Is healthy competition healthy? New evidence of the impact of hospital competition

Competition among hospitals is commonly regarded as inefficient due to the medical arms race phenomenon, but most evidence for this hypothesis predates the Medicare prospective payment system and preferred provider legislation. Recent studies indicate hospital competition reduces costs and prices, but nearly all such research has focused on California. We add to the body of literature that analyzes the effects of competition in hospital markets. Using data from the state of Washington, we show that hospitals assume more risk in competitive markets by being more likely to accept prospective payment arrangements with insurers. If the arrangement is retrospective, the hospital is more likely to offer a discount as the number of competing hospitals increases. Both findings indicate that competitive forces operate the same in hospital markets as in most others: as the number of competitors increases, prices decrease and market power shifts from the suppliers to purchasers. The medical arms race hypothesis that favors more concentrated hospital markets no longer appears to be valid.