Research Highlights Article
March 27, 2024
Expanding public options
When should state-owned companies compete with the private sector?
Source: anekoho
Interest in state-owned services competing with the private market has been on the rise in recent years. Several US states are experimenting with public options on their health insurance exchanges in the hopes that it will deliver quality services at affordable prices, and the Biden administration is renewing efforts to make public health care options available on all Affordable Care Act exchanges.
Advocates believe that public options help to discipline markets prone to failures, such as information asymmetries and market power, whereas critics often argue that public options are prone to inefficiencies, low quality, or political interests.
In a paper in the American Economic Review, authors Juan Pablo Atal, José Ignacio Cuesta, Felipe González, and Cristóbal Otero provide empirical evidence on the effectiveness and equilibrium effects of public options, showing that public options can bring down spending overall, but may increase costs for some. Their findings are based on the decentralized entry of public retail pharmacies to local markets in Chile between 2015 and 2018.
In 2008, it became public knowledge that Chile’s three largest retail pharmacies were colluding to keep drug prices inflated above competitive rates. The scandal caused a wave of outrage, and one left-wing mayor responded by opening the first public pharmacy in October 2015. The move was widely seen as a success, and dozens of other mayors from across the political spectrum followed suit. By the end of 2018, 146 out of the 344 counties in the country were operating a public pharmacy.
Public pharmacies in Chile
The chart below shows the opening dates of public pharmacies (red bars) and the total number of public pharmacies operating (gray bars) in each month between January 2015 and December 2018. The vertical dashed line indicates a month in which many mayors who opened public pharmacies ran for reelection.
The authors found that, on average, these public pharmacies were charging roughly a third of what their private counterparts were charging for the same drug.
The discrepancy between the prices was driven primarily by two factors: On the one hand, the substantial market power of the private companies allowed them to keep prices high. And, on the other hand, the large buying power of public pharmacies allowed them to negotiate lower prices, giving them a cost advantage which they were able to pass along to the customer.
“The procurement system in Chile is such that a government agency procures in a centralized way for a large share of public hospitals and manages to obtain low prices from manufacturers,” Cuesta told the AEA in an interview.
However, the significant discounts offered by the public pharmacies did not induce all customers to switch.
Analyzing the rollout between 2015 and 2018, the researchers compared counties before and after a public option entered a local market to counties without a public option. This comparison revealed that private pharmacies lost only 4 percent of their sales to public pharmacies. Moreover, private pharmacies actually increased their prices by 1 percent on average.
So why were many consumers sticking with private pharmacies?
Importantly, the public options were substantially less convenient. They were located further from most households, had longer waiting times, and had fewer drug varieties to choose from. While price-sensitive customers were willing to incur these convenience costs, many other customers were not, leading to market segmentation. Private pharmacies could then use their market power to raise prices even more.
A similar phenomenon has been documented in the market for generic drugs, known as the “generic paradox.” Researchers have shown that when low-priced generics enter US markets, prices of branded drugs sometimes go up instead of down.
Even when a public option could offer lower prices than private options, I think our results call for more attention to making sure that when you do create a public option, it’s done in a way that is appealing to people so it gets adopted and further strengthens competition with private options.
José Ignacio Cuesta
Still, the consumer savings overall were substantial, according to the researchers.
They estimated that the introduction of public pharmacies in every county in Chile would reduce yearly drug expenditure by 1.6 percent or $61.5 million, which would be more than 8 percent higher than the cost of such a policy. These savings were especially concentrated among public pharmacy customers with chronic conditions, who could save, on average, around $550 per year, which is more than the minimum-wage income in Chile at the time of the rollout.
The authors’ findings suggest that advocates of public options should keep in mind both the market environment—including elements such as downstream market power and government leverage over upstream suppliers—and the price sensitivity and preferences of consumers.
“Even when a public option could offer lower prices than private options, I think our results call for more attention to making sure that when you do create a public option, it’s done in a way that is appealing to people so it gets adopted and further strengthens competition with private options,” said Cuesta.
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“The Economics of the Public Option: Evidence from Local Pharmaceutical Markets” appears in the March 2024 issue of the American Economic Review.