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Market Socialism and Community Rating in Health Insurance

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.

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  1. 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.

  2. 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.

  3. The “Central Planning Board” is misnamed because it merely announces prices and then gropes toward a market-clearing set of prices, rather than planning.

  4. One difference is that there is false trading (i.e., trading at disequilibrium prices) in market socialism, but not in a Walrasian auction.

  5. Page cites are to the reprinted version of 1938.

  6. See e.g. Laffont and Montmort (2002).

  7. Leeman also considers the possibility of average cost pricing to avoid subsidies for natural monopolies, who are characterized by marginal cost below average cost.

  8. 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.

  9. 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).

  10. 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.

  11. For an example of an adverse selection death spiral, see Frech and Smith (2015).

  12. See Pauly (1970) for an early analysis.

  13. 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.

  14. Examples of the latter include private supplemental insurance for US Medicare beneficiaries, the French Sécurité Sociale, and Australian Medicare.

  15. This section draws on Zweifel and Breuer (2006). See that paper for more detail.

  16. For a recent discussion of the advantages of marginal cost pricing in a different industry, natural gas, see Davis and Muehlegger (2010).

  17. 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.

  18. 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.

  19. Thirty-three states have allowed some degree of continuation of canceled plans (transition plans) (Huth and Karcher, 2016).

  20. 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.


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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.

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Correspondence to H. E. Frech III.

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Frech, H.E., Zweifel, P. Market Socialism and Community Rating in Health Insurance. Comp Econ Stud 59, 405–427 (2017).

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  • health insurance
  • market socialism
  • quasi-markets
  • pricing
  • community rating
  • new public management
  • corporatization

JEL Classification

  • I13
  • P51
  • P27
  • I18
  • D47
  • B24
  • D02
  • L31