Economics of Health Care

John Henderson, Alastair Mcguire, Gavin Mooney

• Publisher: Routledge
• Year: 2005
• Print ISBN: 9781138132191
• eBook ISBN: 9781134963300
• Topic: Business
• Subtopic: Business General
• Index: Business

Gives an understanding of the economic theory underlying health economics, supplemented with practical case study material to show how the theory has been applied.

1: The economics of health care: an overview

1.1: Introduction

Economic analysis, like the study of the relationship between health and health care, may be pursued at a number of different levels. This book is predominantly concerned with the micro-economic analysis of health care. This introduction attempts to explain the coverage of the text, as well as outlining some definitional concerns.

It may immediately be asked what has economics to do with health care in any case? Is not health such a fundamental concern that absolute priority should be given to maintaining and improving it? However, resources are scarce and choices over patterns of allocating resources, therefore, must be made, ideally with recourse to the principle of minimising opportunity costs. Some of these choices inevitably relate to the resources allocated to health care. As health care may be viewed as one of the many inputs into the production of health, such choices will also affect the health of the population. Such choices are problematical, not only because the relationship between health care and health status is not exact but, additionally, there is no widely agreed definition of health.

Often health is defined simply as the lack of illness, but unless illness is itself defined, this is not helpful. There are many different ways of defining illness and each may be related to the different actors supplying the definition. For example, the medical model of illness, as proffered by the medical profession, defines illness in terms of physical and mental disorders. The presence or absence of disease and the stage of its invasiveness dominate such definitions which are pathologically based. Other definitions, however, may be more functionally based. It is possible to define illness in terms of its effects upon the way in which individuals function in their daily lives. For example, emphasis would be placed upon the amount of pain suffered or the degree to which individuals are restricted in undertaking normal activities.

The difficulty in defining health is reflected in the relationship between health care and health status. Thus the maintenance of health may be seen to involve, for many, not just the treatment of disease but also the prevention of disease. On another level it may be argued that the maintenance of health is also linked to the social environment. In this respect health may be linked to, for example, unemployment and wealth.

The broadest definitions of health would appear to accept that anything and everything can affect health status. This immediately presents the economist with the problem of defining the parameters of economic analysis relating to health. To the political economist the widest possible approach would be the only acceptable one. Economic issues, for him, must be set against the socio-political background and are analysed only to support social and political policy initiatives. Economics would have no meaning without detailed consideration of the complexities of the real world.

Economics as a social science has moved quite a way from political economy and has tended to concern itself with abstraction, model building and hypothesis testing. Obviously, political economy underlies modern economic analysis as the model building is inevitably based upon explanations of economic behaviour and may lead on to predictions, which in turn may lead to the advocacy of particular economic policies. However, modern economic analysis remains founded upon abstraction and upon a distinction between normative and positive positions, even if such a distinction is sometimes less than clear. An aim of this text is to consider the application of the normal analytical simplifications and abstractions of economics to the health care sector. Given this, it may then be asked: Why the interest in health care? Why not concentrate upon health per se? And at what level of aggregation are we operating? Let us address the first two questions. Health has value in use but not value in exchange. A full explanation of this statement is given in chapter 3, but essentially this means that health cannot be traded and, therefore, markets in health do not exist. Health care is tradeable. The important distinction is that health cannot be purchased directly while health care can. Certainly the consumption activities of an individual help to produce health, but there is no market in which health itself may be traded directly. Now while a large number of marketable commodities affect health, health care is consumed specifically and singularly because of its relationship with health. Health care is only consumed on the presumption that it has investment benefits in health status. The demand for health care is, therefore, a derived demand based upon the consumer’s desire for health which in turn is desirable for the full enjoyment of all other production and consumption activities. It is thus not surprising that society holds health care in an especial esteem.

Moreover there is the added complication that, given the choice, the overwhelming majority of people would not wish to participate in the consumption of most forms of health care. The actual process is not one that is willingly engaged in under normal circumstances. In the consumption of most health care, for rationality to hold, the consumer must be ill and most individuals would prefer not to be. This simple fact has significant consequences for the economic analysis of health care. Of course in considering preventive health care the consumer may not be ill at the time of purchase. However, preventive health care retains some of the characteristics of its curative counterpart, for example, the demand for it remains a derived demand based upon its expected investment benefits with regard to health.

The importance of highlighting health care in this way is that it serves, as Evans (1984) points out, to distinguish it from other commodities. Generally the consumption of other commodities is not primarily related to health status. While the consumption of a vast range of commodities may have important health effects, they are primarily consumed for other reasons. While there are, as we shall see, economic arguments that have been forwarded suggesting that health care is somewhat different from other commodities, it should certainly be appreciated that it is only consumed because of its effects upon health status.

