23. Within the protective programs of the Welfare State, health care services are, quantitatively, a highly significant activity in all countries. After pensions, they represent the second largest program in terms of size, and often exhibit the highest growth rate in expenditure.

In general, the GDP percentages committed by OECD countries to health care expenditure range from the USA's extraordinary maximum (around 14 per cent) to around 6-8 per cent for most other countries. In systems based on public financing (the vast majority) this represents about 15 percentual points of total public expenditure. On the other hand, for reasons that will be discussed later, expenditure growth rates are fairly estable at 5-6 per cent per year, which implies a continuous growth in real terms.

These figures provide an approximate idea of the enormous quantitative importance health care systems have, and of the strongly positive slope of health expenditure.

But, also, its qualitative relevance is significant. In general, in practically all western societies there is a basic consensus that the State should insure the entire population against illness, not only for serious conditions but also providing basic services (e.g. Eurobarometer of November 1994: 67 per cent). At the same time the overall opinion is that it is not possible to maintain a high continuous increase in expenditure because this will lead to a decline in health benefits (ibidem: 54 per cent).

24. Health care systems under public financing began to consolidate in circumstances where any cost-benefit analysis (whether private or social) bore very positive results: low cost to health care access considering the level of medical and pharmaceutical technology; great relevance of average and marginal external effects; simple programs which did not entail significant problems in the management and supply of benefits; moderate percentage of population covered; and low development of private health care, which was not a profitable business.

However, the passage of time and the very process of economic development, gave rise to a substantial change in this scenario, that evolved in a way characterized by:

a) a strong rise of demand derived from the increased quality of life (which in Western economies began in the 60s);

b) the tendency to universalize public health care services;

c) an accelerated technical process, partly redundant and excessive, in the areas of diagnosis and treatment, and

d) the very success of these systems, evidenced by a strong decreased of morbidity rates and increased life expectancy.

25. All of which implies that, since budgetary restrictions will not allow to maintain the trend of real increases in public health expenditure, the future of health care benefits will necessarily go through one or a combination of the following alternatives:

1) Rationing of quantities.
2) Decreased quality.
3) Freezing of present situation by not incorporating new treatments.
4) Privatization of health care services.
5) Improved efficiency in management and supply.
6) Cost-sharing.

26. Rationing of quantities is not an attractive alternative, but two aspects should be taken into account by the very logic of the welfare system. Some benefits do not cover illnesses in the strict sense of the term (the treatment of influenza with antibiotics in low-risk groups, mild headaches, constipation, hair loss, etc.). Some treatments do not hold up to a cost-benefit analysis, neither private nor social, given the tendency in medical technological change to generate innovations which, in most cases where therapeutic benefit is demonstrated, entail marginal therapeutical improvements with total ignorance of costs. This issue of benefits which do not cover «real» illnesses, highlights the importance of having positive lists of benefits to be funded by the public health care system, i.e. the need to specify the content of the public health care policy.

The second issue is a matter of efficiency which shall be treated below (paragraph 34 and following).

27. Decreased quality is the usual escape forward in the case of benefits which have to satisfy certain levels of demand, with budgetary restrictions and in the absence of any gain in efficiency. The typical case is, perhaps, education where it is possible to achieve an increased output (students registered, degrees) by increasing the student/professor ratio, or by lowering the standards of exams or the actual teaching content. Also, poor quality ultimately increases the expenditure required to maintain health care levels, because poor quality has a negative effect on these levels. In quite a number of health care systems, notable savings have been achieved by improving the quality of benefits, albeit at mid-term.

Finally, with regard to quality, it is necessary to bear in mind that health care, an activity with asymmetrical information, tends, in the absence of regulation, to present competitive equilibria where quality is lower than the optimum and price is higher. This is a typical regulation problem that particularly affects health care systems.

28. Freezing of benefits at present levels is a simple variant of the zero-game option (see paragraph 16), in which the protected group maintains its benefits, but where budgetary restrictions are met by not taking new actions, whether preventive or curative.

29. The issue of privatization requires to distinguish between two very different meanings of the term. The first one is total privatization including: private insurance and funding. The second one, total or partial privatization of health care supply, while maintaining public funding.

Obviously, if a basic aim for reforming the system is to reduce public deficit, the greatest reduction will be achieved through total privatization. But this is an unsatisfactory alternative because it gives rise to an unequal and inefficient system.

30. In the present case, equity requires cross-subsidies between individuals due to the negative correlation between the level of income and health and life expectancy. An insurance system which differentiates premia according to effective differences in risk, would mean that low income levels and high risk groups would not be for the most part insured. A system of equal premiums would give rise to the well-known phenomena of moral hazard.

What frequently lurks behind proposals for an apparently total privatization, is the maintenance of a system of public welfare for bad risks (understood as costly health processes when compared to the therapeutical result) at all levels of income, but very concentrated at low income levels and high-risk groups; together with a private offer for good risks and high income consumers, where all inefficiencies may be readily transferred to higher premiums.

31. Regarding efficiency, it is clear that the supply of health benefits cannot be efficiently accomplished within a framework of private unregulated provision, because:

(i) There are market failures (externalities and asymmetric information), which means that competitive equilibria are not efficient allocations of resources.

(ii) The agents involved (physicians, manufacturers of hospital equipment, pharmaceutical companies), follow strategies which prevent competitive market equilibria.

32. An alternative route to analyze why the supply via an unregulated market of health benefits constitutes an inefficient mechanism, is to discuss the circumstances required for private supply of health benefits to be efficient, and the role prices play in such a setting.

To achieve an efficient private supply, the following must be accomplished:

a) Reduced transaction costs. Just remember that in the USA, administration costs make up for 25 per cent of total resources dedicated to health, while Great Britain reaches only 4 per cent.

b) The public sector should recover part of the surplus from producers. This is impossible if we take into account that demand for health benefits is inelastic regarding price, and consequently any procedure to tax surplus can be transferred to greater insurance premiums by insurance companies.

c) Suppliers should be diversified and should not act in collusion. The industrial structure of the two main suppliers of intermediate inputs (equipment and pharmaceutical products), as well as the strategic behaviour by suppliers of health services, make difficult to believe that this will in fact occur.

33. In turn, in order for prices to meet their role as efficient indicators of allocation, demand should be an adequate criterion for the allocation of health resources. This is not so when demand is not restricted or is unrestrictable by prices, unless the system loses any equity content. Moreover if as is the case, demand greatly depends on supply, price will not efficiently regulate expenditure.

34. In short, for equity reasons, funding of health care services should be public; and for reasons of efficiency production cannot be accomplished via a free and unregulated market. Nevertheless, this is not an obstacle to believe that the absence of competition generates incentives for inefficiency. For this reason, the introduction of competition in health care systems constitutes a pressing need.

Therefore, the reference frame for the discussion of health care reforms is an increase in efficiency by introducing competition in a regulated and publicly funded market.