Journal Issue

Financing of Health Services in LDCs: An agenda for reform

International Monetary Fund. External Relations Dept.
Published Date:
June 1987
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John Akin and Nancy Birdsall

Despite remarkable reductions in the incidence of disease and mortality rates over the past 30 years, the degree of ill health in developing countries remains enormous. In 1983, average infant mortality rates were eight times higher, and female life expectancy about one third shorter, than in the industrial countries. In pockets of Africa, nearly one fifth of all infants die in their first year. Available data also indicate extremely high levels of largely preventable illness.

Future efforts to further reduce morbidity and mortality in the developing world will depend primarily on the capacity of health systems to deliver basic health services and information to households that are often dispersed and poor. Meanwhile, however, rising incomes, larger numbers of older people, and urbanization are increasing the demand for conventional hospital-based services. These competing needs have put tremendous pressures on health systems in developing countries, at a time when public spending in general cannot easily be increased. Indeed, many countries are being forced to cut back on official expenditures as a result of slow economic growth and record budget deficits. Against this background, what can be done to finance the expansion of critically needed health services in these countries?

This article is based on Financing Health Services in Developing Countries: An Agenda for Reform, a World Bank Policy Study, Washington, DC, 1987, $7.50 (French and Spanish, forthcoming).

This article proposes that developing countries reduce government responsibility for high-cost health services for treatment of individuals and redirect resources toward basic health services, such as immunization, that benefit society as a whole. Such a shift would relieve government of the burden of providing costly health care for economically better-off, largely urban populations, freeing government resources for basic, less costly services that are more likely to benefit the urban and rural poor.

Health sector problems

While the characteristics and performance of the health sector vary tremendously among developing countries, most countries face three problems:

• an allocation problem—too little spending on basic cost-effective services compared with costly services;

• an internal efficiency problem—public health programs that do not work well; and

• an equity problem—the poor benefit little from public health spending.

Allocationproblem. In most developing countries, neither government nor private health expenditures are mainly for such basic health services as control of communicable diseases, immunization, health education, family planning and maternal care, and provision of affordable and effective drugs. Most are for more costly yet less effective curative services provided almost exclusively by hospitals. In Bangladesh, for example, the Government subsidizes specialized orthopedic, cardiovascular, and eye institutions catering to a relatively small number of persons, while each year an estimated 324,000 active tuberculosis patients above the age of ten receive no treatment, at least 90,000 children under age five die of pneumonia, and 136,000 infants die of tetanus. If the public resources tied up in the few, mainly urban, hospitals were directed to lower levels of the health system in the countryside, many common causes of illness and hospitalization could be treated at an earlier and controllable stage, or prevented altogether.

Internalinefficiencyproblem. The resources that are available for government health programs are not used well. One symptom of inefficiency is the widespread use of higher-level health care facilities by patients who could be treated in less sophisticated units. Typically, urban health facilities (both clinics and hospitals) are overcrowded, while rural facilities have few clients. In Colombia and Somalia, tertiary care hospitals in major cities have occupancy rates of over 80 percent, while secondary hospitals in smaller towns have rates of 40 percent or less. In Rwanda, 70 percent of the beds in city hospitals are occupied, but only 30 percent in rural health centers. Patients crowd into higher-level facilities for obvious reasons: the higher-level facility is free (or no more expensive than the lower-level one), and personnel have more training; equipment and laboratories are better; a wider array of diseases and emergencies can be handled; and the institutions are located in cities, where drugs and related services can be purchased.

A second symptom of inefficiency is lack of such critical complementary inputs as fuel and drugs in public health systems. Pressure to expand the urban health system under tight budgetary conditions leads to cuts in these critical inputs rather than in salaries. Because these inputs are a small proportion of total costs, they must be cut drastically to achieve a significant reduction in total spending. The result is a large drop in the effectiveness of health systems. In Zambia, for example, free government health services are reportedly inoperative because fuel and drugs are unavailable; yet private health services continue to flourish.

Equityproblem. In most developing countries a large proportion of the population lives in the countryside, but 70 percent or more of government health spending is on hospital-based care in cities, where family incomes are significantly higher. In Peru, per capita Ministry of Health expenditures from 1970 to 1981 in the metropolitan area of Lima were over five times that spent in the most rural area of the country. Even in China, total 1981 subsidies were estimated at $6 per capita in rural areas and $19 per capita in urban areas. While the poor, particularly in rural areas, benefit little from tax-funded subsidies to urban hospitals, they often pay high prices for drugs and traditional care from private health facilities.

