The Economics of Health Care Bureaucracy

In the American Economic Review in 1968 William Niskanen (the former leader of the Cato Institute) wrote an article on the peculiar economics of bureaucracies. Niskanen argued that bureaucrats work to maximize their budgets while entrepreneurs work to maximize outputs. When downturns occur, because the bureaucrats don't care as much about their service provision, the first thing they reduce is service. Entrepreneurs, because they directly benefit from the growth of the firm, reduce services last. A firm that is run by managers would be expected, because of the less direct benefit to managers for better growth, are expected to act more like bureaucracies.

A demonstration of that came last fall when the public segments of higher education in California lost the first of two pretty substantial portions of their budget. Both immediately announced a significant reduction in the number of spaces offered to students. The independent colleges and universities, although they had suffered economic challenges, did everything to maintain enrollments.

As I have thought about the health care debates, I have wondered which model would apply to the House bill or other alternatives. A good portion of the health care industry is run out of either government or large bureaucracies. While Niskanen argued that there were slight differences between bureaucracies and manager led firms,both reduce their commitment to protecting the level of service over entrepreneurial firms. It is pretty clear however that applying Niskanen's theory to the public option suggests that services would be reduced first over other alternatives for saving money - more cost, less service; not exactly a good combination.