The growing importance of health care services



On the effectiveness of Publicly or Privately produced

Health care services

Sotiris Theodoropoulos*

University of Piraeus

Abstract

The production of goods and services in every sector of the economy has to be realized according to socioeconomic efficiency criteria. The maximization of social welfare demands that the production of goods and services fulfill Pareto optimal conditions.

This naturally applies to the efficient provision of health care services, which in the modern welfare state, seems to be mostly a state responsibility. Regardless of the provision, the production of these services covering the ever growing needs of the modern society – mainly in a comprehensive and free, without exceptions for the whole population, manner – can be driven publicly or privately, usually parallel or in various forms of complementarity.

Since many countries are faced with growing costs of health care services, and subsequently focus on cost-saving and efficiency within restrained government budgets, the controversial issue of public or private health care production, remains high in the related debates.

In this paper we illustrate the ground cost framework, which determines the state and private health care services production. State production is being realized and provided ‘at the cost’ covering the means of production plus the labor of the health care workers.

On the other hand, in the case of private production, we have to add on the above, the profits of private health service providers, just as in the purchase of other goods.

In comparing the state-produced health care services with the privately produced ones, we explore the determinants of the same production function, the preconditions for such comparison, and also review the related market failures and regulatory framework.

In conclusion, we point out the importance of the effectiveness in health care services production, not only in the scope of socioeconomic efficiency, but also on ‘Social Wage’, income distribution and competitiveness of modern economies.

JEL Codes: H44, H51, I10, I12, I18, L33.

Sotiris Theodoropoulos

Associate Professor

Department of Maritime Studies

University of Piraeus

stheod@unipi.gr

1. Introduction

The role and the importance of health care systems in the quality of life and social welfare in modern society, have been broadly well recognized.

Also, due to their growing importance in public finances and the economy, they have become a dominant economic and political issue. The need and pressure for efficiency and effectiveness and an old controversial debate about the role of public and private sector in the provision of health care goods and services, remain strongly up to date. In this context, a vast related literature and a broad range of implemented reforms in various countries have created huge knowledge and experience, valuable for health care policies and efficient management of health care systems.

By this paper, we try to discuss the theoretical background of the importance of the health care sector in modern societies, the complexity in nature and special character of health care services and their imperfect market and also underline the changing role in the provision of these services by public or private sectors.

We point out and discuss the ground and related factors of public and private efficiency and cost effectiveness, emerging from the welfare states’ experience and the changing role of the state and the market in modern economies.

Section 2 refers to the importance of health care services in modern societies and their public finances.

Section 3 analyzes the particular nature of health care goods and services, distinguishing them from other goods and services, due to the increased complexity of their markets.

Section 4 gives a review of the theoretical background, related to efficient functioning of the health care system and refers to the controversial issue of public or private health care provision.

Section 5 discusses the determinants of the effectiveness of public or private production for health care goods and services, based on related theory and recent experience of health care systems.

Concluding, we point out the growing importance of the public sector’s stewardship in efficiency and cost-effective functioning of the health care sector and the “return flow” through “Social Wage”. Also in this effort we address the appropriate mixture of both public and private sectors as a result of the new roles of the state and the market.

2. The growing importance of health care services

Achievements in health worldwide in the twentieth century and especially during the past few decades are impressive. The increase in life expectancy and the decrease in fertility throughout the world have been greater in the past 40 years than during the previous 4000 years. Life expectancy is almost 25 years longer today than at similar income levels in 1900 (Preker A. et al 2000). These gains in health and quality of life are mainly the result of achievement and development of medical care industry, producing and delivering in broader parts of population a complex of services that center about physician, private and group practices, hospitals and public health. To these health gains, other causal factors such as improvements in income and education, nutrition, clothing, shelter and sanitation have also contributed.

On the other hand, in developed and high-income countries, new factors related to the living standard and the way of life, negatively affect the population’s health.

As an example we can mention Greece, where life expectancy at birth for males and females increased by 10 years during the last 50 years. At the beginning of this period, the country ranked second in the OECD in terms of life expectancy at birth, but now it’s in the fifteenth position. High tobacco consumption, traffic accidents, obesity, change of food habits that are increasingly Americanized, low level of physical exercise, can explain that evolution (OECD 2010).

Health and health care, are becoming a dominant economic and political issue in most countries, with increasing magnitude and importance of the health sector. Because of this, most countries have experienced a rapid increase in health care expenditure over the last decades. It exceeds on average 9% of GDP for OECD countries.

