Code Red: Two Economists Examine the U.S. Healthcare System

September 19, 2007

Evanston Northwestern Healthcare

Filed under: Competition — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 6:51 pm

David Dranove

Will,

The recent 5-0 ruling by the FTC Commissioners in the Evanston Northwestern Healthcare (ENH) antitrust case was a real body blow to those of us who support competition in healthcare.  The Commissioners agreed with a federal district judge’s ruling that Evanston and Highland Park Hospitals had achieved excessive market power by forming ENH.  But instead of affirming the judge’s order to force ENH to split up, the Commissioners instead ruled that ENH could remain intact provided that the member hospitals set prices independently.  The FTC seems to be saying that it is okay for hospitals to dominate a market, so long as they do it with a nod and wink.

You know the history of this case.  During the 1990s, the FTC repeatedly tried and failed to block mergers that seemed to be creating local monopolies.  Time and again, the courts accepted misplaced theories about the size of healthcare markets, allowing what looked to be obvious monopolies to claim, with a straight face, that they faced ample competition.  Do you remember Ted Frech’s paper showing that one of the theories embraced by the courts – the Elzinga-Hogarty (E/H) model – led to the bizarre conclusion that all of California was a single market?  Well, the E/H model was wrong.  My Antitrust Bulletin paper with Cory Capps, Shane Greenstein, and Mark Satterthwaite described what we called the “silent majority” fallacy with the E/H model and even Ken Elzinga agreed with us.  By the early 2000s, the FTC was prepared to present new theories to the courts, theories similar to those we developed in the Antitrust Bulletin paper.  The FTC also had supporting evidence that mergers caused higher prices without any predictable efficiencies.  Again, I contributed some of the foundation research.  The FTC went looking for a good test case and found it right in my backyard.

Evanston Hospital (along with its longtime partner Glenbrook Hospital) is one of the most popular providers on Chicago’s ritzy North Shore.  About a decade ago, it merged with another North Shore stalwart, Highland Park Hospital, to form ENH.  Unfortunately for ENH, the FTC was hoping to lick its wounds after a decade of futility.  The FTC built a dossier of seemingly damning facts against ENH and Ken Elzinga testified as a star witness for the prosecution.  The FTC proved to a lower court judge that the North Shore constituted a distinct market.  It also presented evidence that the merger was accompanied by substantial price increases.  No surprise there – you and I have done a lot of research showing that market power has the same harmful effects in health care as in any other sector.  In what seemed like a turning point in healthcare antitrust, the district court judge sided with the FTC and ordered ENH to split up.  It was now up to the FTC to enforce the order.

So what do the Commissioners propose?  ENH can stay together, provided that Evanston and Highland Park Hospitals set prices independently.  It is as if the case had not yet been decided and the FTC offered a “plea bargain” that ENH would find too good to pass up.  Not only that, the most likely party to appeal such a decision would seem to be the FTC, had it not been their own decision!

And what a strange decision to make.  Supposing that Evanston and Highland Park Hospitals manage to avoid all communication about pricing (a big supposition for sure), the solution is still ridiculous.  If Highland Park holds out for high price in negotiations with managed care purchasers and somehow manages to get excluded from managed care networks, its patients will just end up at Evanston Hospital, and vice versa.  ENH corporate office surely knows this, and will send word to both hospitals to hold out for high prices.  In economics parlance, prices will become “strategic complements.”  I have done some back of the envelope simulations using a newer version of my RAND Journal hospital/insurer bargaining model and I think prices could rise even higher than monopoly levels!  The FTC would have been better off if they had not gone after ENH in the first place.  Surprisingly, ENH is making noises about appealing the FTC remedy.  It should take the offer and quit while it is ahead.

Let me try to put a positive spin on this.  The FTC proposal resembles the “messenger model” that it currently permits for physician pricing.  The fact that the messenger model is acceptable might put the FTC in a bind.  The FTC may feel that it can not be tougher on ENH than it is on other merged healthcare providers.  On the other hand, this may simply be heavy handed politics.  The ENH investigation was the brainchild of former chairman Tim Muris, who was a well-respected academic before taking the helm of the FTC in 2001.  Muris left the FTC in 2004 and the Commission is now chaired by Deborah Platt Majoras, a lawyer who seems to be following the Republican tradition of turning a blind eye to monopoly.  (Do you remember the Department of Justice “remedy” in the Microsoft case?  That was another example where the antitrust enforcers in the field did their job brilliantly, only to have political appointees undermine their efforts.)

