Health Economics Series: Cost Efficiency and Allocative Efficiency

A government can be cost-efficient but have poor allocative efficiency. Cost efficiency achieves the maximum health benefit at a given cost while allocative efficiency maximizes the health of society by achieving the right mixture of health goods and services according to preferences.

Say for example the government wants to produce more midwives under a national scholarship program to address the lack of health care professionals in community health care settings, particularly in BEMONC facilities. The choice of producing more midwives gained traction because it was perceived as relatively cheaper than producing medical doctors. If the cost of producing one midwife is 150,000, the cost of producing one doctor is 200,000 and the budget is 100,000,000, the government will have to look for a combination of inputs that results in the maximum output at minimal costs in order to be cost-efficient.

The red points in the first graph (Figure 1) shows different combinations at which the production of midwives and doctors are technically efficient. The green point shows the maximum number of midwives and doctors that can be produced at the given budget of 100,000,000. In this example, the government is cost-efficient if it produces 400 midwives and 200 doctors.

While producing these numbers of midwives and doctors are said to be cost-efficient, it would not immediately mean that the action depicts allocative efficiency. This type of efficiency occurs when goods (midwives/doctors) are distributed or allocated according to consumer preferences. Usually, allocative efficiency is seen as an output level where price (P) is equal to the marginal cost (MC) of production because the willingness to pay is equivalent to the marginal utility derived from the good consumed. Thus, the optimal distribution is achieved when marginal utility (MU) equals marginal cost.

At an output of 100, the marginal cost of the good is roughly 100 (Figure 2). But at is this output, society is willing to pay a price of 600. Therefore, society is said to be under-producing midwives. At an output of 500, the marginal cost is 600, but society is willing to pay only 100. Thus, society is said to be over-producing midwives. In this example, allocative efficiency will occur at a price of 350 with an output of 300. This is the point where the marginal cost is equal to marginal utility.

Health Economics Series: Average Productivity and Marginal Productivity

Average productivity (AP) is simply the quotient of the total output (O) divided by the number of units of a certain input (I) [i.e. AP = O / I]. Marginal productivity (MP), on one hand, is the additional output derived from an additional unit of a certain input [i.e. MP = ∆O / ∆I].

Example: Suppose that the Philippine Congress is currently deliberating on a bill that seeks to convert the Aparri District Hospital to Aparri Regional Hospital. One of the factors considered in this type of hospital conversion is the increase in the hospital’s authorized capacity which entails the creation of new plantilla positions. We take nursing personnel in the Out-Patient Department as the focus of this example. Table 1 shows the relationship between the nursing input (number of nursing staff), and the desired output (measured in the number of patient visits / attended).

Table 1. Input, Output, Average Productivity and Marginal Productivity for a Proposed Staffing Complement
Input

(Nursing

Staff)

Output

(Patient

Visits)

Average

Productivity

(O/I)

Marginal

Productivity

(∆O / ∆I)

0 0 0
5 10 2.0 2
10 30 3.0 4
15 45 3.0 3
20 50 2.5 1
25 55 2.2 1
30 60 2.0 1

The average productivity provides an insight into the “production process”. This product simply presents the average quantity of service (in this case, nursing services) produced by a nurse. With five nurses, a nurse can attend an average of two patients. Ten and 15 nurses tend to produce the same average productivity per nurse which happens to be the highest among the other averages. At first glance, decision-makers are given the option to choose whether to allocate funds for ten or 15 nurses. Choosing the latter would mean more nurses employed in the government nursing service.

Since decision-makers want to maximize total product, they will look at how adding extra nurses affects marginal product which contributes to the total product. The table shows that adding more nurses generates fewer services in that it demonstrates the law of diminishing marginal productivity. The incremental nurses become less productive due to constraints imposed by other fixed inputs. Thus, at higher levels of output, the marginal productivity of nurses begins to decline. In order for the government to get value for money, decision-makers will look at options where the marginal product continues to rise. In this case, it is at option 3 (ten nurses). While the average productivity of 15 nurses is the same as that of ten nurses, the marginal productivity actually decreased when five more nurses were added to the nursing pool.

Health Economics Series: Uncertainty and Asymmetric Information

Uncertainty is a situation where it is impossible to know the likelihood (unknown probabilities) of an event occurring while information asymmetry is a situation in which one party has more / better information than the other party.

Many Filipinos exhibit the first type of information failure: uncertainty. Filipinos are not keen on examining the financial implications of contracting a disease/illness. Because of the perceived uncertainty of acquiring the disease and its associated financial repercussions, many Filipinos do not know their need for health care. Two policy responses are widely accepted in the country (social health insurance and private insurance) to help address this. Through these insurance schemes, financial uncertainties directly connected to future disease or disability are minimized.

Information asymmetry is seen in the classic case of tobacco smoking. Smokers usually do not know the addictive properties and health consequences of tobacco use. As such, in 2014, the Graphic Health Warnings bill was signed into law. This law seeks to curb tobacco smoking by providing health information through graphic health warnings in tobacco product packages. The law is the government’s response to information asymmetry happening between tobacco manufacturers and tobacco smokers.

Free-rider Problem in the Philippine Health Care System

From an economic perspective, the production of public goods can lead to a market failure. A market fails when the free market economy does not achieve efficient results. Such failure can be attributed to the free-rider problem. A public good has a classic free-rider problem because of its two characteristics: non-excludability and non-rivalry. A good or service is non-excludable when it is impossible to stop anyone from consuming it. It is non-rivalrous when the consumption of an individual does not reduce the amount available to others. Therefore, public goods such as national defense may not be provided in a free market.

