Should governments intervene to correct market failure in

the medical care industry by providing a tax-financed and

free at the point of delivery health care service?

- A case study of the British and American systems -

Ioana Dumitru
Public Economics

1. Introduction
2. Health care market failures resolved by a tax-financed system
2.1 Externalities
2.2 Risk and uncertainty
2.3 Dealing with lack of competition
3. Failures of a tax financed system
3.1 Funding and its effect on the level of provision
3.2 Inefficient and unequal distribution between regions
3.3 Inequalities between patiens
4. Conclusion
 Should governments intervene to correct market failure in
the medical care industry by providing a tax-financed and
free at the point of delivery health care service?

1. Introduction

Paying for health services out of government tax revenues is a fairly recent
innovation in health care financing(Savedoff, 2004, p.1). Until the mid-twentieth
century, healthcare was viewed as a priced economic good, which would take after the
laws of demand and supply laws of a perfectly competitive market.

However, Fucsh (1972) would argue that a standout amongst the most widely
recognised contentions for barring ideal rivalry from health care market is that
individuals consider wellbeing to be a fundamental right, making health economics
one of the newest and most controversial branches of human resources economics
(p.3). Thus, should some sort of degree of social insurance be provided in a perfectly
competitive market or not?

Donaldson and Gerard (1993, p.12) argue that although free market solutions are
upheld as efficient , Arrow (1963, p.967), explains that in reality these solutions do
not work as well for some economic goods and services as for others. Therefore, is
the general social consensus, that the laissez-faire solution for medicine is intolerable
which makes almost all health care systems in the world operating with some level of
government intervention (Donaldson and Gerard, 1993, p.12). The main reason for
why so many are advocates for government intervention in health care has to do with
several characteristics of the market which prevent an efficient and equitable
allocation, and thus, do not produce welfare for society.

The following essay aims to firstly understand such faulty characteristics of the
healthcare market and to discuss the solutions offered by both public and more
privately orientated systems. The final part of the essay will also examine more closely
the trade-off between equity and efficiency when implementing government
intervention while bearing in mind that the degree of intervention is an entirely
subjective political matter.
 2. Health care market failures resolved by a tax-financed system

The purpose of the government intervention implies social welfare has two imperative
components, efficiency and equity. Lipsey and Chrystal (2011) allude to the Pareto
efficiency as the resource allocation in which the social benefit surpasses social cost.
Equity, on the other hand represents a more controversial concept in health care as it
manages with the possibility of fairness which is a purely subjective matter. Horizontal
equity, a declared aim of the British National Health Service, represents equal
treatment of equal needs; and vertical equity refers to unequal treatment for unequal
needs (e.g. treatable maladies versus untreatable ones).

To accomplish such standards, the market needs to provide certain conditions: no

externalities, perfect knowledge from the consumer which is likewise the best judge of
its welfare, as well as a high level of competition. Medical care, is unique in this sense,
is unique as it poses all the opposite attributes. For the most part, states manage them
by using different degrees of government intervention which cannot be graded but
only empirically analysed and compared.

2.1 Externalities and public goods

The primary failure of healthcare market has to do with the concept of externality
which occurs when a third party receives some benefits or suffers some loss without
explicitly choosing to do so (Cullis and West, 1991, p.33). If left to a private market
of provision in which no mechanism exists to induce or coerce the trans actors to take
account of them, the amount of transfer will be less than if the transfer was through
other means ;and thus, will fail to achieve optimality(Cullis and West, 1991, p.35).

For instance, relying on philanthropy or the altruism of the general population or is too
costly in terms of money and time. Not every person will contribute and accordingly,
in assessing the desirability of spending extensively to remove a disease which will
benefit all regardless of payment, the issue of free riders needs to be considered. Not
only that by this it creates the problem of a public good but also some might derive
their utility to see others better of as Fuchs (1972) would argue that one of the most
prevalent arguments for excluding the idea of perfect competition from health care
market is that some people see health as a fundamental right, and thus as a merit want,
considered to be of such importance that it should be financed and provided by the
public sector. Such individuals consider the utility level as a function of the degree of
equality with which health care is distributed.

