XV. Health

Ke-young Chu, and Richard Hemming
Published Date:
September 1991
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Which health needs should be met by the public sector?

Can the efficiency of public health care services be improved?

Is there scope for targeting primary health care more directly toward the poor?

To what extent can user charges be imposed for public health care services in developing countries?

Public expenditure on health care ranges from about US$6 per capita in low-income developing countries to about US$600 per capita in high-income industrial countries. Health expenditure is highly correlated both with income levels—the income elasticity is usually well in excess of unity—and health indicators, such as life expectancy. From an economic standpoint, adequate health care improves human capital by strengthening an individual’s capacity to work productively. To improve health standards, developing countries will have to generate resources to support larger health sectors. At the same time, they have to ensure that existing programs are effectively tailored to health needs. In this connection, developing countries face quite different problems from those that raise so much concern in industrial countries. In particular, the sources and implications of the rapid growth of expenditure on health care, and the role of insurance arrangements (both for consumers and producers) in explaining this growth, are of little immediate relevance to developing countries. While developing countries should seek to avoid the problems faced by industrial countries as their health sectors expand, the overriding concern should be with the efficient and equitable delivery of basic health services.

The Market for Health Care

In a properly functioning private market, the demand for health care would reflect consumer needs, preferences and willingness to pay, with unpredictable and potentially life-threatening contingencies provided for through efficient insurance markets. Distributional concerns would be addressed by income transfers, guaranteeing an appropriate degree of equality of access to health care. Competition among suppliers would ensure that least-cost methods of responding to health demands are adopted.

The characteristics of health care may, however, prevent a private market from functioning properly. A number of health services have public good characteristics, and consumers cannot be directly charged because others benefit from them once provided. Disease control and health education are examples. The private sector will not provide such services. Other services confer external benefits on individuals other than the direct consumers, for example, immunization against infectious illness. The demand for such services will be too low in a private market. Medical ethics make competition in supply difficult, and while the medical profession is regulated, information about medical competence is often denied to consumers. The medical profession can take advantage of less well-informed consumers to supply services on the basis of the profit they generate, rather than medical need; or they may collude with better-informed consumers to provide high-cost, discretionary services, and increase profits at the expense of insurance companies and, ultimately, consumers at large. As medical costs escalate, the poor and the chronically sick are excluded from insurance markets (see below), with the result that their health needs are not met and quality health care becomes the preserve of well-off insured consumers.

The failure of private markets for health care justifies government intervention. But the form this intervention should take is less clear. A fully subsidized public health system could clearly compensate for all the market failures just described. But it would be costly, and dispensing with the market mechanism entirely makes it difficult to regulate demand and contain costs effectively. Moreover, attempts to contain costs manifest themselves not so much in improvements in efficiency but more in a lowering of quality. In designing an appropriate health care system, the challenge is to identify: those activities that should be provided by the public sector and ensure efficiency in their provision; those activities that can be provided by the private sector but with a government subsidy; and those that can be left to the private sector. The private sector should be regulated to compensate for informational asymmetry, and especially the lack of consumer knowledge about health care.

Public Health Care in Developing Countries

Public goods are normally provided directly by the public sector and financed from general revenue. To the extent that a significant part of the health care budget in developing countries is devoted to providing primary health care with public good characteristics, it is appropriate that this should be in the public domain. Moreover, given that the external benefits associated with the private components of primary health care—such as immunization, pre- and post-natal care, and family planning services—are large, it is probably appropriate that these too are provided by the public sector.

The main problem in developing countries is that not only are financial resources limited and basic needs not met, but health care delivery is also inefficient. While improving the efficiency in resource allocation is desirable, there are constraints. It is not easy to determine how resources should be allocated in the health sector, as the benefits are difficult to identify and measure and often only the most obvious expenditure imbalances will reveal themselves. But, even these may not be easily reversible. For example, the health care system may exhibit middle-class capture, whereby better-off consumers use their influence to ensure that their nonbasic needs are met. There may therefore be strong political opposition to reducing the services used by the middle class. Moreover, it may not even be desirable. Given that the overall quality of supply may be higher because the better-off take more interest in the performance of the health service and willingly pay the bulk of the taxes which finance it, an expenditure reallocation toward primary health care could also harm the poor, because the quality of basic health services suffers. While there is in most cases some scope to improve efficiency and simultaneously target health care benefits more effectively to the poor by diverting resources to primary health care, there may be limits to what can be achieved.

