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Viewpoint (July 2003)

Author: Bill Savedoff, Senior Health Economist, WHO. 

One of the most striking facts of modern life is rapid increases in productivity due to technology, but it is easy to forget that technology is more than computers and machinery.    

Technologies also include innovations in the way we organize ourselves -- whether into work teams, corporations, or governments. It is often in this realm of organization that the tradeoffs between efficiency and equity can be overcome, because greater efficiency makes it possible for the same resources to produce more services for more people.

The importance of breaking the efficiency-equity tradeoff is nowhere more important than in the case of health services. In countries where substantial resources are already being spent on health services (in 2000, about half of the world's countries spent more than 5% of GDP on health), inefficiencies mean fewer services are provided, fewer people are served, and health status suffers. Furthermore, the restricted output of services generally means that better-off households seek and obtain privileged access to services, thereby generating inequities.

Agency Problems

There are many ways to analyse inefficiency in health systems, but one of the most common is a principal-agency framework. This framework, which was applied to the health sector as early as 1963, looks at the relationship between a "Principal" who hires an "Agent" in order to reach some objective (Arrow, 1963).

The major finding in this literature is that whenever there is divergence between the Principal and the Agent in objectives, and uncertainty or differences in information about the task, it is difficult to design a contract that achieves an optimal outcome (Newhouse, 1978; Ellis and McGuire, 1993; Savedoff, 1998).

The Principal has a dilemma. In the simplest case, when an Agent is assigned a task, the Principal must specify how the task is to be accomplished and then monitor to assure compliance with his or her orders. In such a case, the Principal assumes the risks of failure because the Agent is constrained to do only that which the Principal ordered. But the Principal also assumes the cost of monitoring performance, along with the risk that the Agent will not comply and the risk that monitoring will not detect this non-compliance.

Therefore, the Principal needs other ways (1) to improve the information revealed by the Agent or (2) to give the Agent an incentive to perform better through assuming some (or all) of the risk of failure. Of course, if the Agent and the Principal share the same objectives, none of this is necessary. But the number of cases where this perfect identification of interests occurs is rare. Nevertheless, measures that increase this identification of interests can also be an effective policy.

Typically, in the private sector, firms use a variety of tools to motivate workers and improve productivity. They use non-pecuniary forms of motivation, such as awards, team-building exercises and flexible working hours. They sometimes pay directly for output, but this tends to occur only in firms with simple identifiable products (such as clothing) or in sales (where commissions are paid). Firms also use pecuniary motivation in the form of bonuses or career advancement for better performers.

The public sector generally has a more limited range of tools available to promote productivity. Public health systems in particular tend to be extremely large, making it difficult to motivate workers through a sense of vocation and shared goals. When the employment contract is tied to civil service regulations, it tends to limit managerial discretion over recruitment, pay, discipline and redeployment of staff. Finally, measuring "outputs" and performance is frequently difficult in the public sector because the services provided are diverse, dispersed and heterogeneous.

Health systems face the most difficult challenges posed both by markets and by bureaucracies. In the market for health services there are problems of moral hazard, administrative and marketing costs, difficulty of mobilizing public resources, and variable quality and access. On the other hand, markets hold the potential for providing incentives for good performance, greater attentiveness to patients and accommodation of differences within the population. In public health bureaucracies, countries often experience inefficient allocations of resources that raise costs, lack of transparency and accountability, restricted managerial discretion and unresponsiveness to patients. However, public bureaucracies have the potential to increase health system efficiency through improved and rational resource allocation, explicitly redistributive policies across income and geographical groups, and lower overall administrative costs.

The question facing policy-makers is how to maximize the potential of market and public sector mechanisms and minimize their defects in a way that serves the goals of public policy: improving the population's health equitably. Countries have used many different approaches in their health systems to better reach this goal. Sometimes these changes are system-wide and sometimes they address only specific parts of the health system, but successful cases have invariably addressed the agency problem in specific ways.

Toward Improvement

There are numerous ways to address the agency problem, but they generally fall into three categories: (1) non-pecuniary mechanisms that bring Agents' objectives into closer alignment with the Principal's objective, (2) mechanisms that improve information about performance, and (3) mechanisms that create financial incentives for better performance.

Non-pecuniary mechanisms are used widely in public and private institutions. Induction programs familiarize staff with an institution's mission and work processes. Socialization in the work place establishes norms of behavior and work habits. Recognition in the form of status or explicit awards can be used to establish role models in an organization. Successes based on better aligning the Principal's and the Agents' objectives in these ways have been documented in smaller organizations, but they are rare in system-wide reforms where they tend to accompany rather than drive major changes.

The second approach, improving information about performance, makes it possible for the Principal to better monitor compliance with contracts. It is difficult to manage health service systems when those who are responsible lack the tools to measure the net impact on the main goal: improved health status. So, it is common to rely on other intermediate factors such as the numbers of consultations and surgeries. In cases where these outputs are not monitored, managers may only observe work attendance and consumption of supplies. Unfortunately, in many health systems, even the number and kinds of workers on the payroll isn't well known. The less information, the more difficult it is to motivate improvements in health services.

When reforms have generated improved information for managers, boards, or officials with decision-making power, the results can be quite dramatic. For example, Bolivia delegated responsibility for municipal hospitals to local hospital boards that included community representatives. One study found that, after controlling for a variety of other factors, municipalities with active hospital boards (measured by citizen participation in budget decisions) had informal charges that were one-third the level measured in hospitals with inactive boards (Grey-Molina, et al, 2001). In Argentina, the variation across hospitals in prices paid for medical supplies dropped by 50% after the Ministry began to disseminate information about how much hospitals were paying for their supplies (Schargrodsky, et al, 2001). In both cases, outside scrutiny appears to have improved performance even though no specific disciplinary actions or discretional authority was used.

The third approach, financial incentives, can be extremely powerful, both for good and ill. Hence, assuring good designs for programs that use financial incentives is particularly important. However, identifying the specific form of financial incentives that will best serve depends critically on the context. For example, in a country that spends large amounts of money on health services, reimbursing providers on a fee-for-service basis will exacerbate the problem of rising costs. By contrast, in a country that spends very little on health and has limited availability of health services, fee-for-service payments can increase access to services.

In the mid-1990s, Guatemala defined a basic list of health services and offered to pay NGOs a fixed payment per person in underserved areas. In a matter of only a few years, some 3 million people (about 20% of the population) gained access to health services for the first time. As one measure of success, immunization rates for children rose substantially in this period.

Colombia also used financial incentives to expand coverage. In 1993, it enacted legislation establishing a national universal insurance program, in which people would be able to choose their insurer and provider. In this system, the government subsidizes the insurance premiums for the poor. The existence of these subsidies gives insurers an incentive to enroll poor and rich alike. By 1998, insurance coverage had increased six-fold among the poorest two quintiles and more than doubled in higher income categories, so that the insurance coverage had increased to 53% and 67%, respectively. About 8 million Colombians who had had little or no access to health insurance, particularly for high cost treatments, now have coverage.


When health system policies are evaluated from the perspective of agency theory, the differences between successful and unsuccessful policies become clear. Efforts to decentralize health systems only work to the extent that they both delegate authority and achieve accountability for local management of health services. Efforts to improve hospitals by making them autonomous will work to the extent those hospitals are subject to oversight by someone who has an interest in better performance (e.g. citizens) and are financially rewarded for more and better quality output. Efforts to improve equity will succeed to the extent that providers are rewarded for extending services to the poor. Successes rely on better aligning objectives, generating good information, and rewarding better performance.

Bill Savedoff

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