Almost 100 years ago, Ludwig von Mises and Friedrich Hayek argued that a socialist state could not determine marginal cost prices and therefore could not allocate resources rationally. Oskar Lange and Abba Lerner responded with the market socialist model. Subsequent scholars have refined the model (Leeman, Roemer). Views on market socialism for an entire economy are mixed (Phelps, Shleifer and Vishny, Roemer). We briefly review the debate. We argue that a form of market socialism exists and is especially important in education, health care, and health insurance. In these sectors, prices are often set or restricted centrally, while many providers are state-owned, nonprofit, or mutual firms. We argue in favor of applying market socialist principles to health care and to health insurance policy. In particular, we show that these principles imply that community rating of health insurance is a source of major inefficiencies and harmful regulatory pressure. We suggest moving in the market socialist direction – toward marginal cost pricing and therefore away from community rating. The desire for universal or expanded coverage can be fulfilled by explicit, politically transparent subsidies paid to consumers who are both poor and high risk.
Similar content being viewed by others
Notes
The same argument was independently made by Weber (1978, p. 103), in his massive two-volume Economy and Society, which was published in German in 1922, 2 years after his death. Weber’s contribution is not well known to English-speaking economists for three reasons. First, the book was not translated into English until 1968. Second, Weber died before the debate occurred. Third, Weber’s fame as a founder of sociology has overshadowed his contributions to economics. Interestingly, Weber considered himself to be a political economist.
We focus on Lange’s version because it is relatively simple, clearly described, and the best known. It may be considered the “classic” version of market socialism. Along with more recent literature, we will introduce a broader definition below.
The “Central Planning Board” is misnamed because it merely announces prices and then gropes toward a market-clearing set of prices, rather than planning.
One difference is that there is false trading (i.e., trading at disequilibrium prices) in market socialism, but not in a Walrasian auction.
Page cites are to the reprinted version of 1938.
See e.g. Laffont and Montmort (2002).
Leeman also considers the possibility of average cost pricing to avoid subsidies for natural monopolies, who are characterized by marginal cost below average cost.
Shleifer and Vishny (1994) oppose market socialism for different reasons, grounded in theoretical and applied work in public choice. In their view, market socialism would be much more vulnerable to governmental intervention in favor of interest groups than capitalism. While fascinating, this idea is beyond the scope of our work. Consciously making a strong simplifying assumption, we assume a benevolent government, in keeping with the explicit assumptions of the founders of market socialism, Lange (1938, p. 75) and Lerner (1944, p. 6). See the discussion of public choice literature in education and health care below.
One can think of a spectrum. The market socialism view fits easier with sectors with much choice and competition (e.g., US higher education) than with sectors with little choice (e.g., where students are required to attend schools in their geographic district).
There is a large literature on this in both economics and public administration; see, e.g., Powell (2014), Klien (2014), Bradley and Taylor (2010), Gruening (2001), Cooper et al. (2011), Gaynor et al. (2013), and Glennerster (1991). In a rare application of public choice theory, Klein demonstrates that there is less political influence on the pricing of water by Austrian water suppliers after corporatization than there was under direct state control, suggesting that movement from direct bureaucratic control to a decentralized, market-based system leads to less political distortion.
For an example of an adverse selection death spiral, see Frech and Smith (2015).
See Pauly (1970) for an early analysis.
US health insurance has long been regulated by federal and state mandates, requiring certain types of coverage (Morrisey, 2014, pp. 358–372). The ACA has strengthened the federal mandates.
Examples of the latter include private supplemental insurance for US Medicare beneficiaries, the French Sécurité Sociale, and Australian Medicare.
This section draws on Zweifel and Breuer (2006). See that paper for more detail.
For a recent discussion of the advantages of marginal cost pricing in a different industry, natural gas, see Davis and Muehlegger (2010).
For now, we simplify by ignoring the possibility of nonprice rationing as a tool to mitigate both ex ante and ex post moral hazard. We will introduce this later.
