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Monopoly Power Isn’t Why Hospital Prices Are So High

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Monopoly Power Isn’t Why Hospital Prices Are So High

January 30, 2020

Elizabeth Warren recently proposed bringing down the cost of health care by appointing “aggressive antitrust enforcers who recognize the problems with hospital and health system consolidation.”  Rising prices for hospital care are indeed responsible for much of the rising cost of health insurance, but these prices have risen almost as rapidly in the most competitive local markets as they have in highly consolidated ones.  Hospitals compete by making expensive investments to upgrade equipment and facilities, knowing that price rarely determines where patients go to seek care.  While antitrust intervention may be justified in some cases, it would do little to alter the dynamic that is most responsible for the overall growth of hospital costs.

Hospital costs are the largest and fastest-growing major category of medical expenditure.  Total U.S. spending on hospital care increased from $692 billion in 2007 to $1.143 trillion in 2017, and accounts for 39 percent of health insurance costs.  This is in part due to increased use of outpatient services, but is also the result of rapidly rising prices – the consumer price index for hospital and related services has increased almost four times faster than the general rate of inflation over the past two decades.

These price increases have been widely blamed on the consolidation of hospitals into larger systems, which has made it easier for them to raise rates without being left out of insurers’ networks.  Both the House Judiciary and House Energy and Commerce committees have recently held hearings on consolidation and anticompetitive behavior in the health-care industry.  In his testimony, Martin Gaynor of Carnegie Mellon University noted that there have been 1,600 hospital mergers over the past two decades and cited studies finding that mergers consistently result in price increases – often of 20 to 30 percent.

But monopoly market structure explains little of rising hospital costs.  While hospital prices are up 92 percent in real terms since 2000, prices at hospitals with monopolies in their local markets are only 12 percent higher than those with four or more local rivals.  At the same time, hospital prices vary more within local market areas than between them.  

Hospitals’ pricing power and the increased concentration of market share are both symptoms of a deeper underlying problem: insensitivity to prices on the demand side.  This is most notoriously the case for emergency care (accounting for seven percent of hospital spending), for which patients have little ability to shop around on price.  But it is also true for scheduled in-network hospital procedures, for which insurance covers the bulk of the cost.  Under such circumstances, hospitals seek to attract patients by differentiating themselves in terms of reputation, quality, amenities, and convenience, but rarely by competing aggressively on price.

Such a dynamic encourages hospitals to compete by spending millions of dollars constantly upgrading equipment and the buildings needed to house them – a phenomenon known as the “Medical Arms Race.”  This dynamic is encouraged by top physicians, who prefer to practice at facilities equipped with cutting-edge technology and refer patients to colleagues practicing at them without paying much attention to cost.  Prices are highest at academic medical centers, which often have many other hospitals nearby.

At most, monopoly is a local phenomenon, and one that is most acute in rural areas.  But rural residents receive 48 percent of elective surgeries from someone other than a local provider, often traveling to more expensive hospitals.  A recent study found that patients bypassed an average of six lower-priced treatment locations on their way to receive an MRI scan. 

In a well-functioning market, individuals would purchase health-care plans that have negotiated the best possible rates with medical providers.  But 89 percent of privately insured Americans are enrolled in plans purchased by their employers, which must satisfy many different members of staff living in entirely different neighborhoods.  This makes it hard for employers to exclude hospitals from their network, enabling facilities to insist on inflated reimbursements.  

A recent regulatory change allowing employers to make pretax funds available so that staff  can purchase their own coverage might empower individuals to get a better deal by allowing them to keep the savings generated by narrower network plans.  But this option is made unattractive by individual market rules, which have caused premiums to soar far beyond the value of coverage for individuals who sign up before they get sick.  A full solution to the increasingly rapid inflation of hospital prices is therefore likely to require a broader reform of the structure of health insurance markets. 

While consolidation has clearly increased the pricing power of hospitals, this dynamic is contingent on the price-insensitive nature of employer-sponsored insurance.  Rather than proposing a revolution that  entirely eliminates private insurance or an antitrust initiative that leaves the health insurance market’s dysfunctions intact, policymakers should return to the more involved but still achievable task of making the individual market work again.

Chris Pope is a senior fellow at the Manhattan Institute.

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