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Health-Care Reform: Deja Vu All Over Again

Steven Horwitz

The authors are Eggleston Assistant Professor of Economics at St. Lawrence University in Canton, New York, and Professor of Finance at Oakland University in Rochester, Michigan.

Imagine that a major sector of the economy is widely thought to be in crisis: it consistently fads to provide the expected level of service; it leaves people without access to its product; and everyone agrees that it needs to be dramatically reformed. Imagine further that study commissions are formed and retreats are held using the talents of industry, academia, and government to diagnose the problem and provide solutions. Imagine also that virtually all involved are convinced that more government intervention is the answer but they want to avoid centralized, public sector solutions.

Eventually a reform package is passed creating regional quasi-governmental institutions designed to supplement what markets already provide. These are overseen by a weak national board located in Washington whose job is mainly to coordinate the activities of the regional entities. Imagine the reformers claim this new system will capture what’s good about both competitive markets and government intervention while avoiding the problems of centralized bu reaucracies.

If you guessed this imaginary scenario refers to health-care reform, give yourself only half credit. In fact, this scenario was played out over 80 years ago when the United States reformed its banking industry and created the Federal Reserve System. The Fed, much like the regional alliances in the original Clinton health reform plan, was initially designed as a decentralized system of regional reserve banks that would supplement market-driven institutions, but evolved into a centralized regulatory bureaucracy that replaced the systems it was intended to supplement. The lessons of that history are instructive as Congress continues its debate over health-care reform.

Both the Fed and the Clinton plan grew out of legitimate concerns over the way each industry was operating. In both cases, the commonly accepted view was that the market had failed and government help was needed. However, in both cases government interventions were the contributing causes of many of those failures.

Prior to the enactment of the Federal Reserve Act, the banking industry had regulations which included prohibitions on interstate banking that prevented sophisticated interbank relationships, stiff reserve requirements that put New York City banks at the base of an inverted pyramid of bank reserves, and requirements that banks purchase government bonds to serve as collateral for the currency they issued, leading to seasonal currency shortages. Very few voices pointed out that these regulations, and not inherent market forces, might have caused the banking industry problems that were leading to the calls for reform.

Analogously, as critics of the Clinton plan have noted, many of today’s health-care problems are themselves the result of existing government intervention. For example, a disproportionate amount of increasing health-care costs are due to government-run Medicare and Medicaid. From 1989 to 1991, the absolute level of personal health-care spending from those two programs rose at an average of 15 percent per year, while private sector spending grew at 9 percent. Further, the differential tax treatment of fringe benefits has led to employer-provided health insurance. Because employees can purchase health insurance through employers using pre-tax dollars, obtaining it outside the workplace has become prohibitively expensive. This partially explains why those who are between jobs and those who are employed but are either part-timers or recent hires tend not to have health insurance. In addition, licensing laws that prevent more doctors from entering the market and restrict the sorts of services that qualified nurses and other physician-substitutes can perform limit the supply of health care and prevent effective price competition.

Like the Clinton health-care plan, the Federal Reserve Act shied away from complete nationalization as a solution. Instead the Act created twelve ostensibly autonomous reserve banks, each responsible for a specific geographic region and all overseen by a Federal Reserve Board in Washington, whose function was limited to coordinating the policies of the district banks. The system’s main task was to end seasonal currency shortages by more efficiently managing reserves and supplying currency. If the term had been in the vernacular in those days, such a scheme might have been tagged “managed competition.”

More Centralization, More Power

Despite these intentions, the Fed quickly evolved into a more centralized institution, with increased power in the Federal Reserve Board (later the Board of Governors and the Federal Open Market Committee) in Washington. There are two explanations for this shift and increase in power. First, if the regional banks could not cooperate and generate consistent policies, the Board’s job was to adjudicate such disputes and thus, de facto, create policy. It was only a matter of time before the Board itself gained de jure policy-making power by creating “appropriate” policies in the first place and forcing the district banks to fall into line.

Second, Federal Reserve Board appointees were, as they are today, political. The members of the Board then, and the Board of Governors today, owe their positions to the political process and, as much research indicates, are likely to conduct policies that benefit that process.

The Fed’s acquisition of the power to deal in the open market (as part of the Banking Act of 1935) was an inevitable result of the Federal Reserve Board’s assuming powers that went beyond mere adjudication; once it tried to centrally direct policy, it needed the tools to do so. However, this new power brought further problems, such as instability in the money supply (and prices and output), leading in turn to more crises and more cries for increased and centralized power. So, what was originally supposed to assist a competitive market that didn’t work well, eventually wound up replacing large sections of the market. This is instructive as we contemplate the possible long-run results of health-care reform.

Rather than a Canadian-style single payer or a British-style nationalized system, the Clinton plan (like the original Fed) was based on regional health alliances that were intended to lower costs by acting as group buyers of health insurance. Either through employers or through the alliances directly, all Americans would have had health insurance that included a standard package of minimum benefits. Overseeing all of this was to have been a National Health Board (politically appointed) which would have been responsible for restraining costs across the alliances and ensuring that the system as a whole did not exceed a national healthcare spending limit. Supporters of the plan claim it was not a centralized bureaucracy, while critics claimed it was.

The system was not intended to be centrally run. However, the issue is not intentions, but the likely unintended consequences of adopting such a reform plan. As with the Fed, the creators’ intentions are likely to be markedly different from what eventually emerges in practice. With the power to set premiums and determine benefit packages, a National Health Board would likely be the focal point of disagreement and debate among major health-care players, including the various alliances. As was the case with the original Federal Reserve Board, attempting to coordinate these diverse demands is likely to quickly turn into pre-emptory policy-making with the other players following the National Health Board’s lead.

It is also likely that any national health board will become highly politicized, especially with statutory limits on total expenditures. Imagine the opportunities for political dealing if the FOMC had strict limits on how much base money it could create, yet had discretionary control over which bond dealers it would buy from. The only thing worse than rationing is politicized rationing and, given the historical evidence for the eventual centralization of power in a political board and limits on spending, that seems a probable outcome.

Despite claims to the contrary, the Clinton health-care reform plan, if enacted as first presented, would have likely become another centralized and politicized bureaucracy. Like the Fed, we could have expected recurring “crises” leading to further calls for the National Health Board to have more power, and hence even more crises and a further centralization of power. Something close to nationalization could eventually result. One need only compare the Fed’s powers today with those stipulated in the original Act for a perfect historical parallel.

Although the disappearance of purchasing alliances in more recent proposals is an encouraging development, most of the bills under consideration as Congress adjourned included a provision for setting health plan standards at the national level and called for a National Health Board to determine the scope and duration of services and cost-sharing details. Even if the stipulated pow ers of such a board are weak, as was the case in the early years of the Fed, it would not be surprising if it acquired greater powers in the chaotic environment that would follow its creation. As a result, Congress would still be wise to remember the experiences of the Federal Reserve System.

As history demonstrates, the banking crises before so-caned reforms pale in comparison to those that followed it: the bank failures of the Great Depression, the inflation of the 1970s and ‘80s, and the savings-and-loan crisis and commercial bank failures of the mid and late ‘80s. All of these can in some way be attributed to those very “reforms” and the increased government intervention they entailed. The evidence suggests strongly that (to borrow an appropriate metaphor) an interventionist cure is often worse than the disease. We had best heed the lessons of history if we are to avoid an uncomfortable feeling of déjà vu after “reforming” the health-care delivery system.

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