Introduction to Health Economics and Policy

1. Introduction to Health Economics and Policy Introduction to the Economics of Health and Health Care Folland et al, chap1 EC386 Campaniello, N.

2. Logistics • Dr. Nadia Campaniello • Email: ncampa@essex.ac.uk • Room: 5B.340 • Office hours: Wednesday 2.30 p.m– 4.30 p.m. (but it could change, so please check my web page!) • Textbook: The Economics of Health and Health Care by Sherman Folland, Allen C. Goodman and MironStano, Seventh Edition, 2013, Publisher: Pearson • Other good reference text: Phelps C E, 2010, Health Economics, Fourth Edition, Pearson

3. Logistics • Class: Wednesday, 9-10 a.m. Presentations. In classes we will try to develop our ability to discuss health economics topics. Hence, in each class you will be asked to read a paper from the economics literature, summarize its main points and discuss them. As a formative assessment, one of you will be asked to present this using slides. It is NOT compulsory, so you can choose whether or not to do that, but it is a good chance to improve your communication skills and it will give you the opportunity of getting immediate feedbacks. Furthermore term paper will be based on papers you presented. • Evaluation: max{50% term paper +50% exam, 100% exam} • Term paper due on the 2nd may 2014 at midday • Attendance is not compulsory, but highly recommended. • Please do not forget to sign the attendance sheet!

4. Outline Aim: Discuss concepts of health and health care • What is health? • What is health care? • What is special about health care? • What is health economics? • Why is health relevant for Economics? • What is the size of the health sector?

5. What is health? • ‘Health is a state of complete physical and mental well-being and not merely the absence of disease or infirmity’ (World Health Organization, 1948) • Health is an asset, which depends on past health and current inputs. • What kind of inputs? - Lifestyle: diet, exercise - Health care

6. What is health? (cont) • Health: A product – the quantity and quality of which depends on a number of inputs, including life style choices and health care . health →labour→productivity and wages → economy output • More important, health is an asset: Health accumulates and depreciates over time. It can be thought of as a product (i.e. output) but also as an input.

7. What is health care? • Health care: The prevention, treatment, and management of illness and the preservation of mental and physical well-being through the services offered by the medical and allied health professions. So ‘ health’ cannot be the same as the ‘health care’ • We demand health care to improve our health and society supplies some level of it for efficiency and equity reasons - Demand for Health Care - Supply of Health Care

8. What is special about health care? • Externalities • Presence and Extent of Uncertainty • Prominence of Insurance • Problems of Information • Large Role of Nonprofit Firms • Restrictions on Competition • Role of Equity and Need • Government Subsidies and Public Provision These features are not wholly distinctive to health care markets, but the extent to which they matter exceeds the level found in almost any other sector of the economy

9. What is special about health care? (cont) • Externality • External benefits (or costs) arise when one’s person actions create benefits (or impose costs) on others, and when those benefits (or costs) are not privately accounted for in the person’s decisions. • There are both positive and negative spillover effects on decisions individuals and societies make about health care. E.g. sewage control, use of mosquito nets to control malaria, use of condoms to control HIV infection, drink and drive decision, etc. • Uncertainty When consumers make decisions, they are uncertain about - their own health status ( demand for health care is irregular ) - what physician and/or treatment to undertake - outcome of treatment - cost of treatment

10. What is special about health care? (cont) • Prominence of insurance Consumers purchase insurance to guard against this uncertainty and risk. • Uncertainty on both the supply and demand sides might lead to the result that insurance markets for various risks would often fail to raise • These factors suggest a role for government

11. What is special about health care? (cont) • Problems of information Uncertainty can in part be attributed to lack of information. For example, neither gynecologists nor their patients may recognize the early stages of cervical cancer without Pap smears. At other times, the information is known to some parties but not to all, and then it is the “asymmetric information” that is problematic. For example consumers may not know which doctors or hospitals are good, capable or even competent. The individual consumer (the principal) depends on the provider (the agent) in a special way: the provider offers both the information and the service, leading to the possibility of conflicting interests.

12. What is special about health care? (cont) • Large role of Non-profit Firms Economists assume that firms maximize profits, but many health care providers (hospitals, nursing homes, etc.) have non profit status. What, then, motivates these non profit institutions if they cannot enjoy the profits of their endeavors? Economists must analyze the establishment and perpetuation of nonprofit institutions, and understand the differences in their behaviors from for-profit firms

13. What is special about health care? (cont) • Restrictions on competition Health sector has developed many practices that effectively restrict competition: • Licensure requirements for providers; • restrictions on provider advertising; • regulation to promote quality or to curb costs. The causes and the impacts (who loses? who wins?) of regulations require considerable attention by economists! Control of the monopolies or antitrust action can serve to promote competition.

14. What is special about health care? (cont) • Role of Equity and Need Poor health of another human being often evokes a feeling of concern that distinguishes health care from many other goods and services. “People ought to get the health care they need regardless of whether they can afford it.” BUT in practice “need” is difficult to define…

15. What is special about health care? (cont) • Government Subsidies and Public Provision In most countries, the government plays a major role in the provision and financing of health services.

