Economic Concepts in Healthcare
ECONOMIC CONCEPTS IN HEALTHCARE•••
Healthcare has always been an economic activity; people invest time and other resources in it, and they trade for it with each other. It is thus amenable to economic analysis—understanding the demand for it, its supply, its price, and their interrelationship. Economic analysis, of course, does not merely discern what the supply, demand, and price for healthcare in private or public markets are. It also attempts to understand why they are what they are: What behavior on the part of suppliers affects the demand for healthcare? How does a particular insurance framework affect supply and demand? And so on. Moreover, economic analysis is indispensable in the larger attempt to improve healthcare—to make it more efficient, for example, so that people can accomplish more with their investment in healthcare, or more in life generally with their resources.
The economics of healthcare, in fact, has grown into an established specialty within professional economics. Though virtually every good is in some sense an economic good, economists have been quick to notice some differences with healthcare. Final demand seems to be more supplier-created in the case of healthcare than it is with most goods; both the shape of health services and their price are very directly influenced by providers. Other forms of what economists call market failure occur in healthcare—for example, when people with a considerable demand for healthcare do not receive services because their high risk to insurers drives prices for even the most basic insurance to unaffordable levels.
As people have become increasingly concerned about rising cost, economic concepts have gained greater general currency in society's consideration of healthcare. Price is seldom no object, and the search for efficiency is vigorous. This entry on economic concepts in healthcare will:
- Clarify the differences between two important forms of efficiency analysis in healthcare;
- Articulate some of the difficulties in devising and using a common unit of health benefit;
- Examine the monetary evaluation of one health benefit, life extension;
- Focus on some of the fundamental moral difficulties that the demand for efficiency poses for clinical practice; and
- Briefly explore the notions of externality and public good and their role in health policy.
Many other economic concepts apply to healthcare, but these are some that obviously raise ethical issues and are therefore most appropriate to include in this volume. Throughout, however, it will be important to keep in mind that economists, qua economists, usually think of their primary task as describing the world, not saying what it ought to be.
One should also note that although many economic concepts may appear to be more at home in capitalist than in centralized, collectivist, or socialist economies, they virtually always have a role to play in those other economies, too. For example, cost-effectiveness and cost-benefit analysis are used at least as much in socialist as in more capitalist healthcare systems. While the economic concepts developed here may not be ideology-free, they are hardly confined to free-market frameworks.
Cost-Effectiveness, Cost-Benefit, and Risk-Benefit Analysis
Efficiency involves the basic economic concept of opportunity cost: the value sacrificed by not pursuing alternatives that might have been pursued with the same resources. When the value of any alternative use is less than the value of the current service, the current one is efficient; when the value of some alternative is greater, the current service is inefficient. In thinking of the possible alternative uses, our sights can be set either narrowly or broadly. If we focus just on other options in healthcare, wondering whether we can get more benefit for our given healthcare dollars, or whether we can get the same health benefit more cheaply, we are engaged in cost-effectiveness analysis (CEA). If, on the other hand, we are comparing an investment in healthcare with all the other things we might have done with the same time, effort, and money, we are engaged in cost-benefit analysis (CBA). CEA asks whether the money spent on a particular program or course of treatment could produce healthier or longer lives if it were spent on other forms of care. CBA involves an even more difficult query: whether the money we spend on a particular portion of healthcare is matched by the benefit. We determine that by asking in turn whether, spent elsewhere, it could produce greater value of another sort, not just healthier or longer lives.
Both kinds of analysis are important. We want to get the most health and life for our investment in healthcare (CEA), but we also want neither to be so occupied with other investments that we ignore improvements in health that would be worth more to us, nor to pass up other things in life because we are investing too much in relatively unproductive healthcare (CBA). CEA is the less ambitious enterprise: We compare different healthcare services, detecting either final differences in expense to achieve the same health benefit or differences in some health benefit (for example, added years of life, and reductions in morbidity). That itself is a tall order, but it is less daunting than CBA. CBA is difficult, of course, because the advantages gained from such other investments often seem incommensurable with health and longevity. Improvements within healthcare, though, often seem terribly incommensurable, too: How do we really compare the values of non-life-extending hip replacement, for instance, and life-extending dialysis or transplants?
