Rx for the U.S. health care crisis.

• Author: Brock, Horace W.
• Position: Viewpoint

The nation is clearly at a crossroad in the financing of health care, an issue that will loom large in the forthcoming presidential elections. While most people welcome a long-overdue debate on this issue, there is a very real possibility that we will make serious mistakes in dealing with it. Since the business community will find itself front and center in the debate over who should pay for what, executives should understand the prerequisites for rationality and join forces with the medical community to press for policies that embody them. Failure to do so could be catastrophic both for companies' bottom lines and ultimately for U.S. global competitiveness.

THE LOGIC OF HEALTH CARE INSURANCE

At one level, insurance is just another commodity bought and sold on the market. Yet it is unlike any other commodity in several important respects. This was first appreciated in a systematic manner by Kenneth Arrow, the Stanford University Nobel laureate economist whose pioneering research on the economics of insurance in the 1960s remains state-of-the-art today.

One of Arrow's insights was that neither the market nor the government can ever provide a fully "efficient" (i.e., non-wasteful) allocation of risk throughout society. The principal reason is the so-called "moral hazards" problem endemic to insurance: The act of providing insurance changes the probabilities of occurrence of those very outcomes that are insured. We witness this phenomenon in everything from arson, on the one hand, to statistics of phantom back injuries in Holland, on the other. In Holland, the provision of overly generous health-care insurance caused a 400-percent increase in alleged back injuries.

Somewhat related to the moral hazards problem is the peculiar nature of the demand for insurance in health care. Evidence shows that if people receive blanket first-dollar coverage, the demand for coverage will explode. Each of us will think nothing of charging "the system" $200 for a visit to a doctor to remove a hang-nail. There is simply no incentive to weigh benefits against costs.

Yet demand drops off rapidly once people are charged a portion of the costs incurred by such visits, as studies carried out by the RAND Corporation have shown. This is taken as proof positive that first-dollar coverage needlessly inflates the demand for medical services, and thus gives rise to uncontrollable medical care inflation. So much so, in fact, that in many nationalized health care systems abroad that are touted as "successful," medical services are now being rationed according to "true need." This was hardly an objective of the original programs. And it is a denouement no one likes.

The principal lesson to be drawn from these observations is the need for a...