Information Failure in the Healthcare Market and Policies to Correct It

Question

Asymmetric information or incorrect estimations of the true benefits or costs of consuming a good are forms of information failure.

(a) Explain how the market for healthcare may fail due to information failure. [10]

(b) Evaluate the policies that the Singapore government can undertake to correct the market failure due to information failure in the market for healthcare. [15]

Answer

Part (a)

Market failure occurs when the free-market interaction of consumers and producers leads to an inefficient allocation of resources, so that society’s welfare is not maximised. In healthcare — a market spanning screening, vaccination, primary care, hospital care and insurance — information failure arises in two forms: imperfect information and asymmetric information.

Imperfect information occurs when consumers have incomplete or inaccurate data and so make sub-optimal choices. Treating themselves as rational utility-maximisers, consumers weigh the private marginal benefit of a healthcare service against its private marginal cost. For preventive care such as cancer screening, the out-of-pocket payment is the private marginal cost, while the private marginal benefit is the early detection of disease and the lower treatment cost that follows. But consumers often undervalue this benefit — they do not appreciate that early detection sharply raises the chance of cure — so their perceived private marginal benefit lies below the actual private marginal benefit. The free-market equilibrium therefore settles where private cost meets perceived benefit, at a quantity below the level that would obtain under full information, where private cost meets actual benefit. The result is under-consumption of screening, and a deadweight welfare loss over that range, since the actual benefit of the foregone units exceeds their cost. This perceived-versus-actual divergence is an individual cost-benefit failure, examined in prose rather than as an externality diagram; care must be taken not to conflate it with a negative-externality figure, which it is not.

Asymmetric information arises where the two sides of a transaction hold different information, distorting incentives and producing inefficient outcomes through adverse selection and moral hazard.

Adverse selection occurs before a transaction, when a hidden characteristic lets less desirable parties dominate a market. In health insurance, an insurer charging a premium based on the average person attracts disproportionately the less healthy, who know their own risk. Claims escalate, the insurer raises premiums, healthier policyholders drop out, and the proportion of unhealthy insured rises further. This spiral continues until the market for health insurance unravels — a “missing market” in which a welfare-enhancing product ceases to be supplied. Even though insurance could raise welfare, its absence is a case of complete market failure.

Moral hazard occurs after a transaction, when an agent behaves differently because another party bears the cost of his actions. Once insured — especially with full coverage or a rider — an individual has weaker incentive to stay healthy and tends to demand more, and higher-quality, healthcare than if uninsured, since he faces no out-of-pocket cost. More of society’s resources are then allocated to healthcare than is efficient, so welfare is not maximised.

Thus information failure, in both its imperfect and asymmetric forms, causes the healthcare market to allocate resources inefficiently.

Part (b)

Given the under- or over-allocation identified in part (a), there is a role for government intervention through both market-based and non-market policies. This part argues that no single tool suffices: the government must match each instrument to the specific type of information failure, and a complementary mix is required because the healthcare market harbours several sources of failure at once.

Policies for imperfect information.

Provision of information. Public health education lets consumers value their private benefit accurately, closing the perceived-actual gap and raising consumption towards the efficient level. Singapore’s Ministry of Health, for instance, runs the National Adult Immunisation Schedule to guide adult vaccination. Education attacks the root of imperfect information, but outreach through traditional channels may miss the target audience, and the budget carries an opportunity cost — funds could go to other pressing needs. To counter incorrect information, the Health Sciences Authority regulates drugs and devices for safety and efficacy and acts swiftly against adverse events; the limit is potential government failure if the agency lacks the competence or up-to-date knowledge to regulate new procedures well.

Compulsory consumption. Mandatory childhood immunisation under the National Childhood Immunisation Programme guarantees consumption of high-benefit services. The administrative cost of enforcement must be adequate, though this is less of a constraint for a small, well-monitored state like Singapore.

Subsidy. A subsidy lowers the price of healthcare and raises consumption towards the socially desirable level, eliminating the deadweight loss from under-consumption. Its weakness is that it does not address the root of imperfect information — the more severe the information gap, the costlier the subsidy — and it must be weighed against its opportunity cost.

Policies for asymmetric information.

Mandatory coverage. Making health insurance compulsory — as with MediShield Life — prevents the healthy from exiting, so effective risk-pooling is achieved at reasonable cost, defeating adverse selection. Lower-income households may struggle to pay, so subsidies are often needed, straining the budget, and duplication can arise where the wealthy also buy private cover.

Co-payment. Requiring claimants to bear part of the treatment cost reduces moral hazard by curbing excessive demand. The difficulty is calibration: too high a co-payment burdens the average patient, too low a one fails to deter over-consumption.

Provision of information and signalling. Requiring hospitals to publish average bills for common procedures, and offering financial counselling, helps patients choose informedly — though access to the information is itself a barrier for some. The government can also award recognisable quality marks to institutions with good records, but a poorly defined yardstick risks misleading signals.

Licensing. A professional-standards framework, enforced by the Singapore Medical Council under the relevant Acts, sets ethical practice and disciplines breaches — though distinguishing genuine diagnostic necessity from profiteering is not always straightforward.

Evaluation and judgement. The reasoned verdict is that the government must select the policy tool suited to the specific type of information failure, and that — because the healthcare market contains imperfect information, adverse selection and moral hazard simultaneously — a combination of complementary policies is required rather than any single instrument. To correct imperfect information, subsidies can raise consumption in the short run while education changes mindsets over the long run; to correct asymmetric information, mandatory coverage and co-payments address adverse selection and moral hazard respectively, with published information supporting both. Each, however, carries an opportunity cost and a risk of government failure, so the government must conduct cost-benefit analysis to allocate its limited resources to the areas of greatest welfare gain. On balance, the most effective response is a contextualised mix — education and subsidy for imperfect information, mandatory pooling and co-payment for asymmetric information — co-ordinated so that the instruments reinforce one another across the market’s several failures.