Formal, economic CBA puts into common monetary terms the various benefits of the endeavors in life that are being compared—a life saved with healthcare is seen to have a value, let us say, of $1 million. With the benefits thus monetarized, the conceptual package of resource trading is tied together; we are able to compare the benefits of healthcare and those of other endeavors with each other in the same terms (i.e., monetary ones). If benefits are assigned a monetary value, then, since costs have been stated from the beginning in monetary terms, we can ascertain straightforwardly whether the benefits are worth the costs. If, for example, it will likely take three $500,000 liver transplants to get one lifesaving success, and if a life saved has a monetary value of $1 million, then the transplants cost more than the life they save is worth. Whether we are achieving actual value for money—efficiency—now gets an explicit answer (though critics will doubt that we can ever sustain the judgment that a life saved has a monetary value of only $1 million).
Another, less formalized kind of analysis is risk-benefit analysis: One compares the probabilities of harm presented by a certain course of action with its likely benefits. If another procedure is likely to produce similar benefits with less risk, the latter is obviously preferable. It is not always clear, however, when one risk is less than another; the two may be risks of different things—one, say, of paralysis and the other of chronic pain. Moreover, one procedure may harbor lower risk but also promise fewer health benefits; again we are left with non-comparables. Unlike CEA, the beneficial effects in risk-benefit analysis are not all measured on a common scale, and unlike CBA, the benefits are not put in the same terms as the costs or risks.
We use the economic tools of CEA and CBA to discern potential improvements in efficiency. The existence of a potential efficiency improvement, however, does not by itself tell us that we should pursue it. Efficiency is only one goal; we might also need to consider the fairness of distributing goods and resources in the most efficient way. Economists, though, will be quick to note efficiency's especially great moral force in two sorts of circumstance: where the new, more efficient distribution is Pareto superior (someone gains, and no one loses), or where the gain to some is sufficient to allow them to compensate the losers back to their reference point and still retain some net benefit for themselves. If, for example, so many people gain from water fluoridation that they are better enough off even after being taxed to provide a really ample compensation fund for those who suffer some side effect, then all, even the losers, gain by fluoridation.
Health Benefit Units: Well-Years or Quality-Adjusted Life Years (QALYs)
CEA, unlike CBA, does not venture answers to the question of how much money to spend for a given health benefit. It does, however, attempt ambitious as well as modest comparisons within healthcare. What it needs to be able to do this is a common unit of health benefit. In some contexts this will quite naturally be present; suppose we are comparing the respective prolongations of life provided by bypass grafts and coronary medical management (drug therapy). The more difficult task for CEA comes in translating widely different health benefits into a common conceptual currency. The notion developed for this purpose goes by various labels: a well-year, a quality-adjusted life year (QALY, pronounced to rhyme with holly), or health-state utility. The essential idea is a unit that combines mortality with quality of life considerations—a year of healthy life, as one defender of QALYs puts it. We can then compare not only life-prolonging measures with each other but also measures that enhance quality with those that prolong life—hip replacements with kidney dialysis, for example. And then we can also track the health of a population, calculating changes in per capita years of healthy life.
Having available a unit that combines mortality and morbidity will be immensely useful if we are trying to maximize the health benefit of a given amount of resources invested in healthcare. Suppose dialysis patients' self-stated quality of life is 0.8 (where 0 is death and 1.0 is normal healthy life). They would gain 8.0 QALYs from ten years on $40,000-a-year dialysis, a cost-benefit ratio of $50,000 per QALY. Suppose hip replacements improve fifteen years of life from 0.9 quality ranking to 0.99. That will be a 1.35 QALY gain for the $10,000 operation, a cost of less than $7,500 per QALY. To achieve greater efficiency, we apparently should expand the use of hip replacements and look toward reducing dialysis.
A sizable literature of CEA has developed, not only studies of particular procedures but also discussions about the construction of common units of health benefit. Take the QALY. Questions abound. Whom does one ask to discern quality-of-life rankings for different sorts of health states—patients with the problems, or other citizens and subscribers who are less dominated by their desire to escape their immediate health need? What questions do we ask them? Those building the QALY and well-year frameworks have used time trade-off (how much shorter a life in good health would you still find preferable to a longer lifetime with the disability or distress you are ranking?), standard gamble (what risk of death would you accept in return for being assured that if you did survive, you would be entirely cured?), and several others. Whatever question people are asked, it should convey as accurately as possible what might be called the QALY bargain: their exposure to a greater risk of being allowed to die should they have an incurable, lowranking condition, in return for a better chance of being helped to significant recovery or saved for prospectively normal health.
