Compensating Differentials

“Compensating differentials are the observed wage differentials required to equalize the total monetary and nonmonetary advantages or disadvantages among work activities and among workers themselves,” says Sherwin Rosen, a modern labor economist, in “The Theory of Equalizing Differences,” The Handbook of Labor Economics (Rosen, 1986).

The principle of compensating differentials, as noted, is based on an economics paradigm holding that this formulation is based on market clearing, in which the problem of wage differentials involves heterogeneous workers and jobs. “This is in contrast to the standard market paradigm, where the identities of the traders is immaterial to final outcomes and indeed is the ultimate source of efficiency of a decentralized competitive market system, with whom and for whom one works is generally of considerable importance for achieving efficient labor allocations” (Rosen, 1986).

Medical economics differs from the policies of a competitive market system. The medical system is not a freemarket system and is not based on a free-market economy. There is no remaining method in the U.S. health care economy that is based on supply and demand.

In the past, fees and choice of location of care were determined by the interaction between the patient and the physician. Today, compensating differentials in the economics of the current medical system are skewed by the dominant third-party payer system in the United States. From the Medicare program, with its establishment in [Page 89]1965; to the Medicaid or Welfare system, in the mid-1960s; to the fee-for-service model, which most closely represented a free-market system (prior to third-party coverage); to “usual and customary” reimbursement; to capitation models; to prospective payment; to DRGs (diagnosisrelated groups) and APGs (ambulatory patient groups), the health care economic picture has moved totally away from any system that is recognized as free market, whereby workers receive payment from employers based on economic principles of efficiency in a decentralized competitive market system.

All the reimbursement forms just listed interfere with the compensating differentials as discussed in economic models. Regardless of whether provided by individuals or by organizations, health care reimbursement has moved away from the transactions that mirror supply and demand. The concept of a competitive market system where price fluctuates freely, adjusted spontaneously and in consideration of other factors (such as quality of service, timeliness of service, type of services, and location, in addition to cost) is no longer present in health care management. Health care has lost a driver. Attempts to relocate one have fallen short even after limiting services, attempting gatekeeper models, measuring, and valuing “quality issues” or outcomes.

Health care reimbursement companies, as third-party payers, do not employ physicians to provide health care, unless in the staff model scenario, which is dying across the country. The agreement between the physician providers and the third-party payer relates to accepted reimbursement as a set amount (usually set unilaterally by the payer). This amount is lower than charges and is expected to compensate for services provided to members. However, the negotiated amount may still be denied by the third-party payer. Consistent with economics, if there is an oligopoly in the third-party payer arena, the compensation for the health care entity or the provider is limited by the lack of competition between payers. In the current health care environment, this fact allows the payer to dictate reimbursement without effective recourse. There is no avenue for the end organ, as the recipient of care, to seek other alternatives. The recipient in the health care marketplace is forced to accept the care as dictated by the insurance plan, contracted to control provider (hospital and physician) costs. The “choice” claims that can be heard in the setting of an insurance oligopoly remain under the umbrella of unilaterally controlled, nonnegotiable compensation; the choice is in the level of copayment for which the member or patient will be responsible.

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