Can you regulate your way to lower costs?

The answer, at least in some cases, is no. This is an example were regulations were put in place in the hope of restraining the growth of health spending, but failed.

In most states in the US, health care providers who seek to open a new hospital must obtain a "certificate of need" (CON) from a state board certifying that there is an "economic necessity" for their services. A new working paper, by James Bailey, published by the Mercatus Center at George Mason University, finds that states with CON laws spend 3 percent more on health care than other states.

Bailey discusses his work in a blog post at the ProMarket blog. He writes,

What does it take to open a new hospital or health facility? Certainly a building, equipment, supplies, and a staff of trained medical professionals. But in most states, this is not enough. Health care providers must also obtain a “certificate of need” from a state board certifying that there is an “economic necessity” for their services.

Certificate of need (CON) laws were passed rapidly between 1964 and 1980 in the hope of restraining the growth of health spending. By 1980, every state but Louisiana had a CON program, and the federal government was pushing states to adopt CON by threatening to withhold Medicare funds from states without it.

But by 1986, the feds were no longer convinced that this approach to keeping costs down was working, and they stopped pushing CON onto states. Since then 15 states have repealed their CON laws, allowing healthcare providers to make their own decisions about how to expand.

Bailey's research investigates how health care spending has changed in the 15 states that repealed CON compared to the 35 states that have not. The punchline from his study is,

I find that CON laws have not led to lower spending. In fact, states with CON laws actually spend 3 percent more on health care than other states.

In other words, not only have CON laws failed in their goal of reducing health care spending, they have backfired and driven spending upward.

An obvious question to ask is, Why? A bit of simple economic theory explains the result.

High spending can be driven by two factors: a high quantity of sales, or high prices. By restraining the supply of new health care, CON laws try to push quantities down. But with fewer competitors entering the market, existing providers find themselves able to raise prices without jeopardizing their market. Because the demand for health care is relatively inelastic, supply restrictions like CON increase prices more than they decrease quantities, leading to an increase in total spending. While data on health care prices are notoriously difficult to acquire, my paper shows that hospital charges fall by 1 percent per year over 5 years in CON-repealing states relative to CON-maintaining states.

The moral of the story is, regulating your way to lower costs need not work.