Why economics is good for your health. 2004 Royal Economic Society Public Lecture

HEALTH ECONOMICS

Health Econ. 14: 987–997 (2005)

Published online in Wiley InterScience (www.interscience.wiley.com). DOI:10.1002/hec.1024

Why economics is good for your health. 2004 Royal EconomicSociety Public Lecture

Carol Propper*Department of Economics and CMPO, University of Bristol, UK

Introduction

Economists are often stereotyped as only beinginterested in money. In the health field, thisstereotype comes in the form that all economistsare concerned with is the cost of healthcare. Buteconomic analysis is far broader than simplycounting the costs of activities in hospitals or thatof new drug developments. The idea that indivi-duals make trade-offs, based on the benefits andthe full prices of competing activities is central tounderstanding why we are getting fatter, whynurses fiddle the figures in A and E departments,and why hospitals want to merge together. On theresearch agenda are such topics as understandingwhether restricting fast-food outlets will curb thegrowth in obesity, whether bans on smoking inpublic places will stop people from starting tosmoke, and whether the new market reforms inhealthcare in the UK will deliver better healthoutcomes.

Central to economic analysis is the idea thatindividuals make trade-offs based on relativeprices. Conceptually economists use a broaddefinition of price, called the opportunity cost ofan activity. In the case of consumption thisincludes not only the monetary price of buying aproduct, but also the time and other costsassociated with using it. So the price of consuminga restaurant meal will include the travel time to therestaurant as well as the bill for the meal. Closelylinked to the notion of price is the idea ofincentives: a change in the relative price of anactivity represents a change in incentives toundertaken that activity. So often economists use

the idea of prices and incentives interchangeably,and I’m going to do this here.

This focus on responses to full price helpsus to understand the behaviour of individualswith respect to decisions about their health(consumption decisions) and the responses ofsuppliers of healthcare (production decisions).I’m going to illustrate this by examining at a smallset of case studies, drawn from the health andhealth-care field. I’ll begin by looking at theconsumption side, where I’m going to look at theeconomics of obesity and addiction. Then I’llmove onto at the production side and look at theresponses of suppliers of healthcare – doctors,nurses and hospitals – to changes in the incentivesthey face.

The economics of obesity

The facts

Obesity – being too heavy for your height – is fastbecoming the number 1 public health issue in theWestern World. The US leads the way in the worldleague tables of obesity: the percentage of adultswho are obese (which is defined in terms of a ratioof weight to height) has doubled since the late1970s and tripled for children. The UK is notfar behind an OECD perspective and indicatesthat the UK and the US – together with the twocountries in the former Czechoslovakia – are at thetop of the league obesity table [1] (Table 1). Thisincrease has a cost. In the US it is estimated thatobesity is the second leading cause of death,

Copyright # 2005 John Wiley & Sons, Ltd.

*Correspondence to: Department of Economics and CMPO, University of Bristol, Bristol BS8 1TN, UK.E-mail: [email protected]

accounting for around 300 000 deaths per years,compared to smoking at around 400 000. In theUK over 30 000 deaths a year are caused byobesity in England alone. The National AuditOffice [2] estimated the condition costs the NHSd500 million a year and the economy d2 billionthrough sickness and early deaths.

The rise of obesity has been blamed on a hostof factors, including genetics, fast-food outlets,cars, TV viewing, a lack of participation in sportsand working women. With the exception ofgenetics, all of these factors exhibit upward trends.However, just because they increase at the sametime as obesity has risen does not mean that theycause increases in obesity: some may well bethe outcome of increased obesity rather thanthe determinants. Economists have focused onthe determinants of this rise and have argued thattechnology may be fattening. This possibly sur-prising argument goes as follows.

The economic argument: technology is

fattening

We begin with the fact that over the 20th century,obesity has grown with a modest rise incalorie consumption, falling food prices and asubstantial increase in both dieting and recrea-tional exercise [3]. This means any explanationhas to take into account that people are not eatingthat much more and they are doing morerecreational exercise. The first economic explana-tion is a long-run once and argues that long-runtechnological change has led to weight gain overthe last century.

