Wednesday, March 16, 2016
The blog of the Stigler Center at the University of Chicago Booth School
March 15, 2016
"There Is Regulatory Capture, But It Is By No Means Complete"
Interview of Kenneth J. Arrow
Kenneth J. Arrow, one of the most influential economists of the 20th
century, reflects on the benefits of a single payer health care system,
the role of government and regulatory capture.
Kenneth J. Arrow requires very little introduction. Very few people, if
any, can say they have influenced the development of economic theory in
the 20th century as deeply as Arrow, who revolutionized the field of
economics with groundbreaking contributions to general equilibrium
theory, welfare theory, social choice theory and risk. In 1972, at the
age of 51, Arrow won the Nobel Prize in Economics (sharing the prize
with John R. Hicks). Arrow was the youngest economist ever to win the
prize, a title he still holds to this day.
Born in New York in 1921, the son of Romanian-Jewish immigrants, Arrow's
life and work were profoundly influenced by the experience of growing up
during the Great Depression. Over the years, his published papers on a
wide variety of subjects, from innovation and monopolies to racial
discrimination, information and climate change. In 1963, he published
his classic paper on health care, Uncertainty and the Welfare Economics
of Health Care, which was the first to show that existing competitive
market models cannot be applied to the health care industry. The article
effectively created the field of health economics, and is still
frequently cited in debates regarding the role of non-market forces and
institutions (like government) in the health system.
*Q: looking back on your seminal 1963 paper about healthcare industry –
it seems that the American health care system has only gotten worse
since. /Some people claim that it is the worst among developed nations
in terms of cost, waste and wrong incentives to physicians, hospitals
and research, and influence of special interest groups – producing very
high rents, and little value./*
Certainly in terms of inefficiency, I don't think it has improved at
all. The system is about as inefficient, and it was pretty inefficient
then too. If we look at measurements like cost per capita, compared to
comparable countries like Canada or the UK, it got worse. The rather
reasonable attempts to improve the delivery, that is to extend health
care to more people, have led to a bigger system, and therefore more
complexity and more chance for exploitation. We talk about a price
system, but that is not what we have. What we have is a system in which
one buyer will pay ten times what other buyers will pay for similar
medical devices, or services. So the idea of a price system as the
source of efficiency fails at the most elementary level.
These things are never simple. You do want incentives for pharmaceutical
companies to generate new drugs. Developing drugs is a pretty expensive
proposition, and the failure rate is pretty high, so we have to create
incentives for companies to innovate. The problem with what's happening
now is that to some extent, because the American market is not
uncontrolled and other markets are, we are subsidizing new drugs to
*Q: Is there a way to mitigate this problem?*
This is not a problem that's just confined to the pharmaceutical
industry, but I think it's most intense there. The question of
intellectual property goes back several hundred years. Since the 17th
century, the basic deal is that in return for the innovation, you give
[innovators] monopoly power. That's the way you pay for the upfront
costs and provide incentive. This of course gives rise to monopolies,
which is an inevitable conflict. Even Hayek was disturbed about whether
intellectual property is really property in the same sense that a house
The truth is it's very easy to rail against it, but it's not easy to
find a substitute. People have proposed substitutes from time to time,
like paying the innovator the social value of the innovation, and insist
on free competition after that. But since no one knows how to evaluate
the social value, it's not a very practical answer.
There is no easy way out of this conflict, though a better-regulated
system could help. A better bargaining position will improve matters,
but you have to be a little careful, because you don't want to hurt
innovation. What you have under the present situation is a great
incentive for health providers, hospitals and HMO, to get bigger,
because that improves their bargaining position vis-à-vis the insurance
A single payer will have control that will allow it to prevent things
like differential pricing from happening. If the government was allowed
to use its bargaining power, it would dominate. There will be
monopolies, but they would be facing a single payer. A monopoly usually
has power because it is the only one facing a large market of diverse
I'm afraid you're talking to someone who's an "on the one hand, on the
other hand" type of person, which makes me a poor advocate.
*Q: It does sound like you are strongly in favor a single-payer system,
though. Last year you signed, along with 266 other economists, a
declaration that called on policymakers around the world to work toward
universal health coverage.*
I wouldn't say I'm strongly in favor of a single payer system. I can
find objections to it. But I still think it's better than any other
system. However, the idea of permitting private practice must not be
ruled out. Similar to the UK, there can be a single payer system which
everybody can go to, and private medical practices for those who want.
In the UK, private medicine is about 20 percent of the total, so there
is this escape valve for those who want it, but also a single payer
system that anybody can join.
*Q: Perhaps the way to fix the American health care system is simply to
adopt the UK model?*
I would say the Canadian model, rather than the UK model. But it's so
politically out of the question I don't even think about it.
*Q: So you're saying that one answer to the influence of special
interest groups in the health care system is to have the government
intervene in a major way, whether it is through a single payer system or
something more akin to the UK model?*
That's right. Of course, George Stigler would say that there could be
regulatory capture, but so far it doesn't seem to have happened really.
*Q: Doesn't the rather-muted regulatory response to phenomena like
pharmaceutical price hikes and "evergreening" – making minor tweaks to
existing formulations in order to artificially extend patents – suggest
at least a possibility of a capture?*
There's no question that every time you have interaction between
government and private interests, especially concentrated ones, they're
always going to have power. In this case, I think there's no alternative.
Medicare particularly has succeeded in imposing price regulations of a
pretty detailed nature without too much trouble. Recent regulations
regarding readmission rates for Medicare have gone through a surprising
lack of opposition. We know that other countries have also succeeded in
doing this without too many scandals, even countries that are not
thought of as models of good government.
*Q: In that 1963 paper you wrote that "the laissez-faire solution for
medicine is intolerable." 50 years later, do you still believe that to
We don't have a laissez-faire system. The intervention of the federal
government, as measured by expenditures, is growing. It is not a private
system at all. Roughly 50 percent of health costs are paid for by the
government, and state governments are spending more and more on health.
It's crowding out education. State budget-support for education,
especially higher education, is crowded out by two things: health and
prisons. Nobody is prepared for the idea of a laissez-faire system, and
we never really had one.
Arrow, Kenneth J., "Uncertainty and the Welfare Economics of Medical
Care, The American Economic Review, December 1963:
Comment by Don McCanne
Nobody understands markets and health care better than Nobel laureate
Kenneth Arrow who wrote the classic treatise on the topic over half a
century ago. Based on his work, it is clear that the government must be
involved if we are to improve efficiency in the system as we attempt to
expand it to include everyone. So what does Kenneth Arrow think about
single payer as a model for health care?
Although he understands that there are some deficiencies in the single
payer model, he states, "it's better than any other system." He does say
that he believes that private practice should be permitted as an option,
like they have in the United Kingdom. But when asked if the United
States should adopt the UK system, he says, "I would say the Canadian
model, rather than the UK model." That's interesting in that Canada does
not permit health care to be paid for privately if it is covered by
their single payer Medicare program (although that continues to be
challenged by the Canadian privatizers).
Kenneth Arrow is not an ideologue. He is a gifted, two-handed economist
(i.e., looks at the options). He has stated that single payer is better
than any other system, and we should listen to him.
at 1:37 PM