On the effectiveness of Publicly or Privately produced
Health care services
Sotiris Theodoropoulos*
University of Piraeus
Abstract
The production of goods and services in every sector of the economy has to be
realized according to socioeconomic efficiency criteria. The maximization of social
welfare demands that the production of goods and services fulfill Pareto optimal
conditions.
This naturally applies to the efficient provision of health care services, which in the
modern welfare state, seems to be mostly a state responsibility. Regardless of the
provision, the production of these services covering the ever growing needs of the
modern society – mainly in a comprehensive and free, without exceptions for the
whole population, manner – can be driven publicly or privately, usually parallel or in
various forms of complementarity.
Since many countries are faced with growing costs of health care services, and
subsequently focus on cost-saving and efficiency within restrained government
budgets, the controversial issue of public or private health care production, remains
high in the related debates.
In this paper we illustrate the ground cost framework, which determines the state and
private health care services production. State production is being realized and
provided ‘at the cost’ covering the means of production plus the labor of the health
care workers.
On the other hand, in the case of private production, we have to add on the above, the
profits of private health service providers, just as in the purchase of other goods.
In comparing the state-produced health care services with the privately produced
ones, we explore the determinants of the same production function, the preconditions
for such comparison, and also review the related market failures and regulatory
framework.
In conclusion, we point out the importance of the effectiveness in health care services
production, not only in the scope of socioeconomic efficiency, but also on ‘Social
Wage’, income distribution and competitiveness of modern economies.
JEL Codes: H44, H51, I10, I12, I18, L33.
Sotiris Theodoropoulos
Associate Professor
Department of Maritime Studies
University of Piraeus
stheod@unipi.gr
1. Introduction
The role and the importance of health care systems in the quality of life and social
welfare in modern society, have been broadly well recognized.
Also, due to their growing importance in public finances and the economy, they have
become a dominant economic and political issue. The need and pressure for efficiency
and effectiveness and an old controversial debate about the role of public and private
sector in the provision of health care goods and services, remain strongly up to date.
In this context, a vast related literature and a broad range of implemented reforms in
various countries have created huge knowledge and experience, valuable for health
care policies and efficient management of health care systems.
By this paper, we try to discuss the theoretical background of the importance of the
health care sector in modern societies, the complexity in nature and special character
of health care services and their imperfect market and also underline the changing role
in the provision of these services by public or private sectors.
We point out and discuss the ground and related factors of public and private
efficiency and cost effectiveness, emerging from the welfare states’ experience and
the changing role of the state and the market in modern economies.
Section 2 refers to the importance of health care services in modern societies and their
public finances.
Section 3 analyzes the particular nature of health care goods and services,
distinguishing them from other goods and services, due to the increased complexity of
their markets.
Section 4 gives a review of the theoretical background, related to efficient functioning
of the health care system and refers to the controversial issue of public or private
health care provision.
Section 5 discusses the determinants of the effectiveness of public or private
production for health care goods and services, based on related theory and recent
experience of health care systems.
Concluding, we point out the growing importance of the public sector’s stewardship
in efficiency and cost-effective functioning of the health care sector and the “return
flow” through “Social Wage”. Also in this effort we address the appropriate mixture
of both public and private sectors as a result of the new roles of the state and the
market.
2. The growing importance of health care services
Achievements in health worldwide in the twentieth century and especially during the
past few decades are impressive. The increase in life expectancy and the decrease in
fertility throughout the world have been greater in the past 40 years than during the
previous 4000 years. Life expectancy is almost 25 years longer today than at similar
income levels in 1900 (Preker A. et al 2000). These gains in health and quality of life
are mainly the result of achievement and development of medical care industry,
producing and delivering in broader parts of population a complex of services that
center about physician, private and group practices, hospitals and public health. To
these health gains, other causal factors such as improvements in income and
education, nutrition, clothing, shelter and sanitation have also contributed.
On the other hand, in developed and high-income countries, new factors related to the
living standard and the way of life, negatively affect the population’s health.
