By Carlos Fuentes
“Winning or Losing the Game?” (Contingencies, July/August 2016) introduced certain basic ideas of game theory to analyze the economics of integrated health care systems. That article, like this one, stresses the fact that interactions arise in a wide array of contexts and that fundamental strategic principles must be commensurately broad. The analytical power of such principles is linked to our ability to adapt them to the situation at hand and employ them as reasoning tools.
Game theory can be used to develop mathematical models, as in “Winning or Losing the Game?” But it can also be deployed to create conceptual frameworks—the “soft” approach—for analysis. Conceptual frameworks are the hallmark of strategists, most of whom never had any formal training in game theory but nonetheless have fostered the ability to use them effectively because such frameworks are rooted in common sense and a deep understanding of human nature.
The purpose of this article is to apply the “soft” approach of game theory to analyze the strategic interactions of those who participate in the U.S. health care system, understand the fundamental elements of the system (cost, access, quality, efficiency), and draw conclusions about plausible mid- and long-term outcomes.
A Quick Review of Basic Concepts
A great many men have imagined states and princedoms such as nobody ever saw or knew in the real world, for there’s such a difference between the way we really live and the way we ought to live that the man who neglects the real to study the ideal will learn how to accomplish his ruin, not his salvation.
—“The Prince,” Machiavelli
The Game and The Players
A fundamental requirement to act strategically is to understand the rules of the game—the real game, not the imagined one—and gather information about the players. If the opportunity arises, strategists can modify the game in their favor by defining some of its rules, changing the payoffs through the shaping of perceptions, and even driving out strong opponents.
Players are individuals or groups (e.g., firms) capable of making decisions and influencing outcomes. Although followers—say, soldiers or employees—have a role, leaders are the key participants. Indeed, this trivial observation is often overlooked. In the business space, corporations are often seen as homogenous entities whose decisions reflect the will of management, staff, and shareholders. A moment of reflection shows that reality is different. Although administrative staff and top management work for the same company, their ability to influence outcomes is not the same, their compensation schemes are vastly dissimilar, and in general their payoffs have little in common. Furthermore, the interests of top management can be, and usually are, in conflict with the interests of owners, whose business knowledge is limited. Economists have coined a term for this type of game with asymmetric information: the principal-agency problem.
How can real players be identified? Understanding motivations and payoffs is often the key. They range from a sense of patriotic duty, to disinterested care for the wellbeing of others, to desire for status, to envy, to hunger for power, to monetary gain. The following penetrating question helps uncover the players’ true identity: “Cui bono?”—“For whose benefit?” The answer can provide meaningful insights into the game at hand.
The Tragedy of the Commons
and the Invisible Hand
The Tragedy of the Commons is an analytical framework in game theory that has justly become famous. It was described by biologist Garrett Hardin from the University of California at Santa Barbara in his article by the same name published in Science. Hardin depicts a situation, particular in its details but applicable to many real-world problems, where individual interest and freedom to choose lead to societal catastrophe. Mayhem, it turns out, can be avoided by restricting the individual choices that affect others. The conclusion is unavoidable but contradicts the widely held belief that “the invisible hand” maximizes the benefits to society. How can this be? The answer lies in the common misunderstanding of Adam Smith’s reasoning—the result of careless reading of his writings, or worse yet, relying on hearsay to form opinions.
Smith’s message is simple. However, the popular conclusion—that unfettered ability to choose is optimal for society regardless of consequences to others—remains an article of faith to many who have never understood the context of Smith’s writings. To appreciate the serious limitations of the “invisible hand” it is important to realize that Smith saw the market as the effective regulator of the use of resources: The assumption is that if I acquire or use something, the price I pay compensates society fairly for the resources consumed to create such good or service. And here is the rub: The “invisible hand,” at best, applies to markets with a robust price system. It turns out that there are instances, many of them crucially important to society, where a price system does not exist, or if it exists it does not work properly. A famous example is the pollution produced by factories. In this case, manufacturers never pay a commensurate price for the environmental destruction they generate. Another example, one that has been studied carefully, is the U.S. health care system, where some of the major determinants of prices are the ability of one party to extract concessions from others and the opportunity to game the system. Furthermore, in many instances, the relation between price and quality is elusive at best, information is imperfect—in some cases really imperfect and asymmetric—competition is far from perfect, and so on. Given the poor track record of the U.S. health care system, it is clear that the “invisible hand,” instead of maximizing societal benefits, has produced an inefficient scheme that benefits certain powerful groups at the expense of the many.
