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date: 15 April 2021


Abstract and Keywords

The discipline of health economics builds on the insights of microeconomic theory and has developed a substantial empirical basis. It has contributed significantly to addressing and understanding the profound health issues confronted in almost all countries, and has a large impact on the development, implementation, and evaluation of health systems policy. This article helps to investigate areas of interest to policymakers. It discusses the best way to organize and compensate health care providers and describes the rapid growth in expenditure in most developed countries. It discusses the factors that have driven this growth, such as population aging, general economic growth, and the adoption and use of new medical technologies. It surveys the successes and lacunae of the health economics research endeavor and hopes that such successes will be replicated and extended in the future.

Keywords: health economics, health systems policy, empirical basis, population aging, medical technologies

Health policy is a central concern of most economies. In the developed world, the proportion of gross domestic product attributed to health services is growing rapidly, and traditional methods of financing health care are coming under strain. Increasing life expectancies are giving rise to new challenges for the long-term management of chronic disease. Health disparities, caused mainly by factors outside the health system, remain a policy issue in many countries, but there is a shortage of evidence on how to address them. The health care industry and providers of health care have delivered astonishing technological advances, but are also uniquely powerful interest groups, and there are often formidable pressures to adopt new technologies before proper evaluation is possible.

In low income settings an additional set of considerations applies. The problems of infectious diseases remain profound, yet there are also predictions of an imminent epidemic of non-communicable disease, driven by behavioral changes and increased life expectancy. Many countries continue to rely on out-of-pocket expenditure to finance most health care services, giving rise to widespread exposure to catastrophic healthcare-related expenditure. The size and quality of the health workforce is a growing concern, driven by increased migration of skilled workers. Health system financing is often fragile, with many countries operating with very limited budgets and highly reliant on donor funds.

The discipline of health economics builds on the insights of microeconomic theory and has, over the decades, developed a substantial empirical basis. It has contributed significantly to addressing and understanding the profound health issues confronted in almost all countries, and has had a large impact on the development, implementation, and evaluation of health systems policy. As the chapters in this handbook attest, the discipline continues to investigate and shed light upon areas of interest to policymakers.

Any organizational scheme for a volume such as this will be to some extent arbitrary and contested. We have chosen to arrange the chapters into seven broad topic areas: the organization of health systems, determinants of health, institutions and problems of health care finance, institutions and problems of health care supply, assessing (p. 2) performance, fairness, and more general overviews of the field. In this chapter, we provide an introduction to the contents by discussing four critical health policy questions, in particular highlighting novel insights and connections amongst the chapters.

1.1 Why are Some People Healthy and Others Not?

A fundamental and enduring question facing any student of health is why some people are healthy and others not. Medical science suggests that heredity, environment, behaviors, and fortune all play a part in determining underlying health. For policymakers, the question is what policy can and should do to address these differences. The consequent policy questions mainly concern the prevention of poor health (primarily by influencing behavior and environmental factors) and compensating for the consequences of health differences.

Perhaps surprisingly, economics has a played central role in improving our understanding of health determinants. The chapter by Kristian Bolin (Chapter 6) presents the economic theory of health production, originally developed by Michael Grossman, which envisions health as a capital stock, akin to a machine or, as Bolin points out, to education or human capital. Bolin emphasizes the similarities between health capital and human capital and the policy implications of this relationship. The theme of a connection between education and health surfaces again in the chapter by David Cutler, Adriana Lleras-Muney, and Tom Vogl (Chapter 7), who highlight the role of education, both as a direct input into health production, and as a measure of social rank. Cutler, Lleras-Muney, and Vogl note the coevolution of education and health through the life-course. This idea is further elaborated in the chapter by Michael Baker and Mark Stabile (Chapter 8), who describe the determinants and role of investments in child health on later outcomes. Together, these three chapters provide a summary of the scholarly underpinnings—and remaining areas of uncertainty—underlying the recent policy focus in many countries on investments in early childhood.

