The U.S. is a place where the big things — health care, infrastructure and asset management to name a few — just cost too much. Price transparency is an underrated tool for bringing down those costs.
In economics classes, we teach something called the law of one price — the cost of the same good or service shouldn’t be much different for different buyers. In some markets, that law holds very well — the differences in the prices different traders pay for a share of Apple Inc. stock at any given time, for example, are tiny.
But in other markets, the law doesn’t hold well at all. For example, until the rise of internet pricing services like TrueCar, auto salesmen could figure out how to get some buyers to pay much more for the same car than others — a technique known in econ as price discrimination. Because car buyers didn’t know what other buyers paid, they had no way to know if they were getting a good deal or not. They could find out only by laboriously shopping around. Now, the price transparency brought by the internet is probably eroding dealers’ gross profit margins, to the benefit of consumers.
A lot of people hope that the magic of price transparency can score even bigger gains in other areas, like health care. When it comes to medical and hospital care, almost no one has any idea how much they’re actually paying — you’re never told prices up front, and most of it is just billed directly to your insurer. That’s a clear incentive for overcharging — we’ve all heard the horror stories of the $1,000 hospital toothbrush.
This problem is pervasive throughout the industry — health-care quality rarely has any measurable relation to cost. The same scan or procedure can cost three to five times as much in one hospital as in another down the street. Money is getting shoveled in with little regard to necessity, which is probably a big reason that the U.S. pays about twice as much as other rich countries for the same quality of care.
Unfortunately, transparency just isn’t working at the consumer level. There have been a flurry of state laws to mandate price disclosure to patients, and a blizzard of new apps and websites that let buyers compare prices. But they aren’t doing it. Study after study says that patients just don’t shop around based on price, like consumers usually do. That might be because services are so expensive that most patients will reach their deductible, and patients don’t believe purchasing cheaper services will lead to lower premiums in the future. Or it might be because of lock-in effects, in which people are loath to ditch their existing providers.
But elsewhere in the industry, transparency seems to have a much bigger effect. For example, a recent study by Matthew Grennan and Ashley Swanson found that when hospitals joined a benchmarking database, which shows what other hospitals paid for a service, they end up paying a lot less for medical devices. This is similar to how internet services help car buyers avoid paying steep prices at dealerships. Unlike health-care customers, businesses such as hospitals and car dealers have every incentive to focus on cutting costs, have good knowledge about quality, and probably have little emotional attachment to a particular seller. Therefore, business-to-business transparency is more effective than transparency at the consumer level.
Where else might price transparency be effective?
One possibility is infrastructure. It costs the U.S. much more than countries in Europe and Japan to build the same train track or road. No one knows why. It’s probably not due to the usual suspects of unionized labor, environmental regulations or land acquisition costs — those constraints are actually more severe in most of the countries where infrastructure is much cheaper. It might be that the U.S. contracting process is just incredibly inefficient. Better price transparency might lead to more competitive bidding for construction contracts. That would benefit the entire nation, which needs an infrastructure upgrade.
Another example is asset management. Americans pay huge percentages of their lifetime wealth in fees to fund managers, despite getting returns that are often no higher than those available in cheap passive index funds. If investors received regular invoices for those fees, they might start to shop around more, and pay greater attention to whether their financial adviser or retirement-plan manager is worth the extra cost.
If the U.S. is going to get out of the low-productivity doldrums, it would certainly help to attack opaque pricing. In this case, sunshine might turn out to be the best medicine.
Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.