Technological change and long-run weight gain.Weight is the outcome of consuming caloriesand expending calories. If calorie consumptionis greater than that needed to maintain currentweight, people will gain weight and vice versa.Philipson and Posner [3] argue that technologicalchange has altered the relative prices of consumingcalories and spending calories. Technologicalchange on the supply side, through agriculturalinnovation, has lowered the price of food, makingthe price of calorie consumption cheaper. At thesame time, technological innovation has changedthe nature of work. In agricultural and early indus-trial societies, work is strenuous; in effect, workersare paid to exercise. In a post-industrial society,work entails relatively little exercise. Payment ismostly in terms of foregone leisure, because leisure-based exercise must be substituted for exercise onthe job. So the cost of expending calories hasincreased. Together this means weight has risen.

This technology explanation has differentimplications for prices than alternative explana-tions for the rise in weight. If obesity is due to agrowth in the demand for food or a growth in thedemand for fast food, a change in attitude towardsobesity or reduced parental oversight of children,these would all increase the demand for food. Thiswould mean that weight would rise, but as demandfor food shifts outwards for a given supply, soprices and food consumption would unambigu-ously rise. Yet the long-run trends indicatesome periods in the last century in which therehave been declining calorie intake, declining pricesand yet growth in weight. This can be explainedby a combination of sedentary technological thatlowers the demand for food, while agriculturaltechnology expands its supply. The impact onquantity will be ambiguous, but the price effectwill be unambiguously negative. The evidencesuggests that around 40% of the recent growthin weight in the US may be due to agriculturalinnovation that has lowered food prices, while60% may be due to demand factors such asdeclining physical activity from technologicalchanges in home and market production [4].

Technological change in food preparation. Culteret al. [5] also stress the role played by technologicalchange. They argue that the Philipson and Posnerargument may explain long-run changes, butcannot explain the continued rise in US weight.Since the 1980s there here has been little techno-logical change in jobs since the 1980s and most

Table 1. Obesity trends: UK and USA

1946 1993 2000

% Obese, UKMen 12.0 13.2 21.0Women 11.0 16.4 21.4

1960 1993 2000

% Obese, USMen 10.7 23.3 30.9Women 15.8 25.9 34.0

UK Source: National Survey of Health and UK Department ofHealth. US Source: National Health Examination Survey andNational Health and Nutrition Examination Survey.

Copyright # 2005 John Wiley & Sons, Ltd. Health Econ. 14: 987–997 (2005)

C. Propper988

of the other changes in energy expenditure – sport,travel to work, etc. – occurred earlier. TV watch-ing increased considerably in the 1970s, but hasrisen relatively little since. Similarly, travel to workpatterns not changed that much in US since 1980s.

So explanations of recent weight gain mustfocus on reasons for increased calorie consump-tion. As noted above, conceptually, economists usea relatively broad definition of price, whichincludes not only the monetary price of purchas-ing a good, but also the time and other costsassociated with using the product. Culter and hisco-authors argue that there have been largechanges in the price of food consumption asa result of the technological change that havedrastically reduced the time costs of food prepara-tion. We eat more because improved technology –from the microwave oven to flavour-protectingpreservatives to packaging – has cut the time takento prepare food.

Thus food is cheaper, not only in the hours onthe job it takes to earn money to buy dinner (itsdirect price), but also in the minutes needed tomake it. In 1965 non-working married womenspent over 2 h per day cooking and cleaning upfrom meals. In 1995 the same tasks take less than1 h. This fall in time price has led to an increase inthe quantity and variety of food consumed. Culterand co-authors cite the case of the potato. BeforeWorld War II, Americans ate massive amounts ofpotatoes: largely baked, boiled or mashed. Chips(french fries) were rare, because the preparationtime was high. French fries are now peeled, cutand cooked in factories, then shipped frozen, tobe reheated in kitchen microwaves or a fast-foodfryer. The French fry is now the dominant formof potato in the US and between 1977 and 1995,Americans ate 30% more potatoes, most in theform of fattening French fries.

This theory has several implications. First,increased calorie consumption comes from con-suming more meals rather than more at a meal,because of lower fixed costs of food preparation.Second, consumption of mass produced food hasincreased the most. Third, groups in the popula-tion that have had greatest ability to takeadvantage of the drop in price of food preparationhave gained most weight.