As an example we can mention Greece, where life expectancy at birth for males and
females increased by 10 years during the last 50 years. At the beginning of this
period, the country ranked second in the OECD in terms of life expectancy at birth,
but now it’s in the fifteenth position. High tobacco consumption, traffic accidents,
obesity, change of food habits that are increasingly Americanized, low level of
physical exercise, can explain that evolution (OECD 2010).
Health and health care, are becoming a dominant economic and political issue in most
countries, with increasing magnitude and importance of the health sector. Because of
this, most countries have experienced a rapid increase in health care expenditure over
the last decades. It exceeds on average 9% of GDP for OECD countries.
For this remarkable increase in health care expenditure, we can distinguish as direct
reasons the following factors:
a. Rising relative costs. There is a tendency for the relative costs of the health
services to rise faster than the average, so that a higher level of spending is
required year by year just to maintain standards.
b. Changes in population structure, particularly the age structure. The rapid aging
creates new pressure for the health care system.
c. New and improved services and also extension in the coverage, as more
groups in the population and more categories become eligible for the benefits,
that often take the form of a shift from private to public responsibility for a
particular area.
d. Growing social needs due to changing socioeconomic conditions.
How these increased in magnitude and importance resources are allocated to and
within the health economy, become a crucial issue.
The maximization of social welfare, requires increasing efficiency of health
expenditures, avoiding resource wasting, aiming to achieve welfare maximization
situation, according to the principle of Pareto optimality.
In this context, effective policies avoiding weakness and poor performance of health
care systems outcomes, are of central importance in the three core functions of health
systems (Preker A. et al 2000):



The Financing function, including the collection and pooling of revenues and
the use of these revenues through purchasing or budget transfers to service
providers.
The Resource-generation function, including production, import, export,
distribution and retail of human resources, knowledge, pharmaceuticals,
medical equipment, other consumables and capital.
The Service delivery function, includes both population-base and personal
clinical services provided by the public and private sector non-profit and forprofit.
The public sector’s strong engagement and efficiently executing it’s role in all three
functions and the private sector’s involvement in the second function, are some
crucial factors for health care system efficient functioning and its outcomes
maximization.
3. Special features of health care services demand and market
The effectiveness of a health care system, public or private, particularly in the
production and provision of health care services, is strongly related to some unique
characteristics for these services and their market. These characteristics, distinguish
these services from other goods and services and because of this, their market is
differentiated from usual commodity markets, as they are analyzed in economic
textbooks.
In his famous article, Kenneth Arrow (1963) lists the main characteristics of health
care services in the following categories:
A most distinguishing characteristic of the demand for medical services, is that by
nature, it is not steady in origin, but irregular and unpredictable. Apart from
preventive services, medical services afford satisfaction only in the event of illness.
Medical services demand, is associated, with a considerable probability with an
assault on personal integrity, some risk of death or a considerable risk of impairment
of full functioning. Illness is not only risky but a costly risk, apart from the cost of
medical care.
Health care services have to be produced only at the very instance when a need
emerges, otherwise they can be useless.
The expected behavior of the Physician as a seller of medical care, is different than
of businessmen in general, because medical care belongs to the category of
commodities for which the product and the activity of production are identical. The
customer, cannot test the product before consuming it and there is an element of trust
in the relation.
Advertising and over price competition, is virtually eliminated among physicians.
Advice given by physicians, is supposed to be completely diverged from self-interest,
dictated also by the objective needs of the case and not limited by financial
considerations.
Uncertainty as to the quality of the product, is more intense here than in any other
important commodity, because the recovery from the disease is as unpredictable as is
its incidence.
Due to the complexity of medical knowledge, health care market tends to be
characterized by both imperfect information and asymmetric information. In such
a situation, those on one side of the transaction have better information than those on
the other. As a possible consequence of these is that a market will not exist and even
if it exists, it will function inefficiently.
Related to the above, is the phenomenon of supplier-induced demand, where health
care providers have and use their superior knowledge to influence demand for selfinterests. Supply conditions differ also compared to other sectors, due to the entry
barriers such as the licensing restricting the entry to the profession, aiming to
guarantee the quality, as also the high cost and time consuming of medical education,
facing on the other side monopoly power conditions.
There are also limitations in the subsidized education aiming to reduce the cost. Such
factors increase the cost of health care services.