Indemnity, contingent claim health insurance exists only for a small niche product, accidental death and dismemberment insurance, where death or the loss of a limb is the observable event that triggers a preset lump sum indemnity payment. To see how what a small niche product this is, consider the health insurance plans at the University of California, Santa Barbara, the home university of one of the authors. The university offers, but does not subsidize, accidental death and dismemberment insurance up to $500,000 maximum payment. The annual premium is $60 for an individual. In contrast, a typical health insurance plan costs about $8000 for an individual, and the university pays for about 78 per cent of the premium. https://atyourserviceonline.ucop.edu/ayso/loginSubmit.do.
Thirty-three states have allowed some degree of continuation of canceled plans (transition plans) (Huth and Karcher, 2016).
Outside of Australia, lifetime community rating is not very common, but it is used in German private health insurance (a small part of the German system) and US Medicare Part B insurance for physician services.
References
Akerlof, GA. 1970: The market for ‘Lemons’: quality uncertainty and the market mechanism. The Quarterly Journal of Economics 84(3): 488–500.
Alchian, AA and Demsetz, H. 1972: Production, information costs, and economic organization. American Economic Review 62(5): 777–795.
Alliance for Advancing Nonprofit Health Care, nonprofithealthcare.org (2014).
Barone, E. 1908: Il Ministro della Produzione nello Stato Collettivista”, Giornale degli Economisti, (Sept./Oct. 1908), 2: 267–293, 392–414, trans. as “The Ministry of Production in the Collectivist State”, in: Hayek, F. A. (ed.), Collectivist Economic Planning, London: George Routledge & Sons (1935): 245–290.
Beck, K, Zweifel, P and Trottmann M. 2010: Risk adjustment in health insurance and its long-term effectiveness. Journal of Health Economics 29(4): 489–498.
Bhattacharya, J, Chandra A, Chernew, M, Goldman, D, Jena, A, Lakdawalla, D, Malani, A and Philipson, T. 2013: Best of Both Worlds: Uniting Universal Coverage and Personal Choice in Health Care, Washington, D.C.: American Enterprise Institute.
Blomqvist, A. 1997: Monopolistic competition and supply-side cost sharing in the physician services market. Working paper No. 9705, University of Western Ontario.
Blue Cross Blue Shield Association, Newly Enrolled Members in the Individual Health Insurance Market: The Experience from 2014 and 2015 (March 2016). Available from: https://www.bcbs.com/about-us/capabilities-initiatives/health-america/health-of-america-report/newly-enrolled-members.
Bors, M. 2010: Public Schools Through the Public Choice Lens. Atlanta GA: Foundation for Economic Education.
Bradley, S and Taylor, J. 2010: Diversity, choice and the quasi-market: an empirical analysis of secondary education policy in England. Oxford Bulletin of Economics and Statistics 72(1): 1–26.
Breyer, F and Schneider, F. (1992). “Political Economy of Hospital Financing“, in: Zweifel, P. and Frech, H.E., III (eds.), Health Economics Worldwide, Dordrecht: Kluwer: 266–285.
Buchanan, J and Tullock, G. 1962: The Calculus of Consent: Logical Foundations of Constitutional Democracy. Ann Arbor: University of Michigan Press.
Buchanan, JL, Keeler, EB, Rolph, JE and Holmer, MR. 1991: Simulating health expenditures under alternative health insurance plans. Management Science 37(9): 1067–1090.
Buchmueller, T. 2008: Community rating, entry-age rating and adverse selection in private health insurance in Australia. Geneva Papers on Risk & Insurance – Issues & Practice 33(4): 588–609.
Bundorf, MK, Levin, J and Mahoney, N. 2012: Pricing and welfare in health plan choice. American Economic Review 107(2): 3214–3248.
Busemeyer, MR and Iversen, T. 2014: The policies of opting out: explaining educational financing and popular support for public spending. Socio-Economic Review 12(2): 299–328.
Cohen, G. 2013: Director, Center for Consumer Information and Insurance Oversight, Centers for Medicare and Medicaid Services, letter to the Insurance Commissioners (November 14).
Collins, S. 2013: Pros and cons of the president’s policy fix for health plan cancellations. Commonwealth Fund Blog (November 18).
Cooper, Z, Gibbons S, Jones, S and McGuire, A. 2011: Does hospital competition save lives? Evidence from the english patient choice reforms. Economic Journal 121(554): F228–F260.
