Is Hospital Competition Socially Wasteful?

A study finds that competition was good for a group of acutely ill patients, in part because of managed care efficiencies.

August 01, 2000

| by Barbara Buell

Is competition among hospitals good or bad for patients? Stanford Business School economist Daniel Kessler and fellow Stanford economist and physician Mark McClellan found that competition was good for a group of acutely ill patients they studied, and that managed care in part explains why hospital competition has had a positive effect.

Economists long have disagreed about the impact of competition among health care providers on patients and on efficiency overall. One camp has argued that competition in the health care industry is good, for the same reason it works in the economy at large: It leads to high quality and low prices. However, others have observed that unique aspects of markets for health care, such as health insurance, which dampens patients’ sensitivity to differences in prices may lead medical centers to compete in ways that result in the provision of medically unnecessary services.

Assessing the effects of competition in markets for health services is more than just an academic exercise, because these opposing views have different implications for antitrust policy. If competition among hospitals is good, then strict limits on the extent to which hospitals are allowed to coordinate their activities might lead to higher-quality care at lower prices. But if competition among hospitals is socially wasteful, then lenient antitrust treatment of mergers and other forms of coordination may be the better course.

In a study to be published in the Quarterly Journal of Economics, Kessler and McClellan analyze the effect of competition on the medical expenditures and health outcomes of elderly heart attack patients from non-rural areas who were admitted to hospitals between 1985 and 1994. They combine information from elderly beneficiaries’ Medicare hospital claims with information on hospitals gathered by the American Hospital Association.

They find that in the 1980s, competition led to higher costs and somewhat better health outcomes for elderly Americans with heart disease. But in the 1990s, competition led to substantially lower costs and significantly lower rates of mortality and cardiac complications. In particular, after 1990, it was approximately 8 percent more costly to be treated in the least competitive fourth of hospital markets than in the most competitive fourth.

The quality of care in competitive markets was higher as well: Mortality among patients in the least competitive fourth of hospital markets was approximately 1.5 percentage points higher than in the most competitive areas. Expressed as a share of 1994’s average mortality from heart attacks in the elderly, competition had the potential to decrease mortality rates by 4.4 percent. Patients from the least competitive markets also experienced higher rates of readmission for some cardiac complications. “At least in very uncompetitive markets, policies to increase competition among hospitals are good for patients and for society overall,” says Kessler. The authors conclude that the increase in the general population’s enrollment in HMOs during the sample period partially explains the dramatic change in the impact of hospital competition for two reasons. First, hospital competition both reduced cost and improved outcomes throughout the sample period in geographic areas with above median HMO enrollment rates. Second, benefits of competition are measurably larger for patients from states with high HMO enrollment than for patients from states with low HMO enrollment.

Kessler and McClellan suggest that spillover effects from increasingly efficient treatment of privately insured patients in HMOs may have favorably affected the treatment of Medicare patients by mediating the effects of hospital competition in a way that enhances medical productivity. In particular, managed care appears to increase efficiency by reducing the tendency of hospital competition to result in a “medical arms race” of expenditure growth.

These findings, the two economists say, are not affected by differences in structure of the hospital market such as distance to the nearest hospital, hospital bed capacity utilization, and the characteristics of area hospitals. In future work they intend to explore whether these findings extend to patients with non-acute illnesses, such as cancer, and to study further the mechanisms through which competition among health care providers affects quality and cost.

For Profit Hospitals Realize Lower Expenditures Hoover Institution, 2003

Is Hospital Competition Socially Wasteful? Daniel P. Kessler and Mark B. McClellan. Currently available as National Bureau of Economic Research Working Paper #W7266, July 1999

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