument.
And on the flip side, mandatory price transparency can be ineffective and even counterproductive.
There are several reasons consumers, even when armed with transparent prices, may not exert downward pressure on prices. First, during times of emergency (which are not the largest share of medical expenses) — such as a heart attack patient on a gurney — patients are unlikely to do comparison shopping.
Second, patients may care more about factors other than prices. Over 50 or so years of adult care, I have had precisely four primary care doctors — and it has never once occurred to me to compare their prices with other doctors. (I only changed when I moved.) And when these doctors have recommended specialty care, including surgery, I have trusted their recommendations and have never engaged in price shopping.
Third, consumers may not have sufficient skin in the game to warrant price comparisons. If my insurer is paying all but a small co-pay or deductible, why should I worry about costs? Whatever the reasons, consumers don’t engage in much price-shopping, even when given the tools to do so.
Now, on to the counterproductive part.
The biggest problem is a phenomenon that economists call “tacit collusion” — which antitrust attorneys call “conscious parallelism.”
In a market with very few sellers and high barriers to entry by new sellers, mutual knowledge of prices among sellers will enable them to raise prices and restrict supply — without any need for them to communicate with one another.
A major motivation for cost-cutting is to bid low for fear that your competitor will underprice you and snatch away your customers. If prices are posted in public, this motive for cost-reduction vanishes.
With all three ingredients for tacit collusion in place, the competitors act in concert as if they were a cartel — but without any of the communications that make cartels illegal.
Northwestern University professor Craig Garthwaite explained the phenomenon in a superb Forbes article: “What Martha’s Vineyard’s Gas Stations Can Teach Us About Drug Pricing.”
None of this suggests that price transparency is bad. It does suggest that such mandates be applied narrowly and cautiously, with an eye toward the wisdom of Hippocrates: “Do no harm.”