The moral argument for using some such common health benefit unit is more than just some narrow focus on aggregate economic efficiency per se. The major moral argument by many health economists for using both quality adjustment and longevity extension in a serious attempt to maximize the benefit that a plan or an entire healthcare system produces is that it is people themselves who implicitly quality-rank their own lives and thus consent to the allocation priorities that QALYs or well-years generate. Critics charge, however, that maximizing years of healthy life in our lifesaving policies systematically fails to respect the individual with an admittedly lower quality of life. To what interpersonal trade-offs have people consented, even when it might involve themselves? Suppose you yourself now prefer, as you did previously, a shorter, healthier life to a longer, less healthy one. You are now an accident victim who could survive, though paraplegic, while someone else could be saved for more complete recovery. Admittedly, you yourself prefer a life with recovery to one with paraplegia, and you would be willing to take a significant risk of dying from a therapy that promised significant recovery if it succeeded. You do not admit, though (and you never have admitted), that when life itself is on the line, a life with paraplegia is any less valuable to the person whose life it is than life without that disability. Compared with death, your paraplegic life could still be as valuable to you as anyone else's better life is tothem—that is, you want to go on living as fervently as the nondisabled person does.
Some analysts, in attempting to incorporate points such as this and other ethical criticisms of QALYs, have emphasized a standard distinction in economics, that between individual utility and societal (or social) value. Individual utilities convey information about the welfare of an individual, while social values constitute preferences or evaluative claims about communities or relationships between persons. People hold social values, just as they also have preferences about their own lives. For example, they typically believe that those who are more severely ill should get a given healthcare service first before another who is not as severely ill, even if in either case the care produces equivalent improvement in those two persons' individual utilities. They also typically believe that even if the individual utility of a given number of years of life extension is arguably greater for someone in full health than it is for someone with a significant chronic illness, the value of saving either of their lives is equal. Using the person trade-off technique for eliciting such social values, some economists and policy analysts (Nord; Menzel et al) have argued for extending empirical value measurement to so-called cost-value analysis (CVA). Whether a model for health resource allocation developed along such lines will prove to be ethically superior to standard health economic analysis that focuses on individual utility units such as QALYs will undoubtedly be vigorously debated in the coming decade.
Common health benefit units will undoubtedly continue to be developed and used. Their contested character only indicates that the process of economic analysis into which they fit, systemwide CEA, is itself a morally contested vision for healthcare.
The Monetary Value of Life
CBA, in contrast to CEA, demands the assignment of monetary value to the benefits of a program or procedure. The health benefit whose monetarization has received the most explicit attention in the literature of CBA is life itself. Economic evaluation of life itself, as superficial and distorting as it may sound, is in one sense now an ordinary phenomenon. Now that a great number of effective but often costly means of preserving life are available, we inevitably and repeatedly pass up potential lifesaving measures for other good things, and money mediates those trade-offs. In CBA, however, one goes further and assigns a particular monetary value, or range of monetary values, to life. Is that value $200,000 or $2,000,000? Other questions abound. Is the monetary value of a relatively short remaining segment of life (a year, say) simply an arithmetic proportion of the whole life's value? If we assume that the length of different people's lives that remains to be saved or preserved is equal, is the economic value of their lives the same, or does it vary—for example, with income level, wealth, or future earning power? And if it does vary, should we still use those varying values or instead some common average in doing CBA of healthcare?
Independent of the debates on those questions, economists have developed two main models for translating empirical data into an economic value of life: discounted future earnings (DFE), also known as human capital, and willingness to pay (WTP). DFE looks at the future earnings forgone when a person dies. In the economy, those earnings are what is lost when a person dies, so that from the perspective of the whole economy (if we can speak of any such thing), it would be self-defeating not to save a life for $200,000 if the value of the person's earnings (after discounting the future figures back to present value) was more than that. While such DFE calculations continue to be used in some CBAs in healthcare, DFE has been largely surpassed in economists' work by WTP. In WTP the value of life is taken to be a direct function of people's willingness to use resources to increase their chances of survival. Suppose one annually demands an extra $500, and only $500 extra, to work in an occupation that runs an additional 1 in 1,000 risk of dying. Then according to WTP, $500,000 (1,000 × $500) is the monetary value one puts on one's life. Within the context of CBA, this would mean it would be inefficient to devote more than $500,000 per statistical life saved to healthcare that eliminates prospective risks of death.