A certain number of hospitals are essential in any health system, even one whose major emphasis is on primary health care. The problem is not only, nor even primarily, that health systems in developing countries are hospital-based. It is that public subsidies are hospital-based, that is, are mainly for hospitals in cities and thus disproportionately benefit the rich.

Financing reforms

Obviously, these problems cannot be solely attributed to the approach governments have taken to financing health care. Nor will a change in the financing of health services alone solve these problems. Change in financing will not, for example, eliminate the need to improve management, training, and supervision in the public delivery of health services. But financing reforms do deserve consideration as one part of an overall effort to improve health systems. Four policies constitute an agenda for reform:

• charging users of government health facilities;

• introducing health insurance programs;

• encouraging provision by the nongovernment sector of health services for which households are willing to pay; and

• decentralizing certain government health services.

These financing policies are closely related and complementary (see box on effects of policy reforms). They would shift some of the burden of financing health care from the public sector to the beneficiaries, and they would move some decisionmaking from central planning agencies to local health authorities that are better aware of conditions and needs of patients in their jurisdictions.

Chargingusers. Some countries have had user charges for decades, and some others, particularly in Africa, are now beginning to introduce them. But in most countries, government health facilities charge no fees or very low ones for services, drugs, and other supplies. The government health system, therefore, cannot collect revenues from many patients who may be able and willing to pay for health care. The entire cost of health care ends up being financed through frequently over-burdened tax systems.

In these countries, modest charges (amounts that would constitute, even for poor households, one percent or less of annual income, assuming four treatments a year at a government health post) should be considered at government facilities, especially for drugs and for curative care. (Most preventive programs would remain free and be financed directly by government.) A system to protect the poor, such as lower fees in rural areas and at lower-level entry facilities, should be simultaneously introduced. Where there is currently no charge for health services, modest fees could generate revenues covering 15-20 percent of most countries’ operating budgets for health care (excluding administrative costs associated with charging fees)—enough to cover a substantial part of the costs of currently underfunded inputs such as drugs, fuel, and building maintenance.

In the longer run, user charges can provide a way not just to raise revenue but also to help improve the use of government resources. Curative services, mainly for better-off urban populations, currently account for 70-85 percent of all developing country health expenditures, and probably 60 percent or more of government expenditures on health. Once mechanisms to exempt the poor from burdensome charges are working well, charges for curative services for most patients could be raised to levels that more accurately reflect the cost of providing them. This would free as much as 60 percent of government expenditures on health for reallocation to basic, largely preventive programs and to simple curative care for the poor.

An effective policy of user charges involves three complementary steps by government. First, access to and quality of services should be reasonable; otherwise the services will remain underutilized. Second, freed revenues must actually be funneled into those programs now underfunded: preventive health programs and basic curative care for the poor. Third, the poor who cannot afford new or higher charges must be protected.

The four proposed reforms: at work in China

The Chinese health system is an example of how the reforms proposed here can contribute to the effective delivery of low-cost health services. In China, users of public health facilities are charged fees, which cover all nonsalary costs. All drugs are sold at a 15 to 25 percent profit. Moreover, about 14 percent of the population, mostly in urban areas, is covered by health insurance. The health system makes effective use of the private sector through so-called “barefoot doctors,” who are typically well trained and well paid. Finally, China has a long-standing policy that locally collected fees are used by the collecting facility as it sees fit. In part as a result of the effective health care delivery system, life expectancy in China is almost 70 years, well above the average for countries of comparable income.

Effects of policy reforms
Effects on:
Institute user charges
introduce health in-
Encourage private
Decentralize public
health services

As the table above indicates, each of the recommended financing reforms is interlinked with current health sector problems. User charges, for example, not only raise money, they also increase resources for the health system as a whole, allowing a shift in use of government resources to more cost-effective and generally preventive programs. This shift alone will tend to benefit the currently underserved poor, who tend to suffer more than the higher income groups from the health problems that can best be addressed by preventive programs. If revenues from user charges are channeled directly into underfunded nonsalary expenditures, such as drugs, fuel, and maintenance, the efficiency of existing government services will increase. User charges can also play a direct role in making the health system more equitable by reducing subsidies for health care for the better-off and directing freed-up resources into programs and facilities toward the poor.

