All Commentary
Monday, February 1, 1971

The Medical Market Place

Dr. Pruit is a practicing physician at the Hertz­ler Clinic in Halstead, Kansas. This article is from a paper presented recently to the Amer­ican Association of Physicians and Surgeons.

What is the state of the market, what are the economic problems of the health industry today? Re­alistic appraisal of the current situation requires examination of the nature of the market prior to the onset of massive state inter­vention. So let us review the eco­nomic history of organized medi­cine in the United States. Was it an open market? If not, what kind of a market, and what factors led to its development?

American medicine was until about 1850 a free-wheeling, highly competitive, free market industry. Like the ministry in some reli­gious denominations today, anyone who “felt the call” was free to hang out a shingle and declare himself available. The only re­strictions were those put upon him by the quality and availabil­ity of the competition, and by the favor of the customers who dic­tated his rewards. Similarly, med­ical schools were easy to start, easy to enter. These schools taught every conceivable approach to health from the orthodox to the mystic. Many of the schools of this time were organized as profit-making institutions. Some were owned by the faculty. Some were privately endowed. Some were hardly more than diploma mills. Their quality and the quality of their products ran the gamut of the quality spectrum from excel­lence to quackery.

It is easy to understand why many of the finest men in ortho­dox medicine, those dedicated to the development of medicine as a science, would feel totally dissat­isfied with this seemingly chaotic arrangement. One can only applaud their desire to improve the over-all quality of medicine for the public benefit. Their problem was one of implementation. How can this improvement be accom­plished? Can the people, through education or any other means, ever have enough special information to be able to recognize and choose quality care out of this hodge­podge of misinformation and charlatanism? Or, is human gul­libility so great, and human abil­ity to choose responsibly so frail, that some means must be found to protect individuals from their own folly and insure the delivery of what we know to be the highest quality care? Who is to be respon­sible: man or the state? That was their basic question. This trouble­some but fundamental question lies at the root of every sociopo­litical problem which faces us to­day. The men in medicine did not believe that man could be respon­sible. Their answer: the state. They believed that orthodox medi­cine should seek the sanction and protection of the state to help shield the people from their in­ability to choose responsibly.

Origin of the A.M.A.

The American Medical Associ­ation was organized in 1847 and committed itself to two proposi­tions which, when fulfilled, would improve the over-all quality of American medicine. But these same propositions led to sharp restriction of the medical market place. From a free market, it quickly changed to what many economists call a discriminatory monopoly, which simply means a market place which favors, in­variably through legislative fiat, one competing group over all others. How did this come about?

The two propositions were (1) that medical students should have acquired by the time they were ready to practice a “suitable edu­cation”; and (2) that a “uniform elevated standard of requirements for the degree of M.D. should be adopted by all medical schools in the U. S.” What would be “suita­ble” and “elevated” was to be de­termined by a consensus of the best minds within the organiza­tion.

Certainly, these laudable goals of themselves could have no pos­sible bearing on medical econom­ics. What did bear on the medical market place, however, was the method of implementing those propositions. The method was to exclude, by state intervention, all undesirable or unqualified com­petition: first, by licensure of only qualified M.D.’s, and second, by control, through the state mecha­nism, of medical school standards.

These objectives were achieved in two stages. It took the A.M.A. fifty years to convince all state legislatures that licensure was necessary, but by 1900 this goal was accomplished. The states in turn delegated the power of licen­sure to organized medicine through the State Boards of Med­ical Examiners, all of whom were members of orthodox medicine. Subsequently, control of standards of medical schools was accom­plished comparatively quickly fol­lowing the now famous Flexner Report in 1910. With licensure already in effect, it was a simple matter to change the rules of the State Examining Boards to con­sider only graduates of medical schools which were approved by the A.M.A. and/or the Association of American Colleges, whose lists were identical. A short time later, these controls were extended to many of the hospitals of the coun­try by defining standards for hospitals eligible for internship and residency programs. Today, through the efforts of the Joint Accreditation Commission, these controls have been extended to all the hospitals in the country. The delegation of these powers by the state, making A.M.A. a quasi state agency, gave it complete con­trol over entry into the practice of medicine as well as control over access to the nation’s hospitals. It is this control over entry and access that prompts Prof. Milton Friedman of the University of Chicago to call the A.M.A. the most powerful trade union in the world. Control over entry and access is also the reason other economists call the health industry a discrim­inatory monopoly.