Of course, investments in good health do not end in childhood. What people do—and do not do—as adults also has substantial effects on subsequent health. Over-eating, smoking, and failing to exercise, or not making appropriate use of preventive medical interventions, can cause serious damage to outcomes. Observers are often perplexed by the evidence that people continue to indulge in unhealthy behavior, even when they understand the consequences of this behavior. Likewise, many people complain that policymakers and health systems place an inadequate emphasis on prevention, overspending on treatments for diseases that could have been avoided altogether at lower cost. The chapter by Donald Kenkel and Jody Sindelar (Chapter 10) takes on the first of these questions, describing how traditional and behavioral economics, and new empirical studies, have improved our understanding of the decision to engage in (p. 3) dangerous behaviors. Kenkel and Sindelar's chapter devotes considerable attention to new econometric methodologies that have been used to assess the causal determinants of dangerous behavior. These methodologies are further explored in the chapter on health care econometrics by Andrew Jones and Nigel Rice (Chapter 37) at the end of the volume. Jane Hall (Chapter 23) addresses the complementary question about prevention policy decisions, often in very similar terms. She explains the continued skepticism among health economists about the maxim that an ounce of prevention is worth a pound of cure. Hall points out that questions about who benefits, and when, are critical determinants of decision-making about investment in prevention.

Infectious diseases remain a central preoccupation in many countries, and a global pandemic is an ever-present risk that transcends national borders. Ramanan Laxminarayan and Anup Malani (Chapter 9) set out the economic issues that arise in this highly complex domain. They point to the need to consider the often perverse incentives that occur when seeking to put in place mechanisms to control infectious disease. Careful policy design is needed to avoid the tendency for individuals, organizations and nations to “free-ride” on the preventive efforts of others.

The likelihood that, as these chapters suggest, some disease is a consequence of individual decisions to take risks or to under-invest in prevention, or education, raises challenges for the distribution of health care resources. Jan Abel Olsen (Chapter 34) takes on the question of which inequities in health outcomes are properly the scope of government policy. He argues that inequity can only be understood and addressed once the cause of the inequality is known.

All these questions, in turn, depend on having an understanding of what constitutes health. While clinical indicators for specific diseases are well-established, determining the optimal balance of resource allocation between prevention and treatment, or among persons whose illnesses arose for different reasons, requires health status measures that are comparable across conditions. Donna Rowen and John Brazier (Chapter 33) assess the current state of health utility measurement, closing with a discussion of the question of whose assessment of a health state should be used in economic evaluation.

1.2 What is the Best Way to Organize and Compensate Health Care Providers?

Medical care is, in large measure, a service industry, with services provided by highly skilled and well-compensated professionals. All health care systems—in developed and developing countries—struggle with the question of how best to deliver medical services. The health economics literature approaches these questions at three levels. One set of studies focuses on the supply and compensation of individual workers; a second set examines the design of intermediary organizations, including hospitals and insurers; a third set examines the question of optimal organization at the level of the system itself.

(p. 4) The first element of a health care system is the skilled workforce that provides treatment. Consistent with the centrality of the health care worker in the system, workforce planning was one of the earliest problems addressed by health economists. Till Bärnighausen and David Bloom (Chapter 21) trace the evolution of the economic approach to this question in their chapter, also addressing the role of the workforce in achieving health goals in developing country contexts.

Once health care workers have been trained, they must be compensated. Three chapters, by Thomas McGuire; Anthony Scott and Stephen Jan; and Jon Christianson and Douglas Conrad explore aspects of this compensation problem. McGuire (Chapter 25) addresses the economic literature on physicians as agents, illustrating this concept through reference to the situation where policymakers would like a primary care physician to provide a “medical home” for the patient. He concludes that certain forms of mixed payment systems are most likely to achieve this goal. Scott and Jan (Chapter 20) expand on this idea, examining the role of primary care providers in the health system. Scott and Jan emphasize the dual agency role of primary care doctors—as agents for their patients and, in many models, as agents for payers. These dual roles can create conflicting incentives. Both McGuire and Scott and Jan emphasize the role of incentives in affecting the volume of services. Christianson and Conrad (Chapter 26) turn attention to the question of how incentives might affect the quality of care. This chapter summarizes the growing literature on “pay for performance” schemes in a range of countries, noting the rather ambiguous results of many of these efforts.