For this remarkable increase in health care expenditure, we can distinguish as direct reasons the following factors:

a. Rising relative costs. There is a tendency for the relative costs of the health services to rise faster than the average, so that a higher level of spending is required year by year just to maintain standards.

b. Changes in population structure, particularly the age structure. The rapid aging creates new pressure for the health care system.

c. New and improved services and also extension in the coverage, as more groups in the population and more categories become eligible for the benefits, that often take the form of a shift from private to public responsibility for a particular area.

d. Growing social needs due to changing socioeconomic conditions.

How these increased in magnitude and importance resources are allocated to and within the health economy, become a crucial issue.

The maximization of social welfare, requires increasing efficiency of health expenditures, avoiding resource wasting, aiming to achieve welfare maximization situation, according to the principle of Pareto optimality.

In this context, effective policies avoiding weakness and poor performance of health care systems outcomes, are of central importance in the three core functions of health systems (Preker A. et al 2000):

▪ The Financing function, including the collection and pooling of revenues and the use of these revenues through purchasing or budget transfers to service providers.

▪ The Resource-generation function, including production, import, export, distribution and retail of human resources, knowledge, pharmaceuticals, medical equipment, other consumables and capital.

▪ The Service delivery function, includes both population-base and personal clinical services provided by the public and private sector non-profit and for-profit.

The public sector’s strong engagement and efficiently executing it’s role in all three functions and the private sector’s involvement in the second function, are some crucial factors for health care system efficient functioning and its outcomes maximization.

3. Special features of health care services demand and market

The effectiveness of a health care system, public or private, particularly in the production and provision of health care services, is strongly related to some unique characteristics for these services and their market. These characteristics, distinguish these services from other goods and services and because of this, their market is differentiated from usual commodity markets, as they are analyzed in economic textbooks.

In his famous article, Kenneth Arrow (1963) lists the main characteristics of health care services in the following categories:

A most distinguishing characteristic of the demand for medical services, is that by nature, it is not steady in origin, but irregular and unpredictable. Apart from preventive services, medical services afford satisfaction only in the event of illness.

Medical services demand, is associated, with a considerable probability with an assault on personal integrity, some risk of death or a considerable risk of impairment of full functioning. Illness is not only risky but a costly risk, apart from the cost of medical care.

Health care services have to be produced only at the very instance when a need emerges, otherwise they can be useless.

The expected behavior of the Physician as a seller of medical care, is different than of businessmen in general, because medical care belongs to the category of commodities for which the product and the activity of production are identical. The customer, cannot test the product before consuming it and there is an element of trust in the relation.

Advertising and over price competition, is virtually eliminated among physicians. Advice given by physicians, is supposed to be completely diverged from self-interest, dictated also by the objective needs of the case and not limited by financial considerations.

Uncertainty as to the quality of the product, is more intense here than in any other important commodity, because the recovery from the disease is as unpredictable as is its incidence.

Due to the complexity of medical knowledge, health care market tends to be characterized by both imperfect information and asymmetric information. In such a situation, those on one side of the transaction have better information than those on the other. As a possible consequence of these is that a market will not exist and even if it exists, it will function inefficiently.

Related to the above, is the phenomenon of supplier-induced demand, where health care providers have and use their superior knowledge to influence demand for self-interests. Supply conditions differ also compared to other sectors, due to the entry barriers such as the licensing restricting the entry to the profession, aiming to guarantee the quality, as also the high cost and time consuming of medical education, facing on the other side monopoly power conditions.

There are also limitations in the subsidized education aiming to reduce the cost. Such factors increase the cost of health care services.

Unusual practices by medical professionals in pricing of their services is also common, because they have traditionally held some monopoly power over their clients.

To the above mentioned characteristics, we have to add that health care markets are subject to prevalent externalities, motivations other than pure profit are common, health care services are not uniform in quality or character, often firms are so few in number that they have some degree of monopoly power (Folland S. et al 1997). Due to such particularities and market failures, the health care market deviates from the competitive assumptions and sometimes significantly.

Market forces alone fail also to secure equity, since individuals and families often fail to protect themselves adequately against the risks of illness and disability on a voluntary basis, due to short-sightedness (free-riding) (Preker A. et al 2000).

