NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Are Invisible Hands Good Hands? Moral Hazard, Competition, and the Second Best in Health Care Markets

Martin Gaynor, Deborah Haas-Wilson, William B. Vogt

NBER Working Paper No. 6865
Issued in December 1998
NBER Program(s):   HE

The nature, and normative properties, of competition in health care markets has long been the subject of much debate. In particular, policymakers have exhibited a great deal of reservation toward competition in health care markets, as demonstrated by the plethora of regulations governing the health care sector. Currently, as consolidation rapidly occurs in health care markets, concern about reduced competition has arisen. This concern, however, cannot be properly evaluated without a normative standard. In this paper we consider what the optimal benchmark is in the presence of moral hazard effects on consumption due to health insurance. Moral hazard is widely recognized as one of the most important distortions in health care markets. Moral hazard due to health insurance leads to excess consumption, therefore it is not obvious that competition is second best optimal given this distortion. Intuitively, it seems that imperfect competition in the health care market may constrain this moral hazard by increasing prices. We show that this intuition cannot be correct if insurance markets are competitive. A competitive insurance market will always produce a contract that leaves consumers at least as well off under lower prices as under higher prices. Thus, imperfect competition in health care markets can not have efficiency enhancing effects if the only distortion is due to moral hazard.

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Published: Journal of Political Economy, Vol. 108, no. 5, (October 2000): 992-1005

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