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Why ban some for-profit businesses but not others?

Dr. Paul Ellwood, often called the father of HMOs, coined the term in 1970, the year this photo was taken in his Minneapolis office. His argument that health-maintenance organizations would help drive down health-care costs while keeping patients healthy culminated in a 1973 federal law that led to the proliferation of HMOs.
Dr. Paul Ellwood, often called the father of HMOs, coined the term in 1970, the year this photo was taken in his Minneapolis office. His argument that health-maintenance organizations would help drive down health-care costs while keeping patients healthy culminated in a 1973 federal law that led to the proliferation of HMOs. Associated Press file

An era has ended in Minnesota: For-profit health maintenance organization now may operate.

This may sound strange to people in Idaho and elsewhere but, for a time, similar bans existed in 12 states, including Oregon and Washington. Why?

Ending the ban is an occasion to consider when and how for-profit firms, nonprofit enterprises, or government itself, should provide goods and services. Neither side of the political spectrum thinks about this with much consistency.

Few people, for example, want to let for-profit companies broker transplantable organs or babies for adoption. So we all have some point at which profit-motivated enterprises seem wrong.

Along with most other economists, my default is that private businesses should not be banned from providing any product unless there are strong reasons for such a ban. And this position in the discipline comes as much from dogma as from anything else.

Also note that some of the strongest opposition to letting private, for-profit firms run HMOs in the state comes from the similarly dogmatic, inherently suspicious view that businesses, especially incorporated ones incline toward illegal and immoral practices. Indeed, some believe, market incentives motivate such practices.

Between these poles, many centrists don’t have any particular animus against making money or any conviction that unfettered markets are always optimal. Yet they nonetheless have much well-founded skepticism about U.S. health care.

So why did 12 states ban for-profit HMOs when allowed for-profit doctors’ practices or hospitals or health policies issued by for-profit insurance companies?

One implicit argument 40 years ago was the vulnerability of an infant industry to predatory pricing.

In everyday terms, when HMOs were few, small and financially weak, people feared that large, well-established and well-capitalized for-profit insurers that already sold health policies would horn into this new market by setting up their own HMOs. The financial strength of such insurance companies would allow them to price the services of their subsidiary HMOs very aggressively — in other words, cheaply — driving the weaker fledgling non-profits out of business. Then the big boys would exercise monopolistic power and raise prices. That is predatory pricing. It should be familiar to anyone who followed American Airlines over the years.

That is one possible rationale for the ban. There are others.

Some economists see rent-seeking, the abuse of political power to secure public policies favoring their own finances. HMOs were a new model for that promised economies of size and scope. Early entrants had a “first mover advantage.” If they got laws enacted to keep potential competitors out, it would foster their own monopoly power. As nonprofits, they lacked incentives to maximize profits for shareholders.

But many incentives push nonprofit managers to increase the size of their organizations and thus earn higher compensation. In huge organizations, day-to-day incentives for managers don’t differ much between for-profit and nonprofit.

That the industry association for nonprofit HMOs lobbied heavily over the years to preserve the law supports the rent-seeking explanation. But Minnesota, where I live, has notoriously low margins for providers. Historic nonprofits may have tried to defend a monopoly position, but it is hard to argue they got much wealth.

Opponents of the ban long argued that letting for-profits participate would increase choices for consumers, create more competition, and thus motivate efficiency and innovation. Economic theory and history of supports this.

However, whether this actually will be true here remains to be proven. Margins already are low. It is hard to imagine corporate HMO heads salivating about getting into a lucrative bonanza.

Other states that had such bans repealed these over time, There is little indication that the public in those states suffered from repeal, but it is also hard to identify any great flowering of efficiency or service after repeal elsewhere.

Are there any general lessons here?

Economists have focused on discerning when government must act to provide something vital — say fire protection or tornado warnings — and when leaving things to private companies is fine, say providing onions, automobiles or bowling balls. But there has been little work on when nonprofits are optimal.

Historically, nonprofits arose where a market seemed too small for profit-making firms to jump in. Miners formed burial funds and farmers organized township mutual insurance agencies when commercial insurers scorned these markets.

Such mutuals — essentially owned by customers — also took root where information was valuable but scarce and members of some group could compile information better than for-profits. Close relationships between members made nonprofits more responsive.

For-profit competitors assert nonprofits have gotten tax or regulatory advantages. Commercial banks assert the same about credit unions.

Some humble mutuals have grown to enormous size. Some remain responsive: The uniformed-services mutual that insures my cars and house is among the best-run enterprises I know. Meanwhile, my college teachers’ retirement mutual is one of the worst. And it is not clear why either should get a special edge in taxation or regulation. Their managers probably would respond that at their scale, the advantages over a purely commercial firm are small.

Compare this to other countries, especially poor ones, and the importance to the U.S. economy of nonprofit enterprises comes into sharper relief. These entities have added diversity and responsiveness to our economy that is sorely lacking in nations having less-propitious cultures and institutions.

Repealing this ban constructs an interesting experiment. How things now change, if at all, will teach us something about the wisdom or silliness of the old ban.

My own prediction is that it will turn out like the federal law that prohibits onion-futures contracts. No evidence shows that the old law really helped or seriously harmed anyone. That will prove true for the repealed HMO ban.

St. Paul economist and writer Edward Lotterman can be reached at boise@edlotterman.com.

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