Glocal Economics | From plan to market within the health sector

This article was contributed by economics professor Karen Eggleston from an article by Eggleston, Jian Wang and Keqin Rao, in a forthcoming book from University of Hawaii Press.

Countries worldwide confront the challenge of defining and achieving appropriate roles of the government and market forces in the health sector.

China – as both a developing and transitional economy – represents an important case. Since 1980, economic reforms have spurred unprecedented economic growth and lifted millions out of poverty. To what extent these achievements can be sustained and deepened will not only impact the lives of one-fifth of mankind, but will also affect the global course of such health threats as tuberculosis and HIV/AIDS, and the world’s ability to achieve the Millennium Development Goals.

How has the health of China’s population, as well as the performance of its health system, changed during the reform era? The World Health Organization’s World Health Report 2000 ranked China’s health system performance quite low: 144 out of 191 countries. Despite a relatively high ranking for level of population health (61), China’s system was deemed weak in the distribution of health and responsiveness, as well as particularly unfair in distributing financial burdens of health coverage and illness expense. Although many might quibble with the performance metrics, few would disagree that China’s health sector faces tremendous challenges.

Health Spending, Financing and Insurance

Although China pre-reform was a relatively low health spender for its income level, by 2000 China’s health spending (at 5.3 percent of GDP) was about average for its per capita income. China spends more of its national income on health than Indonesia or Sri Lanka, about average for transitional economies, and less than high-income European and North American countries. China’s health spending growth does not seem unsustainable in light of China’s income level and rate of economic growth.

More dramatic and worrying has been the change in structure of China’s health spending. Most countries increase the proportion of public spending as they develop. In China, by contrast, the share of health spending paid by public sources – government financing and social insurance – has declined significantly, with an ever-larger burden falling directly on patients. China’s reliance on out-of-pocket household payments for healthcare exceeds that of international outliers like South Korea and Mexico, is not even accounting for under-the-table payments (hong bao), which are pervasive. Since a single hospitalization might cost more than the annual income of the poorest citizens, the current system leaves the Chinese exposed to the risk of significant financial hardship from catastrophic illness expenses and a potentially vicious cycle of illness-induced poverty.

Collapse of China’s community financing institutions in rural areas, combined with lack of true risk pooling in urban areas, produced a dramatic fall in coverage at the onset of economic reforms. China is trying to revamp its health sector to match new economic and social realities. The current strategy for health insurance is two-pronged: pool risk at the municipal level in urban areas and re-establish a system of community financing with government subsidies in rural areas. Implementation has been slow, but official policy aims to cover all rural households with the new health insurance system by 2010, and all urban employees with basic social insurance even sooner.

China’s incomplete insurance coverage undermines the income- and health-protection aims of social insurance. Moreover, gaps in coverage exacerbate a problem called adverse selection: the insured are much older and sicker than average, driving up the cost of providing insurance. China is not nearly as regimented as many in the West perceive it to be – citizens routinely undermine official policies through various strategies of self-interested behavior or passive “resistance.” In the case of urban health insurance reforms, for example, although firms are under pressure from local social insurance bureaus to pay insurance contributions, these agencies often lack legal authority. Unsurprisingly, the firms that choose not to participate employ disproportionately young and healthy workers, whereas the firms that do participate have higher burdens of older workers and retirees.

Pricing, Payment and the Supply Side

Provider payment in China is predominantly on a fee-for-service (FFS) basis, with a government-regulated fee schedule. Under this payment system, doctors earn more money by charging for more services. Much evidence suggests that FFS payment leads to high and rapidly growing healthcare spending. In China, this problem with FFS is compounded by the way prices are set. Prices do not closely reflect the average costs of services. In fact, prices are intentionally set to provide implicit insurance for poor patients. Prices for basic services often do not cover even marginal cost.

