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Richard Smith and Johanna Hanefeld
Global trade—the movement of goods, services, people, and capital between countries—is at the center of modern globalization. Since the late 20th century trade has also become established as a critical determinant of public health. As the raison d’être of trade is to increase both wealth and the availability of goods and services, changing trade patterns will inevitably impact many of the known determinants of health, including employment, nutrition, environmental factors, social capital, and education. Trade will also impact the health sector itself, most clearly through direct trade in health-related goods and services (such as pharmaceuticals, health workers, foreign direct investment in health services, and mobile patients), but also more broadly in determining tax receipts and thus overall public expenditures. It is also the case that trade—especially rapid and widespread movement of people, animals, and goods—may facilitate the rapid and widespread spread of disease. Trade, and associated policies governing and responding to that trade, has thus become increasingly recognized as a critical driver of health issues.
The design of trade policies that reduce the potential health risks associated with freer trade while maximizing the positive impact of trade liberalization on the social determinants of health is still in its infancy. There remains a lack of sound empirical evidence demonstrating how trade liberalization links directly and indirectly to health. Even though the positive link between increased trade, poverty reduction, and economic growth is widely accepted, evidence regarding the impact of trade liberalization on the social determinants of health varies from one national context to another. Hence, adapting trade liberalization to national conditions is important in ensuring desired outcomes. Yet although evidence is necessary, it is not sufficient to ensure that health is more integrated in trade negotiations and decision-making. There is a substantive requirement for those with a health remit to engage in negotiation with those from other sectors and from other geographic locations.
Sushant Acharya and Paolo Pesenti
Global policy spillovers can be defined as the effect of policy changes in one country on economic outcomes in other countries. The literature has mainly focused on monetary policy interdependencies and has identified three channels through which policy spillovers can materialize. The first is the expenditure-shifting channel—a monetary expansion in one country depreciates its currency, making its goods cheaper relative to those in other countries and shifting global demand toward domestic tradable goods. The second is the expenditure-changing channel—expansionary monetary policy in one country raises both domestic and foreign expenditure. The third is the financial spillovers channel—expansionary monetary policy in one country eases financial conditions in other economies. The literature generally finds that the net transmission effect is positive but small. However, estimated spillovers vary widely across countries and over time. In the aftermath of the Great Recession, the policy debate has devoted special attention to the possibility that the magnitude and sign of international spillovers might have changed in an environment of low interest rates worldwide, as the expenditure-shifting channel becomes more relevant when the effective lower bound reduces the effectiveness of conventional monetary policies.
Thomas E. Getzen
During the 18th and 19th centuries, medical spending in the United States rose slowly, on average about .25% faster than gross domestic product (GDP), and varied widely between rural and urban regions. Accumulating scientific advances caused spending to accelerate by 1910. From 1930 to 1955, rapid per-capita income growth accommodated major medical expansion while keeping the health share of GDP almost constant. During the 1950s and 1960s, prosperity and investment in research, the workforce, and hospitals caused a rapid surge in spending and consolidated a truly national health system. Excess growth rates (above GDP growth) were above +5% per year from 1966 to 1970, which would have doubled the health-sector share in fifteen years had it not moderated, falling under +3% in the 1980s, +2% in 1990s, and +1.5% since 2005. The question of when national health expenditure growth can be brought into line with GDP and made sustainable for the long run is still open. A review of historical data over three centuries forces confrontation with issues regarding what to include and how long events continue to effect national health accounting and policy. Empirical analysis at a national scale over multiple decades fails to support a position that many of the commonly discussed variables (obesity, aging, mortality rates, coinsurance) do cause significant shifts in expenditure trends. What does become clear is that there are long and variable lags before macroeconomic and technological events affect spending: three to six years for business cycles and multiple decades for major recessions, scientific discoveries, and organizational change. Health-financing mechanisms, such as employer-based health insurance, Medicare, and the Affordable Care Act (Obamacare) are seen to be both cause and effect, taking years to develop and affecting spending for decades to come.
