Certificate-of-Need Regulation and Entry: Evidence from the Dialysis Industry

Abstract

Certificate-of-need (CON) regulation is widely used in the health care industry.1 The primary alleged purpose of this regulatory tool is to reduce industry costs by preventing unnecessary duplication of facilities.2 While specific CON regulations vary from state to state, virtually all require new firms planning to enter the industry and incumbent firms planning an expansion of productive capacity to submit an application in which the applicant must demonstrate: (1) a market demand (or need) for the incremental output, investment, or new service being proposed, and (2) the inability or unwillingness of existing firms to meet that demand with facilities already in place. Moreover, incumbent firms are offered the opportunity to formally intervene during the CON review process to express their opposition to the proposed entry or expansion plans. Economists have long been skeptical of this form of regulation. At least three fundamental reasons underlie this skepticism. First, private investors are likely to have vastly superior information to that held by regulators on the need for new capacity. These investors are much more familiar with industry conditions than regulators, and they are placing their own money at risk by entering and/or expanding. Second, given the obvious incentive of existing firms to oppose virtually any entry, expansion of capacity, or introduction of new services by competitors and the fact that this policy provides an open forum for such opposition, the likelihood that CON regulation actually serves the interests of consumers by fostering lower industry costs is remote. And third, to the extent that CON regulation is effective in reducing net investment in the industry, the economic effect is to shift the supply curve of the affected service back to the left. Since most medical services are thought to exhibit inelastic demand (due to the general unavailability