About the only argument I have heard that might justify mergers like ENH is that they are necessary to create “countervailing power” against dominant managed care payers.  Has competition come to this?  Instead of insurers and providers competing by delivering value to consumers, they are instead accumulating market power.  If this continues, we may as well give up on free market healthcare altogether.  The solution must be vigorous antitrust enforcement on both sides.

This is not to say that all mergers should be blocked.  Providers who are genuinely committed to clinical integration can still generate substantial savings through consolidation.  At the same time, vertically integrated delivery systems, a failed strategy in the 1990s, could take advantage of modern information technology to truly streamline healthcare delivery.  Nor are all insurance mergers anticompetitive.  Lots of folks have picked on the Anthem/Wellpoint merger as the poster child for payer market power. But these insurers had very little market overlap and, by merging, have created a national competitor to vie against Aetna, United, and the like.

It goes without saying that you can’t have a competitive healthcare system without competitors.  But the recent decision by the FTC Commissioners seems to me to be a retreat from a pro-competitive strategy.  All Americans will suffer the consequences.

All the best,

David


William White

David,

I think we are on the same page on this one.  Anyone who supports competition in healthcare has got to be worried, very worried, about the FTC ENH decision.  It’s not just bad from the perspective of price competition—as you note it could actually lead to prices above the monopoly level.  It could be bad from a quality perspective too.  The FTC decision tells the hospitals not to talk about price.  But hospitals compete not only on price, but also on quality and the FTC says nothing about talking about quality related issues.  It’s not hard to imagine a situation where this could cause serious problems.

It is possible quality competition may occur on general dimensions—e.g. efforts to cut down on prescribing errors for medications.  But the literature suggests that very often, competition centers on the availability of services.  Under the banner of improving efficiency, what if Evanston and Highland Park decide to segment the market—say let Evanston dominate in heart care and give cancer to Highland Park?  This could easily create a “must have” situation for both hospitals, putting managed care plans in the situation of having to contract with both if they want to serve the north shore market.

There could, of course, be accompanying quality gains and cost reductions. (An almost certain claim by the hospitals).  But any gains need to be weighed against the potential consumer benefits which would have occurred from head-to-head price/quality competition if the two hospitals hadn’t merged.  Further, while it’s possible the merged hospitals might pass along any cost savings, I wouldn’t bet on it.

The FTC could respond to this critique by trying to regulate hospital strategic manipulation of service offerings.  But, like the present ban on price discussions, if anything, this has the potential of making a bad situation worse.  Just imagine the agency trying to sort out all the minutia of proposals for increased clinical integration.  Alternatively, suppose the FTC bans discussion of clinical integration entirely.  This would essentially vitiate one of the primary rationales for mergers.

On the issue of “countervailing power,” I think it’s worth elaborating a little more.  In no small part, I suspect past court decisions have been influenced by a climate of managed care “backlash.”  In an environment in which Managed Care Organizations (MCOs) are the villains everyone loves to hate, it’s easy to confound the interests of consumers and providers, especially since hospitals and doctors often assume the mantel of consumers’ champions.  But as your discussion suggests, market power that is good for hospitals can be bad for patients.  An interesting twist is the rise of “consumer directed” strategies.  By recasting consumers in the role of cost conscious shoppers, this could potentially drive a wedge between the traditional alliances of consumers and providers against MCOs.

On the bottom line, I agree:  if you are going to go with a pro-competitive strategy, it’s critical to preserve competition in the marketplace and the FTC’s ENH decision is clearly a step in the wrong direction from this perspective.

Will

5 Comments

  1. David and Will,

    You’ve both made very cogent and compelling points. The Commissioners’ decision is indeed troubling. I’d like to explore further what may have motivated their decision.

    It may be that politics is behind this. It is also possible, however, that the Commissioners do not feel comfortable with competition in hospital markets. There has been much discussion regarding the nature of competition among hospitals over the years. I believe that recent research has clearly laid to rest the notion that competition is ineffective in this industry. Research clearly shows that hospitals do compete on price, and mergers can have substantial anticompetitive effects.

    The conclusions of this research, however, do not seem to have diffused to the courts. Judges have made decisions time and again in favor of merging hospitals and against the enforcement agencies. I think that it is possible that a reason for these decisions is a discomfort with viewing hospitals in the same way (with regard to antitrust) as aluminum manufacturers, brewers, etc.

    I am concerned that this may also be true of the Commissioners. If that is indeed the case, then the future of antitrust enforcement, and effective competition in health care, looks very grim.