In economic theory, WTP is generally regarded as the superior model; it captures the range of life's subjective, intangible values that DFE seems to ignore. Generally people spend money for reasons of subjective preference satisfaction quite independent of monetary return. That is, economic value incorporates consumption values, not just investment. Despite that firm basis in underlying economic theory, WTP has raised a host of objections. For one thing, questions arise similar to those that afflict DFE. Just as there are in DFEs, there are wide variations in willingness to pay—largely based on people's wealth and income. May those variations in value legitimately affect what is spent on lifesaving measures? If their effect is legitimate, is that only for services privately purchased, or also for those funded publicly? Defenders of WTP have articulated many responses to handle these and other critical questions, but the model may still seem suspicious. Any statement to the effect that "it was efficient not to save his life (now lost)—it was worth only $500,000" is not easily accepted. Consequently, despite its professional popularity, WTP has hardly gained widespread moral acceptance for actual use in health-policy.
The basic problem is simply that in the end the world is such a different place for a loser than it is for a winner. Suppose one refuses to pay more than $500 (when one could) for a CAT scan or magnetic resonance image (MRI) that one knows is likely to eliminate a 1-in-1,000 portion of the risk of dying from one's malady, and that then one later dies because of that decision. Of course one has in some sense consented to what happened, but one never thought anything remotely like "$500,000—no more—is the value of my life," the life that after the fact is irretrievably lost. The move that economists make in WTP to get from an initial trade-off between money and risk to the value of a real, irreplaceable life is puzzling. One critic has claimed that in principle only valuations of life made directly in the face of death are correct reflections of the actual economic value of life (Broome). And as another contributor to this discussion has noted, we do not know of anyone "who would honestly agree to accept any sum of money to enter a gamble in which, if at the first toss of a coin it came down heads, he would be summarily executed" (Mishan, p. 159–160). Some conclude from this that CBA can set no rational limit on what to spend to save a life because no particular finite amount of money is adequate to represent the real value of life.
Even if this point about the actual value of a life is correct, however, it may not render WTP estimates of the value of life irrelevant for use in health policy. In the context of setting policy about whether to include a certain service in our package of insurance, we cannot just assume that the later perspective of an individual immediately in the face of death is the correct one from which to make decisions. Such a perspective may be proper for the legal system to adopt in awarding compensation for wrongful death, for there we are trying to compensate people for losses actually incurred. But perhaps healthcare decisions ought to be made from an earlier perspective. In modern medical economies, after all, most people either subscribe to private insurance plans or are covered by public ones. Once insured, whether in private or public arrangements, subscribers and patients as well as providers find themselves with strong incentive to overuse care and underestimate opportunity costs. Why should we not address the problem of controlling the use of care in the face of these value-distorting incentives at the point in the decision process, insuring, where the major cost-expansion pressure starts? In the context of CBA for health policy, while it may not be necessary to claim that willingness to risk life shows us the value of life, willingness to risk may still be appropriate to use in any case. Perhaps what is important in decisions to invest resources in healthcare is only that what gets referred to as the monetary value of the benefits should be derived from people's decisions to bind themselves in advance to certain restrictions on the provision of care. The problem with WTP may then be narrower: Many of the values of life generated by WTP are not sufficiently close to the actual decisions of people to take risk by limiting their own investment in lifesaving. That would render any resulting CBAs that used them crude and ungrounded, but would not necessarily seal the fate generally of WTP-using CBA.
It is possible that as a formal method of analysis, CBA will never have great influence. Even if that is true, however, the larger enterprise of less formal CBA will remain an active and crucial dimension of the broader attempt to find the proper place of healthcare in our lives overall.