These findings are broadly confirmed for theUS. Increases in calories consumption are due tomore snacks rather than more calories per meal.Around 28% of people reported eating two ormore snacks per day in 1977–1978, while in 1994–

1996 this number was 45%. Table 2 shows changesin calorie consumption in the US, the rise in thenumber of meals consumed, and the dramaticincrease in the calories from snacks. In contrast,the amount of calories eaten at each meal has risenmuch less, and in some cases (such as at dinner forwomen), has actually fallen. This increase insnacking means obesity gains can’t be due solelyto bigger portions in restaurants (because whatis eaten is primarily dinner) or fattening mealsat fast-food restaurants (because this is usuallyeaten as a formal meal in the USA). The increasein snacks is largely concentrated in snacks athome, and to a lesser extent, bought in stores andrestaurants.

In addition, food items with large amounts ofcommercial preparation have increased most inconsumption: those with less commercial prepara-tion have fallen. Groups who previously spentmost time preparing food in the early 1970s –primarily married women – have increased most inweight.

These economic analyses can also explain whythere are differences across income groups inweight gain. In the US, the rich tend to be thin,the poor overweight. One in four adults below the

Table 2. Changes in US calorie consumption 1977/1978–1994/1996

Calories

Meal 1977–1978 1994–1996 Change

Male Total 2080 2347 267Breakfast 384 420 36Lunch 517 567 50Dinner 918 859 �59Snacks 261 501 240Caloriesper meal

573 566 �7

Mealsper day

3.92 4.53 0.61

Female Total 1515 1658 143Breakfast 286 312 26Lunch 368 398 30Dinner 676 602 �74Snacks 186 346 160Caloriesper meal

422 408 �14

Mealsper day

3.86 4.44 0.58

Source: Culter et al. [5].

2004 Royal Economic Society Public Lecture 989


poverty line is obese, compared to one in six inricher households. In post-industrial society, peo-ple must pay for, rather than be paid, to under-taken exercise. If work is sedentary, an increase inearned income will have a larger effect on weightthan an increase in unearned income, becauseearned income also reduces physical activity.Exercise is also more expensive for those whohave earned income, because they must give uptime that could be spent in work. Therefore thosewith greater income from asset markets maybe less obese than those who get income fromemployment markets. Further, in terms of foodprices, calorifically speaking, the best bargains arepacked with sugar, fat and refined grains. Pro-cessed foods are also more accessible: their longshelf life means they can be found in most stores,so the travel costs to access them are less. Thisis perhaps less a European problem – where thedensity of living and food outlets in urban areas ishigh – than a US one – where many people don’thave close markets, but do have petrol stationsand small convenience stores close by. Thus in theUS, for poorer individuals the cost of use suchstores and buying such foods is lower than the costof searching out the healthy and more expensivealternative. Poor children – at least those in urbanareas – also face higher costs of exercise: greenspaces are further away; the streets are less safe.

Implications of these explanations

These economic analyses draw attention to the factthat some of the culprits blamed for the increasein obesity – the rise in restaurants and fast-foodoutlets the greater amount of pre-prepared foodin supermarkets – are not the causes of the increasein obesity, but are the correlates. Faster food isa natural response to the increased value of timeinduced by technological change: the outputforegone by a meal produced at home has risen,so individuals will demand faster food, both athome and in the market.

The analysis also suggests that while geneticsand food addiction may play a role, geneticscannot be the driving force. Genetics or addictionmight explain cross-sectional differences within apopulation. However, the rapid increase in weightgain is unlikely to be genetic. Rather, the rise isdue to the interaction of genetics and changes inprices: the drop in the price of food has allowedindividuals who might be addicts or need less

calories to eat more. In other words, the changein budget sets is the causal force, not the change intastes.

Should fast food be taxed?

Economic analyses also cast doubt on the value ofsome of the policies advocated to combat obesity.If health is not everything in life, then interplay ofpreferences and technology may mean that peopleare better off being above their own ideal weight.People are likely to prefer higher paying sedentaryjobs to more physically demanding ones withlower pay. In general, when technology makessomething easier, quicker or cheaper, we consumemore of it, and that’s generally a plus. Thinkbroadband, faster planes and heart surgery.

Several economists would argue that the issue isnot the provision of greater information, as someof the health lobby argue, but changed incentives.Most people know that more calories in meansweight gain, while fewer means weight loss.Labelling food products may help some people,but if the price differentials are large, or healthyproducts not available, this information may havelimited impact.