One practical way to protect the poor is to reduce or eliminate charges in predominantly poor rural areas and urban slums. Another option is to issue vouchers to the poor, based on certification of poor households by local community leaders (a practice that appears to work well in Ethiopia). Other options include allowing staff discretion in collecting charges (although this is difficult to do in the government sector) or, in middle-income countries, the use of a means or income test. A few countries, including Indonesia, Jamaica, and Thailand, are experimenting with more or less formal income tests, relying either on declarations by patients or on documentation from the patient’s village headman or other community leaders. Finally, in a well-functioning referral system (in which patients enter the system at a low-cost, low-level facility and, only if they cannot be treated there, are referred to more complicated care in a higher-level facility), a schedule of low fees or free care at the lower level, and referrals at no additional cost, also helps protect the poor.

Insuranceprograms. A modest level of cost recovery is possible without an insurance program. But in the long run, the widespread availability of health insurance is necessary to relieve the government of subsidizing the high costs of hospital-based curative care.

Currently, insurance programs cover only a small portion of low-income households in most developing countries, especially in Africa and South Asia. Excluding China, where the majority of urban residents are insured, no more than 15 percent of the people in developing countries take part in any form of risk-coverage scheme (other than free public health care provided with tax revenues). Most of these are covered under government-sponsored social insurance plans in the middle-income countries of Latin America and Asia. Private insurance, prepaid plans, and employer-sponsored coverage are all still relatively rare.

An effective way to encourage insurance in developing countries is for the government to make coverage (whether provided by government or the private sector) compulsory for employees in the formal sector. Then at least the relatively better-off will contribute to the costs of their own health care. A few low-income countries and most of the middle-income countries in Latin America and Asia have taken this step, using payroll taxes to fund social insurance that also covers health care.

Insurance programs in industrial countries and in Latin America have undoubtedly contributed to rising health care costs. When insurance plans cover most or all costs, and patients and health providers perceive care as “free,” some unnecessary visits and procedures are likely, leading to escalating costs in the system as a whole. To avoid such escalation, compulsory insurance plans in low-income countries should not cover small, predictable costs (for example, low-cost curative care); they should cover only “catastrophic” costs (defined, where possible, in terms of household income). Cost escalation in such systems will also be less likely if consumers pay an entrance fee (or deductible) and share the costs for treatment of each illness. To protect the poor, the cost of insurance premiums can be subsidized through vouchers, and deductibles and copayments can be reduced. When catastrophic illness strikes, and even a small charge per service adds up to a heavy financial burden as a proportion of income, payments above a specified level can be forgiven.

Competition among insurance providers will also help prevent cost escalation. Without effective competition, insurance providers will have little incentive to keep costs and premiums low. Wherever possible, therefore, government should avoid crowding out private insurers. Finally, government-run insurance programs should avoid subsidizing the insurance system with general tax revenues; this allows costs to rise in the health system and eventually means the insurance program will benefit the better off, while being financed, in part, by the poor.

Thenongovernmentsector. Government is an important, but by no means the sole, provider of health services in developing countries. Missionaries and other nonprofit groups, independent physicians and pharmacists, and traditional healers and midwives are all active in the health sector. Direct payments to these groups account for up to one half of all health spending in many countries.

The appropriate size and roles of the government and nongovernment sectors is bound to vary among countries. However, governments reduce their own options for expanding access to health services when they actively discourage nongovernment health care, or fail to seek efficient ways to encourage it. Expansion of nongovernment health services can reduce the administrative and fiscal burden on the government and broaden consumers’ options. For some types of health care, especially simple curative care, nongovernment services may be more efficient than the government, providing comparable or better-quality services at lower unit costs. Competition from the nongovernment sector can also encourage improved efficiency in government services.

In many developing countries, however, there are formidable barriers restricting community organizations and private groups from initiating, expanding, or improving health care services. In Benin, Cameroon, Chad, and Togo, health services outside the state-administered health system are discouraged. In Malawi, restrictions on private practice led to the emigration of indigenous doctors. Private voluntary organizations, including churches, are often treated more as a nuisance than as a partner by government authorities. In some societies, traditional practitioners—instead of receiving the training and support that would enable them to collaborate better with the modern sector to promote primary health care—are dismissed as incompetent.

