You don’t come across that slightly touching, naive market fundamentalism quite as often now as you did a few years ago. The financial crisis and its aftermath has increased the circumspection of some market advocates, at least for the moment. One place you do sometimes come across the dogmatic view of markets is among those who live in former state socialist and communist countries. The other would appear to be the Coalition government.

I quite regularly have the opportunity to discuss the relative merits of the state, the market and points in between with citizens from transition and developing economies coping with the legacy of state socialism. While some have a sophisticated understanding of the issues, others could perhaps engage with the complexities a bit more deeply. There is a strand of very simplistic thinking which sees the public sector as fundamentally corrupt and markets as a solution to most of society’s ills. The former view may be born of bitter personal experience, but it is treated as an inherent characteristic. Markets, on the other hand, have almost magical properties.  They are the repository of dynamism, entrepreurialism, efficiency. Markets are reified and deified. The idea of private sector inefficiency, monopoly or villainy doesn’t compute. Even when the post-transition society they live in might reasonably be characterised as a kleptocracy.

So what about the Coalition? A questionably complacent strand of thinking about market mechanisms runs through policy proposals in a number of policy fields. But it has emerged most clearly in the recent discussions of the proposed reforms to the health service.

These reforms can be criticized from several perspectives. First, we might question their very legitimacy. The Coalition agreement states there would be no top-down reorganisation of the health service and the Prime Minister is on record prior to the election as stating that there would be none. Yet, both the Liberal Democrat and Conservative manifesto hinted at significant change. And it was really no more than a hint. Is there a mandate for such far-reaching change? Both critics and apologists can find fragments of text that support their position.

Second, we might criticize the timing of reform – is it wise to attempt this change, which will cost significant amounts of money in the short term, at a time of fiscal restraint? Third, we might criticize the speed with which the agenda is being pursued. Anyone who has any familiarity with even relatively small scale organisational change will know that it has to be handled with considerable care and takes many months of careful planning. There are respectable organisational analysts who would argue that it takes up to a decade for significant change to be successfully implemented and embedded. The Coalition approach of lobbing a ‘hand grenade’ into the heart of the NHS and seeing what happens is, from this perspective, unlikely to end well.

Fourth, we might debate whether it will result in the privatisation of the NHS. The apologists say no. The critics say yes and point to the funding from private health providers that has flowed to the Tories, and the current Health Secretary in particular. Once the NHS is no longer a protected sector and becomes subject to competition law there are no very effective levers for stopping privatisation. And the speed of change suggests that it is big commercial operators who will benefit from restructuring simply because they are more fleet of foot and setting up local not-for-profit alternatives will not happen fast enough (an argument that, in my view, applies to the Big Society agenda more generally, as discussed here). And alongside the question of privatisation is the broader issue of the implications of these reforms for the accountability of health provision. The apologists see them as enhancing local accountability, while the critics point out that GPs, who will drive the service, are private contractors subject to very limited democratic scrutiny.

But there is an equally important critique of these proposals focusing on the logic of the underlying model, which is less than transparent. In Who’s wrong? The Government or the Economists? I argued that many of the reforms the Government is seeking to implement pose a challenge when viewed from an economic perspective: either they are not going to work as the government claims or the microeconomic theory of markets and market failure is wrong. The situation is not unique. In a recent blog at Progressonline, Rachel Reeves reports Larry Summers, director of President Obama’s National Economic Council, as saying in response to a question about the wisdom of Coalition macroeconomic policy: ‘Either it will fail or else everything I know about economics will have turned out to be untrue’. If I’m honest, I have more confidence in the economic analysis.

These points were vividly illustrated by the discussion of the health reform proposals on a recent edition of Newsnight. The starting point for reform – in public at least – is a desire to improve UK health outcomes which are comparatively poor by international standards. This has got to be a laudable objective. The question is how these reforms are going to deliver that objective. The Health Minister at this point reached for the policy buzzword generator and set it to the max. Distilled to its essence the argument was:

patients + local + choice + empowerment + competition + provider diversity = better health outcomes

The longer version was not much more informative. This doesn’t get us much further in answering precisely how the reforms are supposed to deliver the objectives.

Clearly there is some sort of loose idea that patients who are empowered to exercise choice will in some way indicate something about the quality or desirability of what providers are offering – assuming that their choice isn’t significantly constrained by gatekeeping at GP level – and that they are better served by having a range of providers available locally to choose from. Resources will be (re)allocated more efficiently as a consequence of such decisions. So in that sense we are asked to accept that a health care market works in the same way as the market for apples or any other private good.

Which is odd, because just about all the economic textbooks on the topic suggest that there are good reasons for thinking that it doesn’t. And that isn’t something to do with the need for institutional change – for example, an absence of a sufficient variety of providers. It is more to do with the technical nature of ‘health care’ as a good.

For market mechanisms to deliver a socially optimal allocation of resources various conditions need to hold. And if they don’t then there can be a problem. We can summarise the issues in various ways, but one way to think about it is in terms of information, incentives, and institutions.