Are there conditions that allow or force better results? In researching the subject (and in the process, winning the 2009 Nobel Prize in economics), professor Elinor Ostrom from Indiana University developed a list of conditions that foster cooperation—but, she concluded, “the dilemma never fully disappears, even in the best operating systems. … Instead of thinking of overcoming or conquering tragedies of the commons, effective governance systems cope better than others.” Students of strategy, applying common sense or mathematical models, have come to the same conclusion from different angles.
Let’s apply these concepts to the U.S. health care system.
About the U.S. Health Care System
What is the problem with the U.S. health care system? Answering this question is important because it specifies the game. Accordingly, it should be expected that players attempt to define it in ways that advance their cause. Let’s explore the real problem first and then the problem that has been presented to the public.
The real problem, stated in objective economic terms, is the following: The U.S. health care system is expensive, inefficient, doesn’t cover a substantial portion of the population, and if left unchecked will continue to deteriorate. How .do we know that? All serious studies on health care economics that compare the United States with other industrialized countries agree with the following:
Cost—The United States devotes much more than any industrialized country to medical care. Here is a snapshot of spending as a percentage of GDP: 7% in 1970, 9% in 1980, 12% in 1990, 13% in 2000, 14% in 2010, 18% in 2016. Unless the system is revamped—not patched—the trend will continue until it reaches unsustainable levels. Is the U.S. health care system wasteful? Yes, for two reasons: The United States pays more and gets less than other countries, and resources that could be used elsewhere are consumed by an inefficient scheme.
Access—By virtue of being the only industrialized country that lacks universal coverage and that conditions access on ability to pay (as opposed to medical need), the United States scores low in this category.
Quality—The United States is in the middle of the pack when it comes to effective care, safe care, coordinated care, and patient-centered care. This outcome—that the United States is not the leader in quality—may surprise many.
Efficiency—The United States is at the bottom when it comes to effective administration, avoidance of emergency room care, and coordinated care.
Mortality and life expectancy—The United States ranks very low in population mortality, infant mortality, and life expectancy.
The point is that the U.S. health care system underperforms by a wide margin in all important macroeconomic indicators despite the resources devoted to it (in 2014, expenditures per capita were $8,508 in the United States compared to $3,405 in the U.K.). But this is not the game presented to Americans. The public has been led to believe that some of these results are unimportant, incorrect, or misleading; that other considerations have been left out; and even that certain proposed solutions like universal health care are not only ineffective but also anti-American and morally flawed. Let’s review and unpack the most important smoke screens that have changed the game successfully:
Whatever the flaws of the American health care system, the “invisible hand” ensures that it is the best the United States can do—This Panglossian argument relies on the quasi-religious status granted to Adam Smith’s “invisible hand” and the lack of understanding of basic macroeconomic principles.
Anti-American solutions will compromise freedom and democratic values. Government intervention is pernicious. A single-payer system and/or universal coverage will not improve the health care system but instead will lead to totalitarianism—This argument ignores the fact that other industrialized countries have never been in danger of becoming communist as a consequence of universal coverage. It also ignores the experience of the United States when Medicare was introduced in 1965—the American Medical Association and future president Ronald Reagan, among others, warned that Medicare would lead to socialism and the destruction of American democracy. Leaving aside concerns about totalitarianism, many people are worried (with reason) about the prospect of a hugely bureaucratic system that may not be responsive to the needs of individuals.