David E. Bloom, Michael Kuhn, and Klaus Prettner
The strong observable correlation between health and economic growth is crucial for economic development and sustained well-being, but the underlying causality and mechanisms are difficult to conceptualize. Three issues are of central concern. First, assessing and disentangling causality between health and economic growth are empirically challenging. Second, the relation between health and economic growth changes over the process of economic development. In less developed countries, poor health often reduces labor force participation, particularly among women, and deters investments in education such that fertility stays high and the economy remains trapped in a stagnation equilibrium. By contrast, in more developed countries, health investments primarily lead to rising longevity, which may not significantly affect labor force participation and workforce productivity. Third, different dimensions of health (mortality vs. morbidity, children’s and women’s health, and health at older ages) relate to different economic effects. By changing the duration and riskiness of the life course, mortality affects individual investment choices, whereas morbidity relates more directly to work productivity and education. Children’s health affects their education and has long-lasting implications for labor force participation and productivity later in life. Women’s health is associated with substantial intergenerational spillover effects and influences women’s empowerment and fertility decisions. Finally, health at older ages has implications for retirement and care.
Important health system challenges in the east and southeast Asian countries/territories of Japan, South Korea, Taiwan, Hong Kong, Malaysia, China, Thailand, Vietnam, Indonesia, the Philippines, Laos, Myanmar, and Cambodia exist. The most commonly adopted health system among these areas is social health insurance. The high-income, aging societies of Japan, South Korea, and Taiwan have adopted single-payer/single-pipe systems with a single uniform benefit package and a single fee schedule for paying providers for services included in the benefit package. All three have achieved universal coverage with relatively equitable access to affordable care. All grapple with overutilization, aging populations, and hospital-centric and curative-focused care that is ill-suited for addressing an increasing chronic disease burden. Rising patient expectations and demand for expensive technologies contribute to rising costs. Korea also faces comparatively poorer financial risk protection.
China, Thailand, Vietnam, Indonesia, and the Philippines have also adopted social health insurance, though not single-payer systems. China and Thailand have established noncontributory schemes, whereby the government heavily subsidizes poor and non-poor populations. General tax revenue is used to extend coverage to those outside formal-sector employment. Both countries use multiple, unintegrated schemes to cover their populations. Thailand has improved access to care and financial risk protection. While China has improved insurance coverage, financial risk protection gains have been limited due to low levels of service coverage, fee-for-service payment systems, poor gatekeeping, and the fee schedule that incentivizes overprescription of tests and medicine. Indonesia, Vietnam, and the Philippines use contributory schemes. Government revenue provides insurance coverage for the poor, near-poor, and selected vulnerable populations; the rest of the population must contribute to enroll. Therefore, expanding insurance coverage to the informal sector has been a significant challenge.
Instead of social health insurance, Hong Kong and Malaysia have two-tiered health systems where the public sector is financed by general tax revenue and the private sector is financed primarily by out-of-pocket payments and limited private insurance. There is universal access to care; free or subsidized, good-quality public-sector services provide financial risk protection. However, Hong Kong and Malaysia have fragmented delivery systems, weak primary care, budgetary strains, and inequitable access to private care (which may offer shorter wait times and better perceived quality).
Laos, Cambodia, and Myanmar’s health systems feature high out-of-pocket spending, low government investment in health, and reliance on external aid. User fees, low insurance coverage, unequal distribution of health services, and fragmented financing pose pressing challenges to achieving equitable access and adequate financial risk protection.
These countries/territories are diverse in terms of demographics, epidemiological profiles, and stages of economic development, and thus they face different health system challenges and opportunities. This diversity also suggests that these nations/territories will utilize different types of health systems to achieve universal health coverage, whereby all people have equitable access to affordable, good-quality care with adequate financial risk protection.
Jan C. van Ours
There are three main topics in research on the effects of work on health.
The first topic is workplace accidents where the main issues are reporting behavior and workplace safety policies. A worker seems to be less inclined to report a workplace accident for fear of job loss when unemployment is high or when the worker has a temporary contract that may not be renewed. Workplace safety legislation has intended to reduce the incidence and severity of workplace accidents but empirical evidence on this result is unclear.
