How Medical Licensing Drives Up Health Care Prices

The role of licensing in driving up health care costs has been almost completely ignored. The apparent explanation is that nobody can imagine that there is any alternative.

By Brink Lindsey and Steven M. Teles.

"What to do about spiraling healthcare expenditures has been a central topic in the national policy debate for decades now. Furthermore, it is common knowledge among experts that America’s record-setting level of spending—now exceeding 17 percent of GDP—reflects not only higher utilization of services than elsewhere but also significantly higher prices for those services. In particular, it is widely known that doctors in the United States earn much more than their counterparts in other countries. Given that doctors are the second largest occupational category in the top 1 percent of income, their outsized pay is a big part of the story of American inequality.

Yet despite all this, the role of licensing in driving up healthcare costs has been almost completely ignored. The apparent explanation is that nobody can imagine that there is any alternative. The obvious complexity of modern medicine, the obvious need for extensive training to master that complexity, and the obvious harms that can be inflicted by incompetent physicians all lead to the seemingly obvious conclusion that state screening of physicians is inescapably necessary. In fact, even critics of the expansion of licensing into areas like cosmetology and interior decorating are usually careful to point out that doctors should, obviously, be licensed.

This point of view was encapsulated in an exchange between Justices Stephen Breyer and Antonin Scalia in a 2015 Supreme Court case that addressed the composition of state licensing boards for dentists. During oral argument Breyer observed, “I would like brain surgeons to decide [who can perform brain surgery in this state].” Scalia, no stranger to dissent, found nothing to disagree with. “I want a neurologist to decide,” he added.

A strong status quo bias is understandable here: after all, state licensing of doctors has been around for more than a century. But when looking at the situation with fresh eyes, it is striking how little in the way of genuine consumer protection the current licensing system provides. Indeed, there are good arguments that existing policies actually reduce the overall quality of American healthcare.

Let’s start with the fact that Justices Breyer and Scalia were incorrect in thinking that state licensing decides who can perform brain surgery. A medical license entitles its holder to practice medicine generally; no specialties are licensed by the state. Complete an approved residency program in the United States in podiatry, pass the state medical examination, and you are legally authorized to do brain surgery, heart transplants, or any other procedure you wish. Given how specialized medicine is these days, a state medical license is therefore not a reliable indicator of relevant competence in a wide range of critical, life-or-death situations.

Furthermore, medical licensing’s stringent requirements are imposed only on those entering the profession. Since a career can span many decades, during which time best practices frequently change in dramatic fashion, here again the mere possession of a license offers little assurance that large numbers of practicing doctors are actually competent. Yes, licensing boards do have the power to suspend or revoke licenses as well as issue fines and reprimands, but the actual discipline imposed by such boards is notoriously lax. Of doctors who made at least 10 separate malpractice payments between 1990 and 2005, only one-third received any kind of discipline from their state medical boards. When sanctions are imposed, they are usually for illegally prescribing drugs, or substance abuse, or inappropriate behavior with patients—not simple incompetence.

Virtually all the real quality screening that does occur is performed by the private sector. Private specialty boards certify competence in particular practice areas. Practice groups and health maintenance organizations decide which physicians to hire, while hospitals decide which physicians will be granted admitting and surgical privileges. These decisions about employment and affiliations are made with a view toward burnishing and safeguarding reputation and minimizing exposure to liability.

In particular, the looming threat of malpractice liability—and the consequent need to acquire insurance—creates strong incentives for greater quality. Insurance premiums are heavily “experience-rated”—that is, they go up sharply for physicians that have to pay claims. Malpractice insurers offer discounts for participation in risk management programs; they impose surcharges for things like failed board examinations and failure to obtain hospital privileges; they can even restrict a physician’s practice or require supervision or more training.

Despite claims from conservatives and the medical profession that the system is out of control, there is good evidence that malpractice awards are in line with actual damages— and little evidence that a so-called “liability crisis” is driving doctors out of practice or forcing them into wasteful defensive medicine. All told, normal commercial motives for providing good service, backstopped by the courts and malpractice insurers, do much more to protect the public from bad doctors than anything accomplished by state medical boards.

Indeed, there is a strong case to be made that state licensing actually reduces the overall quality of healthcare. A fascinating study of Soviet physicians who immigrated to Israel, some of whom were required to take an exam to get a medical license while others were exempted, showed that the exam requirement actually resulted in “negative selection” or a reduction in physician quality. Here’s the basic logic: in the face of an onerous entry barrier, the strongest performers with the most attractive career alternatives options are more likely to be deterred from entering the profession.

