Medical Antitrust Reform: Arrow, Coase and the Changing Structure of the Firm

The collapse of national health care reform has focused attention on private markets as the primary mechanism driving change in medical markets, but physicians and hospitals continue to seek legislation changing the antitrust rules that govern those markets. Physicians seek reforms that would permit greater collective action against third party payors. Hospitals want rules governing mergers relaxed to permit greater collective decision making in the allocation of medical resources. These proposals present a direct challenge to the prerogative of private markets and raise questions over when markets should be trusted and when they should be supplemented or displaced with social institutions. Kenneth Arrow envisions a range of possible non-market institutions filling the "optimality gaps" caused by medical market failures. Ronald Coase's theory of the firm provides a framework for understanding the transformation of the health care industry and for determining which interventions are likely to be helpful and which are likely to be harmful in emerging medical markets. This paper examines these theories and proposes a set of evaluative criteria for assessing health care reforms, concluding that appropriate non-market interventions should (1) be targeted at correcting recognized market failures; (2) result in a net increase in social welfare (static efficiency); and (3) not structurally interfere with the prospective development of efficient market operations (dynamic efficiency). Physician and hospital antitrust reforms are then evaluated in light of these criteria. Physician calls to collectively bargain or to form physician networks in the absence of substantial integration are largely unpersuasive. Antitrust rules should be defined in terms of structural economic considerations that are likely to facilitate more rational behavior in the health care sector. Permitting physician combinations or collective bargaining without integration or risk sharing will not yield the same economic benefits and will likely frustrate future market development. Hospital antitrust reforms raise a different set of questions. The central issue is whether greater cooperation among hospitals is necessary to counteract rent dissipating forms of non-price competition - the so-called medical arms race. While such claims possessed a plausible economic foundation in pre-integrated health care markets, the claims are outdated and unpersuasive by contemporary standards. Integrated firms directly internalize the costs of underutilized capital and equipment and are likely to make appropriate investment decisions. Moreover, to the extent that excess hospital capacity does exist in many markets, such capacity will play an important role in ensuring that future health care markets are maximally competitive. Rather than justifying exceptions to antitrust laws, emerging medical markets call for vigilant antitrust enforcement. Competition between integrated health plans not only facilitates lower prices, it also checks the most significant danger associated with integration: the potential under provision of care. Whether such competitive forces will be sufficient, or whether additional remedies are called for, particularly in markets too small to engender effective competition, remains an important policy question.