Martin Gaynor

Competition Among Hospitals

We examine competition in the hospital industry, in particular the effect of ownership type (for-profit, not-for-profit, government). We estimate a structural model of demand and pricing in the hospital industry in California, then use the estimates to simulate the effect of a merger. California hospitals in 1995 face an average price elasticity of demand of -4.85. Not-for-profit hospitals face less elastic demand and act as if they have lower marginal costs. Their prices are lower than those of for-profits, but markups are higher. We simulate the effects of the 1997 merger of two hospital chains. In San Luis Obispo County, where the merger creates a near monopoly, prices rise by up to 53%, and the predicted price increase would not be substantially smaller were the chains not-for-profit.

Moral Hazard and Risk Spreading in Partnerships

Partnerships provide a classic of tradoff between risk spreading and moral hazard. The degree to which firms choose to spread risk and sacrifice efficiency incentive s depends upon risk preferences, for which data are typically unavailable. We use a unique dataset on medical group practice to investigate this tradoff.

Change, Consolidation, and Competition in Health Care Markets

The health care industry is being transformed. Large firms are merging and acquiring other firms. Alliances and contractual relations between players in this market are shifting rapidly. Within the next few years, many markets are predicted to be dominated by a few large firms. Antitrust enforcement authorities like the Department of Justice and the Federal Trade Commission, as well as courts and legislators at both the federal and state levels, are struggling with the implications of these changes for the nature and consequences of competition in health care markets. In this paper we summarize the nature of the changes in the structure of the health care industry. We focus on the markets for health insurance, hospital services, and physician services. We then discuss the potential implications of the restructuring of the health care industry for competition, efficiency, and public policy. As will become apparent, this area offers a number of intriguing questions for inquisitive researchers.

Uncertain demand, the structure of hospital costs, and the cost of empty hospital beds

In this paper we reformulate the theory of cost and production to take account of uncertain demand facing a firm. In the reformulated theory the duality between cost and production no longer obtains, and demand distribution parameters enter the cost function as well as the traditional outputs and input prices. We then estimate a short run cost function for a hospital facing uncertain demand using data from a national sample of over 5000 hospitals for the years 1983-1987. The traditional cost model is strongly rejected in favor of the reformulated model. This model is used to calculate the cost of empty hospital beds, controlling for the effect of uncertain demand on the structure of hospital costs. The cost of an empty hospital bed is calculated as

The Volume-Outcome Effect, Scale Economies, and Learning-by-Doing

36,443 in 1987 dollars. We estimate that a one percent decrease in the number of hospital beds would decrease hospital costs by slightly over one-third of one percent. Increasing the occupancy rate from the average 1992 level (65 percent) back to the average 1980 level (76 percent) is estimated to save the average hospital over

Physician Incentives in Health Maintenance Organizations

2 million, or 9.5 percent of costs.

Competition and Quality in Health Care Markets

There is a large empirical literature documenting the existence of a positive correlation between the number of times a hospital performs a given surgical procedure and the rate of good health outcomes achieved by patients at that hospital receiving that procedure. Typically, it is found that mortality is lower in hospitals that perform more of a given procedure. This result has been found for a wide variety of different procedures, time periods, and locations (David M. Shahian and Sharon L. Normand, 2001; John D. Birkmeyer et al., 2002; Ethan A. Halm, 2002). The two leading explanations for this correlation are the “practice makes perfect” and “selective referral” effects (Harold S. Luft et al., 1987). In the practice-makes-perfect hypothesis, either learning-by-doing or qualityenhancing scale economies cause large hospitals to provide better quality care, improving outcomes. In the selective-referral hypothesis, hospitals with higher quality attract greater demand and therefore have a greater volume of patients. The direction of causality matters for policy. If volume causes outcome, then policies supporting centralization of procedures in a few facilities may make sense. Hospitals that specialize in treating one or a few conditions may have the benefit of producing better outcomes. Antitrust analysis of hospital mergers should probably consider any improved outcomes when evaluating the impact of the merger. If, on the other hand, causality runs from outcomes to volumes, then these issues are no longer relevant. Two recent papers have employed instrumentalvariables techniques using newly developed instruments to address this question. Both find that the direction of causation largely runs from volume to outcome (Gaynor et al., 2004; Gautam Gowrisankaran et al., 2004). These papers use instruments that exploit the geographical distribution of patients and hospitals and the well-established fact that patients strongly prefer hospitals closer to their homes (see Gaynor and Vogt [2000] for a review). If the causation runs from volume to outcome, then it also matters for policy whether the causation is mediated through a static scale economy, in which today’s volume affects today’s outcome, or via a learning-by-doing effect, in which today’s volume affects both today’s outcome and future outcomes. In the static story, it matters less at which hospital volume is concentrated: high volume at any hospital will generate good outcomes. In the learning-by-doing story, it matters more: shifting volume from one hospital to another will involve “stranding” the experience built up at the hospital losing volume. Thus, the benefits of the concentration of volume in one hospital would develop over time, reducing the net benefit. This would tend to make new specialty hospitals, mergers, or regulatory approaches that result in consolidation of volume in one hospital less attractive than they would be in the static story. † Discussants: Paul Gertler, University of California– Berkeley; Dana Goldman, RAND Corporation; Patricia Anderson, Dartmouth College.

ENTRY AND COMPETITION IN LOCAL HOSPITAL MARKETS

Managed care organizations rely on incentives that encourage physicians to limit medical expenditures, but little is known about how physicians respond to these incentives. We address this issue by analyzing the physician incentive contracts in use at a health maintenance organization. By combining knowledge of the incentive contracts with internal company records, we examine how medical expenditures vary with the intensity of the incentive to cut costs. Our investigation leads us to a novel explanation for high‐powered group incentives: such incentives can improve efficiency in the allocation of resources when the allocation process is based on the professional judgment of multiple agents. Our empirical work indicates that medical expenditures at the HMO are 5 percent lower than they would have been in the absence of incentives.

Can governments do it better? Merger mania and hospital outcomes in the English NHS

The goal of this paper is to identify key issues concerning the nature of competition in health care markets and its impacts on quality and social welfare and to identify pertinent findings from the theoretical and empirical literature on this topic. The theoretical literature in economics on competition and quality, the theoretical literature in health economics on this topic, and the empirical findings on competition and quality in health care markets are surveyed and their findings assessed. Theory is clear that competition increases quality and improves consumer welfare when prices are regulated (for prices above marginal cost), although the impacts on social welfare are ambiguous. When firms set both price and quality, both the positive and normative impacts of competition are ambiguous. The body of empirical work in this area is growing rapidly. At present it consists entirely of work on hospital markets. The bulk of the empirical evidence for Medicare patients shows that quality is higher in more competitive markets. The empirical results for privately insured patients are mixed across studies.

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

We extend the entry model developed by Bresnahan and Reiss to make use of quantity information, and apply it to data on the U.S. hospital industry. The Bresnahan and Reiss model infers changes in the toughness of competition from entry threshold ratios. Entry threshold ratios, however, identify the product of changes in the toughness of competition and changes in fixed costs. By using quantity data, we are able to identify separately changes in the toughness of competition from changes in fixed costs. This model is generally applicable to industries where there are good data on market structure and quantity, but not on prices, as for example in the quinquennial U.S. Economic Census. In the hospital markets we examine, entry leads to a quick convergence to competitive conduct. Entry reduces variable profits and increases quantity. Most of the effects of entry come from having a second and a third firm enter the market.