The second topic is employment and health where the focus is on how job characteristics and job loss affect health, in particular mental health. Physically demanding jobs have negative health effects. The effects of working hours vary and the effects of job loss on physical and mental health are not uniform. Job loss seems to increase mortality.
The third topic concerns retirement and health. Retirement seems to have a negative effect on cognitive skills and short-term positive effects on overall health. Other than that, the effects are very inconsistent, that is, even with as clear a measure as mortality, it is not clear whether life expectancy goes up, goes down, or remains constant due to retirement.
Jordan Everson and Melinda Beeuwkes Buntin
The potential for health information technology (HIT) to reshape the information-intensive healthcare industry has been recognized for decades. Nevertheless, the adoption and use of IT in healthcare has lagged behind other industries, motivating governments to take a role in supporting its use to achieve envisioned benefits. This dynamic has led to three major strands of research. Firstly, the relatively slow and uneven adoption of HIT, coupled with government programs intended to speed adoption, has raised the issue of who is adopting HIT, and the impact of public programs on rates of adoption and diffusion. Secondly, the realization of benefits from HIT appears to be occurring more slowly than its proponents had hoped, leading to an ongoing need to empirically measure the effect of its use on the quality and efficiency of healthcare as well as the contexts under which benefits are best realized. Thirdly, increases in the adoption and use of HIT have led to the potential for interoperable exchange of patient information and the dynamic use of that information to drive improvements in the healthcare delivery system; however, these applications require developing new approaches to overcoming barriers to collaboration between healthcare organizations and the HIT industry itself. Intertwined through each of these issues is the interaction between HIT as a tool for standardization and systemic change in the practice of healthcare, and healthcare professionals’ desire to preserve autonomy within the increasingly structured healthcare delivery system. Innovative approaches to improve the interactions between professionals, technology, and market forces are therefore necessary to capitalize on the promise of HIT and develop a continually learning health system.
Gregory Colman, Dhaval Dave, and Otto Lenhart
Health insurance depends on labor market activity more in the U.S. than in any other high-income country. A majority of the population are insured through an employer (known as employer-sponsored insurance or ESI), benefiting from the risk pooling and economies of scale available to group insurance plans. Some workers may therefore be reluctant to leave a job for fear of losing such low-cost insurance, a tendency known as “job lock,” or may switch jobs or work more hours merely to obtain it, known as “job push.” Others obtain insurance through government programs for which eligibility depends on income. They too may adapt their work effort to remain eligible for insurance. Those without access to ESI or who are too young or earn too much to qualify for public coverage (Medicare and Medicaid) can buy insurance only in the individual or non-group market, where prices are high and variable. Most studies using data from before the passage of the Patient Protection and Affordable Care Act (ACA) in 2010 support the prediction that ESI reduced job mobility, labor-force participation, retirement, and self-employment prior to the ACA, but find little effect on the labor supply of public insurance. The ACA profoundly changed the health insurance market in the U.S., removing restrictions on obtaining insurance from new employers or on the individual market and expanding Medicaid eligibility to previously ineligible adults. Research on the ACA, however, has not found substantial labor supply effects. These results may reflect that the reforms to the individual market mainly affected those who were previously uninsured rather than workers with ESI, that the theoretical labor market effects of expansions in public coverage are ambiguous, and that the effect would be found only among the relatively small number on the fringes of eligibility.
Health insurance increases the demand for healthcare. Since the RAND Health Insurance Experiment in the 1970s this has been demonstrated in many contexts and many countries. From an economic point of view this fact raises the concern that individuals demand too much healthcare if insured, which generates a welfare loss to society. This so-called moral hazard effect arises because individuals demand healthcare that has less value to them than it costs to provide it. For that reason, modern health insurance plans include demand side cost-sharing instruments like deductibles and copayments. There is a large and growing literature analyzing the effects of these cost-sharing instruments on healthcare demand.
Three issues have recently received increasing attention. First, cost-sharing instruments such as yearly deductibles combined with stop losses create nonlinear price schedules and dynamic incentives. This generates the question of whether patients understand the incentives and what price individuals use to determine their healthcare demand. Second, it appears implausible that patients know the benefits of healthcare (which is crucial for the moral hazard argument). If patients systematically underestimated these benefits they would demand too little healthcare without health insurance. Providing health insurance and increasing healthcare demand in this case may increase social welfare. Finally, what is the role of healthcare providers? They have been completely absent in the majority of the literature analyzing the demand for healthcare, but there is striking evidence that the physicians often determine large parts of healthcare spending.
