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close this bookHealth Economics for Developing Countries: A Survival Kit (London School of Hygiene and Tropical Medicine, 1998, 134 p.)
View the document(introduction...)
View the documentPublication Series - Health Policy Unit
View the documentAcknowledgements
View the documentPreface
View the documentChapter 1: Health Economics and its Contribution to Health Planning
View the documentChapter 2: Economic Development and Health
View the documentChapter 3: Financing Economic and Health Development
View the documentChapter 4: Health Care: the State versus the Market
View the documentChapter 5: Demand, Supply and the Price System
View the documentChapter 6: Concepts of Economic Efficiency
View the documentChapter 7: Inputs, Resources and Costs
View the documentChapter 8: Outputs, Health and Health Indicators
View the documentChapter 9: The Techniques of Economic Evaluation
View the documentChapter 10: National Accounts and the Health Sector
View the documentChapter 11: Health Sector Finance and Expenditure
View the documentChapter 12: Sources of Finance for the Health Sector
View the documentChapter 13: Budgetary Procedures: Budgetary Reform and Programme Budgeting
View the documentChapter 14: Approaches to Financial Planning: Resource Allocation Planning and the Financial Master Plan
View the documentSelected Bibliography
View the documentGlossary
View the documentBack Cover

Chapter 6: Concepts of Economic Efficiency

1. Introduction

A central theme running through much of health sector economic analysis relates to the evaluation of health services. The importance attached to this activity has increased in recent years as economic recession has restricted the level of real resources available to health services. Now more then ever it is necessary to ask such questions as:

- are limited resources used in the best ways possible?
- is value for money achieved in their use?

In order to begin to answer these apparently straightforward questions a number of preliminary issues must first be resolved. In particular, it is necessary to have a clear understanding of:

- what one is trying to achieve i.e. objectives

- what 'the best use of resources' means i.e. evaluative criteria

- how to compare both the amount and the value of resources used in an activity with the amount and value of the output of that process i.e. measurement and valuation techniques.

In studying these issues a number of conceptual and methodological problems emerge. By highlighting them and by clarifying a number of associated concepts, definitions and techniques, the application of economic principles and methods to the planning, implementation and evaluation of health services is discussed.

This chapter covers the basic concepts of economic efficiency. Subsequent chapters consider the measurement and valuation of inputs, the measurement and valuation of outputs, and, finally, the way that these are combined in techniques of economic evaluation.

2. The Production Function and the Health Sector

In order to understand better the process of evaluation, it is important to identify three interrelated, although conceptually distinct, components common to all productive activities. These are: input, process, output.

Inputs are the various resources such as manpower and equipment that are available for use in a productive activity. Process describes the transformation or productive technique which changes inputs into the desired outputs. Output refers to the end result of production. In economics these relationships are usually explored within the framework of the production function.

Production functions are merely a way of representing, both qualitatively and quantitatively, the relationship that exists between inputs and outputs. Within this framework the quantity of a particular type of output (Q) is represented as being determined by the various inputs that go into its production, such as labour (L), and capital (K). The way that these inputs are combined is represented by the factor (T), which assumes a given (fixed) state of technology, or the use of a particular type of production process.

The relationship between input and output is often represented by a production function of the type:

Q = f (L, K, T)

which is simply mathematical shorthand for saying that output (Q) is a function of (or dependent upon) combinations of labour (L) and capital (K), and the way in which they are combined (T).

Although this conceptual distinction seems clear, in practice, analysis is not quite so straightforward. In the social services in general and in the health sector in particular, a number of factors make the study of productive relationships extremely problematical.

In large part these are due to the complexity of the health sector itself. Health care systems are not simple productive units. They are highly complex, dynamic mechanisms, using a wide range of different resources, in a multiplicity of ways. They produce many different types of output simultaneously, and sometimes even unintentionally. The way in which these outputs are produced is often poorly understood and it is often difficult to relate a particular output to any one intervention or activity.

These are not the only difficulties. A large number of different types of resources are used in health activities. Because of poor information systems it can be difficult to identify, measure or value these inputs. Even greater problems exist on the output side of the equation. For example, a major problem relates to the confusion surrounding the true output of health services. If it is 'health', then it is necessary to define what one means by that term. Even if this were done satisfactorily, the concept still has to be measured and valued.

These problems relating to the output of the health sector have been explored by many researchers and from many different perspectives. The work remains largely at the conceptual stage and only recently have attempts been made to develop and use measures of health outcome in health services planning and evaluation. There is, however, growing support for the development of such measures and the near future may see their practical use increase. These issues will be explored in Chapter 8.

3. Economic Efficiency and Evaluation

In everyday use, the term efficiency is generally understood as the process of acting with a minimum of expense, waste or effort; or of getting 'value for money'. It certainly involves these things, but for the economist it also has a more precise meaning. In order to appreciate this concept of efficiency it is useful to consider its implications, first within the health sector and then outside it.

Within the health sector, economic efficiency requires that available resources are used in a way that guarantees that the population is as healthy as possible. For this state to be achieved, it is necessary that two separate criteria are simultaneously met. These may be termed effectiveness and efficiency. The first identifies the technical possibilities for transforming inputs into outputs; the second ranks these alternatives by comparing the costs of the inputs with the value of the outputs. In order to avoid the confusion that often surrounds their use in everyday language, it is useful to distinguish between these two terms.

Consider effectiveness first. Usually there will exist many ways of producing a particular type, level or mix of outputs. Some of these, however, will use inappropriate technologies or more resources than are necessary to produce a given level of output. In this sense, effectiveness is concerned with the process of minimizing waste or effort when achieving a given objective. Applying the technical consideration of effectiveness allows one to restrict the set of options that one needs to judge by the second 'criterion, that of efficiency.

Although a necessary first step, effectiveness is concerned only with the technical relationship that exists between input and output, it is not concerned with issues of value or of cost. Efficiency on the other hand, additionally requires that one takes into account the costs of the resources used in production and then compares them with the value of the output produced.

Exclusive concentration on what goes on within the health sector overlooks two important points. First, health and health services comprise only a tiny part of all those things which are valued by society; and they are not so highly valued that society is prepared to forego all those other things in order to obtain perfect health. Full efficiency requires that society compares the value of health and health services (and their resource costs), with the value (and resource costs) of all those other things. Efficiency in this respect requires that resources are allocated to productive activities in accordance with their value relative to their resource costs. In other words, society must choose how much health will be produced.

Second, health services are only one of the many determinants of health. Again, efficiency requires that one looks wider than health services and considers both the relative effectiveness and efficiency of other ways of bringing about changes in health.

In short, economic efficiency is a way of assessing choices with regard to the value that chosen activities yield against the resource costs they imply. In practice such a comparison may prove difficult and a number of techniques have been developed that attempt to make this process easier, such as cost-effectiveness analysis, cost-benefit analysis and cost-utility analysis.

These techniques of economic evaluation differ considerably in their degree of sophistication and information requirements. Which one is appropriate in a particular situation will depend upon the question being asked and the degree of specificity required in the answer. These techniques are considered at greater length in Chapter 9.

In order to implement one of these evaluative techniques, it is necessary that inputs to and outputs from a health sector activity are qualitatively and/or quantitatively assessed. Although the economist is interested in how the production process effects the change from input to output, production techniques lie within the specialist expertise of the medical profession. Economists therefore concentrate on defining, measuring and valuing both health inputs and health outcomes.