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Sunday, November 6, 2011

Administrative prices and economic triangles as creators of new information asymmetries

Much has been made of Kenneth Arrow's famous critique of health care economics and his observation that information asymmetry made the delivery of health care different from other information. While I cannot disagree with Arrow that information asymmetries create challenges for consumers of health care, I believe there are elements of the payment system which actually worsen this situation.

Within a market system, the role of prices is to convey information. Pricing is a remarkable information system which merges both conscious and unconscious individual and group preferences. Prices derived from market mechanisms are amazing in terms of the information they reveal. While each of us may consciously believe we have certain preferences, our cognitive unconscious may play an even more important role is the expression of our actual preferences and value trade-offs. The expression "Put your money where your mouth is" is a commonly accepted understanding of this.  Money is a synthesizer of conscious and unconscious preferences.  Thus market price information is valuable in that it tends to reveal real preferences in a format that virtually everyone understands.

When Arrow wrote his analysis, the world of medicine in the US was very different from what the current state is. Most medical encounters involved people who were acutely ill whose questions were rather straight forward. Why am I sick, will I get better, and can you do something for me? The time frame was measured in days or weeks, not years or decades. The resources available to patients was vanishing small (Merck Manual) and the way that physicians practiced invoked the mantle of more the magician than scientist.

Furthermore, in the early 1960's medicine still focused around the two way exchange of physician and patient and the role of third party payers was nowhere near what it is today. Physicians knew more than patients but in reality they did not know too much and for the most part, health care encounters consumed a trivial amount of overall household resources. There were exceptions but there are outlier circumstances in all realms of life where events result in huge and unexpected financial impact. That is why we have insurance.

There are information asymmetries which occur is all elements of exchange. Frank Knight highlighted this in the early portion of the 20th Century when he viewed that risk and uncertainty were drivers of all sorts of transactions, where parties contract with other parties in order to manage risk and uncertainty. I beleive that there is no reason to believe that health care information asymmetries are inherently any more than exists in the interactions of humans in other realms.

Yes, medicine has made incredible strides in the past 100 years, perhaps temporarily outstripping the capacity of the general public to fully comprehend the impact on them and their options when dealing with illness and health business. It was Arthur C. Clark who said "Any sufficiently advanced technology is indistinguishable from magic". Ultimately, the magic trick becomes common knowledge and few are impressed or baffled. The microwave was magical when first available. Now it is used without a moments thought and units can be purchased for less than a tank of gas.

As a practicing physician, I am constantly amazed how little we can predict reproducibly and how little we actually know. There may be a perceived asymmetry of knowledge but the differential of what is known between physician and patient is likely less than one might believe. Generally, physicians (and other health care providers) know substantially less about what is really important to patients their patients and patients, particularly educated ones with chronic problems, know immeasurably more of what is important than any of their treating agents.

The information asymmetry still exists, but in an entirely different form. Instead of a two-way transaction, we now have a three way transaction. Each of the parties has information that is not shared with the other parties, sometimes intentionally but often quite by accident. Each party has different goals and different priorities. In a situation where market prices were actual information tools and could convey information regarding preferences of the various parties involved, perhaps they could serve to work toward shared goals and efficient allocation of scarce resources. However, administratively set prices in health care are simply accounting tools and not information tools.

Thus, we lose the use of perhaps the most important information tool available in a price coordinated economy. We no longer just have information asymmetries. We end up with information voids. Physicians have little or no idea of what patients really value since patients are for the most part not asked to value their preferences in the format which we all understand.

Marketers of health care services game the system and are driven to respond to a payment system devoid of real patient preferences. They move to where the margins are, whether what they do delivers the most value to patients. Payers are driven by pressures from their biggest customers and those who can exert political pressure. Without a dynamic pricing system, the feedback loop which operates in other vibrant elements of the economy is not present. Without information that comes from market based prices, resources are allocated poorly, productivity fails to increase (or falls), and scarcities are worsened.

Our present circumstances are all too predictable based upon what we have done to the pricing mechanism in health care and its impact on information exchange.

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