Joachim Winter and Amelie Wuppermann
Choice of health insurance plans has become a key element of many healthcare systems around the world along with a general expansion of patient choice under the label of “Consumer-Directed Healthcare.” Allowing consumers to choose their insurance plan was commonly associated with the aim of enhancing competition between insurers and thus to contribute to the efficient delivery of healthcare. However, the evidence is accruing that consumers have difficulties in making health insurance decisions in their best interest. For example, many consumers choose plans with which they spend more in terms of premiums and out-of-pocket costs than in other available options. This has consequences for the individual consumer’s budget as well as for the functioning of the insurance market.
The literature puts forward several possible reasons for consumers’ difficulties in making health insurance choices in their best interest. First, consumers may not have a sufficient level of knowledge of insurance products; for example, they might not understand insurance terminology. Second, the environment or architecture in which consumers make their decision may be too complicated. Health insurance products vary in a large number of features that consumers have to evaluate when comparing options, introducing search or hassle costs. Third, consumers may be prone to psychological biases and employ decision-making heuristics that impede good choices. For example, they might choose the plan with the cheapest premium, ignoring other important plan features that determine total cost, such as copayments. There is also evidence that consumer education programs, simplification of the choice environment, or introducing nudges such as setting smart defaults facilitate consumer decision making.
Despite recent progress in our understanding of consumer choices in health insurance markets, important challenges remain. Evidence-based healthcare policy should be based on an evaluation of whether different interventions aimed at facilitating consumer choices result in welfare improvements. Ultimately, this requires measuring consumer utility, an issue that is vividly debated in the literature. Furthermore, welfare calculations necessitate an understanding of how interventions will affect the supply of health insurance, including supply reactions to changes in demand. This depends on the specific regulatory setting and characteristics of the specific market.
André Medici and Maureen Lewis
Latin American and Caribbean (LAC) countries have experienced a long-term process of improvement in populational health conditions, shifting their health priorities from child–mother care and transmissible diseases to non-communicable diseases (NCDs). However, persistent socioeconomic inequalities create barriers to achieve universal health coverage (UHC). Despite a high level of governmental commitment to UHC, and rising coverage, approximately 25% of the population does not have access to healthcare, particularly in rural and outlying areas.
Health system quality issues have been largely ignored, and inefficiency, from health financing to health delivery, is not on the policy agenda. The use of incentives to improve performance are rare in LAC health systems and there are political barriers to introduce reforms in payment systems in the public sector, though the private sector has opportunity to adapt change.
Fragmentation in the financing of healthcare is a common theme in the region. Most systems retain social health insurance (SHI) schemes, mostly for the formal sector, and in some cases have more than one; and parallel National Health System (NHS)-type arrangements for the poor and those in the informal labor market. The cost and inefficiency in delivery and financing is considerable.
Regional health economics literature stresses inadequate funding—despite the fact that the region has the highest inequality in access and spends the most on healthcare across the regions—and analyzes multiple aspects of health equity. The agenda needs to move from these debates to designing and leveraging delivery and payment systems that target performance and efficiency.
The absence of research on payment arrangements and performance is a symptom of a health management culture based on processes rather than results. Indeed, health services in the region remain rooted in a culture of fee-for-service and supply-driven models, where expenditures are independent of outcomes.
Health policy reforms in LAC need to address efficiency rather than equity, integrate healthcare delivery, and tackle provider payment reforms. The integration of medical records, adherence to protocols and clinical pathways, establishment of health networks built around primary healthcare, along with harmonized incentives and payment systems, offer a direction for reforms that allow adapting to existing circumstances and institutions. This offers the best path for sustainable UHC in the region.