In some contexts, health is not considered a public good. Non-paying individuals (e.g. uninsured individuals) are not allowed to consume a good or avail a service. The introduction of the universal health coverage, however, moves health care closer to being a public good. Social health insurance, such as Philhealth, makes it possible for citizens to become insured and therefore utilize health care goods and services regardless of whether they can afford it or not. Social health insurance makes health care goods and services non-excludable and non-rivalrous; thus, making health care more like a public good.

People generally tend to behave according to the perceived benefits and consequences of their actions. In the case of health, incomplete (and even complete) information does not necessarily lead people to behave in a manner expected of sufficiently informed health care consumers. Moreover, there is usually a long period between the development of risk factors and the onset of illness, especially for non-communicable diseases. Such delay obscures the link between unhealthy behaviors and diseases unlike other risky behaviors where costs and benefits are usually immediately appreciated.

Thus, people often underestimate the benefit of health care or their future health needs. Because sickness and health emergencies strike at any time, people do not have an incentive to whether participate or not in the health care market. Because of these reasons, many people often do not purchase health insurance even if they have the resources to do so. Eventually, these uninsured people obtain free medical care when the need arises.

Philhealth intends to decrease out-of-pocket expenses by transitioning as the “single payer” in the health care market, where the government buys the health care and chooses the quantity to supply. However, latest data from Philhealth shows that its support value stands only at 42%, which means that the majority of health expenses are still out-of-pocket. Hence, some of the quantity demanded for health care is dependent on the quantity demanded by patients at the out-of-pocket price. This is observed in the private sector where health care providers supply the quantity demanded by patients which often exceeds the efficient quantity (creating a deadweight loss).

In 2014, Philhealth introduced the Point-of-Care (POC) Enrollment program where qualified patients and their qualified dependents are provided with insurance coverage under the Sponsored Program. Their premium contributions are borne by the government facility, provided that they are certified poor by the social worker at the time of admission. It seeks to change traditional health-seeking behavior especially of the poor who opts to defer treatment because of financial constraints. The program aims to change such behavior to one that voluntarily seeks treatment by indicating that help is waiting at the point of care. Since these patients are supposedly accessing health care at zero or lower price, the quantity demanded almost always exceeds the quantity supplied. In this scenario, patients wait for treatment as seen in most of the government hospitals.

Given that only Sponsored or indigent members qualify for “free” health services, there may be questions regarding the extent of the free rider problem if it actually exists. Someone always has to pay for the health care that must be provided. We see that in the Philippines, the government pays the cost that is not borne by uninsured individuals, including the Sponsored and indigents. In 2018, 31% of covered members were either Sponsored or indigents suggesting that about a third of Philhealth-insured members are entitled to free health care. More than 40 million pesos (or 34% of total benefit payment) were paid by Philhealth for benefit claims of these indigent and Sponsored members in 2018.

This is not to say that the uninsured (and Sponsored or indigent) members of Philhealth are “parasites” who choose to pass on their health care expenditures to the rest of society by receiving health care without paying for it. In reality, many people who cannot afford health insurance also cannot afford to pay for even the most basic health care. Some of these people who cannot afford insurance or health care do not really choose to be in this predicament.With the government pushing for 100% social insurance coverage, the free-rider problem becomes more significant and apparent. Take a patient diagnosed with alcohol withdrawal as an example. He/she usually comes from the indigent sector of the society. Dire situations in the community, among other factors, compel binge drinking leading to alcohol addiction/intoxication. Since this patient receives care for free, there is little incentive for him/her to seek further management (i.e. rehabilitation) after the symptoms of alcohol withdrawal are addressed even when adequately referred to a rehabilitation facility by a medical professional. Therefore, there is quite a chance that the problem becomes cyclic – patient returning to the hospital for the same medical problem.

In a way, the case above presents a problem similar to that of a free-rider problem. Since health care in the Philippines is considered a public good, people try to avoid paying for it because the payment will likely have no perceptible effect on the amount of health care a person consumes. Because insurance coverage is ensured at point-of-care, people do not have the incentive to pay for premiums that are usually perceived to be in excess of the actuarial cost of the coverage – meaning, they pay more than the value they receive – even when they have enough resources to do so.

Unfortunately, the free-rider problem takes a toll in the health care system as the present service delivery model somehow pushes some people to further underestimate their health needs. This affects the healthcare system by (1) incurring additional health costs, and (2) allotting scarce resources to treat the same people with the same preventable medical problems rather than allotting these resources to other patients in the waiting line.

The government’s intention to expand Philhealth coverage, most especially to the poor, probably rests on purposes including the achievement of universal health care and the efficient redistribution of wealth. Since universal health care cannot be achieved unless there is an efficient redistribution of wealth, the government will continue to provide insurance coverage for Sponsored and indigent members at point-of-care. The resulting free-rider problem begs the government to look at ways on how to help these people internalize the value of health care. Investing in one’s health doesn’t only include purchasing health insurance. It also points to the strong need for investment in public health and primary care where mindset and health-seeking behavior are primarily shaped.

References:

Dayrit, M., Lagrada, L., Picazo, O., Pons, M., Villaverde, M. (2018) The Philippines healthsystem review. World Health Organization Regional Office for South-East Asia. Retrieved from http://apps.searo.who.int/PDS_DOCS/B5438.pdf

Gemeniano-Aragones, P. (2014). Point-of-Care Enrolment: Providing Coverage RightWhere It Matters. Philhealth. Retrieved from https://www.philhealth.gov.ph/news/2014/pointofcare_enrolment.html

Parkin, M. (2014). Microeconomics 11th edition. Pearson Education, Inc. USA

Philippine Statistics Authority. (2018). Philippines in Figures 2018. Retrieved fromhttps://psa.gov.ph/sites/default/files/PIF%202018.pdfPhilhealth. (2018). Stas & Charts. Retrieved fromhttps://www.philhealth.gov.ph/about_us/statsncharts/