Monopoly Practices

Viewed in the light of the cur­rent acute shortages of physicians, the successful argument deriving from the Flexner Report is iron­ical. In brief, the argument held that America was suffering from an overproduction of doctors and that it was in the public interest to have fewer doctors who were better trained. It was recom­mended, therefore, that a sub­stantial fraction of the medical schools be closed; that standards be raised in the remainder and admissions be sharply curtailed. This is to say, in effect, that the public should be protected against the consequences of buying medi­cal services from inadequately trained doctors by legislating poor medical schools out of business—as if all could have Cadillacs if Fords were outlawed.

Whatever names one may apply to the industry or to the A.M.A., it is a fact that the number of doctors produced by the medical schools has remained relatively static for many years despite a rapidly increasing population. In 1910 when the Flexner Report was published there were 23,300 med­ical students in the United States and the total population was roughly 100,000,000. Today, there are 35,883 medical students, to serve a population of approxi­mately 200,000,000. The effort to upgrade the quality of medicine, by controlling the standards re­quired of medical schools, has re­sulted in a sharp decrease in the number of medical schools avail­able to the students. In 1910 there were 162 medical schools in the United States. By 1920 this num­ber had been reduced to 85; by 1930 to 76; and by 1944 it reached a low of 69. It seems clear, then, that control over entry has result­ed in a restricted and controlled medical market with the number of physicians, as well as the med­ical schools, in chronically short supply.

When Demand Exceeds Supply, Prices Tend to Rise

It is axiomatic that when de­mand exceeds supply, other fac­tors being equal, the price of the goods or service in demand also increases. It is also true that when standards of quality are elevated, the price of the better quality product is also elevated. A Cadil­lac necessarily costs more than a Ford. To know that these laws have held true in medical econom­ics, we only need remember that the medical profession has become one of the highest paid of all the professions—thus reflecting the relatively higher costs of medical care to the general public. Ordi­narily, however, one would expect, in a market where supply is so severely restricted, a much greater cost differential than there has been. The medical profession has been able to deliver quality med­ical care to the general public, rich and poor, at prices within the reach of any who needed care.

There were many mitigating factors which made this possible. Once the barriers to entry into the profession were overcome, the in­dividual physician was free to practice when, where, and how he pleased. There was no Board of Directors making decisions for everyone. Competition with his fellow physicians helped to keep his prices down and the quality of his care high. Contract with each patient through “fee for service” demanded his personal involve­ment with the singular problems of the individual, the essential in­gredient in quality medical care. The ancient Hippocratic tradition that care would be provided re­gardless of ability to pay was an extremely important factor. Free­dom of choice by the physician and by the patient, community respect and its derivative, the sense of responsibility to the com­munity, all played important roles. The success of the system depend­ed precisely upon the fact that it was not an organized business en­tity. There were no police commit­tees like peer review, or utiliza­tion review. Competition, contract, and freedom of choice provided all the restraints that were necessary.

This, then, is an economic over­view of the American medical sys­tem prior to the advent of govern­ment inflation of the nation’s sup­ply of money. It was not a perfect system. There are no perfect sys­tems this side of heaven, in spite of the contrary declaration of the planners of the American utopia. But that system functioned bril­liantly enough to bring American medicine into world-wide esteem. It is the very nature of this high quality but severely restricted and inelastic supply market and of the control mechanisms which sustain it, as outlined here, which makes the system so vulnerable to mas­sive intervention. At the same time, the system raises almost in­surmountable obstacles in the way of those who are totally opposed to this intervention and to the philosophy which prompts it. Who­ever controls entry and access has the power to control the economic destiny of every physician in the industry if he chooses to use that power.