Health status measurement issues arise across a wide spectrum of applications in empirical health economics research as well as in public policy, clinical, and regulatory contexts. It is fitting that economists and other researchers working in these domains devote scientific attention to the measurement of those phenomena most central to their investigations. While often accepted and used uncritically, the particular measures of health status used in empirical investigations can have sometimes subtle but nonetheless important implications for research findings and policy action. How health is characterized and measured at the individual level and how such individual-level measures are summarized to characterize the health of groups and populations are entwined considerations. Such measurement issues have become increasingly salient given the wealth of health data available from population surveys, administrative sources, and clinical records in which researchers may be confronted with competing options for how they go about characterizing and measuring health. While recent work in health economics has seen significant advances in the econometric methods used to estimate and interpret quantities like treatment effects, the literature has seen less focus on some of the central measurement issues necessarily involved in such exercises. As such, increased attention ought to be devoted to measuring and understanding health status concepts that are relevant to decision makers’ objectives as opposed to those that are merely statistically convenient.
Ciaran N. Kohli-Lynch and Andrew H. Briggs
Cost-effectiveness analysis is conducted with the aim of maximizing population-level health outcomes given an exogenously determined budget constraint. Considerable health economic benefits can be achieved by reflecting heterogeneity in cost-effectiveness studies and implementing interventions based on this analysis. The following article describes forms of subgroup and heterogeneity in patient populations. It further discusses traditional decision rules employed in cost-effectiveness analysis and shows how these can be adapted to account for heterogeneity.
This article discusses the theoretical basis for reflecting heterogeneity in cost-effectiveness analysis and methodology that can be employed to conduct such analysis. Reflecting heterogeneity in cost-effectiveness analysis allows decision-makers to define limited use criteria for treatments with a fixed price. This ensures that only those patients who are cost-effective to treat receive an intervention. Moreover, when price is not fixed, reflecting heterogeneity in cost-effectiveness analysis allows decision-makers to signal demand for healthcare interventions and ensure that payers achieve welfare gains when investing in health.
While the modern theory of international trade allows for many different modeling assumptions, the gains from trade can often be calculated using a common set of statistics. In particular, the share of a country’s output that is consumed domestically, the elasticity of bilateral trade with respect to trade costs, and the relationship between markups and firm size, each have a clear role in the gains from integration. All of these statistics may also be structurally linked to the degree of firm heterogeneity, usually the dispersion in firm-level productivity. Accordingly, the presence of firm heterogeneity may have a meaningful impact on the welfare response to trade liberalization. A quantitative application of a common firm heterogeneity model indicates that increased dispersion of firm-level productivity has a disproportionately large and positive impact on the gains from trade for smaller, less-developed countries.
Home bias in international macroeconomics refers to the fact that investors around the world tend to allocate majority of their portfolios into domestic assets, despite the potential benefits to be had from international diversification. This phenomenon has been occurring across countries, over time, and across equity or bond portfolios. The bias towards domestic assets tends to be larger in developing countries relative to developed economies, with Europe characterized by the lowest equity home bias, while Central and South America—by the highest equity home bias. In addition, despite the secular decline in the level of equity home bias over time in all countries and regions, home bias still remains a robust feature of the data.
Whether home bias is a puzzle depends on the portfolio allocation that one uses as a theoretical benchmark. For instance, home bias in equity portfolio is a puzzle when assessed through the lens of a simple international capital asset pricing model (CAPM) with homogeneous investors. This model predicts that investors should hold world market portfolios, namely a portfolio with the share of domestic asset equal to the share of those assets in the world market portfolio. For instance, since the share of US equity in the world capitalization in 2016 was 56%, then US investors should allocate 56% of their equity portfolio into local assets, while investing the remaining 44% into foreign equities. Instead, foreign equity comprised just 23% of US equity portfolio in 2016, hence the equity home bias.
Alternative portfolio benchmark comes from the theories that emphasize costs for trading assets in international financial markets. These include transaction and information costs, differential tax treatments, and more broadly, differences in institutional environments. This research, however, has so far been unable to reach a consensus on the explanatory power of such costs.
Yet another theory argues that equity home bias can arise due to the hedging properties of local equity. In particular, local equity can provide insurance from real exchange rate risk and non-tradable income risk (such as labor income risk), and thus a preference towards home equities is not a puzzle, but rather an optimal response to such risks.