Consumers need good quality information about both prices and qualities before informed decisions can be made. They also need an understanding of the nature of the goods on offer and the extent to which they are going to satisfy their wants/needs. It is arguable that health consumers are not well placed in respect of any of these key pieces of information. We can argue that league tables of outcomes can be produced to give consumers information. But the problem with that approached – amply demonstrated under Labour in the 2000s – is that it sets up incentives for providers to seek to shape outcomes in order to appear stronger in league tables – eg. by selection of patients and avoiding difficult cases. We could say that health consumers will be able to turn to their GP for guidance on the appropriateness of the providers/procedures on offer. But that sets up an agency relationship and it cannot be assumed that the GP’s objectives when presenting the options are entirely aligned with those of the ultimate consumer. That might particularly be the case if the GP is also responsible for managing the budget that will be funding the procedures.

Services are experience goods. You can’t fully know how good they are until you’ve consumed them. Consumers’ understanding of the quality of service on offer can be improved by regular participation in a market, shopping around and building up a quality distribution of what is available. But in health care that is only possible for certain chronic conditions. It also needs to be understood in relation to irreversibilities and switching costs. If you buy your apples from supermarket X one week and discover they are not as nice as they look, you are out of pocket and you might avoid them in future but nothing too terrible has occurred. If you go to a restaurant and end up with food poisoning the consequences are worse but not (typically) fatal. You’ll avoid it in future. But with health care things are different and rather more serious. Often a course of treatment is a once in a lifetime experience. There is no scope for building up a quality distribution through learning in the market. If a service is poor quality that can have serious and irreversible – indeed literally fatal – consequences. So ideas of switching away from poor quality are rather more problematic.

Indeed, with some experience goods even after you have received the service you are not entirely sure whether you have received quality. You went to the solicitor for advice but still you lost the case. Weak case or bad advice? The same applies to health care. Did you not recover because your case was too severe or your treatment poor? Sure, a pattern of poor outcomes may emerge such that over time resources and patients are switched away from poor quality suppliers. But that is of little consolation to those who have experienced irreversible poor quality treatment in the meantime.

Another way of looking at the conditions of success for market functioning is to focus on the observability and measurability of service outcomes. If outcomes are not observable then it is difficult to assess whether suppliers offering low priced services are genuinely more efficient or are simply degrading quality. This is vital to the economics of health care. There is evidence that earlier experiments in introducing competition to healthcare in UK urban areas delivered improvements in health outcomes. But in the previous phase of competition, under Labour, it was on the basis of fixed price tariffs. So if suppliers were going to compete they had to compete on the basis of genuine efficiency rather than quality reduction. There was no ‘race to the bottom’ on quality. In contrast, the current reforms propose abolishing the fixed price tariffs. That takes us back to the internal market of the 1990s. Evidence from that era suggests that buyers will focus on price and as a consequence quality will decline (see CMPO blog and associated references here). This one simple change to the detail of the rules of the game – the institutional framework within which the market mechanism has to operate – will have massive ramifications.

Even when competition delivers a positive impact for health outcomes it is most closely associated with urban areas. Hospitals and PCTs – and no doubt GP consortia in their turn – are often used as examples of spatial monopolies, particularly in rural areas. It can make no sense to have more than one hospital supplying a sparsely populated area. So the idea of competition in the market is a non-starter.

It is possible to develop arguments that while competition in the market is limited the markets are in fact contestable: the incumbent provider must stay competitive in order to deter new entrants to the market. However, health care is not like your local corner shop. So-called ‘hit and run’ entry and exit are not very plausible, in part because of cost conditions and in part because of reputation effects. One solution to this is franchising or competition for the market (a la rail privatisation), but we’re not quite in that territory yet.

One component of this picture that could benefit from further elaboration is precisely what sort of providers the government is anticipating will exist in this more plural health care system. Markets work to deliver socially optimal outcomes, under certain conditions, because providers and consumers are seeking to optimise profit and welfare respectively. In a mixed economy of providers, where there are some that are public sector, some that are not-for-profit and some that are commercial, it is not so evident that the way providers respond to prices will guide the market to the socially optimal allocation of resources. In fact it can be difficult to predict precisely what will happen. This point was made forcefully during the debates over the quasi-market experiments of the 1990s. It is no less relevant now.

I could go on. But I don’t think it’s necessary. There is plenty of theory, evidence and debate out there to throw into question the Coalition’s simplistic assertions about the benefits of marketising health in the way they are proposing. The case being made in favour of the reforms is rather feeble: it demonstrates either no familiarity with the evidence on the subject or a worrying disregard for that evidence.

That isn’t an argument against markets in general. Of course not. But good quality economic analysis requires much closer attention to the particularities of the case we are considering, It requires a recognition that markets do not have magical properties. They are created and sustained by social action. And the need to be shaped carefully by policy. Someone once said that all the economics necessary for policy advice is contained in Econ101. That is mainly because that is about as much economics as politicians can digest. I have never agreed with this position. The economics contained in Econ101 is generally too simple to capture characteristics of the real world that are crucially important. The current health reform proposals are grounded in an understanding of markets that would not even score very highly in the Econ101 end of term examination. That there is a strong possibility that it will nonetheless drive policy is just deeply dispiriting. Muppets.