Do incentives need changing? The standardrationale for government intervention to alterprices, through either taxes or subsidies, is marketfailure. One common form of market failure thatmay warrant taxes is that private costs divergefrom social costs. Individuals based their actionson private costs: if these actions impose a cost onother than they don’t take into account, thensocial costs are higher than private ones, and a taxmay be warranted to lower the total amount of theactivity. This is the classic argument, for example,for cigarette taxes. Smoking by an individualimposes costs on others (the health consequencesof ‘passive smoking’) that the individual does nottake into account. A tax paid by the individual willreduce their consumption and so also reduce theamount of passive consumption and the costsimposed on others.

But the market failure arguments in favour ofreducing obesity may be limited. The privatebenefits of (lack of) obesity far outweigh the socialbenefits. In a world in which being slim, even thin,is seen as beautiful, there are large private gains tobeing thin but few external benefits to others.However, one potential external benefit fromobesity derives from the public financing of care.

C. Propper990


Taxing obesity would reduce the costs, borne byall of society in a tax-financed system, of treatingthe medical care that is associated with obesity.But there is a trade-off between health expenditureper period and the number of periods over whichthat health expenditure is incurred. If reductionsin obesity cause longer life, then the number ofperiods for which subsidies will be paid willincrease. Economists have also pointed out that,paradoxically, the increase in taxes to combatsmoking,a which are believed to have beensuccessful in the USA, may have contributed tothe increase in obesity, because food and cigarettesare substitutes. These arguments do not suggestthat governments should tax fast food or imposecontrols on the number of fast-food outlets. Andnote that taxing fast food would hit the poorest in(Western) societies hardest, as they are the biggestconsumers of such food.

However, there may be two groups of people forwhom changes in price-based incentives are useful.If certain people have trouble controlling howmuch they eat, then technological changes thathave lowered the costs of calorie consumption mayexacerbate these problems. For these people,increasing prices may increase welfare. The policyimplications therefore hinge on what proportionof the population have self-control problems. Ifmany people fall in that category, then taxation offattening foods, or subsidisation of healthy foodsor regulation may be warranted. There may alsobe grounds for changing prices to change thechoices children make. Children may be less ableto make rational, well informed choices thanadults and health in childhood is an importantfoundation of health in later life [Case A, Fertig A,Paxson C. The lasting impact of childhood healthand circumstances. J Health Econ, forthcoming.].

Cigarettes consumption (and otheraddictions)

Economic analysis has been used to understand,and make policy recommendations for, consump-tion of addictive substances, including tobacco. Ifocus here on analyses of tobacco, but the sameanalytical frameworks have been used to explainaddiction to ‘hard’ drugs, such as heroin.

Prior to the early 1960s, tobacco consumptionwas not seen as a significant social issue. Followingthe publication of seminal British and American

reports on smoking and health (Royal Collegeof Physicians 1962, US Department of Health,Education and Welfare 1964, [7]) public policy hasmoved to curb tobacco consumption. Under-standing people’s responses to price – in terms ofstarting, continuing and quitting – has been centralto the debate about the usefulness of using taxesof tobacco as a tool to discourage smoking. Inaddition to price, a variety of other factors,including income,b promotional activities (advert-ing) and taste can affect the demand for cigarettes.These are important and receiving increasingattention from economists but I’m not going tofocus on them here.

Modelling the demand for cigarettes (and other

addictive goods)

Early economic analyses often ignored the addic-tive nature of the good and estimated demand as afunction of current price, as if tobacco consump-tion was a standard good. But addiction meansthat short- and long-run responses to price maydiffer considerably and prices are likely to havevery different effects on starting smoking, con-sumption as a smoker and quitting. To modeladdiction, economic analysis has recognised thatthe full measure of price must include past andfuture prices as well as current price.

Three broad approaches to modelling addictionin the economic literature can be distinguished. Inthe first, labelled imperfectly rational addictionmodels, it is assumed individuals have stable butinconsistent short- and long-run preferences.Schelling [8] describes a smoker trying to give up:

Everyone behaves like two people, one who wantsclean lungs and a long life and another who adorestobacco. . . . The two are in a continual contest forcontrol; the ‘straight’ one in command for most ofthe time, but the wayward one needing to getoccasional control to spoil the other’s best laid plans(p. 290).

