On the world stage, U.S. health care is a topic of almost humorous discussion: an American attempt at free market ideals failed — miserably. As a citizen, it is merely depressing. In this immensely wealthy nation, 15% of the population goes without basic health coverage; private sector spending is enormous while government spending is disproportionately daunting. A brief Wikipedia skim will give you a sense of the problem.

The United States has established a fairly privatized health care system in contrast to many other industrialized countries. In the U.K., basic health care is free for all residents (NHS). In the U.S., coverage is only provided for to the elderly and the disabled with Medicare and Medicaid, respectively, while spending much more per capita than Britain spends in their public and private sectors combined. In fact, U.S. government health care spending is the highest in the world. Why has the ever-efficient market system failed? There are a number of reasons we can choose from:

(1) The first, and primary, is a matter of inside information. When purchasing health insurance, the consumer knows more about their likelihood and frequency of coverage use than does the insurance company. This failure can be explained by George Akerlof’s work on asymmetric information, commonly explained in the market of used cars:

Let’s say you want to sell your car. Your potential buyer has no idea if your car is the remarkable feat of engineering you say it is, or if it’s a pile of junk with a nice paint job. And worse yet, you have no way to prove it to them. Because of this risk, the buyer is only able to offer you a diminished amount, below what the car is actually worth. Since you know the true value, you’re not going to part with it for anything less. In the end, you decide to keep your car because no one will pay you what it is worth. The market for your nice car doesn’t exist. The market for health insurance, however, is not as easily avoided. This is because the risk of being caught without is so great.

(2) The current system also slows the job market. Almost 60% of Americans are insured through group coverage with their employer. This causes workers to hesitate when leaving their job, reducing sensitivity to wage and other working conditions. Conversely, employers subsidize health care expenses, increasing their cost structure.

(3) Finally, incentives are out of place. It is in the employer’s best interest to choose a single company with a set of insurance policies that will work for the majority of their employees and cost the company the least. The insurance policy has every incentive to deny coverage or pay the absolute least for the health care provided. Doctors compete for contracts with insurance companies rather than for patients and their recommendations.

Although the universal health care systems enacted by many other industrialized nations (Canada, Britain, France) has proved to be substantially less costly while providing similar adequate coverage, major problems still exist. Wait times at government provided facilities are, on average, much longer than in the U.S. and incentives are still not appropriate.

How can we fix U.S. health care?

Tim Harford explores a simple and obvious (in retrospect) idea in Undercover Economist. Rather than eliminating the market entirely (like many of our industrialized counterparts), simply alter it by focusing on deterring Akerlof’s dilemma of asymmetry and aligning incentives. When insurance companies or the government provides health care, these parties take over interest in making decisions for the patient, which is less efficient. The reformed system would allow a patient to pay for most of the costs and only leaving the most severe costs to government or insurance—however which we want to handle it (I prefer the latter). The self-interest provides an incentive to make the most efficient choice by researching practitioners and care methods.

The proposed system would require a compulsory savings account — this could be subsidized by a tax cut of around $1,500 (roughly the current tax allocation to health care). The savings is invested similarly to a retirement savings to grow over a lifetime. Because most health needs come about in later life, this savings account has time to grow. Leave it up to the individual to make their consumption decisions, as the free decision to consume best maximizes the individual’s utility.

To cover the unfathomable, loss-of-limb type of accidents, catastrophe insurance will be available fairly cheap because of the reduction of inside information. Private companies would find it profitable to sell this type of insurance because their customers sincerely hope they will never have the opportunity to use it — much like home owners insurance, etc.

This system has proven successful over the past twenty years in Singapore. Comparing per capita costs and benefits in Singapore and the U.S. will give us a sense of the urgency to reform.

Source: UC Atlas of Global Inequality 2000

U.S. spending is outrageous, even if you argue that the discrepancies in death rates and life expectancies are a result of our nasty health habits. The figure is still seemingly disproportionate.

Why have we not reformed?

Nikolai Skievaski is a graduate student in Boston University’s Department of Economics and co-authors the Econ by the Pool blog.