    I’m afraid that many observers are misled about the true effects of monopoly power in health care due to the fact that most of the bills are paid via employer provided health insurance. Some may feel less concerned about hospital monopoly power if they feel that insurers or employers absorb any increased costs. What has to be understood, however, is that increased hospital prices are actually paid by consumers, not insurers or employers. If hospitals raise prices due to increased market power, insurers pass those higher prices on to employers in the form of higher premiums. Employers don’t really bear those costs—- workers end up paying for higher health insurance premiums through lower wages (or lower wage increases) or reduced benefits, including loss of coverage. This effect has been well documented by research. There is even a recent paper that shows that hospital mergers lead to an increase in the number of the uninsured.

    There are also some that feel that nonprofit hospitals will refrain from exercising market power by raising prices or doing less than they could on quality, even if a merger would appear to increase their ability to do so. Again, I think that research clearly shows this to be false. Nonprofit hospitals probably don’t have the same objectives as do for-profit hospitals, but they exploit monopoly power if they have it in order to achieve gains for their own purposes.

    If the Commissioners are uncomfortable with competition in hospital markets then some serious educating needs to be done. No matter how one views our health system, one thing is clear—monopoly makes things worse, not better.

    Best,

    Marty Gaynor
    Carnegie Mellon University

    Comment by Martin Gaynor — October 14, 2007 @ 1:07 pm

  2. On hospital competition: The link between economic research and public policy—in the present context, anti-trust policy—is complex. Yes, I am convinced that hospital competition affects prices, more monopoly power leading to higher prices. I am also convinced that this is true for nonprofit hospitals and for for-profit hospitals (although I am less clear that the quanitative responses are the same).
    But what this implies for anti-trust policy is not entirely clear. For one thing, hospitals clearly face budget constraints for providing charity care or other public-goods outputs such as community education, and so we need to know how much more of these outputs would be provided if a hospital had more monopoly power and, as a result, could charge higher prices. In short, to conclude that greater monopoly power causes higher prices, which I believe is not in doubt, does not have clear implications for public policy in an industry such as hospitals in which added competition would not necessarily be economically efficient.

    Comment by Burton Weisbrod — October 27, 2007 @ 1:08 pm

  3. Burt,

    I’m going to disagree with you. If a not-for-profit hospital earns profits due to monopoly power it must spend those profits (eventually). One of the things it might spend those profits on is charity care or other things of value to the community. It also might spend those profits on excessive capital (more or fancier imaging facilities, new wings), excessive services, or thick carpets or executive jets (these do happen).

    So, there’s nothing to guarantee that a hospital, even if it is non-profit, will spend monopoly profits on things that a community values.

    However, even if a hospital with market power does spend its ill-gotten gains on things we like, let’s remember how those things were financed. Higher hospital prices are paid for by workers through lower wages or lower health insurance benefits (including the possible loss of health insurance benefits entirely). Even if we like the provision of greater charity care, in this instance it’s paid for by workers who had no say whatsoever in this decision. It’s also true that such “financing” is regressive. The costs of higher hospital prices fall most heavily on lower income workers, who can least afford to pay.

    We wouldn’t allow Bill Gates or the executives of Archer Daniels Midland to defend their exercise of monopoly power by claiming they’d spend some (unspecified) proportion of the profits on charity and we shouldn’t allow hospitals to do this either.

    Marty Gaynor
    Carnegie Mellon University

    Comment by Martin Gaynor — October 28, 2007 @ 1:12 pm

  4. David & Will;

    I agree with you an all of this. I wanted to touch on two points that have been made in passing. First, providers have long argued that managed care plans use their market power, “monopsony power” in these assertions, to drive down prices to hospitals. To my knowledge there is only one rigorous empirical study that has tackled this issue. Feldman and Wholey (Journal of Health Economics 2000) find no evidence of such monopsony power. Instead, they conclude that managed care has reduced the market power of hospitals.

    The second point goes to the issue of consumer and policy maker knowledge. From my perspective the principal disappointment in the FTC’s decision is that public policy community’s familiarity and debate on the issues will be denied because the case will undoubtedly not be appealed to the district and appeals courts. If the economics of the case are as clearly established as the Commission asserted, this would seem to have been an ideal case in which the advantages of market competition and the dangers of consolidation could have debated and the merits and implications of the analysis considered. This truly is unfortunate particularly given the heighten interest in health care reform.

    Michael Morrisey
    University of Alabama at Birmingham

    Comment by Michael Morrisey — October 29, 2007 @ 1:13 pm

  5. Mike,

    Your final point is outstanding. I hope that the ENH case will find its way up to the Seventh Circuit Appellate Court where Judges Posner and Easterbrook might have a chance to weigh in. Their views would likely provide remarkable clarity.

    DD

    Comment by David Dranove — October 29, 2007 @ 1:14 pm


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