This inconsistency between current and futurepreferences arises when individuals discount thefuture very heavily. This means the future gains orcosts are given little weight when consideringtoday’s consumption. While this idea has not yetbeen used to estimate the effect of price oncigarette smoking, it has been taken up byeconomists interested more generally in in-dividuals’ behaviour with respect to actions which



from a distance seem worth doing (like losingweight) but as the moment for self-sacrificeapproaches seem increasingly unappealing. Suchan inconsistency in time discounting mightexplain, for example, why people try to lockthemselves into the investment activity, for exam-ple by signing up for a course of ten sessions witha personal trainer at the gym.c

The second approach is the myopic addictionmodel. This model stresses the role of habit: what Ismoke today depends on what I smoked yester-day.d But behaviour in this model is naı̈ve, in thatthe individual recognises the dependence ofcurrent addictive consumption on past consump-tion, but ignores the impact of current (and past)choices on future consumption when makingcurrent choices. More recently, researchers havemodelled addiction as ‘rational’. A rational con-sumer recognises the future consequences ofcurrent smoking decisions and takes them intoaccount when planning future consumption levels.Given the habit-forming nature of smoking, it isreasonable that a smoker will change their currentconsumption depending on what they expectfuture prices to be. This means that individualsincorporate the dependence between past, currentand future consumption when making decisionsabout current consumption and that all past andall future prices, as well as current prices, willaffect demand in a negative manner. The implica-tions of this model are that the long-run effect of apermanent change in price will be bigger than theshort-run effect. An anticipated price change willhave a bigger effect than a comparable unantici-pated price change, and a permanent price changewill have a larger effect than a temporary change.

Empirical analyses tend to support these pre-dictions. Long-run price responses to price aregreater than short-run ones, and are in the order of�0.5 i.e. a 1% increase in price will lead to a 0.5%decrease in consumption. Women tend to be lessresponsive to price changes than men, and menbehave more myopically [7].

But while there has been considerable empiricalsupport for the model of addiction as rational,there have also been objections. The rationaladdiction approach is one in which addicts aremodelled as not regretting past decisions, andheavy smokers are heavy consumers because theywant to be. Recent work has pursued the idea thatindividuals know that current consumption willaffect future consumption, but have incorporatedideas such that the inexperienced user may not be

fully aware of the potential harm associated withconsuming an addictive substance. These modelscan help explain experimentation with smokingwhen young and the importance of peer influences,both of which are commonly observed facets ofsmoking (and indeed other addictive good con-sumption).

Also on the agenda is to determine how otheraspect of the price of smoking – particularly theuse of smoking bans – influence tobacco con-sumption. As noted above, conceptually econo-mists use a relatively broad definition of price,which includes not only the monetary price ofpurchasing a good, but also the time and othercosts associated with using the product. So, in thecase of smoking, recent restrictions on smoking inpublic buildings in the UK and elsewhere imposesan additional cost on cigarette consumers – thecost of exiting from their offices to stand on thestreet, raising the time and discomfort associatedwith smoking. Because these bans affect all people,they provide a nice opportunity for economists tosee how smoking behaviour (including starting,quitting) is affected by an increase in its time cost.

Health-care reform

Health-care reform has become a perpetualactivity of the UK and other governments. Onereason for this is the large (and growing) amountof money spent on health and the importance oftax finance within this. In seeking to get maximumvalue from this expenditure, we need to under-stand how the suppliers of healthcare behave.Can we use economic analysis to understand andpredict the behaviour of suppliers in health-caremarkets?

The arguments against use of economic analysis

Arguments that might – and indeed have been –made against the use of economic analysis includethat medicine is a ‘caring profession’; thathealthcare is often funded by the state so thatdoctors and hospitals operate in the public sectorand therefore have ‘public sector’ motivation, orthat even where there are few public hospitals, animportant role played by not-for-profits. So, forexample, a recent federal court judgement on amerger case in the USA concluded, ‘The board of

C. Propper992


University Hospital is quite simply above col-lusion’ [9].

It is certainly true that the sector is one to whichindividuals who care about individual’s outcomesare attracted. It is also the case that the stateplays a large role in the provision as well asfunding of healthcare. It is also true that theorganisation of suppliers is such that not-for-profits play a large role. Even in the US in 1994only 12% of general hospitals were for-profits.In contrast, 60% were organised as not-for-profitswith the remaining 28% being operated bygovernments [10].

But it is also an incorrect and unhelpful view toargue that financial and other incentives are notimportant. When we look at the behaviour ofdoctors or hospitals we can observe that theyrespond to financial and other incentives, andfurther that they respond in ways that can bepredicted by economic analysis. This has implica-tions for the design of health-care institutions,payments systems, the use by government offinancial incentives and the regulation of marketsin this sector.