That health is not tradeable is a good starting point for the analysis of health care as an economic commodity. This is not to say that economics cannot contribute to the analysis of consumption or indeed production choices as they affect health. Notable examples of such contributions are the analysis of unemployment as it relates to health and the consideration of health issues in the literature on the economics of pollution. However, the majority of studies in health economics are in practice concerned with health care economics. Given that the industrialised countries, at least, have all seen the establishment of a set of specialised institutions concerned with the production and distribution of health care, this is perhaps not surprising.

Such arguments are also partly responsible for dictating the level of aggregation which dominates most of the economic analysis in this text. Since economics is concerned with choice then it is of interest to examine choice in circumstances where the consumer is ill. Economics assumes normally that the choices which are most consistent with maximising utility are those made under conditions of full information. However, once an illness is contracted it is unlikely that the consumer is going to be willing, even if he is physically able, to start collecting the necessary information to allow an optimising choice to be made. Moreover such informational requirements are likely to be considerable— which is after all the reason for training doctors. The trained doctor not only holds the information required by the consumer but also supplies the treatment. Such considerations obviously affect the basic choices over the form and amount of health care consumed. A large part of the economic analysis of health care discussed in the text is concerned with the implications for choice under such circumstances. In particular, therefore, we shall be concerned with consumer behaviour and the behaviour of producers.

That illness is unpredictable is a fact of life. Added to this is the fact that for a wide range of illnesses the consumer may have little knowledge about treatment and consequently the cost of treatment. Even though health care is a heterogeneous commodity this is generally the case. Therefore, it is not surprising that insurance is sought to cover at least some of the risk of cost bearing. This of course introduces another market into the analysis: the market for health care insurance. Thus health care insurance is demanded because of the risk of incurring health care costs, with health care consumed because of its expected positive effects upon health status. To the extent that insurance is about the pooling and spreading of risks across a number of individuals, then the analysis of health care insurance inevitably moves away from an analysis of individual consumers. Furthermore the form of the insurance system will affect the form in which health care services are supplied, as well as the individual consumer’s choices over consumption. Therefore the introduction of the analysis of health care insurance broadens the economic analysis of health care, introducing such questions as whether health care should be privately or publicly financed.

Such considerations cannot be discussed purely on efficiency grounds, however, as distributional aspects are also important. Thus another aspect of the economic analysis of health care has to be the issue of equity as it relates to the distribution of this commodity. Such considerations must be dealt with at both the micro- and macroeconomic level. With regard to the latter, distributional issues will affect the structure and nature of aggregate health care provision. On the other hand, the introduction of equity considerations into an individual’s utility function raises questions relating to the assumptions made about individual behaviour.

It will be appreciated then that the text is devoted largely to microeconomic analysis. That this forms the dominant part is attributable to the fact that, once the distinctive relationship between health care and health status is recognised and accepted as a starting point for the economic analysis of health care, analysis of decision-making with respect to health care must begin with a re-examination of the process of choice. As we shall see, choice is affected in such a fundamental manner that pure market solutions to resource allocation problems in this sector become untenable. As such a major concern of the text is with the opportunities available to individual consumers and producers in the decision-making process. It is these opportunities which largely determine variations in behaviour and the institutional responses to market failings which are so important in the health care sector.

1.2: Outline of the text

To some extent the reader will by now have an idea of what to expect by way of content. The structure of the book is discussed below. The fact that health itself cannot be, and much of health care in most countries is not, traded in normal markets is widely recognised. The special nature of the purchase and supply of doctors’ services is probably as old as medicine itself, or at least as old as the Hippocratic Oath. This peculiar trading relationship is, we feel, the most distinctive aspect of health economics as a branch of economics and is, therefore, the main theme of this text.

To give some background to our economic analysis chapter 2 discusses the nature of health, the causes of ill-health and their relationship to health care. The measurement of health improvements is also discussed. Taking such measurement as a starting point, chapter 3 analyses health care as an economic commodity. As a basis for this, the chapter begins by considering the axioms of consumer choice under conditions of risk and then proceeds by examining the difficulties in this framework when analysing health care. Not surprisingly then these two chapters are largely concerned with definitional matters.

Chapters 4 to 6 discuss the distribution and evaluation of health care. Although distribution was earlier suggested to be integral to the economic analysis of health care, such issues often receive much less attention than those of production and exchange. Therefore, detailed discussion of distributional considerations is undertaken in chapter 4, where questions of equity are outlined in the context of its relationship to utility maximisation. Other criteria for distribution are also discussed with regard to the most distinctive economic contribution to the evaluation and planning of health care, that is cost-benefit analysis. Why and how it should be used in planning health care are dealt with, at a theoretical level, in chapter 5. Chapter 6 discusses the uses and difficulties which arise in the practice of cost-benefit analysis. These two chapters should be read in conjunction.

Chapters 7, 8 and 9 look at the demand for health and the utilisation of health care. The first of these chapters is concerned particularly with the implications of applying the standard consumer theory to the demand for health. The second emphasises the influence of the supplier in the consumer’s choice of consumption patterns. Chapter 9 considers the insurance market and how the supplier’s role affects the empirical analysis of consumption.