When it comes to selecting providers and health care plans, consumers value freedom of choice, which will be lost if the current system is changed or universal coverage is enacted or a single-payer system is adopted—Oddly enough, the American system places more restrictions on the patient’s ability to select providers than the systems of most industrialized countries, including the U.K. and Canada. As for plans, why would anybody prefer a large number of options that are difficult to understand and require substantial cost-sharing over a simple, comprehensive plan?
Access to care is limited in countries like Canada and the U.K., where people die while waiting for care—Any serious economic study (for example, those conducted by the World Health Organization) contradicts this assertion. Why is it then that Americans think otherwise? The answer is propaganda on two fronts. One is comparing access to care between insured populations, sometimes focusing on elective services. This measure is biased because, on the one hand, elective services have low priority in health care systems that ration care based on medical need as opposed to ability to pay, and on the other, excluding uninsured populations makes the U.S. system appear much better than it is. The second front is anecdotal evidence that may or may not be true but that is statistically irrelevant. As a matter of fact, a study published by the Harvard Gazette reports that in 2009 there were 45,000 deaths in the United States linked to lack of health care coverage.
Health care in the United States is not rationed. Universal coverage or certain types of cost control would result in withholding needed care—These beliefs, although common, are incorrect. Health care in the United States—where access is rationed by ability to pay—is withheld more than in any other industrialized country. Furthermore, U.S. residents are subject to restrictions on certain services, such as hospitalizations, whose length of stay have been reduced dramatically over time.
The best health care in the world can be found in the United States. Changing the system would result in lower quality—Although economic studies rank the quality of U.S. health care in the middle of the pack and life expectancy at the bottom, it is certainly true that the United States leads the world in the use of advanced technologies. The questions to ask are: How broad is access to these innovations? How do the costs/benefits of advanced technologies compare with the costs/benefits of other interventions? The answers to both questions may or may not justify investing disproportionately in advanced technologies, but people should realize that the payoffs of such innovations are usually marginal and associated with end-of-life care at old ages.
The current system is efficient; in particular, administration costs are low—This assertion is a myth, yet a powerful one.
Life expectancy has increased and the United States ranks high in the cure of certain diseases—These are true statements that could distract from the real problem but do not disprove the contention that the U.S. health care system is a poor performer. Life expectancy is greater in most industrialized countries, and whereas the United States does rank high on the treatment of specific diseases such as cervical cancer, it performs poorly overall.
The perceived game can be framed as follows: “The underpinnings of the current system are solid; its shortcomings, primarily cost, can be fixed by fine-tuning competition, preserving doctor and patient freedom of choice, increasing the use of technology, and deepening analytical work, particularly with Big Data and predictive models. Governmental intervention can only have negative effects and, therefore, should be avoided. Universal coverage is not only undesirable but dangerous to the economic and ideological welfare of the country.” Interestingly and not coincidentally, the perceived problem almost suggests its own solution: Let the “invisible hand” take care of business—literally.
The differences between the real problem and the perceived problem are significant. So, who would be interested in preserving a system that has inflicted so much pain on society? To find out, we pose the fundamental question: cui bono?
The list of players deserves close scrutiny:
The public—It has been said repeatedly that insured patients demand immediate access to the best care and that they value freedom of choice and cost control. Even though the United States does not deliver on any of these criteria, the perception is that the systems of other countries are not as good. The fact remains that public opinion could force real improvements, but it doesn’t do so because it is divided, manipulated, and lacks an effective mechanism to impose its will.
Employees and employers—Employers act rationally by shifting costs to employees as health care expenses reduce earnings to levels that are not acceptable to management and owners. In the process, employers display their “negotiating” strength—force, some would say. Employees, with no real power to resist cost shifting, have seen their net pay reduced and are becoming more vulnerable to financial problems that range from manageable inconveniences to financial catastrophes. Employers understand that even with increasing employee contributions, their share of benefits will continue to rise much faster than productivity; such an environment will become unsustainable. For this reason, employers are likely to support mechanisms that limit their financial commitment (not obligation) to provide benefits and, as a byproduct, control health care inflation. This could mean that, indirectly, employers support initiatives to improve quality and efficiency.
