The Private Provision of Public Services: Evidence from Random Assignment in Medicaid

This paper examines the effects of privatizing social health insurance. We exploit a natural experiment in Medicaid, wherein nearly 100,000 enrollees were randomly assigned between a publicly operated fee-for-service system and private managed care. Managed care reduced costs by 5.6 percent via cost-effective substitutions among prescription drugs and via lower prices for outpatient services. We present evidence that pharmacy utilization management was the key mechanism reducing overuse and encouraging substitution to lower-cost drugs without decreasing observed quality. In contrast, privatizing medical benefits led to only modest savings and was associated with decreased health care quality and consumer satisfaction.