Introduction

Many health systems are using market mechanisms, competition, and incentives as a way of driving reform. The benefits of this are seen as increased responsiveness to the needs of patients and payers, the ability to increase and reduce supply quickly when required, greater efficiency, innovation, and less unhelpful meddling in provider management by central authorities. These advantages are potentially important but come with some problems and costs. The policy question is at what point the costs exceed the expected benefits?

Costs of competition

Competition has costs for providers, payers, and patients. Competition reduces some management costs but transaction costs such as billing and contracting are likely to be higher than in managed systems and providers may have large marketing costs. The reforms proposed for the NHS have avoided one important transaction cost by setting prices nationally, although this may be at the cost of removing some of the power of market mechanisms. The more independent providers become, the more they will need to strengthen their governance arrangements and the greater the need for external regulation. Competition requires some duplication and redundancy, which carries a potentially high cost. This means that the evidence on costs is less clear than economic theory suggests,1 particularly as this does not necessarily apply to systems with fixed prices.

The creation of spare capacity, which is required for competition, carries an appreciable risk of creating supplier induced demand because providers need to make productive use of their assets. This creates an industry to manage demand, pre-authorise treatment, review use of services, etc, which adds to costs for a relatively low marginal benefit. Too much effort may be put …