Politicians—Decisions in the political machinery respond to personal convictions, concern for the welfare of citizens, eagerness for support to remain in power (typically through monetary contributions), and desire for personal gain. Because money buys influence and money comes from interest groups, it is reasonable to conclude—like the authors of the Federalist Papers did—that when the dust is settled, in the absence of effective counterbalances, private interests rule. The consequence is that an influential sector of the political apparatus will oppose changes that negatively affect the interests of its financial supporters.
Providers/vendors—These are the key players due to their ability, predicated on economic power, to influence public opinion and buy political clout. The list of providers/vendors is long and includes the usual suspects—insurance companies, physicians, hospitals, and drug manufacturers—but also IT vendors, biotech firms, consultants, wellness program firms, and any group that profits from the health care industry. To be sure, certain products and services are highly valuable, priced fairly, and fundamental to the proper functioning of the health care system. But others are not.
Cui bono? Providers/vendors and some politicians who receive contributions from them. This statement requires elaboration: Although anybody who derives pecuniary gains from the health care system is unlikely to support initiatives aimed at eroding his earnings, this fact, by itself, does not mean that such earnings are unreasonable or that social value—and in some cases great value—is not created. One can easily come up with examples of providers/vendors that have made enormous contributions to the well-being of Americans. In a similar vein, some politicians who receive contributions from providers/vendors may honestly believe that the interests of the country are aligned with the interests of contributors, and such an assessment could be correct. Some of these politicians could be so committed to their views that they might pursue them with or without financial assistance.
In principle, then, providers/vendors that create social value are not part of the problem, even though their driving force—like everybody else’s—is profit. They are, in fact, part of the solution. How can things go wrong? Brent James, Intermountain Health Care’s chief quality officer, and Gregory Poulsen, Intermountain Health Care’s senior vice president and chief strategy officer, show how in their article “The Case for Capitation” published in the July-August 2016 issue of the Harvard Business Review. James and Poulsen recount how Intermountain’s LDS Hospital in Salt Lake City reduced the mortality rates of patients with con.gestive heart failure and, in the process, lost $3.2 million a year in revenues. They also describe how obstetricians and neonatologists at Intermountain’s American Fork Hospital reduced the intubation rates of premature babies, thus curtailing the use of intensive care units—and, unfortunately, depressing revenues. The authors bluntly pose the question: “Should care delivery groups invest in quality improvements that reduce costs if it could mean their own financial demise?” Although the politically correct response is that savings somehow benefit everybody, the authors suggest an approach that allows for quality improvements and preserves provider/vendor earnings—and preserving earnings is the key point.
Almost anybody who would be worse off with spending reductions will oppose them. In the U.S. health care system as currently constructed, personal gain trumps the common good. This is the crux of the matter and the reason why the Tragedy of the Commons is such an important model. This is why costs in the United States are out of control and will remain so until the country faces a major crisis that forces the common good ahead of private interests.
Why would a strong player relinquish an advantage? Justice or moral concern for others, perhaps? In his master work, The History of the Peloponnesian War, Thucydides is unmoved by professed good intentions, but he does concede that honest conviction and altruistic behavior do exist—just not in enough measure to oppose successfully what human nature is earnestly bent on doing. In this context, the likely catalysts to change the game are emergencies, tragedies, and social and political crises.
Existing and new players will continue to seek opportunities to grow, making the industry more complex and expensive. Complexity artificially worsens the situation and helps justify spending on patchy solutions to self-inflicted problems that no other industrialized country faces. Patchy solutions generate unintended consequences and an endless cost spiral. Short periods of moderation notwithstanding, medical inflation won’t be controlled and the United States will continue to lag behind other industrialized countries in key macroeconomic indicators. Cost shifting to employees is here to stay.
