Buyer Power and Healthcare Prices

Posted by Social Science Research Network

Buyer Power and Healthcare Prices John B. Kirkwood (Seattle University)

Abstract: One of the major reasons why healthcare costs are higher in America than in other countries is that our prices are exceptionally high. In this article, I address whether we ought to rely more heavily on buyer power to reduce those prices, as other nations do. I focus on two sectors where greater buyer could easily be exercised: prescription drugs covered by Medicare and hospital and physician services covered by private insurance.

I conclude, first, that the prohibition on federal negotiation of Medicare prescription drug prices should be repealed. Unleashing the government’s buyer power would substantially reduce the prices of many branded drugs without causing large adverse effects on innovation. The bulk of basic scientific research is funded by the federal government, the incentive to develop important new drugs would remain high because the government would have little leverage over the prices of those drugs, and branded drug makers appear to have been exceptionally profitable in recent years. If that is correct, they could lower prices on many medicines and still earn a competitive return on most R&D. Moreover, if problems did develop, payments for new drugs could be increased.

In contrast, encouraging large insurance companies to merge does not appear to be a promising way of lowering healthcare costs. While some mergers may be procompetitive – they may force providers with market power to reduce prices and those price cuts may be passed on to consumers – most large health plan mergers are likely to present significant competitive risks: they may allow the merged firm to exert monopsony power over small providers, they may create market power and raise insurance premiums; and they may allow the merged firm to gain a discriminatory advantage over smaller insurance companies, threatening downstream competition. Because of these multiple risks, it does not appear desirable, as a general rule, to allow large health insurers to merge in order to exert greater buyer power.