In the Nation's Interest

Knees vs. Nikes: How Buying Health Care Isn’t Like Buying Shoes

In a new CED report to be released at our upcoming Spring Policy Conference on April 22-23, the CED examines the Affordable Care Act of 2010 (often referred to as the ACA or “Obamacare”) and suggests ways in which the ACA could be transformed to be more effective at achieving essential health care policy goals.  The positions and recommendations we take in the report are based on CED’s long-standing “vision for health care” which has remained substantially the same over many years (see “Quality, Affordable Health Care for All,” 2007 and “A New Vision for Health Care,” 2002).

The CED believes in these fundamental goals for health care:

1. Every American should have access to health care;
2. Care should be of high quality; and
3. Care should be affordable.

CED believes that all three goals must be achieved, and that to do so, health care must be driven by cost-conscious, market-based competition—where producers are motivated to provide the best possible quality at the lowest possible cost, and where consumers are motivated to make cost-responsible choices.  The central premise dates back to Adam Smith and the “invisible hand”: to the extent that market prices accurately reflect the values held by all participants in the economy, those price signals will steer resources into their highest-valued uses better than a single authority could determine and impose on society.

But while our report calls for a more market-driven approach than taken in the ACA, we do not suggest that this means the government should stay out of health care and let freely-functioning markets do all the work.  That’s because health care isn’t like just any other good or service that is bought and sold in the private marketplace.  A few years ago The Economist magazine made a tongue-in-cheek comparison between the market for Air Jordans and the market for knee replacements.  It noted how marketing campaigns and many other intangible, immaterial, and subjective factors determine the free-market prices customers are willing to pay for “ordinary” (and yet extraordinarily popular) private goods, no matter how low the cost of producing those goods.  The point was that why should we as a society care if some people are willing to pay ridiculously, inexplicably high prices for Nike shoes—when that’s their prerogative and their own money?  (“Beyond a certain point, you can’t explain the value of a great pair of shoes in any rational fashion.”)  In contrast, what is sold and purchased in the health care market is a different, more justifiable concern, because government is already deeply involved in the health care market, and perhaps we as a society shouldn’t be subsidizing, for example, “snazzy new knees that aren’t actually any better than the old ones.”

What are some other ways in which knees (and health care products and services more generally) are different from Nikes?  Our new report explains why market-based incentives are essential to improvements in how our society provides and consumes health care, and yet why a completely unfettered market cannot solve all health care problems.  The health care market doesn’t, and probably cannot, function in the same relatively simple way markets for other goods and services do.  In the case of health care, these “market failures”—or at least what can be characterized as “oddities”—are reasons why some role for government is necessary:

Reason #1: Everyone should be able to afford health care.  Health care is something that all Americans should have access to—and it should be affordable (two of CED’s three fundamental goals in health care).  That suggests government is needed to subsidize the purchase of health care, especially for those who would otherwise get priced out of the market.  Hence, one component of CED’s proposal for health care reform is a system of universal, refundable tax credits that would fully cover the premium costs of the least expensive plan that meets established standards of coverage and quality.  Given our economy’s scarce resources, government must define and provide support for essential health care, but not all kinds of health care.  A knee replacement may be necessary (“essential”) for ordinary “life activities” (walking), but paying for the highest-tech knee available (perhaps one claimed to turn one into a bionic marathoner and not just restore prior function) may not make sense, for either the patient or society more broadly.  This is very different from buying shoes where the government has no role in guaranteeing and subsidizing your purchase of the highest-priced latest (or even retro) models.

Reason #2: Health care is in some ways a “public good.”  The benefits of health care often extend beyond the particular person consuming it and to society as a whole—a concept called a “public good.”  A healthier society is a more productive society (fewer sick days, more output per hours worked), and each person’s contribution to the economy has “multiplier” effects that benefit everyone else in the economy.  When one person in a family or business is in poor health, it reduces the well-being (health or otherwise) and productivity (home- or market-based) of everyone else in that family or business—which means that any individual’s consumption of health care services to improve their own personal health creates positive spillover benefits to others.  An arguably appropriate role of government is to subsidize the consumption of health care so that private market decisions better account for those spillover benefits.  So we may justify government’s involvement and contribution toward knee replacement surgery that is necessary to keep a person mobile and working (and hence contributing to the economy).  But a particular person’s purchase of a pair of high-end Nike shoes conveys purely private benefits to that person—and thus is appropriately left as their own financial responsibility and to their own weighing of whether their personal gain in happiness (marginal benefit) makes the high price (marginal cost) worth it.