It is difficult to imagine the political will to tackle the real problem directly. Change forced by a catastrophe is more likely. The catastrophe could be war, epidemics, crop failure, flooding, droughts, depletion of natural resources, pollution, mass migrations, overpopulation, financial meltdown, political crisis—any of a number of conditions with the potential to force society to optimize resources and protect its members. A catastrophe could change the rules of the game and the balance of power. For one thing, in such a situation the public would be likely to loudly, perhaps violently, demand social protection, including health care.
A Beautiful Mind
Many concepts of game theory are derived from common-sense observations about human behavior and framed in theoretical constructs to facilitate their applications. The serious strategist never falls in the two traps that have misled economists: the first, making simplifying assumptions that allow for the mathematical formulation of problems that do not exist in the real world and whose “solutions” belong to the realm of fantasy; the second, attempting to make reality fit an absurd theory. With these caveats, it can be asserted that game theory is a tool that helps understand the game and increases the chances of winning it.
Carlos Fuentes is president of Axiom Actuarial Consulting. His professional interests include strategy, entrepreneurship, and public policy. He can be reached at firstname.lastname@example.org.
 See “Game Theory, Principal-Agent Problem & Arthur Andersen” (https://vivifychangecatalyst.wordpress.com/2015/08/02/game-theory-principal-agent-problem-arthur-andersen/)
 Science 162, pp. 1243-48 (1968)
 For a description of The Tragedy of the Commons see “In Defense of Machiavelli,” Contingencies, Nov/Dec 2009, p. 30.
 There are many cases where price systems exist but individual freedom is pernicious to society: illegal drugs, prostitution, gambling, and more.
 See “Mirror, Mirror on the Wall, 2014 Update: How the US Health Care System Compares Internationally” published by the Commonwealth Fund (http://www.commonwealthfund.org/publications/fund-reports/2014/jun/mirror-mirror), “Ranking 37th—Measuring the Performance of the US Health Care System” published by The New England Journal of Medicine, January 2010 (http://www.nejm.org/doi/full/10.1056/NEJMp0910064), “World Health Organization Assesses the World’s Health Care Systems” published by the World Health Organization, June 2000 (http://www.who.int/whr/2000/media_centre/press_release/en/), “Measuring Overall Health System Performance for 191 Countries” published by the World Health Organization (http://www.who.int/healthinfo/paper30.pdf).
 According to some researchers, 33 percent of the health care cost provides no value to patients.
 http://healthaffairs.org/blog/2015/09/10/medicare-fair-pay-and-the-ama-the-forgotten-history/. Was socialism the real concern or lower incomes for doctors, the result of curtailed billing abuses?
 See “In Defense of Simplicity,” Contingencies, Sep/Oct 2016 (http://www.contingenciesonline.com/contingenciesonline/september_october_2016?pg=14#pg14).
 See “The Truth About Canadian Health Care” (https://www.youtube.com/watch?v=ChHq5DuBCuw).
 “New Study Finds 45,000 Deaths Annually Linked to Lack of Health Coverage” (http://news.harvard.edu/gazette/story/2009/09/new-study-finds-45000-deaths-annually-linked-to-lack-of-health-coverage/).
 See “Costs of Health care Administration in the United States and Canada,” The New England Journal of Medicine, August 2013 (http://www.pnhp.org/publications/nejmadmin.pdf) and “A Comparison of Hospital Administrative Costs in Eight Nations: US Exceeds Others by Far,” The Commonwealth Fund, Sep 2014 (http://www.commonwealthfund.org/publications/in-the-literature/2014/sep/hospital-administrative-costs).
 There are many examples. Take the widespread simplifying assumption of a “representative agent” under which all individuals make the same decisions, or the decisions of a group are the same as the decisions of the representative agent.
 According to Classical Economics, involuntary unemployment does not exist: unemployment can be only frictional (due to the short period of time between jobs) or voluntary (when workers can find jobs but prefer to wait for salaries that meet their expectations). The conclusion defies common sense.