Unusual practices by medical professionals in pricing of their services is also
common, because they have traditionally held some monopoly power over their
clients.
To the above mentioned characteristics, we have to add that health care markets are
subject to prevalent externalities, motivations other than pure profit are common,
health care services are not uniform in quality or character, often firms are so few in
number that they have some degree of monopoly power (Folland S. et al 1997). Due
to such particularities and market failures, the health care market deviates from the
competitive assumptions and sometimes significantly.
Market forces alone fail also to secure equity, since individuals and families often fail
to protect themselves adequately against the risks of illness and disability on a
voluntary basis, due to short-sightedness (free-riding) (Preker A. et al 2000).
4. On the efficient provision of health care services
By recognizing the importance of health care services provision in modern society
and considering their nature and related significant market failures, the role of the
public sector becomes crucial in all three core functions of the health care system.
Regarding the generation of inputs, the public sector is a major player in the health
care economy as producer, redistributor and regulator.
Most health care goods and services do not behave like perfect private or public
goods. They all have some elements of excludability, rejectability and rivalry and they
can be characterized as private, mixed and public goods, depending on the degree that
they include such elements.
The production of such goods and services by the public sector, should not be
confused with the public provision. The central question here, is who would more
efficiently produce health care goods and services and provide them with universal
coverage, under the principles of accessibility, responsiveness, quality, accountability,
transparency, and equity.
Parallel to the market’s failures due to a number of reasons mentioned above, the
public sector may also fail for other reasons in service delivery. The relative roles of
the public and private sector in health care provision, have and continue to evolve
over time. The debate over the relative merits of private and public provision, as also
applied reforms, stem back to 19th century neoclassical economics until more recently
to the new public management theories.
Proponents of private provisions, cite that the competitive market model of profit
maximization causes potential gains in efficiency, quality, consumer choice and
responsiveness, transparency and accountability (Hsu J. 2010).
Furthermore, focusing on cost effectiveness and quality, the publicly owned
management lacks the freedom and expertise and also has relatively weak incentives
to make necessary investments, in contrast to private owned management or private
regulated contractors.
On the other hand, comparative cross-sectional studies suggested that providers in the
private sector, more frequently violated medical standards of practice and had poorer
patient outcomes, but had greater reported timelines and hospitality to patients.
Reported efficiency tended to be lower in the private than in the public sector,
resulting in part from perverse incentives for unnecessary testing and treatment (Basu
S. et al 2012).
The claim that the private sector is usually more efficient, accountable or medically
effective than the public sector, is not supported by systematic review of a number of
studies evaluating the efficiency of public versus private provision.
In a meta-analysis of 317 published works on efficiency measures, Hollingsworth B.
(2008) concludes that ‘public provision may be potentially more efficient than
private’.
A vast and ever-expanding literature on hospital efficiency, aiming to measure
hospital performance on the basis of their ownership, has emerged internationally. By
using Data Envelopment Analysis (DEA), a number of studies test the technical
efficiency of hospitals, while others test the impact on hospital efficiency of factors
such as hospital size, location, average length of stay, capacity utilization, teaching
mission etc.
Due to different testing factors relating to ownership, empirical evidence give mixed
results affected also by existing conditions in particular countries. This underscores
that one cannot generalize which ownership model is best across countries or even
within countries over time (Hsu J. 2010). Every country has to move towards its best
practices, by reducing waste and producing cost-effective interventions, or structural
changes to improve performance based on routine measurements of inputs and
outputs of systems, to identify and quantify inefficiency.
5. Determinants of public or private production’s effectiveness
The production of health care goods and services under public ownership, likely to be
superior to private ownership, rests on a set of assumptions and circumstances, based
on the belief that the public sector activities maximize social welfare.
Proponents of public sector involvement in health care in most societies, have argued
on both philosophical aspirations related to humanitarian issues and technical grounds
related to efficiency and welfare maximization.
The publicly produced health care goods and services (Qhg), irrelevant of their nature
to be public or private goods, are supplied ‘at cost’.
Public resource spending on health care production, consists of two separate items:

Gw: Wages and salaries of government employees, producing health care
services like doctors, nurses, technicians etc. and

Gr: Government expenditure for drugs, equipment, materials, electricity,
building, food etc.