Dafny, L, Ho, K and Varela, M. 2013: Let them have choice: gains from shifting away from employer-sponsored health insurance and toward an individual exchange. American Economic Journal: Economic Policy 5(1): 257–277.
Dardanoni, VD and Danni PL. 2016: The welfare cost of unpriced heterogeneity in insurance markets. Rand Journal 47(4): 998–1028.
Davis, LW and Muehlegger E. 2010: Do Americans consume too little natural gas? An empirical test of marginal cost pricing. Rand Journal 41(4): 791–810.
De Donder, P and Hindriks, J. 2003: The politics of redistributive social insurance. Journal of Public Economics 87(12): 2639–2660.
Ellis, RP and Savage, E. 2008: Run for cover now or later? The impact ofpremiums, threats and deadlines on private health insurance in Australia. International Journal of Health Care Finance and Economics 8(4): 257–277.
Ericson, KM and Starc, A. 2014: Measuring Consumer Valuation of Limited Provider Networks. NBER Working Paper No. 20812 (December).
Eugster, P, Sennhauser, M and Zweifel, P. 2010: Capping risk adjustment? Journal of Health Economics 29(4): 499–507.
Feldstein, PJ. 2006: The Politics of Health Legislation: An Economic Perspective. Chicago: Health Administration Press.
Frech, HE III and Michael, PS. 2015: Anatomy of a slow-motion health insurance death spiral. North American Actuarial Journal 19(1): 60–72.
Frech, HE III, Hopkins, S and MacDonald, G. 2003: The Australian private health insurance boom: was it subsidies or liberalized regulation? Economic Papers 22(1): 58–64.
Gaynor, M, Moreno-Serra, R and Propper, C. 2013: Death by market power: reform, competition, and patient outcomes in the National Health Service. American Economic Journal: Economic Policy 5(4):134–166.
Glazer, J and McGuire, T. 2000: Optimal risk adjustment in markets with adverse selection: an application to managed care. American Economic Review 90(4): 1055–1071.
Glennerster, H. 1991: Quasi-markets for education? Economic Journal 101(408): 1268–1276.
Goldstein, A. 2016: Average premiums for popular ACA plans rising 25 per cent. Washington Post (October 24, 2016).
Gruening, G. 2001: Origin and theoretical basis of new public management. International Public Management Journal 4: 1–25.
Hart, O and Moore, J. 1990: Property rights and the nature of the firm. Journal of Political Economy 98(6): 1119–1158.
Hayek, FA. 1935: The present state of the (socialist calculation) debate. In: Hayek, FA (ed). Collectivist Economic Planning, London: George Routledge & Sons: 201–244. Available from the Ludwig von Mises Institute, http://wiki.mises.org/wiki/Ludwig_von_Mises_Institute.
Huth, E and Karcher, J. 2016: A financial post-mortem: transitional policies and the financial implications for the 2014 ACA individual market. Milliman (July 1).
Interim Final Rules for Group Health Plans and Health Insurance Issuers Relating to Coverage of Preventive Services Under the Patient Protection and Affordable Care Act. (2010). Federal Register 75(137) (July 19): 41726–41760.
Ip, G. 2016: Obama’s health law’s instability is intrinsic. Wall Street Journal (August 19, 2016).
Jacobs, DB and Sommers, BD. 2015: Using drugs to discriminate – adverse selection in the insurance marketplace. New England Journal of Medicine 372(5): 399–402.
Kaiser Family Foundation 2014: Summary of new health reform law. Kaiser Family Foundation (April 25).
Katterman, S. 2015: Headwinds cause 2014 risk corridor funding shortfall. Milliman (Oct. 5).
Kifmann, M. 2005: Health insurance in a democracy: why is it public and why are premiums income-related? Public Choice 124: 283–308.
Klien, M. 2014: Corporatization and the behavior of public firms: how shifting control rights affects political interference in water prices. Review of Industrial Organization 44(4): 393–422.
Kreier, R and Zweifel, P. 2010: Health Insurance in Switzerland: a closer look at a system often offered as a model for the United States. Hofstra Law Review 39(1): 89–110.
