Incentives are a critical concept in economics. In fact economics has been called the science of incentives, or applied psychology. How do you provide incentives to get people to act in ways that result in the optimal outcome? Every regulation and policy decision should be evaluated in terms of who and what it provides incentives for.
Consider the case of health care. The ultimate goal of health care should be to provide the best health to the most people at the least cost correct? And yet it could be argued that in America, at least when compared to other developed nations, we end up with some of the worst health care to the fewest people at the highest cost by far. Clearly something is wrong in our approach and our capitalist economy has not produced anything close to optimal efficiency. In such situations it is important to look at the incentives.
Much of our health care insurance industry is privately owned and managed for profit. This is unique in the developed world. Insurance companies are highly incentivized to sell policies. This is what generates income, but once the money is received where is the incentive to provide health care? Every procedure paid for represents a loss on the books and as a result we find, as expected, that many insurance companies go to great lengths to avoid actually providing care.
On the other side of the coin, insurance companies have attempted to control costs by determining a set of standard prices they will pay for certain procedures. This has effectively turned doctors into piece rate workers who get paid by the procedure they perform rather than for effective treatment. There is rarely any financial incentive to spend a lot of time with a patient, listening to them, and performing research when they could simply perform an additional procedure and get paid.
The result is a “perverse” incentive in our health care system. That means that the result is opposite of what it is intended. In the tug of war between doctors and insurance companies many people receive less care then they require and others receive far more than they need and we end up with poor health at high cost.