In the U.S., private equity firms have lately been investing heavily in the healthcare sector—from physician groups to hospitals to disease management programs—seeking to capitalize on this lucrative industry. However, this trend has drawn criticism over the potential impact on patient access to healthcare as well as the quality of services. Despite his generally favorable perspective on free markets, the founding father of modern economics, Adam Smith, would disapprove of some of the private equity forays into healthcare, especially those that involve rent-seeking behavior and pose a risk to public health.
Private equity deals in the healthcare industry have increased by 200% in the past decade. And in certain areas growth has been exponential. An example is investment in nursing homes, which has risen from $5 billion in 2000 to more than $100 billion today.
According to an article published last month in The Atlantic, once investors take over a nursing home business conglomerate they often improve profit margins by cutting back on staffing while relying heavily on the use of sedating medicines and psychotropic drugs for nursing home residents. A National Bureau of Economic Research paper concluded that subpar care led to 22,500 premature nursing home deaths from 2005 to 2017. Notably, this was before the Covid-19 pandemic hit. It stands to reason that the situation worsened during the Covid crisis which decimated many nursing homes.
The NBER study suggests that the increase in mortality can be explained by declines in multiple measures of patient well-being, nurse understaffing and lack of compliance with care standards set at the state and federal levels.
What would one of the towering figures in the history of economic thought, Adam Smith, say about private equity’s increasing stake in nursing homes, or public health more broadly?
The name Adam Smith conjures up notions of what a free market looks like and how price signals in such a market can help allocate resources to their most productive uses.
But while Smith certainly believed in the virtues of the private market, he also recognized its limitations, particularly around public goods which can be characterized as items conferring collective benefits which the private sector cannot or will not supply as comprehensively. In this regard, he was troubled by rent-seeking behavior in which individuals increase their own wealth without creating benefits to society.
Smith was well aware that the market can’t solve everything, and may be detrimental in some instances to human wellbeing. There are things that the “invisible hand” of market forces can’t bring about properly.
Besides the enforcement of property rights, contracts, patents and copyrights, he envisioned government’s roles in society to be limited and well-defined: It should provide national defense, the administration of justice, and public goods such as education, elements of infrastructure which Smith termed “public works” and poverty relief.
According to Smith, public goods serve a societal function which in turn benefits the economy as a whole. For instance, he foresaw the importance of investing in what we now call “human capital” through education.
Smith did not explicitly identify healthcare as a sector requiring government intervention. This was mostly because healthcare in the 18th century was fundamentally different than it is today. There wasn’t nearly as much of a circumscribed role for healthcare and its institutions, partly due to the fact that there was a very limited set of tools available to healthcare practitioners.
Yet Smith offered insights on the importance of having a healthy population, suggesting first that the absence of good health in laborers (in agriculture, commerce and the nascent manufacturing industries) would be detrimental to society. After all, a healthier workforce is more productive. In Wealth of Nations, Smith hinted that preventive healthcare is an area where government ought to intervene, drawing a parallel with education. He stated that education deserved “the most serious attention of government, in the same way as it would deserve its most serious attention to prevent leprosy or any other loathsome and offensive disease.”
Here, Smith didn’t confine the significance of a healthy population merely to aspects of labor productivity. Though communicability of certain diseases like smallpox wasn’t well understood, Smith knew that the fewer individuals are infected with a contagion, the less likely it is that a (currently healthy) person gets infected. This pertained to laborers and the non-productive population alike.
Moreover, integral to poverty relief was Smith’s view that the indigent’s lack of means to purchase basic necessities, including healthcare, led to poor health. He outlined the connection between poverty and general health: Children of “the common people” had higher mortality rates because of the inability to “afford to tend them with the same care as those of a better station.”
If Smith was around today, he wouldn’t prohibit private equity from entering the realm of healthcare. But where the risk to public health outweighs the pecuniary interests of investors and business owners, he would call for regulations and government intervention.
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