Bargaining in the Shadow of a Giant: Medicare's Influence on Private Payment Systems

We analyze Medicare's influence on private payments for physicians' services. Using a large administrative change in payments for surgical procedures relative to other medical services, we find that private payments follow Medicare's lead. On average, a $1 change in Medicare's relative payments results in a $1.30 change in private payments. We find that Medicare similarly moves the level of private payments when it alters fees across the board. Medicare thus strongly influences both relative valuations and aggregate expenditures on physicians' services. We show further that Medicare's price transmission is strongest in markets with large numbers of physicians and low provider consolidation. Transaction and bargaining costs may lead the development of payment systems to suffer from a classic coordination problem. By extension, improvements in Medicare's payment models may have the qualities of public goods.