These theories, main advances and results in the macroeconomic literature on home bias are discussed in this article. It starts by presenting some empirical facts on the extent and dynamics of equity home bias in developed and developing countries. It is then shown how home bias can arise as an equilibrium outcome of the hedging demand in the model with real exchange rate and non-tradable labor income risk. Since solving models with portfolio choice is challenging, the recent advances in solving such models are also outlined in this article.
Integrating the portfolio dynamics into models that can generate realistic asset price and exchange rate dynamics remains a fruitful avenue for future research. A discussion of additional open questions in this research agenda and suggestions for further readings are also provided.
Brant Abbott and Giovanni Gallipoli
This article focuses on the distribution of human capital and its implications for the accrual of economic resources to individuals and households. Human capital inequality can be thought of as measuring disparity in the ownership of labor factors of production, which are usually compensated in the form of wage income.
Earnings inequality is tightly related to human capital inequality. However, it only measures disparity in payments to labor rather than dispersion in the market value of the underlying stocks of human capital. Hence, measures of earnings dispersion provide a partial and incomplete view of the underlying distribution of productive skills and of the income generated by way of them.
Despite its shortcomings, a fairly common way to gauge the distributional implications of human capital inequality is to examine the distribution of labor income. While it is not always obvious what accounts for returns to human capital, an established approach in the empirical literature is to decompose measured earnings into permanent and transitory components.
A second approach focuses on the lifetime present value of earnings. Lifetime earnings are, by definition, an ex post measure only observable at the end of an individual’s working lifetime. One limitation of this approach is that it assigns a value based on one of the many possible realizations of human capital returns. Arguably, this ignores the option value associated with alternative, but unobserved, potential earning paths that may be valuable ex ante. Hence, ex post lifetime earnings reflect both the genuine value of human capital and the impact of the particular realization of unpredictable shocks (luck).
A different but related measure focuses on the ex ante value of expected lifetime earnings, which differs from ex post (realized) lifetime earnings insofar as they account for the value of yet-to-be-realized payoffs along different potential earning paths. Ex ante expectations reflect how much an individual reasonably anticipates earning over the rest of their life based on their current stock of human capital, averaging over possible realizations of luck and other income shifters that may arise. The discounted value of different potential paths of future earnings can be computed using risk-less or state-dependent discount factors.
Punishment has been regarded as an important instrument to sustain human cooperation. A great deal of experimental research has been conducted to understand human punishment behavior, in particular, informal peer punishment. What drives individuals to incur cost to punish others? How does punishment influence human behavior?
Punishment behavior has been observed when the individual does not expect to meet the wrongdoers again in the future and thus has no monetary incentive to punish. Several reasons for such retributive punishment have been proposed and studied. Punishment can be used to express certain values, attitudes, or emotions. Egalitarianism triggers punishment when the transgression leads to inequality. The norm to punish the wrongdoers may also lead people to incur costs to punish even when it is not what they intrinsically want to do.
Individuals sometimes punish wrongdoers even when they are not the victim. The motivation underlying the third-party punishment can be different than the second-party punishment. In addition, restricting the punishment power to a third party can be important to mitigate antisocial punishment when unrestricted second-party peer punishment leads to antisocial punishments and escalating retaliation.
It is important to note that punishment does not always promote cooperation. Imposing fines can crowd out intrinsic motivation to cooperate when it changes people’s perception of social interactions from a generous, non-market activity to a market commodity and leads to more selfish profit-maximizing behavior. To avoid the crowding-out effect, it is important to implement the punishment in a way that it sends a clear signal that the punished behavior violates social norms.