The implications of the powerful position of the supplier of health care are debated with respect to the choice of production plans in chapters 10 to 12 where the supply side of the health care sector is discussed. The framework used is the industrial economics paradigm which explores structure, conduct and performance relationships. Chapter 10 gives a theoretical overview of the supply of health care, while chapter 11 analyses the hospital sector in detail. Chapter 12 considers some existing health care sectors.

1.3: Analytical framework

As a branch of economics, health economics draws upon a wide cross-section of economic theory. Readers will become aware that the text draws upon the cost-benefit literature, welfare economics and public finance, consumer theory and industrial economics. That health economics is a relative newcomer to the economists’ baggage is apparent through an examination of the age of the references on health and health care economics, few of which go back beyond the 1960s. The subject may indeed be grouped with the other ‘new’ applied economics literature, such as environmental economics and urban economics, which also developed in the post-war period.

Of course the economic analysis of health care is only as solid as the economic theory upon which it draws, In recent years there has been increasing questioning of the foundations of particular aspects of economic theory. For example there is a growing literature on the alternatives to expected utility theory as a means of exploring risk and uncertainty (see Schoemaker, 1982 and Sugden, 1986 for a review), as well as increasing criticism of the pervasiveness of autonomy and rationality in matters of choice (see Sen, 1982 or Simon, 1959). Throughout the text we have attempted to make the reader aware of the restrictions that traditional (neoclassical) economics may place upon analysis of the health care sector. As an alternative, and given that much of the economics of health care is concerned with the institutional responses to market failings, we have sought refuge in the analysis of transactions suggested by Williamson (1975). This is not new, given that one of his former students has already (successfully, we believe) applied this approach to the hospital sector (see Harris, 1977) and the importance of these institutional responses has already been outlined (with considerable insight) by Evans (1984).

These then are the origins of the text and, given that the economic analysis of health care has many avenues to explore this can only be a starting point. We have tried to indicate the main problems to be addressed and some of the conclusions reached to date. The text is primarily aimed at economics undergraduates who are interested in the economics of health care. It should also be useful to postgraduates who wish an introduction to the subject. However, we have attempted to make the text accessible to those who have had little or no formal training in economics. To this end it is structured such that the more complex literature is dealt with in the later chapters. This is not to say that the earlier chapters are any less formal than the later ones; merely that they contain the parts of economic theory which should be more accessible to the lay person. Thus the non-specialist should have few problems of understanding chapters 1 to 6 and also chapter 12. However, chapters 7 to 11 require prior knowledge of microeconomics.

2: Health and health care

2.1: Introduction

Measuring health and the effects of medical interventions upon health are not new. In Mesopotamia around 2000 BC there was in force a law—the code of Hammurabi—governing the payments to be made to, or forfeits to be suffered by, a medical practitioner (Singer and Underwood, 1962, p. 12):

If a physician has treated a nobleman for a severe wound and has cured him or opened an eye-abscess of a nobleman and has cured it, he shall take ten shekels of silver.

If he has treated a nobleman for a severe wound and has caused him to die, or opened an eye-abscess of a nobleman and has caused the loss of the eye, the physician’s hands shall be cut off.

If a physician has treated the severe wound of a slave of a poor man and has caused his death, he shall render slave for slave.

If a physician has cured a shattered limb, or has cured a diseased bowel, the patient shall give the doctor five shekels of silver.

It was clearly believed, then, that the saving or destroying of eyesight was the outcome of the surgeon’s ability to intervene skilfully.

It has also been appreciated since ancient times that ‘Seventy years is the span of our life; eighty if our strength holds’ (Psalm 90, verse 10, New English Bible, 1970). Life expectancy is today commonly used to describe the health of a population—see Table 2.1, which shows that the life expectancy at birth of males in many industrialised countries is around seventy years while for females it is nearer to eighty.

Table 2.1 Life expectancy

As well as life expectancy, a second fundamental aspect of health is the quality of life. Both are clearly important, and while formal measures that combine the two have been developed only recently, they will undoubtedly prove to be a major advance in evaluation and analysis of health care.

In this chapter we examine the links between economics and the measurement of health and health care, the reasons why health has improved over past centuries, the causes of ill-health today, and what the impact of health care upon health is (section 2.2). Thereafter the ways in which health improvements can be quantified and valued are discussed (section 2.3). Conclusions are summarised in sect...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Preface
• 1: The economics of health care: an overview
• 2: Health and health care
• 3: Health care as an economic commodity
• 4: Distribution
• 5: The cost-benefit approach in theory
• 6: The cost-benefit approach in practice
• 7: The demand for health—a household production theory approach
• 8: Is there a demand for health care?
• 9: The utilisation of health care
• 10: The supply of health care
• 11: The hospital as an economic agent
• 12: The organisation of health care
• Notes
• Bibliography