In many contexts within the health care system, health workers operate as part of teams, in conjunction with one another, or with other types of workers. These situations are considered in the chapters by Pedro Pita Barros and Pau Olivera; Jose-Luis Fernandez, Julien Forder, and Martin Knapp; and Laurence Baker. Barros and Olivella (Chapter 19) describe the economics literature on the operation of hospitals using a framework based on the notion of “teams.” They note both the distinction between ownership of hospitals (which may be public or private) and control of operations within hospitals (often the domain of health care professionals). They then turn to examining how teams operate within hospitals. Fernandez, Forder and Knapp (Chapter 24) consider the very different context of long-term care, where the care team often combines formal and informal workers. They highlight the complexities of incentives and financing in such situations. Baker (Chapter 18) turns to managed care organizations, which formally integrate different provider types. A focus of Baker's chapter is on the potential spillover effects of these arrangements on patients and providers who are not themselves part of the arrangements.

As the discussion above suggests, there are almost always multiple providers or multiple provider organizations within a health system. A basic insight of microeconomic theory is that, in situations of incomplete information, which are rampant in health care, competition among providers may lead to adverse selection, with better and worse risks sorted to different providers or insurance plans. This insight provides the basis of three chapters that explore what happens when multiple providers co-exist. Wynand van de Ven and Frederik Schut (Chapter 17) discuss alternative strategies for addressing (p. 5) selection, and conclude that a system of risk-adjusted subsidies paid to insurers is likely to be most effective. Carol Propper and George Leckie (Chapter 28) scrutinize the empirical literature on competition between providers and, as selection theory suggests, find that the outcomes are highly varied, and that competition generates winners and losers among patients as well as providers. Richard Frank (Chapter 11) notes that problems of incomplete information are particularly salient in the context of mental health. He examines how different health systems have addressed the difficulties of allocating care between different types of providers and different types of patients.

Together, supply levels, payment incentives, and organizational structures determine much of the micro functioning of health systems. Two chapters consider how to compare the functioning of different health systems. Jim Burgess and Andrew Street (Chapter 29) describe econometric approaches to comparing the efficiency of health care organizations (at the level of the hospital, the insurer, or the system). Jack Triplett (Chapter 30) considers approaches to tracking changes in the productivity of a health care system over time. We do not yet have methods that allow a clear determination of system efficiency, but these chapters describe both the progress that has already been made and the steps that need to be taken to bring us closer to such an assessment.

1.3 How Much Should Society Spend on Health Care and Where Should Resources be Focused?

Given the manifest imperfections in the market for health services, and the heavy reliance in many countries on government funding, the question of determining the optimal level and mix of health services is a central policy issue. Michael Chernew and Dustin May (Chapter 14) describe the rapid growth in expenditure in most developed countries, and discuss the factors that have driven the growth, such as population aging, general economic growth, and the adoption and use of new medical technologies. They consider a range of strategies for slowing cost growth, including economic evaluation of technologies. Chernew and May also note the increased reliance on government funding. This gives rise to the particularly important issue of inter-generational equity, addressed by Louise Sheiner (Chapter 36). To what extent should the increasing health expenditure on (current) older people be funded by the current (younger) workforce, and will the current funding arrangements be sustainable in the future?

A particularly influential approach to cost containment developed by economists has been the application of cost-effectiveness analysis (CEA) to health technologies, as described by Simon Walker, Mark Sculpher, and Mike Drummond (Chapter 31). CEA is intended to help collective purchasers of health care (governments and insurers) to determine which interventions to prioritize, by ranking them according to the cost of each unit of “health benefit” they produce. In implementing this principle, uncertainty has (p. 6) become a central concern, and Susan Griffin and Karl Claxton (Chapter 32) describe current approaches to handling the uncertainty inherent in all cost-effectiveness estimates.

