Economic Viewpoint - March 2006

Health Care and the Marketplace

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Author: John C. Langenbrunner, Senior Economist, The World Bank

     In a perfect market, patients seeking health care services express their willingness/ability to pay through consumer demand.  Suppliers compete in a full market, and prices are the equilibrium point between the expressed demand and supply.  In the health care sector, we might first hope that direct payment by the patient could send a clearer signal to the consumer about the price of the service used.  It also makes the service provider, most often a physician -- aware of demands.

But, the relationship with the perfect market ends here; the health sector does not always resemble a working market (Arrow, 1963).  Poor patients, or patients receiving expensive care for major illnesses, may not have the disposable income needed to bridge the period between paying for the service and receiving a full or partial reimbursement.

 The Role of Purchasing

     The high cost and uncertain demand for care leads to the need for a so-called “third party” – public or private -- which pools funds.  Payment to health providers is then typically mediated through a pooling arrangement.  Once funds are pooled, funds then must be allocated in some fashion.  The form of allocation is the purchasing arrangement.  The equilibrium point may be considerably altered by subsidies and co-payments/informal charges in the case of demand, and restrictions in production and monopolies on the supply side.  The net effect of these distortions on market prices will also depend on the provider reimbursement or reward mechanism used.  The mechanism used rather than prices and demand often creates the incentive environment for suppliers of services.

     A final issue is the lack of information and information asymmetry.  Neither consumers nor producers have full information about preferences, prices or the market in which they operate.  The level, mix, and quality of care for consumers can be ascertained only ex-post and good health depends on factors other than the health services consumed.  Although physicians act as agents for their patients (Arrow, 1963), even they often do not know the full impact of the interventions they are recommending.  Both consumer and provider behavior is therefore important.

     So-called “strategic” purchasing connotes an active approach to addressing these various market failures that affect consumers, providers, and social citizenry generally.  Strategic purchasing involves a continuous search for the best ways to maximize health system performance by deciding which interventions should be purchased, how, and from whom.  The approach is especially important in protecting the poor and medically vulnerable.

Strategic Purchasing: Value for Services

     The use of purchasing as a tool to enhance public and private sector performance is well documented in the literature on institutional economics and industrial organizations (Williamson 1985; Milgrom and Robers 1992).  The extension to the health sector has recently been the focus of increased attention among policymakers (Oevretveit 1995; Chalkley and Malcomson 2000).  Lessons learned from this experience are now being successfully applied to developing countries (Bennett, McPake et al. 1997; Preker and Harding 2003; Figueras, Robinson et al. 2005).

     A recent book from the World Bank, Spending Wisely:  Buying Health Services for the Poor, Edited by Alexander S. Preker and John C. Langenbrunner documents the progress and distills the lessons learned in recent years in securing better access and financial protection against the cost of illness through collective financing and purchasing of health care.  A series of policy tools, organizational issues, and institutional arrangements are discussed chapter by chapter.  This publication is part of a series of World Bank books on getting better value for public money spent on health care, and the use of policy tools for reaching the poor.

Efficiency, Equity, and Responsiveness

     Promoting health and confronting disease challenges requires action across a range of activities in the health system.  This includes improvements in the policymaking and stewardship role of governments, better access to human resources, drugs, medical equipment, and consumables, and a greater engagement of both public and private providers of services.  Managing scarce resources and health care effectively and efficiently is an important part of this story.  Experience has shown that without clear allocation and spending policies and effective payment mechanisms the poor and other ordinary people often get left out.

     A sub-theme of the book explores the shift from hiring staff in the public sector and producing services “in house” to strategic purchasing of non governmental providers  – outsourcing  – which has been at the center of a lively debate on collective financing of health care during recent years.  Its underlying premise is that it is necessary to separate the functions of financing from the production services to improve public sector performance and accountability.

     A second lively debate in the volume is the right balance between social responsibility and patient choice.  Does collective purchasing assure patient responsiveness?  Will the so-called “single payer” model now emergent in many countries in Eastern Europe and former Soviet Union effectively respond to patient choice of benefits and providers?  To what extent is consumer choice of purchasers important so that patients have both a say and participate in their own care.  Do competitive models from Chile and Columbia provide a better balance?

     The experience of strategic purchasing is now being extended effectively to the health sector in many developing countries in every region of the globe.  The work demonstrates how the interest of the poor would often be better served through a fundamental shift in the way public money is spent on the health services – notably by moving from passive budgeting within the public sector to strategic purchasing or contracting of services whether public or from non-governmental providers.