Input Constraints and the Efficiency of Entry: Lessons from Cardiac Surgery

by David M. Cutler, Robert S. Huckman & Jonathan T. Kolstad

Overview — Many professions rely on highly and variably skilled individuals. If a new firm is looking to enter a specific market, in addition to setting up a physical facility the company needs to hire or contract with specialized labor. In the short term, the supply of these specialists is relatively inelastic. From the point of view of economics, there remains a well-known potential for free entry to be inefficient when firms make entry decisions without internalizing the costs associated with the business they "steal" from incumbent firms. In 1996 Pennsylvania eliminated its certificate-of-need (CON) policy that had restricted entry by hospitals into expensive clinical programs, such as coronary artery bypass graft (CABG) programs—leading to an increase from 43 to 63 in the number of hospitals providing this service. HBS professor Robert Huckman and coauthors examine the welfare implications of entry in the market for cardiac surgery. Key concepts include:

Following the introduction of new CABG programs in Pennsylvania, volume shifted from incumbent programs to entrants and from lower- to higher-quality surgeons, thereby improving the overall quality of surgical outcomes.
The repeal of CON in Pennsylvania improved the market for cardiac surgery by directing more volume to better doctors and increasing access to treatment.
The benefit of reduced mortality from the increased use of high-quality surgeons roughly offset the fixed costs associated with free entry.

Author Abstract

Prior studies suggest that, with elastically supplied inputs, free entry may lead to an inefficiently high number of firms in equilibrium. Under input scarcity, however, the welfare loss from free entry is reduced. Further, free entry may increase use of high-quality inputs, as oligopolistic firms underuse these inputs when entry is constrained. We assess these predictions by examining how the 1996 repeal of certificate-of-need (CON) legislation in Pennsylvania affected the market for cardiac surgery in the state. We show that entry led to a redistribution of surgeries to higher-quality surgeons and that this entry was approximately welfare neutral. 43 pages.