The Impact of Inflation

Inflation is one of the most dev­astating, destructive, and demoral­izing forces which can be imposed on a civilized society. The distor­tions and dislocations which it produces are so numerous and oc­cur in such rapid succession, that the adjustments and rearrange­ments which society would achieve under normal growth conditions now become impossible of achieve­ment, thus creating permanent dislocations and maladjustments with social disintegration the ul­timate result.

Most of the dislocations and maladjustments which are chronic problems in the health industry today are directly or indirectly an aftermath of inflation. The in­crease of doctors in the cities and their decline in small towns, the growth of specialists and the de­cline of generalists, the increase in emotional and social problems and the decline and distortion of social values and standards, are but a few of the multitude of dis­tortions and dislocations which are aggravated by, or caused by, a continuing general inflation. I mention here these effects of gen­eral inflation because of their bearing on problems to be dis­cussed later.

For discussion purposes, the health industry can be considered as an isolated economic unit which functions within itself in exactly the same way that the national economy does. As such a unit, it is subject to the same laws of the market place. Such an economy tends toward a state of equilibri­um between supply and demand, and the prices of goods and serv­ices to the consumer are reflected in this equilibrium by remaining fairly stable.

If, in this state of relative equilibrium, there is an intrusion of hitherto unavailable money, there occurs an immediate dis­equilibrium. In the general econ­omy the increased demand caused by the influx of new money is met (at least for awhile) by an in­crease in productivity and a rise in prices, which tends to return the market toward a state of equilibrium again.

As long as the producers can profitably increase their produc­tivity by raising their prices, then supply and demand will continue to tend toward equilibrium.

This holds true for the general economy and it holds true for the health industry as long as the in­flation is general. But when a massive increase in the supply of money is suddenly injected into the isolated economy of the health industry, there is an entirely dif­ferent situation. The health in­dustry can cope with general in­flation because its internal equi­librium is not greatly disturbed. However, when a secondary in­flation is imposed on the industry by a sudden vast increase in the supply of money within its iso­lated economy, the disequilibrium which occurs between supply and demand has immediate and seri­ous consequences throughout the industry. The medical market can­not react as the general market reacted for the obvious reason that in the general economy, sup­ply has been relatively flexible and could adequately respond to de­mand; but in the medical economy, supply, particularly in the vital area of physician’s services, is relatively inflexible and cannot re­spond adequately to great in­creases in demand.

Subsidies to Medical Schools

The first major intrusion of government into the health indus­try began with World War II and the subsidization of medical schools. This intrusion did not cause an immediate disequilibri­um in the medical market. It was concentrated in the area of what may be termed a producer’s mar­ket and had no appreciable direct effect on consumer demand. How­ever, when coupled with some of the consequences of general in­flation, it did cause major changes in the distribution of physicians, thus affecting their supply in the vital area of service to the con­sumer.

The initial effect of the use of fiat money to subsidize medical schools was to cause an inflation of research activity. While this in­creased activity did serve to in­crease (inflate) our knowledge and technical ability in many areas, it had other, far-reaching and less salutary, effects. There was, first of all, a great increase in the size of the faculty of med­ical schools. With continued sub­sidization, and through the device of tenure, the number of teachers and research fellows tended not only to grow but to become per­manent, thus greatly increasing the costs. Since the chief source of funds from the government was earmarked for research purposes, the schools tended to be diverted from their main purpose—to teach students—and to become more and more preoccupied with re­search. As the research programs grew, more and more physicians were diverted into research, thus adversely affecting the supply available for private practice.

The availability of fiat money in this area, along with the rapid growth of population and the in­creasing demand for medical serv­ices, did increase, very slowly, the number of medical schools and the total number of medical stu­dents. In 1944 there were 69 med­ical schools. By 1969, their num­ber had climbed to 99. Interest­ingly enough, though hardly sur­prising, every medical school in America is now dependent upon the Federal government for more than 50 per cent of its income. Some, I am told, receive as much as 85 per cent. The medical schools of America can no longer survive without continued government support. The total number of med­ical students attending the vari­ous medical schools by 1969 had risen to 35,883, an increase of about one-third over 1950. I have been unable to obtain any exact figures on the number of these graduates who enter private prac­tice. However, John Gardner, for­mer Secretary of Health, Educa­tion and Welfare, in his 1967 Report to the President on med­ical costs made this statement: “It is estimated that in the period 1950-1965 the demand for physi­cian services increased by at least 41 per cent, probably considerably more. Meanwhile, the total supply of active physicians increased by only about 31 per cent, while the supply of physicians in private practice increased considerably less.” (Emphasis added.)

