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Archive for June 2012

The Power of Monopsony

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I work at a public university. Like many such institutions, we have been dealing with reduced support from the state. In fact, the percentage of the school’s budget that is funded directly by the state has fallen from 50-60% in the 1970s to about 10% (I think it’s less than 10% currently). The school has had to increasingly rely on tuition hikes in order to fund itself. This, of course, is increasingly unpopular with students. No longer can they attend their home state public university at a reasonable cost. In-state tuition is about $12,500 before room and board, about three times more expensive in real terms than in the mid-1980s. Out-of-state tuition, on which the university relies heavily has also seen similar increases. So the only public university in the state receives about 2.4% of the state’s total expenditures.

This seems like a bad idea. In a world in which economic success increasingly relies on completing some level of higher education, the state is not investing in the human capital it will need to grow in the future. Parents and students are upset. Professors and administrators are upset. This doesn’t seem like a political equilibrium. And yet the trend continues. The question, then, is why?

I believe that the answer is the rising cost of health care and specifically the larger and larger percentage of the budget taken up by Medicaid. Medicaid expenditures, of which the state pays slightly less than half of the total (the Fed picking up the rest), now account for 30% of the state’s total budget. This, of course, is up from 0% in the mid-1960s. As Medicaid eats up a larger and larger piece of the budget pie, everything else has to shrink.

So what do we do? I suppose one solution would be to leave our poorest and most vulnerable citizens without access to health care. But I don’t believe that would be the best solution. Instead, we should look at the best way to control our health care costs. And this is where the power of monopsony comes in. A monopsony is like the opposite of a monopoly. In a monopoly, there is only one seller. That seller can maximize its profit by increasing its prices and reducing its output compared to what would exist if there was more competition. In a market with a monopsony, there is only one buyer. That buyer can reduce the sellers’ profits by paying less than they would have to in a more competitive market.

Now normally, I wouldn’t encourage either monopoly and monopsony in any market. But the health insurance and health care markets are not like any market. They are fraught with problems of adverse selection, moral hazard, and information asymmetries. These markets, left on their own, will fail to achieve efficiency 10 times out of 10. That’s where monopsony, in the form of a national, single-payer health plan comes in.

With single-payer health care, everyone is enrolled and pays for it through a tax (similar to Medicare). Out goes adverse selection and moral hazard. The government is in the position to provide information on the efficacy of treatments and only pay for those that work. And the single plan is in a position to bargain prices with doctors, hospitals, and pharmaceutical companies to keep costs low.

The United States spends more than twice as much per person on health care than the median OECD country. And it does so without getting better results. If we adopted a single-payer plan, the potential savings would be measured in the trillions of dollars. We could increase funding to public education (that’s where we started) and infrastructure and everything else that’s being starved. What’s not to like?

Always remember that one person’s spending is another person’s income. Spending $1 trillion less on health care each year means $1 trillion less in income for doctors, nurses, hospital staff, and pharmaceutical workers. This would have to be a gradual process just so we didn’t throw the economy into recession. But these groups will fight tooth and nail to protect their incomes. Bargains will have to be made. I would start with paying off education loans for health care workers. It may also be a good idea to throw more federal research money to the pharmaceutical companies.

But it doesn’t make sense to allow one industry, even one as important as health care, to eat up more and more of our resources if we don’t have to. The power of monopsony would allow the federal and state governments to spend less and less on Medicare, Medicaid, and other health programs, opening up money for investing in the areas that strengthen our economy for the future. What kind of suckers are we that we don’t do this?

Written by Liam C Malloy

June 1, 2012 at 11:13 am