Hoover Daily Report

For-Profit Hospitals Lead to Gains in Productivity

Monday, August 25, 2003

Americans have very different views about for-profit hospitals. Some believe that the financial rewards inherent in for-profit ownership might provide incentives for hospitals to contain costs and respond effectively to patients' needs—for the same reasons that free markets work in the economy at large. Others believe that, because it is difficult for patients and society to evaluate the quality of health care, the opportunity to earn profits might lead hospitals to take advantage of patients or otherwise "cut corners."

These differences in views are at the root of several important policy debates. Should nonprofit and public hospitals be allowed to convert to for-profit status and, if so, with what restrictions? Should nonprofits' exemption from taxes, access to tax-exempt bonds, and ability to solicit tax-deductible charitable contributions be preserved or be limited?

Recent research suggests that for-profit hospitals have created significant productivity gains. To investigate this question, my colleagues and I analyzed data on the medical expenditures, mortality, and rates of cardiac complications of elderly Medicare beneficiaries hospitalized for new heart attacks between 1985 and 1996. We found that geographic areas with for-profit hospitals have approximately 2.4 percent lower levels of hospital expenditures per patient but virtually the same patient health outcomes.

We identified several ways that for-profits keep costs down. Areas with for-profits have both lower labor and lower capital costs. When an area's elderly population declines, for-profit hospitals eliminate unneeded beds quickly, whereas nonprofits eliminate them much more slowly. (Interestingly, public hospitals are almost as responsive to population declines as for-profits.)

These effects are a combination of direct effects of for-profits on their own patients' costs and of spillover effects on neighboring nonprofits' behavior. The bulk of the 2.4 percent savings is achieved when the for-profit presence increases from near zero to only a small fraction of admissions in the area. Direct effects of for-profits on their own patients' costs cannot by themselves account for the savings we observe.

Our study is only one piece of a larger puzzle. We evaluated the effects of ownership on only one facet of health care—productivity. Other studies find that ownership may affect important social and economic outcomes, such as hospitals' propensity to exploit Medicare's complex regulated price system. Also, we examined only one illness and one patient population; the effects may be different in other settings. Finally, our measures of health outcomes—readmission to the hospital and mortality—may fail to capture fully all the health consequences of differences in ownership.

The debate over the effects of for-profit ownership of hospitals must reflect the complexity of hospital care. But with expenditures on hospital care exceeding $350 billion a year, the productivity benefits of free markets and competition deserve careful consideration.