How might health-care suppliers respond to

financial (and other) incentives?

If health-care suppliers do respond to incentives,we cannot assume that their responses will alwaysbe as the body that sets the incentives (generallythe government) wishes. The economic literatureon incentives stresses that individuals will respondin ways that maximise their own net benefits. Thisresponse may or may not maximise the net benefitto society.

What a financial or other incentive will do is toincrease the reward from undertaking the task thatthe government has decided to reward. Whetherthis increased activity on the part of the health-care supplier will lead to the results the govern-ment (on behalf of society) desires depends on,amongst other things, how precisely the govern-ment can specify the task it is increasing thereward for; what other tasks the supplier under-takes (that are now less rewarded); and on thestrength of the incentive.

In many cases, it may not be possible to definethe task to be undertaken very precisely. This isparticularly likely to be the case in the publicsector, and in healthcare too, where precisemeasures of output are difficult to define [11]. So

the government may have to rely on proxies forincreased activity on the task. This means thatsuppliers who are given stronger incentives willfocus on increasing output of these proxies. Thismay lead to better healthcare, but it may alsoresults in suppliers gaming the system: alteringtheir activity to increase the measured output, butnot real output.

Increasing the incentive to do one task alters therelative prices facing the health-care supplier: theother tasks that they may do are now relatively lessrewarded. In response to this relative price change,as suppliers only have limited time, they will switchtheir effort patterns towards the better rewardedtask and away from the less rewarded tasks. Thisswitching of effort will be more likely the less wellthese other tasks can be measured and the bigger isthe reward for the incentivised task relative to theother tasks the supplier carries out.

Below, I provide illustrations of how health-caresuppliers – both individuals and organisations –have responded to incentives. Given the relevanceof the subject for the UK, which is in the middle ofyet another health-care reform, this one entailingthe re-introduction of the ‘internal market’ inhealthcare (more on which later), I focus on threeareas that are particularly pertinent to the UK.These are evidence on how family doctors in theUK (and elsewhere) have responded to changes infinancial incentives, evidence on the response ofproviders of healthcare to performance monitoringand evidence on how UK hospitals responded tothe introduction of competition in the 1990s. Iargue that in most cases health-care suppliers haveresponded to incentives – and have done so rapidly– but that these responses have not always led tothe outcomes desired by the government.

Family doctors and incentives

Evidence that doctors respond to financial incen-tives comes from variation in the way familydoctors are paid. Family doctors (GPs) aretypically paid in one of three ways: salary,capitation and fee-for-service (FFS). Salarieddoctors are paid a salary that is not related tothe exact hours they work. Under capitation, theGP receives a payment for every patient for whomthey provide care. Under FFS, income is directlylinked to the volume of service provided. Thesedifferent types of payment should cause differentwork patterns by GPs.



Evidence generally supports this. In the UK, ithas been found that salaried payments lead GPs toorder higher levels of tests, make more referralsand have lower patient throughput compared toFFS and capitation payments. This fits with thefact that salaried doctors cannot increase income,but can reduce their workload [12]. But it couldalso be argued that these differences reflectdifferent types of doctors, rather than responsesto different forms of payments. Doctors whoprefer more to less leisure will choose to workin salaried environments, while those who valueincome more and leisure less will work in a settingin which their remuneration is linked to the hoursthey work.

So the best evidence comes from cases wheredoctors face a change in their payment system. InDenmark, a move from capitation to FFS sawGPs increase their diagnostic and curative servicesand decrease their prescribing and referrals. Thisfits with the GPs doing more work themselves,rather than referring on to specialists or prescrib-ing medication [12]. In Quebec, in the late 1970s, ina bid to decrease medical expenditure, the govern-ment reduced the reimbursement rate paid todoctors for a set of activities once their totalexpenditure on these activities had hit a target.These targets were set for three month periods,which meant that once the doctors has hit theirceiling the financial payment they earned for eachactivity above this level was reduced. Doctorsresponded to these incentives by sharply decreas-ing the activity they undertook in the third monthof each accounting period, some even takingholidays in each of these months [13].