In the case of public or ‘in house’ production, the taxes needed, cover only the cost of
labor of the health workers plus the means of production as in public production of
any other public good.
Qhg = Gw + Gr
In the case of privately produced health care goods and services (Qhp), to the above
cost of resources we have to add the private sector’s profit (P), on top of its wages
(W) and resources (R). (Gaof I. 1979)
Qhp = W + R +P
This optimal provision mode and cost effectiveness superiority of public sector, is
seriously incomplete and as we mentioned above, rests in a number of assumptions
not always existing in reality.
The welfare-state approach, failed to address many of the health needs of populations
across the world. Due to the distortions of government objectives, governments often
fail to develop effective policies and although state involvement in the health sector is
clearly needed, it is typically beset by public sector production failure.
The production function for health care services (Qh) is the same in public and private
sector.
Qh = f (L,K)
using labor and capital of various categories and forms respectively. By analyzing the
respective items of public and private sector cost for similar activities, the public
production ‘at cost’ may not be cost-effective and also sometimes may be more costly
than the private producing ‘at cost’ plus profit.
However, the prevalence of political patronage, transfers wealth to supporters by
excess employment, jobs at above-market wages or outright transfers, doctors taking
bribes to treat patients, awarding contracts to insufficient providers or overpaying
these providers, failing to make them accountable for quality and even failing to
enforce these contracts.
Along the same line, trade unions in the public sector around the world, are typically
the strongest opponents of privatization of any health sector’s activity, precisely
because they obtain significant benefits for their members in exchange for political
support (Shleifer A. 1998).
When the public sector enjoys monopoly power, people who work for it are given
wide scope for abusing this power, through the extraction of rents, internal
distribution of ‘slack’ to employees and lowering the quality. Such rents like the
informal user charges, various forms of corruption that are commonly levied on
patients and their families and others, can be internally consumed in several ways:
Executives often receive generous social benefits and travel allowances, time keeping
is often not enforced rigorously (doctors often work short hours in public institutions)
and also pursue personal agendas through discretionary spending on special projects
and research (Preker A. 2000).
Due to this burden placed on households and taxpayers charged twice for low quality
of services provided, the pressure to eliminate the public waste has mounted in the
last decades.
Extensive reforms of public sector organizations and state-owned enterprises
implemented over the past 20 years, addressed the same problems encountered in
delivering public health services. The need for a more cost-effective system, does not
comes into conflict with the needs of patients and other consumers.
The restructuring of the whole health care system, setting new roles for the public and
private sector, was an attempt to improve the efficiency in health care services by new
managerial systems of control, measures of rationalization, procurement systems,
using informatics.
The reprivatization of parts of the health care system by giving more space to private
sector, takes place more specifically for expenditure to switch from direct public
provision of services to public subsidization and purchase of privately produced
services. Health care goods and services, categorized from high-contestability and
measurability to low-contestability and measurability. Markets functioning and their
competitive environment, constitutes the framework on which decisions about the
appropriate public-private mix and ‘make or buy’ have to be taken.
6. Conclusions
The growing importance of the health care sector and the public sector’s stewardship
and early participation in health care during the twentieth century, especially in
modern societies is a common matter. The health care system, remains part of the
welfare state and most industrialized countries have achieved universal access to
health care through a mix of public and private arrangements.
Health care services provided without discrimination between households, increase
the living standard. The ‘return flow’ of such state benefits of collective consumption
and services in cash and in kind back to the employed and non employed population,
referred as the ‘Social Wage’, is of crucial importance for low income groups, income
distribution and social welfare.
Population’s health, has become a state responsibility, affecting also competitiveness
of modern economies.
The efficiency and cost-effectiveness in every part of activity and function of health
care system, is of crucial for taxpayer’s ‘value for money’ and the maximization of
social welfare.
Extended research and vast related literature has been devoted to this field.
Massive implemented reforms in the last two decades, have changed the role of public
and private sector in health services. Today the debate of private vs. public seems
anachronistic.
Most health care systems involve a mixture of public and private provision, the extent
of which varies considerably among countries.
References
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