A progressive taxation would be a very efficient arrangement as governments could

bare the administration expenses of the transfers and more individuals will be willing
to make the transfer. Then again, accomplishing equity is not a satisfactory state for
everyone and in this sense it ought not to be compulsory. Therefore, it involves public
decision relying upon specific convictions and qualities.
2.2 Risk and uncertainty

Another negative characteristic is that some healthcare cannot be planned because

deteriorations in health are often sudden or unexpected (Donaldson and Gerard, 1993,
p.27). Further it will prompt developments of insurance markets and the consequent
problems of diseconomies of small scale, of moral hazard and adverse selection.

Firstly, diseconomies of small scale appear to show up in the all the more privately
orientated systems as Richardson(1987, p.34) notices that in Australia, in 1982,
marketing and managerial expenses of private funds amounted to 14.8 percent of
benefits paid to claimants, while the corresponding figure for Medicare (Australias 2nd
current universal public insurance scheme) was just 4.7 percent. It is conceivable that
a person would not be willing to pay for insurance which is inflated by the cost of
small-scale competition or by an exploitative monopolist, but would be willing to vote
for a system involving the collection of premiums through some public mechanism,
such as taxation so that the low cost are maintained without the risk of exploitation
(Donaldson and Gerard, 1993, p. 101).

Secondly, consumer and producer moral hazard emerge from the asymmetry of
information in the market. Concerning the demand aspect, being insured decreases the
costs of treatment at the point of consumption and consequently the incentive to adopt
a healthier lifestyle is diminished. Therefore the demand for health care rises while the
supply stays the same.

One possible solution might be the waiting list that a zero priced based system such as
in the United Kingdom might which reduces the incentives for a reckless behaviour
(Mooney, Russell and Weir, 1980).

Provider moral hazard or overutilization can result from a basic lack of awareness of
costs or from the use of fee-for-service remuneration methods for doctors which
creates financial incentive to provide care in excess, also known as supplier induced
demand (Evans, 1974). Since the consumer does not have perfect knowledge, the price
could be overestimated, and hence, too minimal medical care is picked, or vice versa.
In addition, Donaldson and Gerard (1993) argue that buyers have no monetary
incentive to direct such behaviour due to a third party such as the insurance company
or an employer paying for the care expenses.

In this case, government intervention would emerge in the form of financial limits on
indemnity as in the case of United Kingdom. Yet, fruitful measures have been built in
America as well, such as use of co-payments, fixed periodic per capita prepayment by
consumers directly to the provider (HMO), provision of incentives for consumers to
request care from selected providers, offering low cost bundles.

Finally, asymmetry of data also creates the phenomena of adverse choice as purchasers
of insurance tend to have greater knowledge of their risk status than sellers of health
care insurance.
Some individuals will feel their risk is lower than the average and choose not to
purchase the premium. The hazard for those who bought will expand overall and
hence, will increase the costs for premiums. Empirically, individuals with higher risk
usually have lower income and cant afford the new premiums. Moreover, Cartwright
and OBrien (cited in Cullis and Jones,1992, p.238) have concluded that, not only do
members of higher social classes make greater use of preventive services, but they also
receive better care in some respects because of the unequal distribution of facilities
and their ability to communicate with doctors more effectively. Not settled, these
groups can deliver negative externalities as Donaldson and Gerard (1993) agree.

Despite the efforts in America and Australia, to insure those in special groups
(Medicaid for low income in America and Australia, for elderly) a degree of adverse
selection still exists: 17 percent in America had no cover whatsoever, 15 percent in
Australia (Bleweet, 1988). According to Savedoff ( 2004), a progressive tax financed
system would be more efficient in the sense that it will eliminate the competition
between financial intermediaries.

2.3 Lack of competition

Besides natural monopolies, a spatial or a geographical monopoly may occur because

a particular hospital or doctor may be the only one within acceptable travelling
distance for a local community or communities (Donaldson and Gerard, 1993,
p.39).The hospital is clearly in a position to influence the monopoly profit, create
social welfare loss and thus, might become a target of government intervention.

Seeing the advantages of a tax-financed system free at the point of delivery, such as
delivering welfare by eliminating inequalities and inefficiencies; we will examine
some of the issues that arise when implemented in real life.

3. Failures of a tax-financed system

Britain's National Health Service (NHS) is commonly refered to as the paradigm for
progressive tax-based systems (Musgrove, 2000, p.199) and its maine guideline
involves the tax-financed coverage of all basic health care, so that the consumer is able
to use the health service at zero price.

