856 Journal of Health Politics, Policy and Law 946 THE AMERICAN ECONOMIC REVIEW simply not available. Thus, a wide class of commodities is nonmarket able, and a basic competitive precondition is not satisfied. There is a still more subtle consequence of the introduction of risk- Robinson bearing considerations. When there is uncertainty, information or knowledge becomes a commodity. Like other commodities, it has a cost of production and a cost of transmission, and so it is naturally not spread out over the entire population but concentrated among those who can profit most from it. (These costs may be measured in time or cult to discuss in the rational terms usually employed. The value of information is frequently not known in any meaningful sense to the buyer; if, indeed, he knew enough to measure the value of informa tion, he would know the information itself. But information, in the form of skilled care, is precisely what is being bought from most physi- cians, and, indeed, from most professionals. The elusive character of information as a commodity suggests that it departs considerably from he usual marketability assumptions about commodities, That risk and uncertainty are, in fact, il care hardly needs argument. I will hold that virt features of this industry, in fact, stem from the pi The nonexistence of markets for the bearing of some risks in the first reduces welfare for those who wish to transfer those risks to others for a certain price, as well as for those who would find it proft able to take on the risk at such prices. But it also reduces the desire to render or consume services which have risky consequences; in techni cal language, these commodities are complementary to risk-bearing Conversely, the production and consumption of commodities and serv ices with little risk attached act as substitutes for risk-bearing and are encouraged by market failure there with respect to risk-bearing. Thus the observed commodity pattern will be affected by the nonexistence of m tion of the law of large numbers Since most objects of insu ear that this effect is sufficiently great to create serious y of co (R&D and nat of production. Hence, it is not surprising that a free enterprise economy will ten to underinvest in research; see Nelson [211 and Arrow [41
Arrow a Uncertainty and the Welfare Economics of Medical Care 857 UNCERTAINTY AND MEDICAL CAR The failure of one or more of the competitive preconditions has as bloche, its most immediate and obvious consequence a reduction in welfare chernew below that obtainable from existing resources and technology, in the Glied, Hammer more can be said. I propose here the view that, when the market fails (nonmarket to achieve an optimal state society will, to some extent at least, recog- institutions) nize the gap, and nonmarket social institutions will arise attempting to bridge it. Certainly this process is not necessarily conscious; nor is it uniformly successful in approaching more closely to optimality when the entire range of consequences is considered. It has always been a favorite activity of economists to point out that actions which on their ace achieve a desirable goal may have less obvious consequences, articularly over time, which more than offset the original gains But it is contended here that the special structural characteristics of the medical-care market are largely attempts to overcome the lack of optimality due to the nonmarketability of the bearing of suitable risks and the imperfect marketability of information. These compensatory institutional changes, with some reinforcement from usual profit mo- tives, largely explain the observed noncompetitive behavior of the medical-care market, behavior which, in itself, interferes with opti- mality. The social adjustment towards optimality thus puts obstacles ts own path The doctrine that society will seek to achieve optimality by non market means if it cannot achieve them in the market is not novel Certainly, the government, at least in its economic activities, is usually implicitly or explicitly held to function as the agency which substitutes for the market's failure. I am arguing here that in some circum- that the medical-care industry, with its variety of speciality gap some ancient, some modern, exemplifies this tendency. It may be useful to remark here that a good part of the preference reinhardt for redistribution expressed in government taxation and expenditure policies and private charity can be reinterpreted as desire for insur- ance. It is noteworthy that virtually nowhere is there a system of sub sidies that has as its aim simply an equalization of income. The sub sidies or other governmental help go to those who are disadvantaged in life by events the incidence of which is popularly regarded as unpre- ns have had to eck and Scherer [23, pp. 581 ence to V. Fuchs)and [1, pp. 71-751 or an explicit statement of this view, see Baumol (81. But I believe this position is implicit in most discussions of the functions of governmen
858 Journal of Health Politics, Policy and Lay THE AMERICAN ECONOMIC REVIEW dictable: the blind dependent children, the medically optimality, in a context which includes risk-bearing hat appears to be motivated by distributional value looked at in a narrower context. 