Many higher-level services are closer to private goods in character in that the benefits accrue principally to the consumer. However, to the extent that they give rise to external benefits—and a wide range of secondary health care services, mainly of a curative nature, can be associated with general improvements in productivity and living standards—there may be a case for a subsidy. But there is no reason in principle why these services should be provided by the public sector, and as the health system develops to encompass such services, the private sector can be encouraged to provide them. Where the public sector already has this responsibility, or where there are impediments to appropriate private sector development, the public sector should charge for these services with a view to imposing some market discipline on demand and costs. One reason why public provision of higher-level services may be preferred to private provision is that public ownership can be a relatively efficient form of regulation. This is an argument that opponents of privatization of public monopolies commonly voice, having observed the problems of regulated private markets (see the note on Privatization). Another obstacle to the development of a private health care market, especially in developing countries, is inadequate insurance markets.

Health Insurance

The private market for health insurance is subject to both adverse selection and moral hazard problems. Adverse selection describes a failure of the market because good risks (healthy people) will drop out of the market if charged an insurance premium that reflects average risk, thus raising the premium which in turn leads to further withdrawals. In the end, the market collapses because only bad risks want to purchase insurance but premia are prohibitive. Moral hazard describes a failure of the market because people take insufficient care to prevent health problems, and spend too much correcting those they do have knowing that they have insurance coverage. This causes costs and premia to escalate, compounding adverse selection and accelerating market collapse. These problems can emerge in the insurance markets of both industrial and developing countries. However, in most developing countries, the main problem is the limited availability of private insurance.

While private insurance markets may not be extensive in developing countries, there are alternative ways of pooling risk. Replicating developments in industrial countries, insurance could be employer based. However, this would limit insurance to the formal sector, which would be inequitable. Although community-based insurance could provide for some extension of coverage, the public sector may have to provide wider coverage to ensure equality of access to health care. To the extent that the public sector could be left with the relatively bad risks, it may instead make publicly provided insurance up to some minimum level compulsory. However, while there are examples of public insurance to secure access to private services—including health care—direct public provision is often judged a more manageable alternative.

User Charges

As indicated above, the public good characteristic of many public health services limits the application of user charges. However, where there is a less-compelling case for public intervention, user charges may promote efficiency in public production without conceding distributional objectives. In particular, to the extent that consumers can be distinguished by relevant characteristics (the poor, lactating mothers, the disabled, the elderly, etc.) personalized prices can be used to pursue both objectives (see the note on Pricing and Cost Recovery for further discussion).

Even where there is a strong case for charging, however, it may have to be implemented with caution. For example, efforts may be needed to educate consumers so that they appreciate the private benefits of health services thereby increasing their willingness to pay. For this reason, cost recovery may in the first instance focus on curative rather than preventive health care (see the discussion of rural health care in Benin below, for an illustration). Administrative considerations may also point to a more intensive cost recovery effort in urban areas than in rural areas. In both cases, cost recovery is likely to support distributional objectives. At the moment, user fees cover only a small part of health costs in developing countries. However, evidence from willingness-to-pay studies suggests that the scope for cost recovery is large in the case of many services.

Country Illustration

Rural health care in Benin

The design of a rural health project in the Pahou region of Benin provides for the cross-subsidization of preventive health services from the proceeds of curative health services. User charges are collected for curative services, including charges for visits and the sale of pharmaceuticals. The preventive health care program includes, inter alia, routine home visits for pre-natal and post-natal care, distribution of oral rehydration packets, and provision of malaria prophylaxis. Because the benefits of preventive health care accrue only gradually over time, the willingness of villagers to pay for such services was initially limited, although clearly present. However, it was decided to provide such services free of charge, given that the benefits of the program greatly exceeded its costs. At the same time, it was recognized that the success of the program would eventually increase willingness to pay for such services, and the subsidy element could and would be gradually reduced. Thus the project in Pahou was able to address a difficult financing problem through user charges for relatively inelastically demanded curative services, while simultaneously addressing difficulties related to inadequate awareness of preventive health care benefits.


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