Some governments are removing these kinds of restrictions and encouraging community-run and private sector health services by providing subsidies and administrative support. In Rwanda, for example, the government reimburses missions, which provide 40 percent of the country’s health services, for 86 percent of the salaries of Rwandese staff. In Zambia, government subsidies account for more than one half of missions’ expenditures on health care. Even as it encourages nongovernmental health providers, government must continue its important training, regulatory, and information roles in health. The public health sector in every country needs to take the leadership in training health workers, testing them for competency, and licensing nongovernment facilities. Governments must play a central role in research and development; set standards and regulations to protect the populace from untrained or unethical practitioners, especially in countries where professional associations and standards of professional conduct are not yet well established; develop the legal framework for prepaid health systems; and disseminate information about pharmaceuticals and health insurance options to help consumers deal effectively with private providers.

In some countries, including much of Latin America and the middle-income countries of Asia, it may be possible for the private-for-profit sector to provide most or even all curative care as long as risk-coverage plans and subsidies for the poor are implemented. In others, including Africa and the poorer countries of South Asia, where much of the population resides in rural areas and where basic curative and preventive services are closely and appropriately integrated, the government will need to continue to provide curative care in conjunction with its preventive care (for example, combine treatment of sick children with immunization), ideally in a manner that complements existing mission and other private services. In all countries, most preventive care, with its large social benefits, should remain the clear responsibility of government.

Decentralizingcertaingovernmentservices. Since the government’s role in the provision of health care will remain large, it is important to improve the efficiency of public health services. In countries where managerial resources are scarce, communication is difficult, transportation is poor, and many people are isolated, decentralization of the government health service system should be considered as one way to improve efficiency.

Decentralization is appropriate primarily for services provided directly to people in dispersed facilities, where user charges for drugs and curative care are implemented. Some health programs, such as control of vector-borne diseases, are more logically managed centrally.

By keeping revenues as close as possible to the collection point, decentralization improves incentives for collection and increases accountability of local staff. Within certain limits, decentralization helps assure that local expenditures reflect local needs, and fosters development of managerial talent at the community level.

Decentralization and greater local financial control by no means imply complete financial independence of each individual facility. Government facilities that provide integrated curative and preventive services in rural areas and to the urban poor will continue to require central support. In fact, in rural areas the appropriate unit for planning and budgeting is likely to be a regional or district office, not each of many small health posts.

Implementing a policy of decentralization of government health services is not likely to be easy, and of the four policy recommendations is the least tried. Where other parts of government are highly centralized, there will be considerable obstacles to decentralization. But there are considerable potential benefits as well since, except for agricultural extension, perhaps no other government service is as highly dispersed geographically in its activities. Where overall administrative systems are weak, the quality of staff in remote areas is poor, or positions are unfilled due to long-standing difficulties in attracting staff away from large cities, decentralization will have to be planned and introduced gradually. In some countries, where staff of regional agencies, local hospitals, and clinics have little experience in managing revenues and expenditures, training in and practice of such skills will need to precede decentralization.

Problems and pitfalls

Implementation of these financing reforms will not solve all the problems of the health sector. User charges in public facilities, for example, will not generate foreign exchange to pay for imported pharmaceuticals. Insurance programs will not necessarily assure better quality. Decentralization will not eliminate the need for difficult political decisions at the center regarding new investments, training subsidies, and wage scales for public workers. Even a high-quality nongovernment health sector will not fill such critical needs as environmental disease control, and is unlikely to adequately serve the poor in remote rural areas.

Moreover, financing reforms will have little impact without a political commitment by government to making the health sector more effective. User charges and other reforms alone will not assure that freed government resources will be well spent. Political decisions will largely govern whether freed revenues are used to improve access to and quality of services sufficiently to attract fee-paying and insurance-buying customers, rather than to build urban hospitals and buy expensive, nonessential equipment. Only government action can bring necessary changes in management and training programs—for example, in the medical education system so that training of doctors is more appropriate to needs and training of paramedical personnel is strengthened.

Nor is the financing policy package a simple one to implement. Each of the four reforms has potential drawbacks if implemented without due care. User charges could deter those with the greatest capacity to benefit from seeking care, without recycling funds into health. Risk-sharing schemes could raise costs and augment existing disparities. Deregulation of the private sector and administrative decentralization could increase geographical inequality in provision of health services and decrease their quality. Administrative costs and bureaucratic delays could increase as an unintended result of reform efforts.

For all these reasons, specific approaches to implementation need to be monitored as they are tried; and flexibility in such areas as the size of user charges and the approach to decentralization needs to be maintained. Put another way, avoiding the pitfalls requires that political and social boldness in policy innovation be complemented by systematic and sustained attention to monitoring of health programs, and implementation must be expected to take time, especially in countries where administrative capacity is weak. But in every country, initial steps are possible, and deserve systematic consideration.

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