Jacob K. Goeree, Philippos Louis, and Jingjing Zhang
Majority voting is the predominant mechanism for collective decision making. It is used in a broad range of applications, spanning from national referenda to small group decision making. It is simple, transparent, and induces voters to vote sincerely. However, it is increasingly recognized that it has some weaknesses. First of all, majority voting may lead to inefficient outcomes. This happens because it does not allow voters to express the intensity of their preferences. As a result, an indifferent majority may win over an intense minority. In addition, majority voting suffers from the “tyranny of the majority,” i.e., the risk of repeatedly excluding minority groups from representation. A final drawback is the “winner-take-all” nature of majority voting, i.e., it offers no compensation for losing voters. Economists have recently proposed various alternative mechanisms that aim to produce more efficient and more equitable outcomes. These can be classified into three different approaches. With storable votes, voters allocate a budget of votes across several issues. Under vote trading, voters can exchange votes for money. Under linear voting or quadratic voting, voters can buy votes at a linear or quadratic cost respectively. The properties of different alternative mechanisms can be characterized using theoretical modeling and game theoretic analysis. Lab experiments are used to test theoretical predictions and evaluate their fitness for actual use in applications. Overall, these alternative mechanisms hold the promise to improve on majority voting but have their own shortcomings. Additional theoretical analysis and empirical testing is needed to produce a mechanism that robustly delivers efficient and equitable outcomes.
Economists have long regarded healthcare as a unique and challenging area of economic activity on account of the specialized knowledge of healthcare professionals (HCPs) and the relatively weak market mechanisms that operate. This places a consideration of how motivation and incentives might influence performance at the center of research. As in other domains economists have tended to focus on financial mechanisms and when considering HCPs have therefore examined how existing payment systems and potential alternatives might impact on behavior. There has long been a concern that simple arrangements such as fee-for-service, capitation, and salary payments might induce poor performance, and that has led to extensive investigation, both theoretical and empirical, on the linkage between payment and performance. An extensive and rapidly expanded field in economics, contract theory and mechanism design, had been applied to study these issues. The theory has highlighted both the potential benefits and the risks of incentive schemes to deal with the information asymmetries that abound in healthcare. There has been some expansion of such schemes in practice but these are often limited in application and the evidence for their effectiveness is mixed. Understanding why there is this relatively large gap between concept and application gives a guide to where future research can most productively be focused.
Ching-to Albert Ma and Henry Y. Mak
Health services providers receive payments mostly from private or public insurers rather than patients. Provider incentive problems arise because an insurer misses information about the provider and patients, and has imperfect control over the provider’s treatment, quality, and cost decisions. Different provider payment systems, such as prospective payment, capitation, cost reimbursement, fee-for-service, and value-based payment, generate different treatment quality and cost incentives. The important issue is that a payment system implements an efficient quality-cost outcome if and only if it makes the provider internalize the social benefits and costs of services. Thus, the internalization principle can be used to evaluate payment systems across different settings.
The most common payment systems are prospective payment, which pays a fixed price for service rendered, and cost reimbursement, which pays according to costs of service rendered. In a setting where the provider chooses health service quality and cost reduction effort, prospective payment satisfies the internalization principle but cost reimbursement does not. The reason is that prospective payment forces the provider to be responsible for cost, but cost reimbursement relieves the provider of the cost responsibility. Beyond this simple setting, the provider may select patients based on patients’ cost heterogeneity. Then neither prospective payment nor cost reimbursement achieves efficient quality and cost incentives. A mixed system that combines prospective payment and cost reimbursement performs better than each of its components alone.
In general, the provider’s preferences and available strategies determine if a payment system may achieve internalization. If the provider is altruistic toward patients, prospective payment can be adjusted to accommodate altruism when the provider’s degree of altruism is known to the insurer. However, when the degree of altruism is unknown, even a mixed system may fail the internalization principle. Also, the internalization principle fails under prospective payment when the provider can upcode patient diagnoses for more favorable prices. Cost reimbursement attenuates the upcoding incentive. Finally, when the provider can choose many qualities, either prospective payment and cost reimbursement should be combined with the insurer’s disclosure on quality and cost information to satisfy the internalization principle.
When good healthcare quality is interpreted as a good match between patients and treatments, payment design is to promote good matches. The internalization principle now requires the provider to bear benefits and costs of diagnosis effort and treatment choice. A mixed system may deliver efficient matching incentives. Payment systems necessarily interact with other incentive mechanisms such as patients’ reactions against the provider’s quality choice and other providers’ competitive strategies. Payment systems then become part of organizational incentives.