Bureaucracy versus Markets in Hospital Care: "The Dutch Case"

In this paper we analyze the bureaucratic negotiation process that is implied by the budgeting system applied in Dutch hospital care. This system is based on centralized price setting while simultaneously allowing for decentralized negotiations on volumes. We apply a variant of the bureaucracy theory, according to which the bureaucratic agency (in our case the joint hospitals) are not allowed to price discriminate, but will receive a flat price per unit of output. We find that central price setting, where the insurer cannot exploit its information on hospital costs, leads to a suboptimal supply of hospital care.