15.3 Government Policy

Learning Objectives

  1. What is the basis for government intervention in the market for health-care services?
  2. What forms does this intervention take?

In the United States and around the world, governments are involved in the provision of health care. Some form of national health insurance is commonplace in Europe and Canada. In the United States, bills promoting national health care and universal health insurance have been debated for many years.

Here is a quote from President Dwight Eisenhower’s 1954 State of Union Address: “I am flatly opposed to the socialization of medicine. The great need for hospital and medical services can best be met by the initiative of private plans. But it is unfortunately a fact that medical costs are rising and already impose severe hardships on many families. The Federal Government can do many helpful things and still carefully avoid the socialization of medicine.”AMDOCS: Documents for the Study of American History, “Dwight Eisenhower, ‘State of the Union, 1954,’" accessed March 14, 2011, http://www.vlib.us/amdocs/texts/dde1954.htm.

As we noted earlier, the federal tax code was modified in 1954 to provide incentives for employer-provided health insurance. We structure our discussion of government health policy by answering two questions: (1) why do governments intervene? and (2) how do they intervene?

Why Do Governments Intervene?

As usual, we analyze government involvement in the economy through the lens of market failure. When it comes to health care, there are several market failures to consider.

Externalities. One argument for public involvement in health care is the presence of externalitiesThe direct cost imposed or direct benefit bestowed by one person’s actions on others in society.. If one individual is sick, then the likelihood that others around that person get sick increases. Individuals typically make decisions about their health care without thinking much about the effects of their decisions on the welfare of others. You may decide to go to work even though you are suffering from the flu because you need the money, and you may not think very much about your likelihood of infecting others. This is a classic example of an externality.

Commitment. Hospitals are often unwilling or unable to turn away individuals needing care but lack the resources to pay for that care. Through legislation passed in 1986, hospitals are required to treat patients in emergency situations, no matter what their insurance coverage.The regulation is called EMTALA (http://www.emtala.com/history.htm). It literally applies only to those hospitals that accept Medicare, but this is almost universal. In many cases, this is an inefficient way to treat people. For example, one consequence is that the uninsured have an incentive to seek normal care in hospital emergency rooms, even though this is an expensive place to provide care.

If hospitals could commit not to serve people unless they had health insurance, then some of the uninsured might be induced to purchase health insurance, instead of relying on emergency wards. But hospitals are not able to make such a commitment; although this might be more efficient, it is also unacceptably callous and runs counter to the Hippocratic Oath.

Adverse selection and moral hazard. We explained earlier that when insurance companies are unable to observe the probability of illnesses, some individuals will obtain insurance while others do not. Although these choices may be optimal from the standpoint of an individual, the market outcome is not efficient.

Drug quality. The health-care market is filled with gaps in information. Patients and even their doctors cannot fully assess the safety and efficacy of pharmaceutical products. Although the drug companies test their own products, the government has a role in assessing this information and determining the safety and effectiveness of medications.

Doctor quality. Another informational problem in the health-care market is the inability of a patient to properly evaluate the quality of a doctor. You as a patient can look at some indications of your doctor’s ability, such as years of practice, school of graduation, and number of people in the waiting room. But it is not possible to make a fully informed judgment about the quality of your doctor. Again, the government plays a role by requiring that doctors obtain specialized training and pass a licensing examination before they are allowed to practice.

Patents. The research and development needed to create a new drug is substantial.We also discuss this in Chapter 14 "Busting Up Monopolies". For firms to earn a return on this investment, the patent system exists to provide them protection from other firms producing the same product and selling it at a lower price. Although this type of competition may be valued given that a product exists, it destroys the initial incentives that a firm has to undertake research and development. Governments provide patent protection to induce firms to undertake the necessary research and development.

Market power. Market outcomes are not efficient when there are relatively few sellers of a product. This may occur in various health-care markets because there may be relatively few doctors and few hospitals in a given location. Furthermore, pharmaceutical companies have market power based on exclusive knowledge of their specific product, as protected through patents. Finally, there are relatively few health insurance providers, and some are very large.

Equity and fairness. Even if health-care markets were efficient (and we have explained many ways in which they are not), they may not be equitable. One argument for government involvement is to provide for a more equitable allocation of goods and services. From this perspective, the fact that many Americans lack health insurance and adequate health care is also a basis for government involvement.

Article 25 of the Universal Declaration of Human Rights includes the right to health care: “Everyone has the right to a standard of living adequate for the health and well-being of himself and of his family, including food, clothing, housing and medical care and necessary social services, and the right to security in the event of unemployment, sickness, disability, widowhood, old age or other lack of livelihood in circumstances beyond his control” (http://www.un.org/en/documents/udhr/index.shtml).United Nations, “Universal Declaration of Human Rights,” accessed March 14, 2011, http://www.un.org/en/documents/udhr/index.shtml. To the extent that basic health care is viewed as a basic human right, then the government ought to guarantee access to at least a minimal level of care.

Indeed, if the aim is to move toward equality of well-being, there is an even stronger equity argument for health care. Imagine for a moment that people could decide how to allocate health care and other resources before they knew anything about their own health or well-being. (Thought experiments of this kind are associated with the philosopher John Rawls.In Chapter 12 "Superstars", we discuss this kind of thought experiment in more detail.) People might well agree that those who became sick or disabled should be given extra resources to compensate them for their ill health.

How Do Governments Intervene?

Now that we have some understanding of the sources of market failure in the health-care market, we turn to a discussion of government policy.

Taxes and Subsidies

We have already mentioned one of the key ways in which the government subsidizes health care—by allowing employees tax-free health insurance benefits provided by an employer. In this way, the government reduces the cost of firm-provided health care. It is now common for employment contracts in the United States to include provision for health care.