Reason #3: Health care consumers may not be knowledgeable or engaged or “optimizing” consumers.  It’s easy for people to shop for shoes, especially these days when one need only visit online sites like Zappos.com and search and price-compare across thousands of models and hundreds of brands.  Or with any private market product that you’re shopping for, probably the first thing most of us do is “Google it” and we get to a list of all the different ways we can buy it, complete with product descriptions, prices, and shipping options. We can decide if it’s worth paying a higher price at one online merchant to get the faster shipping and free returns.  We can easily decide whether we want the top-of-the-line Nikes or the discontinued, sale ones, based on our personal calculation of marginal benefit vs. marginal cost.  We know which styles of shoes we like and what we don’t like.  We can be fairly certain that by the time we click the “place order” button that we’ve gotten our most preferred product at the best possible price—and all this in a matter of a few minutes. 

But people lack the necessary information and expertise to “shop” for health care this effectively.  Information about the different products or services that would achieve one’s particular and personal health goal is imperfect and “asymmetric.”  Often the patient doesn’t see the full menu of options and isn’t very involved in the decision about which one to pick—relying on the doctor to decide for him or her.  (I tried to find an online catalog of knee replacement products and failed, although I did find lots of online marketing brochures and videos promoting particular snazzy-sounding knee replacement models and brands.  And I learned about the relatively new “gender specific knees (GSK)” which have been described, coincidentally, as similar to shoes coming in both B and D widths.”)  And even though there are different options which come at different market prices, the patient doesn’t pay and hence doesn’t pay attention to full price (because of insurance), so the true (full) marginal cost doesn’t ever get compared to the true marginal benefit. So in the case of health care, market forces don’t always send the right price signals to the right people, which means market forces alone can’t be counted on to produce high quality outcomes relative to cost.  And add to all this the further complication that to consume an optimal amount and composition of health care services requires a level of foresight and caution over uncertain, often negative developments in our future (getting old!).  Thus, making good choices about health care is really hard, and CED’s new report argues that government has a role in the health care market to provide consumers with “decision support.”

Reason #4: The health care market is more easily monopolized.  Unlike purely private goods (such as those Air Jordans) that can be purchased from merchants all over the world via the internet, health care is largely a service that must be consumed in person.  That means that health care consumers are much more geographically limited in their options. Compared with other industries it is thus easier for health care providers to achieve “geographic monopolies” and use that market power to charge higher fees.  Our new report thus recommends a federal regulatory role that would maintain an appropriate level of market competition both within and across state lines.

Reason #5: Health care decisions can be difficult, emotional ones.  Economists would like to think that in an ideal world we could get the health care market to work more efficiently where people consume services only to the point where true marginal benefits align with true marginal costs.  But even if people had perfect information, many of us would be morally opposed to turning down any positive marginal benefit from the health care of a loved one (including oneself!) simply because it fell short of its marginal (private plus social) cost.  Even with decisions like knee replacements that are not “life or death,” there is ego involved which tends to blow up the perceived marginal benefit of the surgery; we middle-aged baby boomers love to pretend we can be “athletes” (and not just “active adults”) forever, you know.

So, buying health care isn’t like buying shoes.  The benefits and costs don’t flow in the same simple ways (there are too many buyers in the store, so to speak), and we have trouble seeing all the prices we would need to see to be good comparison shoppers.  The central message of our new report is that market-based incentives—those helpful price signals Adam Smith spoke fondly of—could be better brought into our nation’s health care system to improve access, quality, and affordability.  But also consistent with Smith’s views, there will always remain an important role of government in health care, because health care is inherently a different, much more complicated kind of consumer good.

Diane Lim is Vice President for Economic Research at the Committee for Economic Development.