Although the system diminished inequities in access to medical services, it has not
accomplished the promised equality of service which has distinct ramifications for
efficiency (Cullis and West, 1991). The primary issues are in regards to funding and its
impact on the level of provision and inequal distribution amongst regions and between
patients.
3.1 Funding and its effect on the level of provision

Cullis and West (1991, p.226) recognise that there is a component by which a
collective system might be expected to attract fewer resources than a market system
allocation according to priority and political beliefs of the rulling party. In addition,
Buchanan (1966) observes that generally demand is higher when healthcare care is
free.The most readily available data providing an apparent index of unmet demand
are the numbers of people awaiting treatment[...]almost all the major surgical
departements have experienced longer ques recently than at any time in the
past(Cullis and West, 1991, pp 226). And as so long as it is pursued by the medical
technology,waiting list are likely to remain a persisitent inefficient feature of a system
without prices as a rationing device.(Cullis and West, 1991, p.228)

3.2 Inefficient and unequal distribution between regions

Slow pace of hospital development has left many towns of Britain with buildings
pshysically and hygienically unsuitable for the practice of medicine(Cullis and West,
1991, p.228).The raised costs determined by the quick techonlogy advance and the
prerequisites of a Keynesian policy to secure full employment or external trade
balance recommend that the pace of hospital building will always be slow.

Unfortunately it has further contributed to the regional imbalance by falling to fix the
inherited inequalities between regions as the sum given to each was based on the last
years budget.The following table confirms that poor regions did not receive any
aditional revenue which created more inefficiency and inequality.

Acute Geriatic Obstetric and Psychiatric

maternity
Newcastle 3.3 9.2 2.6 3.6
Leeds 3.2 11.0 2.6 3.7
Sheffield 2.5 9.1 2.4 2.8
East Anglia 2.4 8.7 2.3 2.9
NW London 2.5 6.7 2.3 3.4
SE London 3.4 7.8 2.5 3.3
SW London 3.5 7.2 2.4 7.0
Oxford 2.3 9.9 2.3 2.8
South West 2.5 9.0 2.6 4.5
Birmingham 2.7 10.2 2.3 3.1
Manchester 3.1 9.2 2.5 3.1
Liverpool 4.0 9.1 2.6 3.5
Wessex 2.4 7.8 2.3 3.5
3.3 Inequalities between patiens

Another issue with the British framework concerns horizontal and vertical equity.

Horizontal equity alludes to equal acces to care and equal resource provision for a
patient with a given condition of given severity regardeless of where he lives (Cullis
and Jones,1992). However, wide divergencies in treatement policy remain as
Heasman, cited by Cullis and West (1991,p.236) found that while in one hospital area
four-fifths of children having operations to remove tonsils stayed in hospitals for six
days,half those treated in another area were discharged after one day. Not only are
patient treated differentely between facilities, but such inequality also implies
inneficiency as time and staff are squandered.

When examining vertical equity, Barr and Whynes (1993, p.4) discuss the extent to
which individuals suffering from different disorders receive appropriately different
health services. For those in need of care rather than cure, provision was in 1975 still
frequently inaddequate: person per day: 31 for acute hospitals, 12 for geriatic
hospitals and 10 for mental ilnises. (Cullis and West,1991).

4. Conclusion

All things considred, we examined the advantage of a tax-financed system in regards

to managing the issue of equity, externalities, uncertainty and less competition than
desired. Nevertheless, once such a policy was introduced, different problems emerge:
waiting lists and unequal distribution which create inefficiency. So along these lines,
should government intervene to correct market failure by providing a tax-financed
health service that offers medical services free at the point of delivery?

Seeing that it is a trade off between various types of efficiency and equity, the
appropriate answer would be that it is a subjective matter contingent upon basic values
and and the way policy is formulated that differ from country to country.As Donaldson
and Gerard (1993, p.89)add: a health care system which suits candians may not suit
americans.what people want from doctors and from their health services differs from
country to country and thus, such ideological and cultural factors should obviously
have weight alongside economic consideration in deciding on the optimal health care
system for any country. If the ideal of a country is self-interested and therefore is
concerned more with efficiency, then a more private orientated health care market
would be more suited. On the other hand, if the individuals are more worried about
equity and derive more utility from seeing someone better off, then a greater
government intervention like in the case of United Kingdom where the main
motivation behind NHS is to enure that everybody in the country should have an
equal opportunity of acces to healthcare for people at equal risk(1944), would be
better.
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