One of the main issues surrounding employer-provided health insurance is the possibility of losing insurance when you change jobs (sometimes called the “portability problem”). In our economy, shifts in demand for goods and services and changes in productivity naturally lead to the creation of new jobs by some firms and the destruction of jobs by other (perhaps less profitable) firms. The efficient working of an economy therefore requires that workers leave old jobs for new ones. Unfortunately, insurance can get in the way of worker mobility. If you have a job with health insurance, then quitting your job to look for another may be costly for several reasons. First, you may lose insurance coverage during the period of job search. Second, an ailment that was covered by insurance by your existing firm could be viewed as a preexisting condition when you acquire insurance at a new firm. This can have an adverse effect on your insurance rates and the type of coverage you can obtain. In some cases, people choose not to change jobs purely because of the implications for health insurance.

Health care is also subsidized through income taxes. If you look carefully at your income tax forms, you will see that you can deduct medical expenses. If you itemize deductions on your tax form, and if your medical expenses are substantial enough, you can offset those payments against your taxes.


Government regulations are common in the health industry. These regulations influence both demand and supply in this market.

On the demand side, households are required to obtain certain medical services. Some vaccinations are mandatory, for example. At the college level, there is ongoing concern about the spread of meningitis.See “Meningitis on Campus,” American College Health Association, April 27, 2005, accessed February 1, 2011, http://www.acha.org/projects_programs/meningitis/index.cfm. With concerns like this in mind, it is also common for colleges to require some vaccinations prior to admission. The argument for such interventions is that there are externalities from your health to the health of others.

The government licenses many of the actors on the supply side of the health-care market. This is another form of quality control. Doctors who practice in a state must pass exams called medical boards. Hospitals are certified for the types of activities they offer. Often the certification occurs at the state level.For details about accreditation in Texas, for example, see Texas Department of State Health Service, “General Hospitals—Health Facility Program,” accessed March 14, 2011, http://www.dshs.state.tx.us/HFP/hospital.shtm. Other providers of health care are also licensed. For example, a nursing home must be certified as a Medicare provider to receive reimbursements. The rationale for such interventions stems from the extensive information problems in the health-care market. As consumers are unable to accurately assess the quality of care provided by doctors and hospitals, the government provides a service to us all by regulating health-care providers.

Provision of Insurance

The government, through its Medicaid and Medicare programs, provides insurance to both low-income and elderly households. There is continuing debate about expanding the availability of health insurance to the general population. On March 23, 2010, President Obama signed a health-care reform bill.Ample discussion by the White House along with the final bill is available at “Health Reform Puts American Families and Small Business Owners in Control of Their Own Health Care,” The White House, accessed March 14, 2011, http://www.whitehouse.gov/health-care-meeting/proposal. The main goal of the bill is to reduce the number of individuals without health insurance in the United States. This bill seeks to achieve this by requiring that everyone purchase health insurance, either through an employer or individually. The legislation provides opportunities for households to obtain insurance on their own through subsidies and a “marketplace for insurance.”

The bill regulates insurance policies in several ways. For example, it places limits on the ability of insurance companies to exclude people from coverage due to preexisting health conditions or other health risks. It also restricts the ability of insurance companies to set and change rates on insurance policies.

The new policy will not be fully in force until 2014. It is extremely complex (the bill itself is almost 1,000 pages long), and its impact on health-care outcomes, health-care costs, and the deficit remains an open question. (Even the short summary of the actLibrary of Congress, “Bill Summary & Status: 111th Congress (2009–2010), H.R.3590, CRS Summary,” accessed March 14, 2011, http://thomas.loc.gov/cgi-bin/bdquery/z?d111:HR03590:@@@D&summ2=m&. does not make easy reading.) By the time of its implementation, details on the new law may be clearer. In particular, exactly how insurance markets will be organized and regulated will be made more precise. Further, when the bill was passed, estimates were made of the cost savings from the measure. Over time, we will be better able to forecast the spending and taxation implications of the bill once household and firm responses are observed. Then we can see if this legislation improves the efficiency of the health-care market.

A more fundamental question is whether the government should even be in the business of providing health insurance. One set of arguments for government involvement rests on the various market failures that we have identified in this chapter. Health care is complicated, and there are many ways in which health-care markets depart from the competitive ideal. It is sometimes argued that spending on health services in the United States is very high because the market is very inefficient. From that perspective, having the government in charge of this sector of the economy might reduce inefficiencies. Second, government involvement can be justified on the grounds of equity and fairness.

Provision of Information

One of the primary roles of the government is to provide information to the public about health matters. This comes in a variety of forms. In January 1966, the following warning first appeared on cigarette packs: “Warning: Cigarette Smoking May be Hazardous to Your Health.” This initial warning from the Surgeon General’s office of the United States was followed by many others concerning the consumption of cigarettes and other potentially harmful products. Such warnings are a good example of government provision of information. Each consumer of these products wants to know the impact on health. Gathering such information is a public good because the information is available to everyone and can be “consumed” by everyone simultaneously.

Another form of information is through drug testing. The US Food and Drug Administration (FDA; http://www.fda.gov) is responsible for testing drugs before they appear on the market. The FDA also supplies public information about a wide range of food items.

Key Takeaways

  • Government intervention in this market reflects inefficiencies in the market as well as concerns over equity.
  • Government intervention takes many forms around the world, including the provision of health insurance, the direct provision of health-care services, and the regulation of drug companies.

Checking Your Understanding

  1. What is the commitment problem of a hospital?
  2. Recent concerns about the H1N1 virus led the governments in many countries to intervene. How would you explain the basis for this intervention using the list of market failures provided in this section?
  3. Give a recent example where the government provided a health warning.