4. On the efficient provision of health care services

By recognizing the importance of health care services provision in modern society and considering their nature and related significant market failures, the role of the public sector becomes crucial in all three core functions of the health care system. Regarding the generation of inputs, the public sector is a major player in the health care economy as producer, redistributor and regulator.

Most health care goods and services do not behave like perfect private or public goods. They all have some elements of excludability, rejectability and rivalry and they can be characterized as private, mixed and public goods, depending on the degree that they include such elements.

The production of such goods and services by the public sector, should not be confused with the public provision. The central question here, is who would more efficiently produce health care goods and services and provide them with universal coverage, under the principles of accessibility, responsiveness, quality, accountability, transparency, and equity.

Parallel to the market’s failures due to a number of reasons mentioned above, the public sector may also fail for other reasons in service delivery. The relative roles of the public and private sector in health care provision, have and continue to evolve over time. The debate over the relative merits of private and public provision, as also applied reforms, stem back to 19th century neoclassical economics until more recently to the new public management theories.

Proponents of private provisions, cite that the competitive market model of profit maximization causes potential gains in efficiency, quality, consumer choice and responsiveness, transparency and accountability (Hsu J. 2010).

Furthermore, focusing on cost effectiveness and quality, the publicly owned management lacks the freedom and expertise and also has relatively weak incentives to make necessary investments, in contrast to private owned management or private regulated contractors.

On the other hand, comparative cross-sectional studies suggested that providers in the private sector, more frequently violated medical standards of practice and had poorer patient outcomes, but had greater reported timelines and hospitality to patients. Reported efficiency tended to be lower in the private than in the public sector, resulting in part from perverse incentives for unnecessary testing and treatment (Basu S. et al 2012).

The claim that the private sector is usually more efficient, accountable or medically effective than the public sector, is not supported by systematic review of a number of studies evaluating the efficiency of public versus private provision.

In a meta-analysis of 317 published works on efficiency measures, Hollingsworth B. (2008) concludes that ‘public provision may be potentially more efficient than private’.

A vast and ever-expanding literature on hospital efficiency, aiming to measure hospital performance on the basis of their ownership, has emerged internationally. By using Data Envelopment Analysis (DEA), a number of studies test the technical efficiency of hospitals, while others test the impact on hospital efficiency of factors such as hospital size, location, average length of stay, capacity utilization, teaching mission etc.

Due to different testing factors relating to ownership, empirical evidence give mixed results affected also by existing conditions in particular countries. This underscores that one cannot generalize which ownership model is best across countries or even within countries over time (Hsu J. 2010). Every country has to move towards its best practices, by reducing waste and producing cost-effective interventions, or structural changes to improve performance based on routine measurements of inputs and outputs of systems, to identify and quantify inefficiency.

5. Determinants of public or private production’s effectiveness

The production of health care goods and services under public ownership, likely to be superior to private ownership, rests on a set of assumptions and circumstances, based on the belief that the public sector activities maximize social welfare.

Proponents of public sector involvement in health care in most societies, have argued on both philosophical aspirations related to humanitarian issues and technical grounds related to efficiency and welfare maximization.

The publicly produced health care goods and services (Qhg), irrelevant of their nature to be public or private goods, are supplied ‘at cost’.

Public resource spending on health care production, consists of two separate items:

▪ Gw: Wages and salaries of government employees, producing health care services like doctors, nurses, technicians etc. and

▪ Gr: Government expenditure for drugs, equipment, materials, electricity, building, food etc.

In the case of public or ‘in house’ production, the taxes needed, cover only the cost of labor of the health workers plus the means of production as in public production of any other public good.

Qhg = Gw + Gr

In the case of privately produced health care goods and services (Qhp), to the above cost of resources we have to add the private sector’s profit (P), on top of its wages (W) and resources (R). (Gaof I. 1979)

Qhp = W + R +P

This optimal provision mode and cost effectiveness superiority of public sector, is seriously incomplete and as we mentioned above, rests in a number of assumptions not always existing in reality.

The welfare-state approach, failed to address many of the health needs of populations across the world. Due to the distortions of government objectives, governments often fail to develop effective policies and although state involvement in the health sector is clearly needed, it is typically beset by public sector production failure.

The production function for health care services (Qh) is the same in public and private sector.

Qh = f (L,K)

using labor and capital of various categories and forms respectively. By analyzing the respective items of public and private sector cost for similar activities, the public production ‘at cost’ may not be cost-effective and also sometimes may be more costly than the private producing ‘at cost’ plus profit.

