Choice and Public Policy

doors-1767559_1920By Julian Le Grand – London School of Economics and Political Science

Schwartz and Cheek (SC) consider three possible justifications why public policy-makers concerned with promoting individual well-being might consider increasing the range of choices open to individuals: preference-satisfying, utilitarian and self-expressive.  So increasing choice may raise individuals’ well-being by enabling them better to satisfy their preferences between different goods and services; by enabling them to pursue their ultimate ends (such as career paths) more effectively; and by offering a larger set of opportunities to express their sense of identity.  They critique all of these justifications, especially their link with well-being, arguing that, if choice sets become too large, then well-being can suffer, as can the quality of decision-making and even, under some circumstances, individual freedom.

SC’s arguments are powerful and the evidence they cite concerning some of the deleterious effects of large choice sets on well-being is thought-provoking, to say the least.  However, they do not consider a fourth justification for policy-makers to devise policies that increase choice sets, especially over public or social services such as health care and education: one that is, to my mind, the strongest argument for such policies in that context.  This is not related to concerns about individual psychology, and has only an indirect connection with individual well-being (though an important one).   Rather, it concerns the impact of increasing individual choice, not on the individuals themselves, but on the suppliers of public services such as hospitals or schools.

Since Adam Smith, the proposition that, in the absence of significant economies of scale, a monopoly over the supply of a commodity raises its price and reduces both the quantity and quality of provision has been a standard conclusion of economists’ analysis of for-profit firms operating in the private sector.   It has been less widely appreciated (at least outside of the economics profession) that similar arguments can apply when considering the operation of suppliers of public services.  As long as there is any element of self-interested motivation (financial or otherwise) among the providers of a service – and inevitably there will always be some such element – there will always be an incentive to exploit any monopoly position.

For instance, all hospitals, whether for-profit or non-profit, will always have to consider the effect on their budgets of a specific patient’s treatment. If the payment system is fee-for-service, they will have an incentive to over-provide treatment and/or, if they can raise prices, to over-charge patients or third party payers, such as insurance companies or government agencies.  If the payment system is one of a fixed budget, then they have an incentive to under-provide treatment.

That this can be a significant problem for public services such as health care is illustrated by a recent study of the prices charged by hospitals to employer-sponsored insurance companies in the United States (Cooper et al 2015).  This found these prices to be generally 15.3 % higher in monopoly markets than in markets with more than four hospitals.  This study also found an extraordinary dispersion of prices of relatively homogenous procedures, with, for instance, the prices for knee and hip replacements varying by a factor of eight, with, again, the variation being associated directly with the degree of monopoly power.

What can increasing individuals’ choice sets do about this kind of problem?  Obviously monopoly in the provision of a good or a service arises when individual purchasers or consumers have little choice: they are stuck with a single supplier with nowhere else to turn if they are receiving a bad service or are overcharged.  The size of the choice set is one. Hence in such a situation increasing the size of the choice set by increasing the number of suppliers will enable badly-served purchasers to go elsewhere, and thus provide existing suppliers with a strong incentive to improve the service. More generally, economic theory would predict that, under certain conditions, increasing choice sets through increasing the number of suppliers and thereby increasing competitive pressure should improve the quality and quantity of the service concerned, as well as lower prices.

And indeed the theory is born out in practice, at least in health care.  In the US case, there is evidence that the quality of care provided by hospitals and the degree of competition they face are positively associated (Gaynor 2006).  In the United Kingdom, most of the evidence suggests that, following the roll-out of increased patient choice, the quality of care improved faster in more competitive areas than in less competitive ones (Bloom et al. 2015,  Cooper et al, 2011, Gaynor et al, 2013, 2016, Moscelli et al, 2016).

But caveats are in order.   As noted above, SC’s criticisms of large choice sets were not directed at this incentive justification for choice, but they nonetheless have some purchase in this area too.  In particular, the ability of purchasers to determine quality is of crucial importance if the incentive effects described above are to work, and, if large choice sets affect the ability of purchasers to do that, as SC argue, then that is a strike against them.   More generally, of course there are many wider problems with rational decision-making than can adversely affect choice outcomes (Le Grand 2007; Le Grand and New 2015).   Nonetheless, on balance we could perhaps all agree that, at least in the case of public policies towards services such as education and health care, some choice is likely to be better than none; but also that care has to be taken in designing the relevant policies to ensure that purchasers are properly informed, and that the ultimate choice set with which they are faced is not too large.

Read the full article from Schwartz and Cheek Choice, freedom, and well-being: considerations for public policy for free in the first issue of Behavioural Public Policy here.

References

Bloom, N., Propper, C. Seiler,S. Van Reenen,J. (2015) ‘The impact of competition on management quality: evidence from public hospitals’ Review of Economic Studies 82 (2) 457-489.

Cooper Z., Craig S, Gaynor M., Van Reenen, J. (2015). The Price Ain’t Right? Hospital Prices and Health Spending on the Privately Insured. NBER Working Paper No. 21815.

Cooper Z., Gibbons S., Jones S., McGuire, A. (2011) ‘Does hospital competition save lives: evidence from the English NHS patient choice reforms’. Economic Journal  121(554):228 – 260.

Gaynor, M. (2006)  ‘What do we know about competition and quality in health
care markets?’  Foundations and Trends in Microeconomics, December 2006, 2,
6.

Gaynor, M., Moreno-Serra, R., Propper, C. (2013) ‘Death by market power: reform, competition and patient outcomes in the National Health Service’  American Economic Journal: Economic Policy, 5(4) 134-166.

Gaynor, M., Propper, C., Seiler, S. (2016)  ‘Free to choose?  Reform, choice and consideration sets in the English National Health Service’ American Economic Review 106(11) 3321-57.

Le Grand, J. (2007) The Other Invisible Hand: Delivering Public Services through Choice and Competition Princeton and Oxford: Princeton University Press.

Le Grand, J. and New, B.  (2015) Government Paternalism: Nanny State or Helpful Friend? Princeton and Oxford: Princeton University Press.

Moscelli G, Gravelle, H,  Siciliani, L. (2016) ‘Market structure, patient choice and hospital quality for elective patients’ surgery’  CHE Research Paper No 139: University of York.


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