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| How Financial Innovation Enhances Social Harmony: Evidence from Medical Disputes in China |
| DUAN Baige, WANG Yongqin, XIA Mengjia
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School of Economics, Fudan University;
Department of Economics, University of Pennsylvania |
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Abstract Social conflicts (such as physician-patient disputes, labor disputes, and debt disputes) can undermine effective social development. Economic theory suggests that incomplete contracts are an important source of social conflict, and the conflicts themselves can be regarded as unhedged financial risks (incomplete markets). Policy-wise, financial innovation (like insurance) can complete a market, resolve conflict, enhance social harmony, and achieve Pareto improvement. However, no “smoking gun” evidence for this important theoretical idea has been offered, due to the lack of sufficient policy counterfactuals.
In this study, we regard social conflict such as disputes as a risk state and leverage the unique and appropriate quasi-natural experiment of the gradual implementation of compulsory medical liability insurance in China. We draw on the provincial medical damage liability dispute data published by both “China Judgements Online” and the “Magic Weapon of Peking University” (beida fabao) from 2011 to 2019. We apply a multi-period difference-in-differences (DID) method to identify the causal effects and mechanism of liability insurance on physician-patient disputes, to test how financial innovation such as insurance can resolve social conflicts by enhancing social trust. This helps to make contracts and markets more complete, improve efficiency, and promote social harmony. The empirical results show that the average number of medical disputes per 10,000 inpatients, as obtained from the two databases, decreases significantly by at least 0.290 and 0.207, respectively. We test the heterogeneous treatment effects and the parallel trend based on heterogeneity robust estimators to ensure the validity and robustness of our DID identification strategy.
We further identify how compulsory medical liability insurance can achieve Pareto improvement. First, it significantly reduces instances of medical disputes and completes the contract by enhancing trust between physicians and patients, due to a more complete market. The average number of hospitalization days for public hospitals in the treatment provinces increases by at least 0.297. Second, this insurance reduces per capita medical expenses by reducing the level of defensive medicine. The per capita medical expenses of public hospitals in the treatment provinces decrease by at least 322.062, thus improving treatment efficiency. Third, this compulsory insurance also makes the insurance markets more complete and encourages insurers to take on a more effective supervisory role in reducing information asymmetry (adverse selection and moral hazard). The loss ratios of medical liability insurance businesses in the treatment provinces decrease by at least 0.343. Therefore, Pareto improvement is achieved, which benefits all parties.
Our study has important policy implications. First, we show that financial innovation such as liability insurance is an efficient tool for solving social conflicts, promoting social harmony, and maintaining long-term social stability. This reveals how financial innovation can be practically used to solve incomplete market problems caused by incomplete contracts. Second, we also demonstrate that insurance can enhance social trust, which can complete the contract and thus increase the efficiency of socioeconomic activities. Therefore, financial innovation (such as insurance innovation) can solve the problem of incomplete contracts. This extends beyond the medical market, and our methods and analysis framework can be applied to other markets, such as those for other credence goods and those in which contracts are highly incomplete, such as education, labor, and financial markets. Third, unhedged risks are a major constraint to economic development and social progress. Incomplete markets are essentially an indication that the space spanned by financial contracts is not full. To address the incomplete market problem, identifying the relevant missing markets and then creating the relevant financial contracts (such as Arrow securities) to complete the markets is necessary. However, the decentralized system may not spontaneously generate corresponding financial contracts, and appropriate government interventions are often necessary. Therefore, efficient markets and effective government often go hand in hand, which illustrates China's institutional advantages.
Finally, our study provides an important academic foundation for understanding the high-quality development of both medical and insurance markets. The empirical results show that government interventions can achieve Pareto improvement under incomplete markets and that compulsory medical liability insurance is a Pareto-efficient institutional innovation that can promote the high-quality development of the medical system. Education, labor, and financial markets are key to China's high-quality development, and financial innovation can assist in promoting the development of these markets.
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Published: 03 August 2023
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