Walter McNerney, writing re­cently on medical costs, calculated that: “If we double the output of American medical schools today and keep all other factors constant, it will be 30 years before we double the total number of physicians in the country.”

Supply in the medical market place is, indeed, inelastic.

Thirty years of war and the continuous mobilization of huge numbers of men in the armed forces; the tremendous growth of bureaucratic health agencies, state and Federal; the mushrooming of research programs in the medical schools and in the so-called “think tanks”; all of these, made eco­nomically possible only because of fiat inflation of the money supply, have increased the demand for physicians. The entry of doctors into these artificially created areas of demand has, in terms of the supply available to private prac­tice, negated completely the in­creased production of physicians by the medical schools.

Controls Upset Balance Between Demand and Supply

The net result of government intervention in medical education has been (1) the Federal govern­ment has gained virtual control of medical education; (2) in terms of an increasing demand for serv­ices there has been a relative de­crease in the supply of physicians available to render services through entry into private prac­tice.

The passage of the Hill-Burton Act initiated the second major in­trusion by government into the medical market. The rapid in­crease in the number of hospitals which resulted, coupled with the growing demand for medical serv­ices generally, caused a hyper-acceleration of demand for trained auxiliary medical personnel of all kinds. Supply of personnel has not been adequate to meet the de­mand, and a spiral of wage in­creases has resulted throughout the industry. It is significant, as a reflection of this disproportion­ate increase in cost, that until the advent of Medicare, hospital fees were the only prices throughout the health industry which in­creased significantly faster than price levels in the general econ­omy.

According to Mr. McNerney, “over 60 per cent of health care costs are attributable directly to manpower.” When one considers that nursing salaries have more than quadrupled in the last 25 years, that the salaries of other technicians have risen compara­bly, and that all wages are still rising, one can see immediately that the effect of special inflation within an industry where all tech­nical help is in short supply is to put an exorbitant price tag on the services demanded.

With the advent of Medicaid and Medicare the already straining health market was immediate­ly forced into a state of marked disequilibrium. In this instance, vast sums of unearned and hith­erto unavailable dollars were suddenly poured into the demand side of the ledger.

The immediate effect was not just an increase in demand. There occurred a psychological hyper­inflation of demand. The con­sumer, released from all the re­straints imposed by “cost” and “afford,” develops, rather quickly, a whole new spectrum of com­plaints which demand attention. Chronic ailments which were not disabling, with which he had lived and been productive for many years without seeking medical aid, now become more and more emergent. He begins to demand attention for increasingly trivial complaints. His calls upon the physician become more frequent and his hospital admissions more frequent. He demands more so­phisticated and more luxurious services and facilities than he was willing and/or able to pay for be­fore. The physician once had dif­ficulty keeping him in the hospital long enough; more and more the problem now is getting him to leave. As we have already proved, with the vast and never-ending expansion of welfare programs over the past 30 years, there is no end to the growth of needs and demands when they are unre­strained.

As long as the government con­tinues to stimulate demand, and supply remains inelastic, acute shortages will continue and wages will continue to rise. Attempts to further improve efficiency by more mechanization and increased para­medical personnel will only in­crease capital investment and op­erational costs. Physicians and hospitals, who must pay their bills or close their doors, have no choice but to increase fees and to continue increasing them with each new spiral of wage, price, and tax increases. This, in gen­eral, is the situation in the med­ical market today. As long as in­flation continues, this will remain the situation, and no combination of managerial talent under the sun can do anything constructive about it.