The Difficulties That Economic Concepts Pose for Clinical Practice
Suppose that economic efficiency analysis, whether of the CEA, CBA, or other less formalized sort, lays the groundwork for recommendations about the kind and amount of healthcare to use—fewer diagnostic MRIs in certain low-yield situations and very cautious introduction of new, expensive drugs, for example, and more hip replacements and much more assertive and widely diffused prenatal care. The former, service-reducing steps would not constitute the elimination of merely wasteful procedures that generate no net health benefit. They would constitute something much harder: genuine rationing, in which some patients did not get what for them would be optimal care. How does such rationing for efficiency relate to the ethical obligations of healthcare providers? The traditional (at least traditionally professed) ethic of physicians is one of loyalty to individual patients. Generally, in turn, that loyalty is interpreted to mean beneficence: doing whatever benefits a patient the most, within the limits of what the competent patient willingly accepts. If healthcare is to be rationed in order to control the resources it consumes, however, will the basic clinical ethic have to change? This potential clash between traditional ethical obligations and the economic and social demands of the new medicine in an age of scarcity is one of the central foci of ethical controversies in medicine as we enter the twenty-first century.
One can divide the potential views here into incompatibilist and reconciliationist camps: those who think that the demands of societywide (or at least large-group) efficiency cannot be reconciled with the ethical obligations of practitioners, and those who think they can be. The incompatibilists will end up in two different positions: (1) the "well, then, to hell with morality" view in which one is willing to pursue economic efficiency anyhow; and (2) the anti-efficiency stance that opposes rationing in the name of a morality of strict beneficence toward individual patients. Reconciliationist views will also come in distinctly different sorts. (1) Parties more distant from the patient than clinicians should make all rationing decisions, and clinicians should then ration only within pre-determined practice guidelines—the separation-of-roles position. (2) As a provider, one's proper loyalty to a patient, though not dominated by efficiency, is to the patient as a member of a just society; this then enables the clinician to ration with a clean conscience if based on considerations of fairness and justice (Brennan). (3) Patients are larger, autonomous persons; rationing can then be grounded in the consent of the pre-patient subscriber to restrictions on his or her later care (Menzel, 1990). (Why would the patient consent?—to reserve resources for other, more value-producing activities in life.)
The strength of the incompatibilist views may seem to be that they call a spade a spade, but their abiding weakness is that they just dam up the conflict and create later, greater tensions. The reconciliationist views, on the other hand, deal constructively with the conflict and allow conscientious clinical medicine to find roots in a more cost-controlled, socially acceptable aggregate of healthcare. Their weakness may be the great difficulties they face in actual use. The separate-roles view requires extremely clear formulation of detailed care-rationing practice guidelines in abstraction from the medically relevant particulars of individual patients; by contrast, bedside rationing in which clinicians make substantive rationing decisions may be preferable and necessary (Ubel). The patient-in-a-just-society model requires a great degree of agreement on what constitutes a just society. And the prior-consent-of-patients solution requires not only accurate readings of what restrictions people are actually willing to bind themselves to beforehand but also a willingness of subscribers and citizens to think seriously about resource trade-offs beforehand and then abide honestly by the results even when that places them on the short end of rationing's stick.
Undoubtedly this discussion is not about to reach immediate resolution soon in societies that are enamored of ever-expanding healthcare technologies, pride themselves on respecting individual patients, and are determined to steward their resources wisely.
Externalities and Public Goods
Externalities and public goods play a prominent role in economics-informed discussions of public policy. Externalities are costs or benefits of a behavior not borne by or accruing to the actor, but by or to others. They pose a distinct problem for the achievement of efficiency in market economies. If I am making and selling an item whose production involves harms or burdens to others for which I do not have to pay, I will be able to price the product under its true cost and sell it more easily. The solution is to correct incentives by imposing a tax on the item equivalent to its external cost (or a subsidy equivalent to its external benefit). Even better, one could give the proceeds of that tax to the parties harmed by the item's use or production. Externalities, then, immediately propel us into public-policy decisions about taxes and subsidies.
