Mechanism Design has demonstrated that the most efficient systems are created when everyone’s vested interests are aligned.
“An example is defense contracting. If you agree to pay on a cost plus basis you have created incentive for the contractor to be inefficient.
The defense contractor will build enough extra into a fixed price system to account for cost overruns. The cost overrun would be permitted in the rules if the price was transparent. If there were no cost overruns the contractor’s profit would be increased. It would provide incentive to be efficient.
“If you agree to pay a fixed price, you can come close to an efficient price if you have all the truthful information.”
A reader wrote,
History has proven over and over again that only the market mechanism of willing sellers and willing buyers is the optimal way to allocate economic resources. This presumes an informed buyer, and a willingness of sellers to compete for buyers. Adam Smith was clear on this in the Wealth of Nations.
If incentives are aligned and truthful price information is available an efficient system is created. Most stakeholders think they can do better by not sharing truthful information. If the rules of the game require truthful information the system can become an efficient market driven solution.
The healthcare system must become market driven. At present the healthcare system is an artificially distorted free market system. Government intervention has distorted and made the free market inefficient.
The distorted free market has led to higher prices.
The concept of Pareto efficiency implies one stakeholder has to yield something which makes another stakeholder better off. The reality is in an efficient system the first stakeholder is worse off than he/she theoretically could be.
The first stakeholder yielding makes him/her better off than he/she is but still worse than he/she could theoretically be. The temptation is to not be truthful in order to maintain dominance at the expense of others.
Leoid Hurwicz observed as others had that the dispersion of information was at the heart of the failure of a planned economy. He observed that there was a lack of incentive for people to share their information with the government truthfully.
The free market mechanism was far less afflicted than central planning bureaucracy by such incentive problems. The free market economy was by no means immune to this defect.
He observed that the free market economy can get us closer than central planning to incentive compatibility because the end consumer can drive the discovery of truthful information.
This can explain the power of my Ideal Medical Savings Account.
Consumers creating rules of engagement in a market driven economy can get closest to ideal Pareto efficiency. Since customers determine success of an enterprise by creating demand in a transparent environment, they can get closer to an efficient system.
Consumers can create the rules of the game for compatible incentives. Consumers must have the appropriate financial incentives to maintain their health. They must also own their healthcare dollars.
The government should help consumers design the rules of the game and then get out of the way. The rules should be designed so the patient is first.
At present the insurance industry is taking advantage of the patients, doctors and hospital systems. The hospital systems are taking advantage of the patients, doctors and insurance companies. Doctors are taking advantage of the insurance companies, hospital systems, patients and the government. The government is taking advantage of the hospital systems, the doctors and the patients. Everyone is pursuing his or her own vested interest at the expense of other stakeholders.
The insurance companies take advantage of employers. The drug companies are taking advantage of patients and unduly influencing physicians.
In our healthcare system everyone is pursuing his vested interest in a game that has rules that do not lead to “incentive compatibility.”
Some politicians think central planning can result in producing effective rules and appropriate controls.
Historically, central planning has not worked.
Before effective healthcare reform can take place, rules acceptable to all the stakeholders must be in place. Stakeholders must create price transparency and understand the value of compromise.
It must be understood why it is important that consumers drive the healthcare system and not the central government. Only consumers can create an undistorted efficient market driven system.
Consumers have to have be empowered and given incentives to align all the stakeholders’ incentives. The best and easiet program to achieve this goal is my ideal medical saving account.
*This blog post was originally published at Repairing the Healthcare System*