16. What is special about health care? (cont) Selected OECD countries: Public expenditure on health as % of total health expenditure Most health expenditure is provided by the public sector. UK has quite a high public expenditure, while the US is particularly low Source: OECD Health Data 2011 EC386 Carmen A. Li

17. What is health economics? (cont) • Broad range of concepts, theories, and topics. It builds on the insights of microeconomic theory. • Emerged as a sub discipline of economics in the 1960s with the publication of two seminal papers: • Kenneth Arrow (1963) “Uncertainty and Welfare Economics of Medical Care” The American Economic Review. • Mark Pauly (1968) “The Economics of Moral Hazard: Comment” The American Economic Review.

18. What is health economics? (cont) Health economics is the study of how (scarce) resources are allocated to and within the health economy in order to produce health. • Four basic questions: 1. What combination of nonmedical and medical goods and services should be produced? 2. What combination of medical goods and services should be produced? 3. What specific health care resources should be used to produce the chosen medical goods and services? 4. Who should receive the medical goods and services that are produced? 1 and 2→ Allocative efficiency: What is the best way to allocate resources to different consumption uses? 3→ Production efficiency: How can society get the maximum output from its limited resources? 4→ Distribution of output and equity: Is the distribution of services equitable, or fair, to everyone involved?

19. Why is health relevant for Economics? At least three reasons: • the large size of the health sector with respect to GDP; • the cost and availability of health care is a recurring topic in national policy debate; • many health issues (e.g. patents and pharmaceutical industry, aging) are strongly related with the economic activity.

20. Features of Economic analysis Health economists have inherited from economics a set of concepts and questions that have proven to be particularly relevant to the policy problems that have emerged in health during the past three decades: • Scarcity of societal resources • Assumption of rational decision making • Concept of marginal analysis • Use of economic models

21. Features of Economic analysis (cont.) Scarcity of resources • Economic analysis is based on the premise that individuals must give up some of one resource in order to get some of another (“opportunity cost”). • At the national level this means that increasing shares of GDP going to health care imply decreasing shares available for other uses.

22. Features of Economic analysis (cont.) Assumption of rational decision making • Rationality is defined as “making choices that best further one’s own ends given one’s resource constraints”.

23. Features of Economic analysis (cont.) Marginal analysis • To make an appropriate choice, decision makers must understand the cost as well as the benefit of the next, or marginal, unit. • Marginal analysis entails the mental experiment of trading off the incremental costs against the incremental benefits at the margin

24. Features of Economic analysis (cont.) Use of models • Economics develops models to depict its subject matter • Models are often abstract and help to make sense of the world

25. Examples of Health Economic Analysis Some of the earliest work in health economics addressed several of these issues. • Milton Friedman and Simon Kuznets, both later Nobel laureates, studied the so-called physician shortage of the 1930s. They discovered that although physicians earned 32 percent per year more than dentists, their training costs were 17 percent higher. The remaining difference was still large, however, and Friedman and Kuznets (1945) attributed part of the higher returns on investment enjoyed by physicians to barriers to entry into the medical profession.

26. Does Economics apply to health care? Does Price Matter? The curve shown is similar to an economist's demand curve in that it shows people consuming more care as the care becomes less costly in terms of dollars paid out-of-pocket. More importantly, the curve demonstrates that economic incentives do matter. Those facing higher prices demand less care. Figure 1-2 Demand Response of Ambulatory Mental Health and Medical Care in the RAND Health Insurance Experiment Source: Keeler, Manning, and Wells (1980) for mental health care; Keeler and Rolph (1988) for medical care.

27. Size of the health sector • Health expenditure in the USA: • passed $1,000,000,000,000 (one trillion) by 1997 • now accounts for just over 16% of USA GDP • is forecast to account for US$3.6 trillion - nearly one fifth of all US economic activity - by 2014 • will plausibly reach 33% of GDP by 2050 • Health expenditure in the UK: • comprises >18% of all Government spending • UK NHS is Europe’s biggest employer • is a major consideration in fiscal management of the economy • In every developed economy: • health care is a major component of spending, investment and employment • the economic performance of the health care system is linked to the overall economic well-being of a country and its citizens

28. Size of the health sector (cont) Figure 1-1 U.S. Health Expenditure Shares, 1960 – 2020 Source: Centers for Medicare and Medicaid Services

29. Size of the health sector (cont) Table 1-1 Health Expenditures as Percent of GDP in Selected OECD Countries

30. Size of the health sector (cont) Selected OECD countries: Total expenditure on health as % GDP • Expenditure in health is an important % of GDP and its importance has grown over time (double since 70s in some countries) . • US is the biggest spender. It spends twice as much as the UK (national health insurance). • Source: OECD Health Data 2011

31. Size of the health sector (cont) Table 1-2 Total Consumption Expenditures in $ Billions, by Type, 2009 In 1960 food represented about 25% of spending, housing about 15% and medical care only 5%.

32. Size of the health sector (cont) Table 1-3B Active Health Personnel and Number per 100,000 Population (in Parentheses)

33. Size of the health sector (cont) Selected OECD countries:Total expenditure of health per capita (US dollar purchasing power parity) • Very large differences in health expenditure per capita • Japan vs. US • US vs. UK • Sweden vs. Norway • Very large differences in health expenditure per capita: e.g. Japan vs. US, US vs. UK. Source: OECD Health Data 2011 EC386 Carmen A. Li

34. Size of the health sector (cont) UK 2011 Budget • After social protection, it is the most important section of the UK 2011 Government Budget Source: http://www.hm-treasury.gov.uk/2011budget.htm) EC386 Carmen A. Li