However, the prevalence of political patronage, transfers wealth to supporters by excess employment, jobs at above-market wages or outright transfers, doctors taking bribes to treat patients, awarding contracts to insufficient providers or overpaying these providers, failing to make them accountable for quality and even failing to enforce these contracts.

Along the same line, trade unions in the public sector around the world, are typically the strongest opponents of privatization of any health sector’s activity, precisely because they obtain significant benefits for their members in exchange for political support (Shleifer A. 1998).

When the public sector enjoys monopoly power, people who work for it are given wide scope for abusing this power, through the extraction of rents, internal distribution of ‘slack’ to employees and lowering the quality. Such rents like the informal user charges, various forms of corruption that are commonly levied on patients and their families and others, can be internally consumed in several ways: Executives often receive generous social benefits and travel allowances, time keeping is often not enforced rigorously (doctors often work short hours in public institutions) and also pursue personal agendas through discretionary spending on special projects and research (Preker A. 2000).

Due to this burden placed on households and taxpayers charged twice for low quality of services provided, the pressure to eliminate the public waste has mounted in the last decades.

Extensive reforms of public sector organizations and state-owned enterprises implemented over the past 20 years, addressed the same problems encountered in delivering public health services. The need for a more cost-effective system, does not comes into conflict with the needs of patients and other consumers.

The restructuring of the whole health care system, setting new roles for the public and private sector, was an attempt to improve the efficiency in health care services by new managerial systems of control, measures of rationalization, procurement systems, using informatics.

The reprivatization of parts of the health care system by giving more space to private sector, takes place more specifically for expenditure to switch from direct public provision of services to public subsidization and purchase of privately produced services. Health care goods and services, categorized from high-contestability and measurability to low-contestability and measurability. Markets functioning and their competitive environment, constitutes the framework on which decisions about the appropriate public-private mix and ‘make or buy’ have to be taken.

6. Conclusions

The growing importance of the health care sector and the public sector’s stewardship and early participation in health care during the twentieth century, especially in modern societies is a common matter. The health care system, remains part of the welfare state and most industrialized countries have achieved universal access to health care through a mix of public and private arrangements.

Health care services provided without discrimination between households, increase the living standard. The ‘return flow’ of such state benefits of collective consumption and services in cash and in kind back to the employed and non employed population, referred as the ‘Social Wage’, is of crucial importance for low income groups, income distribution and social welfare.

Population’s health, has become a state responsibility, affecting also competitiveness of modern economies.

The efficiency and cost-effectiveness in every part of activity and function of health care system, is of crucial for taxpayer’s ‘value for money’ and the maximization of social welfare.

Extended research and vast related literature has been devoted to this field.

Massive implemented reforms in the last two decades, have changed the role of public and private sector in health services. Today the debate of private vs. public seems anachronistic.

Most health care systems involve a mixture of public and private provision, the extent of which varies considerably among countries.

References

• Arrow K. (1963). “Uncertainty and the Welfare Economics of Medical Care”. The American Economic Review Vol. III No 5 December 1963.

• Basu S., Andrews J., Kishore S., Panjabi R., Stucker D. (2012). “Comparative Performance of Private and Public Healthcare Systems in Low and Middle-income Countries: A Systematic Review”. PLoS Med 9(6).

• Folland S., Goodman A., Stano M. (1997). “The Economics of Health and Health Care Practice”.Prentice- Hall. Second Edition.

• Gough I. (1979). “The Political Economy of the Welfare State”. The Macmillan Press LTD. London.

• Hollingsworth B. (2008). “The Measurement of Efficiency and Productivity of Health Care Delivery”. Health Economics 2008. 17:1107-1128.

• Hsu J. (2010). “The Relative Efficiency of Public and Private Sector Delivery”. World Health Report 2010. Background Paper, 39.

• OECD (2010). OECD Public Management Reviews: “Strengthening Public Administration Reform in Greece”. Working Paper Vol 5. Health Care System in Greece.

• Preker A., Harding A. (2000). “The Economics of Public and Private Roles in Health Care. Insights from Institutional Economics and Organization Theory”. H.N.P. Discussion Paper.

• Shleifer A. (1998). “State versus Private Ownership”. Journal of Economic Perspectives. Vol. 12 No 4. Fall 1998. p. 133-150.

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