The Perverse Consequences of Government Intervention
Milton Friedman spent a lifetime pursuing a simple puzzle: why do government institutions, launched with soaring promises, so often drift into producing their opposites? Nowhere is this paradox more vivid than in American healthcare. From licensing boards designed to protect patients, to insurance rules intended to expand coverage, to Medicare’s sprawling bureaucracy, the structures themselves often create scarcity, inflate costs, and erode the autonomy they claim to defend. The irony — that an intervention meant to heal the system can make it sicker — was a theme Friedman returned to repeatedly.
In his 1978 lecture The Economics of Medical Care delivered at Mayo Clinic, he emphasized that “when the consumer of a service is not the payer, the incentive to economize disappears.” Separating the person paying for care from the person receiving it creates distortions that no regulation alone can correct. Third-party payment, in this framework, isn’t simply a convenience; it fundamentally changes behavior in ways that consistently raise costs and reduce efficiency.
This perverse effect can be seen across modern healthcare. Policies designed to increase access often increase bureaucracy and administrative cost. Measures intended to protect patients can reduce choice. In Friedman’s words, the structure of incentives matters more than intention, and misaligned incentives will produce predictable, sometimes counterintuitive, consequences.
Actuarial Roots and the Formation of Friedman’s Thinking
Friedman’s early life shaped his perspective on risk and incentives. Graduating from Rutgers in 1932, during the depths of the Great Depression, he originally planned to become an actuary, passing several exams before committing fully to economics. Studying risk and probability gave him a lifelong appreciation for how incentives and structures shape outcomes, particularly in complex systems like insurance and healthcare.
He drew a distinction between true insurance—protection against catastrophic events—and modern health coverage, which bundles everyday consumption with catastrophic care. This distinction, he noted, is critical to understanding why costs escalate in third-party payment systems. As he remarked in his lecture, “Price systems work because people directly bear the cost of their choices; when someone else pays, the system loses its feedback.”
This actuarial lens also informed his critique of licensing, regulation, and administrative expansion. He saw healthcare not as a natural scarcity but as a system where rules, payment structures, and bureaucracies shape supply and demand. Friedman’s early training instilled a mathematical and incentive-based approach that he applied repeatedly to the inefficiencies and misaligned incentives of the healthcare sector.
CMS as a Price-Setter
Friedman repeatedly warned that government price-setting, even with good intentions, distorts markets. CMS is the clearest example. Medicare reimbursement rates set the benchmark for nearly all commercial negotiations, while DRG and CPT codes effectively dictate hospital strategy. Innovation flows not toward improving patient outcomes but toward what is reimbursable, creating a system in which policy goals—lower costs and broader access—often produce the opposite effect.
Hospitals respond to these incentives rather than patient needs. As Friedman observed in his lecture, “It is not the number of hospitals or doctors that controls cost—it is who pays and who sets the price.” In this sense, CMS is less a payer than a market architect, and the structure of the system channels behavior in ways that can undermine efficiency, accessibility, and quality.
The result is a paradox familiar to Friedman: well-intentioned policy often entrenches the very problems it seeks to solve. CMS rules, combined with reimbursement formulas and administrative complexity, have created a system that rewards compliance over innovation, coding over care, and bureaucracy over outcomes. This is exactly the type of predictable misalignment Friedman identified decades ago.
Private Insurance: A Market Without Consumers
Private insurance, Friedman argued, amplifies the distortions created by CMS. Because patients rarely see prices, they cannot exert market discipline, and because most coverage is purchased by employers rather than individuals, the real “consumer” is often disconnected from the system. Insurers, in turn, optimize for utilization control rather than improving health outcomes, and complexity becomes a business strategy rather than a byproduct.
Friedman’s lecture emphasized, “Nobody spends somebody else’s money as carefully as he spends his own.” In healthcare, this separation of payment from consumption creates what he called a pseudo-market: an environment where the illusion of competition masks inefficiency and misaligned incentives. Administrative bloat and opaque pricing are not incidental—they are the logical outcome of a system in which the patient’s choices carry little financial weight.
The broader consequence is the erosion of economic agency for patients. When consumers cannot see or respond to the true cost of services, the mechanisms of supply and demand fail to regulate behavior. Friedman saw this as a structural problem: the architecture of payment shapes outcomes more than individual intentions, and misalignment inevitably leads to higher costs and reduced access.
Economic Consequences of Licensing to Practice Medicine
Friedman noted that regulation and licensing, intended to protect patients, often restrict competition and inadvertently raise costs. In his lecture, he observed, “Licences don’t simply certify competence; they restrict competition. And restricted competition means higher cost and fewer choices.” The middle class bears the brunt of this dynamic: premiums rise faster than wages, high deductibles shift routine costs back onto patients, and narrow networks and prior authorization requirements limit access.
This regulatory structure produces a two-tier system. Concierge medicine expands for the wealthy, while middle-class patients navigate a maze of paperwork, delays, and restrictions. Friedman framed these outcomes not as moral failures, but as the mechanical consequences of misaligned incentives and third-party payment structures.
Combined with the pseudo-market created by private insurance, this dynamic ensures that the middle class pays more while losing control over their healthcare decisions. Friedman would argue that the predictable outcome is higher costs, reduced choice, and concentration of power in institutional hands rather than in the hands of patients.
The Bureaucratic Ratchet
Friedman’s “bureaucratic ratchet” concept describes how rules multiply over time, often independently of their original purpose. In healthcare, every new CMS reporting requirement leads hospitals to hire compliance staff, every insurer prior-authorization step requires new administrative roles, and regulators respond by adding more documentation requirements. Electronic health record systems expand to accommodate the paperwork rather than patient outcomes.
Friedman observed, “Administrative rules become the goal rather than the means.” The ratchet effect compounds inefficiency and drives costs upward without improving care, illustrating his broader point about the predictable perverse consequences of institutional incentives.
This accumulation of bureaucracy is not a moral failing; it is a structural inevitability when incentives are misaligned. The healthcare system becomes a maze where patients and clinicians must navigate increasingly complex administrative hurdles, with little impact on actual quality or accessibility.
Friedman-Inspired Reforms
Friedman’s solution was not abolition of CMS or private insurance, but restoring economic discipline. He advocated for true price transparency before care, catastrophic insurance instead of first-dollar coverage, CMS using market signals rather than internal coding to guide reimbursement, expanded scope-of-practice to increase competition, and incentives aligned to improve outcomes rather than paperwork. Above all, he emphasized giving patients meaningful control over their healthcare dollars.
Restoring these pillars of functional economics would realign incentives and reduce the predictable distortions Friedman identified. By connecting payment with consumption and competition with transparency, the system could better deliver both efficiency and access without expanding bureaucracy.
American healthcare in 2025 exemplifies Friedman’s enduring insight: when those paying for care are not the ones receiving it, costs rise, institutions accumulate power, and patients lose. From CMS to private insurers, from licensing boards to middle-class households, the system produces exactly the opposite of what policymakers intended. Friedman’s lecture reminds us that these outcomes are not accidental—they are built into an incentive structure that is in dire need of change.