Trust the Customer!

Josh Wright —  9 March 2006

Nobel Laureate (and GMU Prof) Vernon Smith has a must read column in the WSJ on the growing costs of health care and education. The problem?

“[I]f third-party deep pockets pay whatever is the price B charges A this year, the effect is to reinforce the incentive to raise the price next year. Spending escalates, which leads to a demand for cost control.”

The solution?

“[C]hanging the incentive structure: empowering the consumer by channeling third-party payment allowances through the patients or students who are choosing and consuming the service. Each pays the difference between the price of the service and the insurance or subsidy allowance. Since he who pays the physician or college calls the tune, we have a better chance of disciplining cost and tailoring services to the customer’s willingness to pay.”

How about some evidence?

“[I]n Lancaster County, Pa., an Amish and Mennonite delegation, whose people pay cash for medical services, negotiated discounts up to 40% with their hospital for services. If they can make it work, surely we can as well.”

The punchline:

“Would some one please just trust the customer?”

(HT: Cafe Hayek).

UPDATE: Here is an interesting WSJ column on the Amish and Mennonite negotiations.

6 responses to Trust the Customer!


    I still don’t quite see how that would work, Josh. The only service consumers really demand in healthcare is ‘make me better’– exactly how my doctor does that is largely beyond my understanding. If he recommends a 50-cent antibiotic, I’ll take it. If he recommends a $20,000 MRI for a sore knee, I’ll take that too, solely because I don’t know what services I’m supposed to demand. I’ll have no idea whether that MRI is really necessary, or could be done with a $10,000 test, or anything else about it. I suppose with time consumers *could* develop that sophistication, but most of us fear that ‘with time’ really means many years of their life with greater expense.

    But I would love to see some example of consumer-directed healthcare in other nations as an example to study. Right now the only one I know is China, which is a nightmare.


    Matt, I dont think that the point is for you not to trust your doctor’s recommendations. I’m pretty sure everybody is in favor of specialization. The point is that allowing the customers to control the payments flowing to suppliers of these services (rather than third parties) will help to discipline costs and create incentives to provide the services that consumers demand.


    Well, I am the customer, and I certainly don’t trust myself to make decisions about my healthcare. When my doctor recommends something, I do it. I don’t want to take the risk that not listening to him, or even taking time to solicit better prices, will further worsen whatever health problem I have. I suspect most people feel the same way.


    I bit off topic, but I was reading Scott Adams’ post yesterday on his medical issues and immediately wondered how he would have fared in a single payer system. Would government have allowed him a 2nd, 3rd, 4th, or 5th opinion on his ailment? [I doubt it]. Scott certainly seems to buck Krugman’s expectation that people are too ignorant to make decisions about their own healthcare.


    Bob, I updated the post to link to the WSJ article on the Amish/ Mennonite negotiations. I am not sure if the data in the column answers your question sufficiently (the author simply reports that they received a 40% discount), but there are some comparisons with national 2004 averages that are pretty impressive.


    Just one question: since doctors and hospitals do not post (and are often prohibited by law and/or the AMA from posting) a schedule of fees and costs for the public to see, how could you ever be certain you have received a “40% discount”?