Laffont, J-J and Montmort, D. 2002: The Theory of Incentives. Princeton University Press.
Lange, O. 1936, 1937: On the economic theory of socialism. Review of Economic Studies 4(1 and 2) (Oct. 1936, Feb. 1937): 53–71 and 123–142, reprinted with small changes in Lippincott, B. E., ed., On the Economic Theory of Socialism (1938), Univ. of Minnesota Press (1938): 55–143. The 1938, version will be used for citations.
Leeman, WA. 1977: Centralized and Decentralized Economic Systems. Chicago: Rand McNally.
LeGrand, J. 1991: Quasi-markets and social policy. Economic Journal 101(408): 1256–1267.
Leida, HK. 2013: President Obama’s transitional policy for canceled plans. Milliman (November 19).
Lerner, A. 1944: The Economics of Control. New York: McMillan, reprinted by Augustus Kelly, New York (1970).
Matthews, AW and Christopher Weaver 2014: Sick drawn to new coverage: high rates of serious conditions in health law plans put pressure on premiums. Wall Street Journal (June 25).
McGuire, TG, Newhouse, JP, Normand, S-L, Shi, J and Zuvekas, S. 2014: Assessing incentives for service-level selection in private health insurance. Journal of Health Insurance 35: 47–63.
Montz, E, Layton, T, Busch, AB, Ellis, RP, Rose, S and McGuire, TG. 2016: Risk adjustment simulation: plans may have incentives to distort mental health and substance abuse coverage. Health Affairs 35(6): 1022–1028.
Morrisey, MA. 2014: Health Insurance, 2nd Ed. Chicago: Health Administration Press.
Morrisey, MA. 2016: Issue Brief: Turmoil in the Health Insurance Marketplaces. University of Pennsylvania Leonard Davis Institute of Health Economics (October 27, 2016). Available at: http://ldi.upenn.edu/brief/turmoil-health-insurance-marketplaces
Norris, D, Van der Heijde, M and Leida, H. 2013: Risk Corridors Under the Affordable Care Act – a bridge over troubled waters, but the devil’s in the details. Health Watch 73: 1–10.
O’Connor, JT. 2013: Comprehensive assessment of ACA factors that will affect individual market premiums in 2014. Milliman (April 25), Available at http://ahip.org/MillimanReportACA2013/.
OECD 2011: Pisa in Focus 2011/7. Paris: OECD.
Pauly, MV. 1970: The welfare economics of community rating. Journal of Risk and Insurance 37(3): 407–418.
Pauly, MV. 2010: Health Reform Without Side Effects: Making Markets Work for Individual Health Insurance. Stanford, CA: Hoover Press.
Pear, R. 2013: Insurers are offered assistance for losses. New York Times (December 3).
Phelps, E. 2013: Mass Flourishing. Princeton: Princeton University Press.
Poterba, JM. 1997: Demographic structure and political economy of public education. Journal of Policy Analysis and Management 16(1): 48–66.
Powell, M. 2014: Making markets in the English National Health Service. Social Policy & Administration 49(1): 109–127.
Radnofsky, L. 2016: Insurers seek big premium boosts. Wall Street Journal (May 26).
Roemer, JE. 1994. A Future for Socialism. Cambridge, MA: Harvard University Press.
Robins, L. 1934: The Great Depression. London: Macmillan, reprinted by the Books for Libraries Press, Providence Rhode Island (1971).
Rothschild, M and Stiglitz, J. 1976: Equilibrium in competitive insurance markets: an essay in the economics of incomplete information. Quarterly Journal of Economics 90(4): 629–649.
Sappington, DE. 1991: Incentives in principal-agent relationships. Journal of Economic Perspectives 5(2): 45–66.
Shephard, M. 2015: Hospital network competition and adverse selection: evidence from the massachusetts health insurance exchange. Unpublished paper, Harvard University (Jan. 13, 2015).
Shleifer, A and Vishny, RW. 1994: The politics of market socialism. The Journal of Economic Perspectives 8(2): 165–176.
Schoder, J, Sennhauser, M and Zweifel, P. 2010: Fine-tuning of health insurance regulation – unhealthy consequences for an individual insurer. International Journal of the Economics of Business 17(3): 313–327.
