Certificate of Need (CON) were enacted in order to try to stem the wave of increasing health care costs. In order for hospitals or other providers to expand or build a new facility, CON requires these organizations to get prior government approval. The logic was that when providers expanded medical facilities, supplier-induced demand would increase the quantity of medical care and drive up costs.
CON laws, in effect, made incumbent firms immune from competition since it was difficult for new entrants to receive governmental approval. Were CON laws welfare improving?
A working paper by Cutler, Huckman and Kolstad reviews what happened to coronary artery bypass graft (CABG) surgeries after the CON laws were repealed in Pennsylvania in 1996. CABG surgeries are certainly expensive:
“Huckman (2006) finds the average fixed cost to establish a CABG program in New York State to be $14 million. Further, Jamie Robinson et al. (2001) present reported setup costs of $13.4 and $12 million for two programs entering the Pennsylvania market in 2000. To put such an investment in perspective, we note that the average net income between 1996 and 2005 for hospitals entering the CABG market in Pennsylvania was $3.5 million.”
So do CON laws improve welfare? Using Pennsylvania Heath Care Cost Containment Council (PHC4) data, Cutler et al. find a significant improvement in overall CABG mortality levels after CABG. They claim that this is due to an increase in the number of surgeries allocated to high-quality cardiac surgeons. However, as new institutions enter the market, there is a significant fixed cost to establish a new CABG program. New entrants do expand capacity, but they also steal patients away from existing hospitals. Thus, this duplication of services and fixed cost investment is welfare destroying. The authors conclude that repealing the CON laws was welfare neutral because of the tradeoff between decreased mortality and increased fixed costs.
Healthcare Economists take:
In order for the Cutler paper to be correct, mortality rates have had to decline. However, declining mortality rates may not be due simply to better quality. As new entrants invest in a CABG program, individuals for whom surgery is an option may have been convinced to have the CABG surgery. Thus, surgeon “quality” may improve not because of improved surgeons, but because the patients who are being operated on are healthier. The authors do risk adjust their patients based on age, gender, co-morbidities such as hypertension, heart failure, heart attack, kidney failure and cardiogenic shock. However, even within these categories there are likely to be varying degrees of severity.
In general, prohibiting entry into a market would seem to be welfare destroying. In a health care system plagued with supplier-induced demand, however, this need not be the case. CON laws would be useless in a world with capitation, because providers would not have an incentive to induce demand. However, in a world with Medicare fee-for-service–and Medicare pays for 54% of all CABG procedures–CON laws may be a necessary evil to stem the tide of rising healthcare costs.
- Cutler , Huckman and Kolstad “Input Constraints and the Efficiency of Entry: Lessons from Cardiac Surgery” Harvard Business School Working Paper, July 2009.