Public goods also directly raise questions of public regulation and taxation. A public good in the economist's sense is one whose benefits accrue even to those who do not buy it. If you clean up your yard, I benefit from a somewhat better appearance on the block regardless of whether I clean up my own or help you clean up yours. Or if a large number of people contribute to an educational system in the community, I get some of the benefits of the more civilized culture and productive economy that result even if I never contribute anything. The benefit is thus public and nonexclusive: Once a certain mass of contributors is in place, it is difficult if not impossible to exclude from the benefits an individual who chooses not to contribute. Standard examples of public goods include many of the basic functions of the modern state (public safety, national defense, education, public health, and the reduction of pollution). Thus, public goods constitute a primary justification of the state's coercive power. If I contribute not a penny to a police force, for example, I will still receive most of its benefits; if not taxed, I can thus free-ride on others' willingness to fund public safety. The obvious solution is for the collective to tax me my fair share.
The use of both public goods and externalities is undoubtedly on the rise in discussions of healthcare. Note just two examples of the interesting contexts in which these concepts come up.
An example of externalities is the taxing of health-complicating products such as tobacco and alcohol. Smoking and excessive drinking undoubtedly increase certain costs to others—healthcare expenditures for smoking- and drinking-related diseases; lost work time; displeasure, sadness, and pain in dealing with others' destruction of their social and biological lives; and even direct loss of life (from passive smoking, drunk driving, etc.). These externalities provide part of the momentum behind the movement to increase taxes on tobacco and alcohol. Note, however, that the empirical picture can be much more complicated, and in the case of tobacco it certainly is. First-impression, informal cost analysis of smoking (and many published academic studies as well) leads us to think that smokers cost nonsmokers a great deal of money. That conclusion ignores, however, two hidden savings of smoking that accrue to others: Because smokers die earlier, and generally near the end of their earning years or shortly thereafter, they save others the pension payouts and the unrelated healthcare expenditures they would have incurred had they lived longer, without losing that saving through significantly reduced earnings. One leading study, in fact, concludes that all the costs that smokers impose on others, including losses from fires and the costs of the U.S. tobacco subsidies justify only a cigarette tax of $.37 per pack (Manning et al.). The typically higher taxes that actually obtain in most states cannot then be justified by any empirically well-grounded externalities argument, nor can the state governments' claims to settlements of hundreds of billions of dollars from tobacco companies (Viscusi). This is not the last word on the net external costs of smoking, but it illustrates the subtleties and hidden costs that increasingly sophisticated economic analysis reveals. Economic analysis may turn up equally surprising results in the future as we turn increasingly to prevention in the hope of controlling healthcare costs; prevention that saves healthcare expense in one respect may lose those gains as its longer-living beneficiaries draw more pension payouts and end up incurring higher aggregate costs of illness in their longer lives.
An example of public goods is sharing in the costs of a healthcare system that provides access to those who otherwise cannot pay. Suppose most people think a good society provides basic care to those who cannot afford it, and that they believe that the financial burdens of the medical misfortunes that people cannot have been expected to control by their own choices ought to be shared equally by well and ill. It is then possible to analyze the situation in the traditional and conservative terms of public goods and the prevention of free-riding. If a considerable amount of charity care is societally provided and access is thus improved, I gain both the security of knowing that I will be helped if I become poor or sick, and the satisfaction of knowing that I live in a society that does not neglect its poor and ill. If I do not contribute financially to make this more secure and arguably better society possible, I free-ride on the largess of others. This free-riding situation generates an essentially conservative justification for requiring people to pay into an insurance pool even when they think they are safe.
Many other interesting and controversial instances of the use of these and other economic concepts in the analysis of healthcare could be cited. Without being targeted accurately on identifiable pockets of market failure, tax breaks for health-insurance premiums would seem to create incentives for inefficient overinvestment in healthcare. If physicians significantly create demand for their own services, their incomes will need to be regulated either by the government or by market forces at work among health plans using salary or capitation payments (as distinct from fee for service) to compensate physicians. And so on and so forth. More generally, how to discern what constitutes efficiency in the investment of resources in healthcare, how to arrange incentives to stimulate efficient use of care, and how the achievement of efficiency is to be compared with the realization of other values central to the whole healthcare enterprise constitute the challenge that economic concepts bring to healthcare in the twenty-first century.
paul t. menzel (1995)
revised by author
SEE ALSO: Healthcare Allocation; Healthcare Resources; Healthcare Systems; Health Insurance; International Health; Justice; Just Wages and Salaries; Managed Care; Medicaid; Medicare; Pharmaceutical Industry; Profit and Commercialism; Value and Valuation
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