Taylor, FM. 1929: The guidance of production in a socialist state. American Economic Review 19(1): 1–8, reprinted in Lippincott BE. (ed). On the Economic Theory of Socialism. University of Minnesota Press (1938), pp. 55–143.
Tinbergen, J. 1952: On the Theory of Economic Policy, 2nd ed. published as Contributions to Economic Analysis Vol. 1, Amsterdam: North-Holland.
Tooley, J. 1999: Public versus private provision of education. Arguments for public intervention. Trends and Issues in the Analysis of Public Expenditure. New York: United Nations Dept. of Economic and Social Affairs ST/ESTA/PAD/No. 3.
Tuohy, CH and Glied, S. 2011: The political economy of health care. In: Glied, S and Smith, PC. (eds). The Oxford Handbook of Health Economics. New York: Oxford University Press, ch. 4: 58–77.
Van de Ven, WPMM and Ellis, RP. 2000: Risk adjustment in competitive health plan markets. In: Newhouse, JP and Culyer, AJ. (eds). Handbook of Health Economics, Vol. 1A, Amsterdam: North Holland, ch. 14: 755–845.
von Mises, L. 1920: “Die Wirtschaftsrechnung im sozialistischen Gemeinwesen,” Archiv für Sozialwissenschaften, 47, translated as “Economic Calculation in the Socialist Commonwealth”. In: Hayek, FA (ed). Collectivist Economic Planning. London: George Routledge & Sons, (1935): 87–130. Available from the Ludwig von Mises Institute, http://wiki.mises.org/wiki/Ludwig_von_Mises_Institute.
Van de Ven, WPMM, Van Kleet, Richard and Van Vliet, RCJA. 2015: Risk selection threatened quality of care for certain patients: lessons from europe’s health insurance experience. Health Affairs 34(10): 1713–1720.
Van de Ven, WPMM and Van Vliet, RCJA. 1992: How can we prevent cream skimming in a competitive health insurance market? In: Zweifel, P and Frech, HE. III (eds). Health Economics Worldwide. Dordrecht: Kluwer: 23–46.
Weber, M. Economy and Society 1978: Vol. 1, Berkeley California: University of California Press. (This is a reprint of the 1968 translation, which was published by Bedminister Press.)
Zweifel, P. 2009: Technological change and health insurance. In: Costa-Font, J and Courbage, C. (eds). The Economics of New Health Technologies. New York: Oxford University Press: 93–107.
Zweifel, P and Breuer, M. 2006: The case for risk-based premiums in public health insurance. Health Economics, Policy and Law 1(2): 171–188.
Zweifel, P and Eichenberger, RE. 1992: The political economy of corporatism in medicine: self-regulation or cartel management? Journal of Regulatory Economics 4(1): 89–108.
Zweifel, P and Frech, III HE. 2015: Why ‘Optimal’ payment for healthcare providers can never be optimal under community rating. Applied Health Economics and Health Policy 14: 9–20.
Zweifel, P and Manning, WG. 2000: Moral hazard and consumer incentives in health care. In: Culyer, AJ and Newhouse, JP. (eds). Handbook of Health Economics, Vol. 1, Boston: North Holland: 409–459.
Zweifel, P and Pauly, MV. 2007: Market outcomes, regulation, and policy recommendations. In: Preker, AS et al. (eds). Private Voluntary Health Insurance in Development – Friend or Foe? Washington: The World Bank: 115–145.
Acknowledgements
Earlier versions of this paper were presented at the Allied Social Science meetings in Boston and the International Health Economics Association meetings in Milan. Thanks are due to the participants at those meetings, and especially to Tony Lo Sasso, for helpful comments.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
About this article
Cite this article
Frech, H.E., Zweifel, P. Market Socialism and Community Rating in Health Insurance. Comp Econ Stud 59, 405–427 (2017). https://doi.org/10.1057/s41294-017-0027-3
Published:
Issue Date:
DOI: https://doi.org/10.1057/s41294-017-0027-3
Keywords
- health insurance
- market socialism
- quasi-markets
- pricing
- community rating
- new public management
- corporatization