1 his paper. Section II is a catalogue of stylized generalizations about the medical-care market which differentiate it from the usual commod ity markets. In Section III the behavior of the market is compared with that of the competitive model which disregards the fact of uncer- tainty. In Section IV, the medical-care market is compared, both as to behavior and as to preconditions, with the ideal competitive market that takes account of uncertainty an attempt will be made to demon strate that the characteristics outlined in Section II can be explained either as the result of deviations from the competitive preconditions or as attempts to compensate by other institutions for these failures. The discussion is not designed to be definitive, but provocative. In particu- lar, I have been chary about drawing policy inferences; to a consider- able extent, they depend on further research, for which the present paper is intended to provide a framework IL. A Survey of the Special Characteristics of the Medical-Care Market This section will list selectively some characteristics of medical care which distinguish it from the usual commodity of economics textbook The list is not exhaustive, and it is not claimed that the characteristics listed are individually unique to this market. But, taken together they do establish a special place for medical care in economic analy A. The Nature of demand Sloan (role of the demand for medical services is that it is not steady in origin as, for example, for food or clothing, but irregular and unpredictable. Medi cal services, apart from preventive services, afford satisfaction only the event of illness, a departure from the normal state of affairs. It is ard, indeed, to think of another commodity of significance in the average budget of which this is true. a portion of legal ser oted to defense in criminal trials or to lawsuits, might fall in gory but the incidence is surely very much lower(and, of course, there that all redistribution can be interpreted as"inco a For an illuminating survey to which I am much indebted see S. Mushkin [201
Arrow a Uncertainty and the Welfare Economics of Medical Care 859 ARROW: UNCERTAINTY AND MEDICAL CARE are, in fact, strong institutional similarities between the legal andSage medical-care markets. )13 In addition, the demand for medical services is associated, with a of medicine) considerable probability, with an assault on personal integrity. There is ome risk of death and a more considerable risk of impairment of full functioning. In particular, there is a major potential for loss or reduc tion of earning ability. The risks are not by themselves unique; food is lso a necessity but avoidance of deprivation of food can be guaranteed with sufficient income where the same cannot be said of avoidance of illness. Illness is, thus, not only risky but a costly risk in itself, apart om the cost of medical care B. Expected Behavior of the Physician It is clear from everyday observation that the behavior expected of Bloche, sellers of medical care is different from that of business men in gen- hal eral. These expectations are relevant because medical care belongs to Millenson che category of commodities for which the product and the activity of production are identical. In all such cases, the customer cannot test the Peterson product before consuming it, and there is an element of trust in the (expected relation. But the ethically understood restrictions on the activities of behavior of a physician are much more severe than on those of, say, a barber. His physicians behavior is supposed to be governed by a concern for the customers welfare which would not be expected of a salesman. In Talcott Par- sonss terms, there is a" collectivity-orientation, " which distinguishes medicine and other professions from business, where self-interest on the part of participants is the accepted norm. s A few illustrations will indicate the degree of difference between the behavior expected of physicians and that expected of the typical busi nessman. (1) Advertising and overt price competition are virtually eliminated among physicians. (2)Advice given by physicians as to further treatment by himself or others is supposed to be completely governmental demand, military power is an example o nerged, though the precise social structure is different f not hard run, experience with the quality See [22, p. 463]. The whole of [22, Ch. 10] is a most illuminating analysis of the acknowledge here my indebt I am indebted to Herbert Klarman of Johns Hopkins University for some of the points discussed in this and the following paragraph
860 Journal of Health Politics, Policy and Law THE AMERICAN ECONOMIC REVIEW Kronick divorced from self-interest. (3) It is at least claimed that treatment is harity) dictated by the objective needs of the case and not limited by financial considerations, While the ethical compulsion is surely not as absolute in fact as it is in theory, we can hardly suppose that it has no influence over resource allocation in this area. Charity treatment in one form or another does exist because of this tradition about human rights to ade- quate medical care. 8(4) The physician is relied on as an expert in (lawyerization certifying to the existence of illnesses and injuries for various legal and other purposes. It is socially expected that his concern for the correct conveying of information will, when appropriate, outweigh his desire Needleman Departure from the profit motive is strikingly manifested by the (nonprofits) overwhelming predominance of nonprofit over proprietary hospitals. 20 The hospital per se offers services not too different from those of a hotel, and it is certainly not obvious that the profit motive will not lead to a more efficient supply. The explanation may lie either on the supply ide or on that of demand. The simplest explanation is that public and private subsidies decrease the cost to the patient in nonprofit hospitals. A second possibility is that the association of profit-making with the supply of medical services arouses suspicion and antagonism on the part of patients and referring physicians, so they do prefer nonprofit tions. Either explanation implies a preference on the part of some whether donors or patients, against the profit motive in the bility to pay is strongly ingrained. Such a perceptive observer as Rene dubos has medical ethics, as though this unp ical resources: one has only to have been poor to realize the error. research is a study of the exact nature of the va ved and medical care paid This roie is enhanced in a socialist society, where the state itself is actively concerned th illness in relation to work; see Field [14, Ch 9 About 3 per cent of beds were in proprietary hospitals in 1958, against 30 per cent in Chart 4-2, p. 60] "C.R. Rorem has pointed out to me some further factors in this analysis. (1)Given onomies of scale would dictate a predominance of comnunity-sponsored hospitals,(2)