Review JournalWhat Every Public Finance Economist Needs to Know About Health

Economics: Recent Advances and Unresolved QuestionsBy Glied, Sherry A, Remler, Dahlia K,

National Tax Journal; Dec 2002; 5, 4; ProQuest pg. 771

Reviewed by Iman Sufrian NPM 1206313974

A. BACKGROUND/INTRODUCTORY

The standard theoretical framework of health economics, focuses its attention to four

major problems as follows:

1. Illness and accidents are unpredictable but costly events. This condition provides

justification of the existence of health insurance. However, the existence of health

insurance has insulated people from the true cost of medical care that leads to

too much service use and excessively high medical spending. This problem is a

form of moral hazard problem which is exacerbated by the tax-subsidy for the

purchase of insurance.

2. Adverse selection problem caused low-risk individuals to leave the insurance

market, so that single –pooling equilibrium with one premium for both low and

high risk individuals is frequently unsustainable and low risk individuals are often

underinsured

3. Physicians are better informed than patients and this asymmetric information

caused market failure.

4. There are concerns about inequity of health insurance that revealed the

importance of redistribution related to health care.

This standard theoretical framework support the argument of most empirical health

economics research and is a valuable guide for policy analysis. However, it is also

has significant limitation that recent research try to address.

This paper tried to examine the recent contributions that improve the theoretical

framework of health economics which is based on four problems stated above.

1

B. METHODOLOGY

Authors of this paper conducted a wide literature review of each problems of the

theoretical framework of health economics. Based on literature review, the authors of

this paper then summarize and synthesize the contributions and limitation of the

standard theoretical framework of health economics. Subsequently, the authors of

this paper examine the development of the theoretical framework based of more

recent studies. Lastly, the author of this paper made a conclusion regarding the

theoretical framework of health economics.

C. JOURNAL CONTENT

Contributions and Limitation of the Standard Theory

This healthcare theoretical framework had provided a foundation for empirical

research in this area. Vast research in this area was also supported by the

availability of health economics data. Some major contribution of the standard theory

of health economics are as follows:

a. The standard theoretical framework contributed in understanding the elasticity of

demand for medical care. Research revealed that public as whole experienced

welfare losses associated with voluntarily –purchased private health insurance

are very large, comprising between 8-28 percent of national health expenditures.

b. Standard theoretical background also contributed to explain the existence of

adverse selection problem in the choice between coverage and no coverage.

c. Standard theory give rise to the literature on the effects of payment incentive on

the provision of medical services.

d. Standard theory also contributed to guide analysis of policy. For example, the

standard treatment of moral hazard has led economists to emphasize the value

of withdrawing the favourable tax treatment of employer-sponsored health

insurance. This tax treatment cause both distortionary and inequitable.

However, standard theoretical background also has its limitations. This theory failed

to capture many of the key facts about US health care and therefore provides

insufficient guidance for health care policy. Those key facts were:

a. The standard theory of adverse selection could not explain the reason for the

possibility of a market failure.

b. The health insurance market had shifted away from cost sharing and toward a set

of alternative strategies for controlling moral hazard, knows as managed care.

2

Although this method of reducing medical expenditure are consistency with effort

to reduce moral hazard problem, standard theory did not explain why they

appeared to be preferred.

c. There was a widely documented and substantial prevalence of “flat of the curve”

medicine, care for which the expected benefit is zero. Standard theory could not

give any possible solution to get rid of flat of the curve medicine.

d. Standard theory could not give any possible solution to the problem of equity in

health care.

This paper tried to provide understanding the extensions of the existing framework,

aimed to provide economic explanation for these public policy problems and to focus

policy proposals in new directions.

Lessons learnt from this paper regarding the existing theory were as follows:

a. Medical complexity and moral hazard

New theoretical approach states that people seem to prefer managed care over

cost sharing for addressing moral hazard problem. Managed care also succeed

to reduce welfare losses associated with overconsumption in health insurance.

b. Patient provider informational asymmetries

Standard theory suggests that making providers more responsible leads to

greater incentives for cost control but also increases incentives for selection and

underservice. The optimal form of insurance is therefore a blend of demand side

and supply side cost sharing.

c. Selection

Standard economic theory suggests that pooling equilibria cannot be sustained in

health insurance markets. This lead to rejection of high risk customers by

insurance company to those group of population.

Modified selection model provides a theoretical explanation for why coverage

denials may be evidence of a market failure.

d. Equity concerns in health care and the growth of medical technology

Recent innovation in medical technology is that new technologies have generated

improvements in health that outweigh the new expenditures they generate.

3

D. SUMMARY

Based on above parts, this articles has provided a thorough framework on the

standard theory of health economics. This article also revealed recent developments

that gives extension and modification existing standard theory. Recent developments

are categorized into 4 major problems in standard theory.

Recent developments in health economics theory also shed new light on important

policy problems, help to explain several persistent anomalies, and provide a

rationale for novel policy approaches. Contracts that combine multiple rationing

methods, including cost sharing, supplier incentives, and utilization management

may come closer to the optimal complete contingent contract.

Theories of provider payment showed how different types of payment mechanisms

can generate different quantities, qualities and prices of care. Payment methods that

place health care providers at significant financial risk for patient service utilization

can generate strong incentives for selection of healthier patients. They can also

induce providers to skimp on the provision of treatment.

Adding transaction cost generate the result that, consistent with empirical fact and

policy concern, high risk people, not low-risk people, are underinsured in the health

insurance market. Some market-based approaches to long – term contracting have

been suggested, but the difficulty of making appropriate side – payments, especially

in the presence of uncertainty about future technological progress, make these

contract difficult to write. These problems help explain the persistence of employer-

based private health insurance and pay-as-you-go financed public insurance.

Finally, society’s concern about relative equity in health means that technological

advance in health care generate new public policy problems. We must decide

whether to limit the amount of medical care available to all (a component of the

health care systems of many other nations), tolerate growing inequality in health

care, or accepts the burden of ever greater re- distributional expenditures to cover

ever improving medical care.

4

One important feature of health economics is that all the problems describe above,

overconsumption, informational asymmetries, selection and redistributional concern,

occur at the same time. This problem led to a now proposal of new system of

managed competition. In this model, plans would compete ex ante for consumer on

the basis of both price and quality. A system of risk-adjustment would control

selection.

Achieving the optimal distribution of medical care services appears to be an

extremely complex problem that no one has yes solved. Payment arrangements

between insurers and providers are myriad and endlessly changing; the appeal of

cost control strategies, such as utilization management, goes through regular cycles

of enchantment and disappointment; medical technology continually improves, and

health care remains an enduringly potent political issue. Despite excellent

development there is much we still do not understand about the health care market.

5

REFERENCES

Glied, Sherry A, Remler, Dahlia K , What Every Public Finance Economist Needs to Know About Health Economics: Recent Advances and Unresolved Questions National Tax Journal; Dec 2002; 5, 4; ProQuest pg. 771

Varian, Hal R., Intermediate Microeconomics – A Modern Approach (Fifth Edition),

W. W. Norton & Company, New York-London, 1999.

6