Further Intervention No Cure

What happens when the medical market, as seems likely, becomes a government controlled monopoly, administered by a politically ori­ented bureaucracy? It seems un­likely that the situation will im­prove under the least competent and least efficient form of admin­istration which man has yet de­vised.

The only thing that can possibly be achieved by government intervention is a drastic reduction in the over-all quality of medical care at a tremendous increase in cost to the consumer. The pro­gram will be entirely dependent on a continuation of inflation in spite of massive increases in tax­ation for the already overbur­dened taxpayer, and in spite of wage and price controls which will be applied throughout the indus­try. The demise of competition, the eradication of “fee for serv­ice” contract between the phy­sician and the individual patient, the distortion of freedom of ac­tion and freedom of choice, must all have an almost lethal effect on physician motivation and incen­tive. The art of medicine under these circumstances must degen­erate into a sterile and grossly distorted caricature. There may, for awhile, be luxury care but the element of quality will, all too often, be lacking.

Lower the Standards?

The only possible way to ade­quately increase the supply of physicians under the present cir­cumstances is to lower the stand­ards of qualification. Just as the Registered Nurse shortage of the 1950′s caused the development of Licensed Practical Nurse pro­grams, so will the planners try to meet the physician shortage by the development of what should be, but will not be, called Licensed Practical Physician programs. The imposition of these programs will, in effect, turn the clock back about 70 years, as far as the over-all quality of medical practice is con­cerned. In the pre-Flexner Report era, however, the consumer had a free choice of quality. In our time the poor quality care will be im­posed by the state. The vast ma­jority of Americans will have to accept it. There will be no choice in the matter.

This is not a pleasant report. It is, I believe, an honest one. I can­not here attempt evaluation in depth of the many maladjust­ments which have accrued, not only from external influence and interferences, but also from our own past errors both of omission and commission in the manage­ment of our affairs. Further study and evaluation of these funda­mental problems is, in my opinion, imperative. No useful purpose can be served by minimizing a serious situation. Just how serious our situation is becomes immediately apparent when we realize that the problems of medicine are but one set of symptoms of a disease which threatens our entire social structure.

There is no easy solution. Be­fore we can understand effects, the causes in which they are root­ed must be explored and identified. Until we understand causes, we cannot hope to find effective solutions.

The situation is by no means hopeless. On the contrary, we have every reason to be hopeful. There is more awareness, more concern, more intensive study, more under­standing of fundamental issues today than at any time in the past 30 years. Disillusionment with government policy, its profli­gate spending, its gross inefficien­cy, its monumental failure to im­prove society, is growing rapidly. Inflation cannot last forever. It must end, as historically it always has, in economic and social dis­aster, but this will not be the end of the world. Our form of govern­ment may not survive, but we will. If we know and understand enough, we can, in our turn, and in our sphere, help recapture a heritage which we have somehow lost.


GARRISON, FIELDING H., An Introduction to the History of Medicine, Fourth Edition. Philadelphia: W. B. Saunders Co., reprinted 1966.

KESSEL, REUBEN A., “Price Discrimination in Medicine,” Journal of Law and Eco­nomics, 1958.

FRIEDMAN, MILTON, Capitalism and Free­dom. Chicago: University of Chicago Press, 1962.

Journal of the American Medical Associ­ation, November 24, 1969.

Washington‘s Week” (Column), American Medical News, August 3, 1970.

GARDNER, JOHN W., “Medical Costs: A Re­port to the President,” Condensed Re­port—Medical Economics, April 3,1967.

MCNERNEY, WALTER J., “Why Does Medi­cal Care Cost So Much?” The New England Journal of Medicine, June 25, 1970.


Free Medicine Can Make You Sick

SOCIALIZED MEDICINE includes government care of the sick and support for the family as well. If this support amounts to approximately the same as the man can earn from his own daily labor, he is tempted to be sick continuously. The temptation would be the greatest for people in low income brackets, illness actually being preferable to good health. This may sound strange, but doctors can observe the fact in their daily practice. Many people want to be sick, or sicker than they actually are, because material advantages in the form of compensations and liability payments are involved.