Asking the State for Permission to Buy a Hospital Scanner
In many states a healthcare provider must prove to a regulator that new beds, equipment, or facilities are needed before building them. The stated goal is controlling costs, and the reliable effect is protecting whoever is already there.
Permission Before Investment
In most industries a firm that wants to add capacity does so and accepts the risk of being wrong. In healthcare, across a majority of American states, a provider wanting to build a hospital, add beds, open a surgery centre, or purchase major imaging equipment must first obtain a certificate of need from a state agency.
The applicant must demonstrate that the community needs the additional capacity. Existing providers are permitted to participate in the proceeding, and they routinely oppose applications from would be competitors. The process can take many months and cost a great deal in legal and consulting fees before a single dollar of construction occurs.
The Theory Behind It
The rationale rests on a genuine peculiarity of healthcare economics rather than on ordinary protectionism, and it deserves to be presented properly.
Healthcare exhibits supplier induced demand: because physicians both diagnose the need for a service and provide it, capacity can generate its own utilisation. Build more imaging capacity and more images get ordered. Since most of the cost is borne by insurers and public programmes rather than the patient, ordinary price discipline is weak.
Add to that a cost structure dominated by fixed costs. A hospital with an underused wing spreads its overhead across fewer patients and raises the price of everything else. Duplicative capacity in one region can therefore make care more expensive rather than cheaper, which is the opposite of the usual competitive result.
There is a second argument, about cross subsidy. Profitable service lines fund emergency departments, trauma centres, and charity care. A specialty entrant that takes only the profitable procedures, described as cream skimming, weakens the institution carrying the unprofitable obligations.
The Origin Explains the Geography
These laws spread not through independent state judgement but through a federal statute in 1974 conditioning certain funding on states adopting review programmes. Nearly every state complied.
The federal mandate was repealed in 1987, after evaluations failed to demonstrate the intended cost control. Roughly a dozen states subsequently eliminated their programmes. Most did not, and the ones that kept them have generally retained them for decades since, which is itself evidence about who benefits.
| Claim | What the Evidence Generally Shows |
|---|---|
| Reduces total healthcare spending | Little consistent support |
| Reduces bed and equipment supply | Consistently supported |
| Improves quality through volume concentration | Mixed, plausible for complex procedures |
| Protects rural and safety net facilities | Contested, some support |
| Raises prices in concentrated markets | Supported in several studies |
Why the Cost Control Argument Underperformed
The mechanism assumed that limiting capacity limits spending. In practice providers respond to a capacity constraint the same way any constrained firm does: by using existing capacity more intensively and by raising price where competition is limited.
Restricting supply in a market where demand is largely insured and price is negotiated rather than posted tends to raise the negotiated price. Several studies examining states that repealed their programmes against those that retained them have found higher costs or comparable costs in retention states, which is not what the policy predicted.
A rule requiring a firm to prove that a market needs another competitor, decided in a proceeding where the existing competitors get to argue against it, will produce fewer competitors. Whether it produces lower costs is a separate question, and the evidence there is far weaker.
The Incumbent Advantage Is Structural
The feature critics focus on is procedural rather than substantive. Existing providers have standing to oppose applications, resources to litigate them, and relationships with the reviewing body built over years. A new entrant has none of these and must fund the process before earning any revenue.
Even where an application eventually succeeds, delay has value to the incumbent. Two years of proceedings is two years of protected market position, and the cost of imposing that delay is far lower than the cost of absorbing the competition.
Antitrust authorities have made this argument formally, with federal competition agencies repeatedly submitting comments to state legislatures recommending repeal on the grounds that the programmes restrict competition without delivering the promised savings.
Where the Defence Still Holds
The strongest remaining case concerns rural hospitals. A small rural facility often survives on a narrow set of profitable services, and losing them to a nearby specialty entrant can close the hospital entirely, leaving the community without emergency care at any distance.
That is a real problem, and it is not obvious that unrestricted entry serves the population better. The reasonable criticism is not that the concern is fake but that a broad capital review programme covering entire states is a crude instrument for it, and that targeted rural support would address the problem without protecting large urban systems from competition.
Several states have moved in this direction, narrowing review to specific service categories or exempting rural facilities and physician owned practices, rather than repealing outright.
The Bottom Line
Certificate of need is a policy adopted nationally under federal pressure, abandoned federally when it did not work, and retained by most states regardless. The economic rationale rests on real features of healthcare markets, and the observed effect is a reduction in supply and a durable advantage for incumbents. It is one of the clearest available examples of a regulation whose original justification has weakened considerably while its constituency has not.