The pharmaceutical industry plays a key entrepreneurial role in health systems, and has contributed to some major advances in health care. It has an unusual cost structure, resulting from very long, costly, and uncertain research and development processes, and policy instruments such as health technology assessment rules, patent rights, and safety regulations have a key influence on profitability and investment strategy. Patricia Danzon (Chapter 22) summarizes the literature, and considers the question of who should guide and pay for research and development.

Given the size of the health sector, policy decisions that affect it can have important macroeconomic consequences. William Jack (Chapter 5) summarizes a complex evidence base on the impact of health on income and well-being. There is strong evidence of a potentially strong impact of improved health on the productivity and well-being of individual workers. However, this “promise” of health interventions can be fully effective only if delivered efficiently and aligned (inter alia) with properly functioning education services and labor markets. Furthermore, the extent to which the individual benefits of improved health necessarily feed through to improved macroeconomic performance remains an open question.

Ultimately, many of the crucial decisions that affect national health spending are taken by politicians, and therefore reflect political as well as economic concerns. There is a rich tradition of economists exploring the many political influences on public policy decisions, including powerful interest groups, bureaucratic power, and electoral concerns. Carolyn Hughes Tuohy and Sherry Glied (Chapter 4) explore the relevance of this literature to the health domain, and confirm the powerful influence of politics on the shape of the health system.

1.4 How Should Health Care Services be Financed and Distributed?

There is a widespread belief that the design and operation of the health system can have a profound impact on the efficiency of health services and the health outcomes they secure. However, health systems arise for multiple reasons, not always consistent with economic theory. There is therefore a striking diversity in the organization of health systems around the world, with no clear consensus on many fundamental design issues. Bianca Frogner, Peter Hussey, and Gerard Anderson (Chapter 2) summarize patterns amongst developed countries, and Anne Mills (Chapter 3) describes the even greater diversity found amongst developing countries.

In practice, virtually all health systems rely in part on public financing. Åke Blomqvist (Chapter 12) describes what economics can tell us about the share of expenses that should be covered by the public plan and how those revenues should be raised. Peter (p. 7) Zweifel (Chapter 13) challenges the economic role of public financing in health care, and asks whether a purely private insurance system, with redistributive income-based subsidies only, could satisfy policy goals. Mark Pauly (Chapter 16) describes the implications of third party financing, whether public or private. The key issue is that—in the absence of direct user payment for services—there is an incentive for inefficient moral hazard, or excess use of services.

Insurers—private and public—therefore seek to control moral hazard through the use of co-payments and other rationing devices. Erik Schokkaert and Carine Van de Voorde (Chapter 15) consider how user charges or co-payments are used in both developed and developing countries. There is a fundamental tension between controlling moral hazard and assuring access to needed services, especially amongst the very poor. Many health systems therefore seek to ration access to care using other instruments. In particular, Iversen and Siciliani ( Chapter 27) examine the implications of using waiting times, rather than co-payments, as a rationing device.

Most systems of publicly funded health care, offering universal access to at least some subset of services, have been implemented with redistributive goals very much in mind. Eddy van Doorslaer and Tom Van Ourti (Chapter 35) examine how the success of this redistributive function can be measured, describing strategies used for measuring the inequality of the outcomes of a health care system in terms of use of care.

In concluding the volume, Alan Maynard and Karen Bloor (Chapter 38) survey the successes and lacunae of the health economics research endeavor. They point to the key role that funding agencies have historically had in directing research attention towards particular domains, but argue that the discipline has in recent years become more balanced in seeking to offer policy advice on most of the important elements of the health system. Without question, health economics has had some notable successes in influencing public policy for the good, for example in the design of payment mechanisms, the measurement of performance, and the assessment of health technology. It is to be hoped that such successes will be replicated and extended in the future.