To compensate providers for lost revenue, some other services – primarily high-technology diagnostic procedures and most pharmaceuticals – are priced well above average cost. The unintended (but hardly unpredictable) supply-side reaction is that doctors and hospitals view high tech and drugs as their financial salvation and frequently over-use and over-prescribe these profitable services. Ironically, distorted FFS reimbursement spurs cost escalation and exacerbates the very access problems that distorted prices were meant to prevent.

At the same time, China, like most transitional economies, is allowing more private ownership of healthcare delivery. Clinics and hospitals are mostly government-owned or operated by state-owned enterprises, but village doctors and individual urban providers are largely self-employed – that is, their own private, for-profit firms. Recently, moreover, Chinese policymakers have increasingly come to view government hospitals as a form of state-owned enterprise, meriting experimentation with managerial autonomy, incentives and property rights reforms. Some of the same trends driving ownership reform elsewhere in the economy – such as fiscal decentralization and competitive pressures – also spur property rights diversification in the health sector. Private clinics and hospitals now serve not just expatriates, but also a nontrivial and growing fraction of Chinese patients.

Some Conclusions for Policy

Arguably the most pressing priority from China’s health sector reforms should be to (re-)establish social solidarity through expanded health insurance coverage while upholding what progress had been made in allowing, and being responsive to, individual choice. Expanding insurance will require additional financial commitment or a significant re-allocation of resources toward rural coverage and population health. Health spending in China has grown considerably over the past two decades, exceeding even the blistering pace of growth of China’s overall GDP. An aging population, epidemiologic transition to more chronic diseases, increasing obesity and smoking-related illness, along with a significant burden from communicable diseases like tuberculosis and HIV/AIDS, make it difficult to envision health spending not growing as fast as, if not faster than, per capita income. With proper policy oversight (such as reforming provider payment), this trend is probably affordable.

What China cannot afford is to have that spending concentrated on the urban elite, to the exclusion of basic coverage for China’s rural majority and urban poor. Although the barriers to implementing effective health coverage are formidable, China has confronted and overcome similar challenges in the past. The question of affordability is whether China can afford not to put in place broad coverage for basic care. Since Chinese rural residents are already burdened with many seemingly arbitrary exactions, achieving widespread coverage will almost surely require significant redistribution of resources, particularly from the wealthier coastal and urban areas to the poorer rural and inland areas. Such transfers would seem to be more politically feasible now that the Chinese government has launched a campaign for development of the Western regions and balanced economic development.

Expanded health coverage would be one enabling factor for improving population health and helping to overcome disparities in health status, exacerbated by inequitable access to care. Health insurance expansion is also socially valuable beyond its link to improved health. For example, health insurance provides risk protection, helping to prevent illness-induced poverty and to promote social solidarity. Universal health insurance can also make workers more productive, spur labor mobility between jobs and reduce social welfare burdens on enterprises, allowing governments to harden budget constraints and transition to a market-based system with a social safety net separate from firms.

Economic theory and international experience all suggest an important role for government in organizing broad-based coverage for basic medical care. Expanded public financing strengthens the government’s ability to use its role as purchaser to promote quality care for all at reasonable cost. Social insurance bureaus can take the lead in promoting effective purchasing through payment reform, quality assurance initiatives, and so on.

A second urgent priority is promoting population health. Examples include educating consumers (about individual behaviors such as the risks from smoking, drinking, unprotected sex and sedentary lifestyles) and confronting the potential for a devastating co-epidemic of HIV/AIDS and tuberculosis.

A third and final important government role is in providing prudent regulation of a pluralistic delivery system. Theory does not dictate what the appropriate mix of public and private ownership is, and international experience provides mixed results. Nevertheless, most established market economies have moved toward public financing and pluralistic delivery. Although China’s policy focus elsewhere during initial transition took China in the opposite direction, with less public financing and continued public delivery, recent reforms foretell greater convergence to international norms.

With expanded public financing and effective regulation of pluralistic delivery, China may yet be able to reform the health sector into a model for other countries, as it once was and as other aspects of China’s socioeconomic development have been. These challenges will require financial and political commitment, as well as enlightened policy leadership.


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