Two cheers for the NHS!

Why do we have an NHS? An economist’s perspective

Cam Donaldson

Introduction

Why has the NHS survived to its 60 th birthday and should we celebrate? Of course, there are lots of reasons as to why we have an NHS but this article will focus on the economic arguments. Although coming from the discipline of economics, these arguments would be contended by some. It is fair to say, however, that they would be subscribed to by most health economists in the UK.

Health care as a ‘commodity’

To take the line of reasoning forward, you are now asked to suspend belief for the next few minutes and think of health care as a ‘commodity’. Although an anathema to many, it is vital to the case for significant government intervention in the health care ‘market’, allowing us to strip humanitarian and political arguments from the debate. To illustrate, one could argue that it is more of a fundamental human right to have access to food than health care. But why do we not have a National Food Service? Governments intervene in the food market to maintain production standards and through income supplements. Such intervention is nowhere near as pervasive as in health care; the rest is left to the market. Make no mistake, if governments could do this for health care, they would.

The facts are that government intervention in health care is a global phenomenon. O ver 80% of UK health spend comes from the public purse, in line with other advanced economies. The story we have to articulate is why this is the case. It is the nature of the commodity health care that provides the explanation.

More particularly, health economists would make the case for extensive government intervention on the basis of ‘market failure’. Markets fail when they are so restricted in the function of transmitting information between consumers and providers that government intervention (e.g. an NHS) becomes more efficient and more equitable.

The case for market failure in health care is not new. Specific aspects have been well-rehearsed by Nobel laureates, such as Arrow in 1963, as well as many other social policy commentators. For more detailed arguments and all of the relevant references, see Donaldson and Gerard (2005). The problem, of course is that these points tend to be forgotten. As the great Canadian health economist, Robert Evans, said in 1997:

“…advocates of private markets tend to make their arguments as if the last forty years has never occurred. The issues that were contentious in the 1950s and 60s are being dragged out again, with all sorts of old a priori arguments dusted off, repainted and presented as new thinking about the role of the private sector.” (See Donaldson and Gerard, p.31)

The tale of the duck-billed platypus

Aspects of market failure exist for many commodities. However, in health care, there are three sources of market failure, more than for any commodity in society. In the market-versus-non-market debates of the 1960s, Alan Williams, the eminent health economist from the University of York, drew the analogy of the duck-billed playtpus to illustrate:

“It has a duck-type bill, a furry body like a mole, it lays eggs and it suckles its young. Now the argument you employ would run as follows…Many birds have duck-type bills, and lots of animals have furry bodies, and as for laying eggs, this is common in birds and reptiles, and all mammals suckle their young, therefore the duck-billed platypus ‘would appear to have to have no characteristics which differentiate it sharply from other…’etc. I hope my point is clear.” (See Donaldson and Gerard, p.31-32.)

So, health care is distinct in the comprehensiveness of market failure associated with it. Such failure arises from three main sources:

The failure of health insurance

Without government intervention, an insurance market would develop to deal with unpredictable health care needs. However, insurance is particularly problematic in health care. First, fixed costs of billing and advertising tend to inflate premiums. Note the US, where one in four dollars of health expenditure is spent on administration. This prices some people out of the market who would otherwise have been willing to insure. The only way to mitigate this without exploiting consumers is government intervention.

The second source of market failure in insurance is ‘moral hazard’, whereby the very act of becoming insured changes the way people behave. Because insurance encourages people to think that a third party - the insurer - will pay, the market fails to input cost considerations into the decisions of consumers and providers leading to cost inflation without much return in health benefits. This is the root of the continuing challenge of cost inflation in US health care.

The problem exists in public systems too, but government funding and supply side controls, through the ability to limit human and capital resource, allows the lid to be kept on costs. A naïve observer would say that user charges could control costs. However, charges choke off demand only amongst the poor and less healthy, are indiscriminate in choking off demand for needed as well as unneeded care and do not control total costs anyway, as the system simply switches its care-giving powers to these willing and able to pay. Note the problems with cost control in the systems with the greatest use of user charges, such as France and the US.

The ‘caring’ externality

Well-functioning insurance markets target low premiums to those at low risk and higher premiums to those at higher risk. In health, those at higher risk tend to be less-well-off, and thus unable to afford cover. Here, the market is working too well and it does present a social problem because we tend to care about lack of access to health care amongst less-well-off people. This ‘caring externality’ counts as market failure because society struggles voluntarily to transfer contributions from those willing to pay to enhance others’ access – though not voluntary, taxation is a more effective way of achieving these transfers.

Returning to the food market, a caring externality exists there too. However, food does not possess the other two forms of market failure that we list here- hence the less pervasive forms of intervention. It could also be argued that we could deal with caring through ‘safety nets’ such as the Medicare and the Medicaid systems for vulnerable groups in the US. However, in the US this still leaves around one in six people uninsured or under-insured, which seems to go against the caring externality argument.

Consumer ignorance

Markets work well when consumers are well informed which tends not to be the case in health care. Consumers are then protected in terms of quality through granting license to practice only to those with the qualifications to do so. By doing this, however, we indirectly give market power to professions. This requires what Evans has referred to as the ‘countervailing power’ of government to negotiate with these professions over rates of pay and provision of care.

Some final thoughts and a toast!

The above arguments, although ruling out the market as the basis for a whole health care system, do not rule out the use of market forces within an NHS-type framework. Recent governments have indeed shown this to be the case. The problem, however, is that such governments, including the current one, are good on the rhetoric of evidence but not on the reality. What is the evidence that the extra billions we have put into the NHS in recent years has improved health? Have waiting targets improved health? Has greater private sector involvement improved health? We need to get much smarter in this regard.

Related to this, we need to wake up to recognising scarcity of NHS resources and managing it 1. The NHS used to be good at this, but years of extra money flowing in seem to have de-skilled our managers and doctors in this regard. This is great for the likes of me as a whole new generation require educating in the ways of health economics. But it is not a good situation for the NHS to be in and represents the greatest threat to its sustainability over the next 60 years.

From what I have just said, I would not claim that the NHS is perfect. So, the toast I would propose is “two cheers for the NHS at sixty!”. However, given the earlier arguments about market failure, I would also propose no cheers to any alternative system of health care financing.

Reference

1 C Donaldson: ‘The fiscal future of the NHS: an economist’s rant’ National Health Executive May/June 2007 pp14-15

Further reading

Donaldson C and Gerard K (with Mitton C, Jan S and Wiseman V). Economics of Health care Financing: The Visible Hand (2 nd edition). Palgrave/Macmillan, London, 2005.

Cam Donaldson holds the Health Foundation Chair in Health Economics at Newcastle University where he is director of the Institute of Health and Society. He is also a research professor at the University of Calgary. He can be contacted at cam.donaldson@ncl.ac.uk