In addition, licensing can reduce the quality of healthcare provision by constricting the supply of doctors, raising their fees, and thereby inducing people not to go to the doctor. Instead they rely on self-help or seek out some non-mainstream but more affordable alternative. By reducing the number of qualified physicians and thereby boosting the market share of homeopaths, nutritional supplement hawkers, crystal therapists, and other assorted quacks, licensing pushes the overall quality of healthcare downward.

Medical licensing may not serve the interests of patients well, but it does wonders for physicians’ incomes. A 2008 study compared the salaries of American doctors to those of their counterparts in Australia, Canada, France, Germany, and the United Kingdom. Pre-tax earnings for US primary care physicians averaged $186,600 (in 2008 dollars)—or 54 percent higher than the average of $121,200 for the other five countries. At the top of the pay scale, American orthopedic surgeons averaged $442,500—more than double the $215,500 average for the benchmark countries. Doctors overall are extremely well represented among the top 1 percent of owners: 21.5 percent are members of the club.

Most analysis of American doctors’ lavish pay focuses on the demand side: in particular, heavy reliance on third-party payment (whether by private insurers or the government through Medicare and Medicaid) that renders the actual consumers of healthcare (patients) indifferent to costs at the point of sale, as well as the continued dominance of a “fee for service” payment model that effectively rewards doctors for inefficiency. But supply-side factors play an important role as well. First of all, the rigorous training and examination requirements imposed by state licensing act directly to impede entry into the medical profession. Furthermore, these entry barriers are buttressed by limits on who can provide the necessary training.

Under state licensing laws, the American Medical Association is vested with the authority to provide accreditation for US medical schools, and accreditation is limited to a particular class size. Thus the medical profession controls how many newly minted MDs are produced in the country every year. From 1980 till around 2005 the number of medical school slots was frozen at around 16,000 first-year students, but since then expansion has brought the number above 20,000. Although graduation from a US medical school is not required to obtain a medical license, completion of a US residency program is—in contrast to other advanced countries, which regularly license foreign-born physicians who did their training abroad. The US residency requirement, combined with highly restrictive policies on high-skilled immigration, makes AMA power over medical school accreditation a powerful lever to control supply. Meanwhile, by historical accident the vast bulk of funding for residency slots is provided by Medicare, and for cost-saving reasons the number of slots has been frozen since 1997.

The final layer of supply control consists of laws against the unauthorized practice of medicine. Here physicians have lost some ground in recent decades as midlevel healthcare professionals—physician assistants, nurse practitioners, and midwives—have won the right to perform many functions previously reserved for MDs. The liberalization remains patchy, however: currently just 21 states and the District of Columbia allow nurse practitioners to diagnose and treat patients and prescribe medication without a physician’s supervision. Meanwhile, efforts are underway to boost education requirements for midlevel professionals, so entry into these fields may be more restricted in the future. Despite its limits, an expanded role for midlevel professionals can make a real difference. According to a study by Morris Kleiner and others, restrictions on the ability of nurse practitioners to prescribe medicine translate into an increase in doctors’ earnings of up to 7 percent.

This multilevel system of restricting the supply of doctors is irrelevant to ensuring that highly complicated medical care is provided only by extensively trained professionals. It does ensure, however, that many relatively routine tasks not requiring such training are nonetheless reserved for members of the medical cartel. As a result, consumers are forced to pay extra with no real benefit.

For far too long, efforts to reform the US healthcare system have focused overwhelmingly on the demand side—in particular, the financing of healthcare consumption through private or social insurance. A major reason that effective reform has proved so difficult is that America’s aberrantly high prices for healthcare mean that all proposed changes in financing arrangements have a sticker shock problem. Progressive efforts to expand social insurance, whether the Affordable Care Act’s Medicaid expansion or proposals for Medicare for All, run headlong into the exorbitant costs of expanding access. Likewise, conservative efforts to move to high-deductible policies and large health savings accounts, so that price-conscious consumers spending their own money exert market discipline on healthcare providers, threaten to sock many Americans with much-higher out-of-pocket costs because prices are so high.

It’s time, then, for healthcare reformers to focus on the supply side—i.e., factors that are driving up prices by artificially restricting the number of doctors, nurses, hospitals, etc. Medical licensing, and especially the extensive scope of the “practice of medicine” reserved for licensed MDs, is an excellent place to start.

Brink Lindsey (@lindsey_brink) is vice president and director of the Open Society Project at the Niskanen Center. Steven M. Teles is associate professor of political science at Johns Hopkins University and a senior fellow at the Niskanen Center. This piece is adapted from their new book “The Captured Economy: How the Powerful Enrich Themselves, Slow Down Growth, and Increase Inequality” (Oxford University Press)."