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2010.01.15

2009 Nobel Prize in Economics Provides Insight into Health Reform

Oliver Eaton Williamson, known for his study on how firms choose their organizational structure and its relation to the market, shared the 2009 Nobel Prize in Economics with Elinor Ostrom. In his book titled "The Mechanisms of Governance" (1996), Williamson adopted the concept of "transaction costs" to argue how firms choose organizational structures that would benefit greater economic efficiency.

This theory is effective for explaining why two extreme organizational forms of firms co-exist, i.e. "firms that are vertically integrated and incorporate all related business processes" and "firms that split into separate companies and outsource necessary resources and services through contracts". According to Williamson, in cases where a breakdown in contract negotiations in market transactions wastes no time or cost, the latter organizational form can be adopted. However, if the breakdown would result in high transaction costs, vertically integrated firms with a centralized decision-making structure have the advantage, both in terms of time and cost. As Williamson suggested in the preface of this book, this logic also applies to the healthcare industry. This industry involves extremely high transaction costs among the market participants, and the recent rapid expansion of vertical integration of healthcare providers in the U.S., Canada, U.K., Australia, etc. can be explained well by Williamson's logic.

In order to improve the economic efficiency and quality of the entire industry, healthcare institutions need to focus on providing evidence-based healthcare services and avoid unnecessary services. However, if such unnecessary healthcare services are covered by medical insurance, elimination of unnecessary services would reduce the revenue of healthcare institutions while benefiting the insurers. As can be seen in Chart 1, the economic interests of insurers and healthcare institutions contradict each other. Moreover, advances in medical technology have shortened the duration of hospitalization in acute hospitals and increased the proportion of patients treated by non-acute healthcare providers (e.g. sub-acute hospitals and rehabilitation institutions) or at home, which has sparked competition between acute hospitals and non-acute healthcare providers for patients=profits. Such competition hinders exchange of patient information among the market participants and standardization of healthcare services, ultimately leading to deterioration in the efficiency and quality of the entire healthcare industry.

Such problems in the healthcare market can be solved by promoting vertical integration between insurers and healthcare institutions or between acute hospitals and non-acute healthcare providers so that their mutual interests can be aligned. This solution would not violate the principle of market competition in the healthcare sector; creation of several vertically integrated healthcare providers would result in brand competition based on market mechanisms.

Under an accelerating advance in technology, vertically integrated healthcare providers reaching certain economic scales (e.g. annual revenue of over 50 billion yen, according to the cases in other countries) can efficiently and continuously provide global-standard healthcare to local residents. In our country, competition among healthcare providers has been viewed on an individual institution basis, but in order to transform the healthcare industry into an engine for Japanese economic growth, a policy on competition for healthcare should be discussed on the basis of vertically integrated healthcare providers.

Yukihiro MATSUYAMA , Other Columns & Papers

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