Michael F. Cannon
Today marks the 25th anniversary of one of the most important articles in health economics. In 1963, the American Economic Review published economist Kenneth Arrow’s “Uncertainty and the Welfare Economics of Medical Care.” Since then, Arrow went on to win the Nobel Prize in economics (for other work), and people have cited his market-failure analysis in support of countless government interventions in health care. As a health reform discussion lengthens, the probability that someone will cite Arrow approaches unity. Close behind is the probability that they will cite him inaccurately.
On October 1, 2001, the Journal of Health Politics, Policy, and Law featured a retrospective symposium on Arrow’s article. After decades of watching others use and misuse Arrow’s analysis, UC-Berkeley health economist James C. Robinson responded with “The End of Asymmetric Information.” Robinson’s analysis is even more relevant at the dawn of the artificial intelligence revolution than it was 25 years ago. It begins with perhaps the strongest opening of any health economics article.
The most pernicious doctrine in health services research, the greatest impediment to clear thought and successful action, is that health care is different. Of course the medical sector has features not found elsewhere in the economy and polity, but then there is a uniqueness to every other industry. Each of the salient characteristics of health care, including professionalism, licensure, nonprofit organization, third-party payment, and heavy government regulation, can be found in other sectors, albeit not bundled in quite the same distinct and dysfunctional manner. The uniqueness doctrine hence proves too much. More importantly, the principle serves as a two-way barrier to entry between the health and non-health sectors. In one direction it discourages mainstream economists from importing the principles of industrial organization, game theory, and transactions costs to health care issues by raising a wall of acronyms and institutional trivia that impedes dialogue. In the other direction it fosters a complacency among the virtuosi of health policy analysis, allowing us to achieve fame and fortune in our small pond without fear of competition from denizens of the scholarly shark tank.
To some within the health care community, the uniqueness doctrine is self-evident and needs no justification. After all, health care is essential to health. That food and shelter are even more vital and seem to be produced without professional licensure, nonprofit organization, compulsory insurance, class action lawsuits, and 133,000 pages of regulatory prescription in the Federal Register does not shake the faith of the orthodox. For the sophisticates, however, the uniqueness doctrine does demand a foundation or least a pedigree. It is here that the theory of asymmetric information enters, gets comfortable, and decides to reside permanently in the intellectual edifice of health economics, medical sociology, health politics, and the other subspecialties of this faction-ridden but homologous research community. Which brings me to “Uncertainty and the Welfare Economics of Medical Care” (Arrow 1963).
This is a good article by a great economist, a creative application of the theory of risk and uncertainty to the thorny problems of the health sector, exactly the sort of boundary-crossing, barrier-penetrating work that opens the possibility of progress in thought and action. Would we have more of the same. But its effects on the field of health services research, for which the author cannot be held responsible, must be judged more ambivalently. The central proposition of his article, that health care information is imperfect and asymmetrically distributed, has been seized upon to justify every inefficiency, idiosyncrasy, and interest-serving institution in the health care industry. The article makes the protean claim that unusual contractual, organizational, and normative features of the health care sector derive from efficiency-enhancing responses to underlying informational limitations. This is a fecund alternative to the intellectual status quo of the time, which interpreted unusual institutional features largely as efforts at monopoly power. Yet it has served to lend the author’s unparalleled reputation to subsequent claims that advertising, optometry, and midwifery are threats to consumer well-being, that nonprofit ownership is natural for hospitals though not for physician practices, that price competition undermines product quality, that antitrust exemptions reduce costs, that consumers cannot compare insurance plans and must yield this function to politicians, that price regulation is effective for pharmaceutical products despite having failed in other applications, that cost-conscious choice is unethical while cost-unconscious choice is a basic human right, that what consumers want is not what they need, and, more generally, that the real is reasonable, the facts are functional, and the health care sector is constrained Pareto-efficient…
[T]he dangers of this approach, once in the hands of less-able and more-interested partisans and pleaders, are evident. Imperfect and asymmetric information is at most a necessary, not a sufficient, condition for the observed facts about health care (Arrow never claims otherwise). Informational deficiencies could produce organizational and normative features quite different from those actually observed in the United States of 1963, and in fact they did. The health care systems of Great Britain, the Soviet Union, and the Republic of South Africa in 1963 each lay atop missing markets for information and risk bearing, but nevertheless differed markedly among themselves. It strains the imagination to attribute cross-sectional variation in health system characteristics to cross-sectional variation in information asymmetries. Longitudinal variations are no more easily interpretable in this context. The evolution of the medical profession, the hospital industry, the insurance and managed care sector, and the other components of the system are not immediately and obviously due to contemporaneous changes in the underlying information structure…Arrow’s article thus tends to receive less acclaim among historians than among those for whom history is bunk (Starr 1982).
If imperfect information is not sufficient for explaining the organizational and normative features of health care, neither is it necessary. While a world of perfect information undoubtedly would look quite different from the status quo, it is easy to find explanations for the special features of health care without primary appeal to information asymmetry. The most obvious alternative category of explanations, of course, derives from the vast literature on bureaucratic and legislative capture, contrived monopoly and barriers to entry, mythology and mystification, fraud and abuse, and sleaze in all its manifestations. Arrow does a great service, in my opinion, in promoting an alternative to this class of explanations, which was (and remains) a major explicative contender in some quarters. Arrow cites, and we read updates of, arguments that licensure is a limit on physician supply, sliding-fee scales are evidence of discriminating monopoly, nonprofit hospitals are shells for physician revenue maximization, and so on. But the unfortunate fact that the inhospitality tradition in law and economics (which ascribes every unusual organizational arrangement to monopolization) often spreads beyond its legitimate bounds does not justify an equally unfortunate ascription of efficiency-enhancing attributes to every unusual arrangement. Capture is real. Agency failure is real. People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public or in some contrivance to raise prices (Smith 1776)…
Noneconomists…are socialized to underestimate the capabilities of the price mechanism (and to overestimate the capabilities of formal organization, social norms, professional associations, and legal rules) and thus are at risk of interpreting Arrow as a preeminent economist who agrees with their prejudices. For the noneconomist, Arrow’s primary message should be that most sectors of the economy work reasonably well (at least compared to medicine) without many of the organizational curiosa of this sector and hence that the price mechanism should be accorded greater respect and its potential applicability to the health sector be pushed higher on the list of research priorities.
The Wall Street Journal praised Robinson’s article in 2013. Still, it has not received nearly as much attention as Arrow’s (Google Scholar citations: 67 vs. 13,649). It should. Robinson cites Paul Starr’s parallel (and more pointed) critique of Arrow in the latter’s Pulitzer Prize-winning 1982 book The Social Transformation of American Medicine. Neither is in the public domain. I might share relevant passages with those who ask nicely.