Some of the most robust evidence in the UK onresponses of GPs to financial incentives comesfrom the internal market of the 1990s. In 1991, theThatcher administration in the UK introducedinternal market reforms. These reforms, whichhave been described as the ‘boldest of marketbased reforms’ in public healthcare, were intendedto improve healthcare by linking the income ofproviders of healthcare to their performance byallowing competition between hospitals. Moneywas to follow the patient rather than being set onthe basis of historic activity. The reforms created,out of the public sector, separate sellers and buyersof hospital-based healthcare [14]. The sellers wereto compete with each other (and with privatesector suppliers of hospital care) to win contractsfor care from the buyers. There were two types ofbuyers: buyers responsible for all the population in

their area and a smaller group of buyers, who werefamily doctors, who were given more limitedbudgets to buy care for their practice populations.This group were called General Practice Fund-holders (GPFHs). Crucially, GPFHs were ableto keep any surplus from their budget at the levelof the practice. The GP benefits from this whenthey come to sell the practice on leaving theprofession.

The precise operation of the GPFH schemepermits examination of GPFHs’ responses to thechanged set of incentives embodied in the scheme.I examine here two issues: whether GPFHsexploited features of the system that allowed themto get bigger budgets for their practices andwhether GPs were able to use financial incentivesto get better care from hospitals for their patients.The latter also provides a test of whether hospitalsresponded to the cash incentives provided by GPs.

Impact on referrals. When GPs wished to becomefundholders, they announced their intention andthen waited a year whilst their referrals tohospitals were counted in order to work out theirbudget. So the obvious question to ask waswhether GPFHs increased their referrals in theyear before becoming a fundholder in order toincrease the size of their budget once they becamea fundholder.e In a study of GPs located in onearea of the UK, Propper et al. [16] found thatGPFHs did exactly that: they increased theirreferrals to hospitals relative to their previousreferral patterns (also controlling for changes thatwere happening to non-fundholders) by about10%. Once they became fundholders, their referralpatterns dropped by about 10% and thereafterappeared to revert to their long-run normal levels.We can’t tell precisely whether this was to benefittheir patients or the GPFHs themselves, but cansee that the GPFHs did respond to financialincentives. And in the process, because the totalpot for buying hospital care was finite, theyalso took monies away from practices that weren’tfundholding.

Shorter waiting times? Waiting times have been amajor concern in the UK. One of the ways inwhich fundholding might have improved care is ifGPFHs were able to use their purchasing power tosecure shorter waiting times. A study of over100 00 admissions by Croxson et al. [17] found thatGPFHs secured shorter waiting times for theirpatients compared to all other doctors (including

C. Propper994


themselves before they entered the scheme). Butour findings are quite nuanced. We found thatwhere the GPFHs paid directly for their patients’care, waiting times fell by about 8%. But wherethey were only able to choose – but not pay for –their patient’s care, fundholder were no more ableto reduce waiting times for their patients than non-fundholders. What this suggests is that GPFHs didrespond to the incentives of the scheme byfocusing on an area which patients valued, buttheir ability to alter the behaviour of hospitals islimited. When they pay directly for care, hospitalswill respond. Without those cash incentives,hospitals will not respond to the wishes ofreferring doctors.

The responses of health-care suppliers to

performance monitoring

In the public sector, governments interested inincreasing output often use performance monitor-ing to try to increase productivity in the sector.Performance monitoring takes many forms, but atits core is the idea of measuring output in someway and setting targets based on these measures.Sometimes the targets are tied to financial rewards,but mainly they are linked to less direct, but nonethe less important, rewards [11].

The idea is that such targets will make peoplework harder. However, because the output of thesector is often hard to measure, the measures areimperfect. This gives the people being monitoredincentives to alter their activities – not only towork harder which is what the government wants– but also to manipulate the targets. There is noreason why people in the health service should beanymore immune to this than anyone else.

Two recent TV interviews illustrate these points.The first is a conversation between the manager ofan Accident and Emergency department of aLondon hospital (J.C.) and the interviewer (Den-nis) about the meeting of waiting time targets:

J.C.: We met the target in the week that it wasmeasured, and as expected our performance againstthat target has fallen away since the week ofmonitoring.Dennis: so the whole thing is a bit artificial?J.C.: The whole thing is a bit artificial if you look

at it one way. Because it was... yes clearly it wasartificial, and we put in a lot of additional resources.I think one thing that has been very helpful, is forthat week we’ve actually measured what additional

resources we put in. (Newsnight (BBC), ‘HealthDelivery’, May 2004).

Or there’s James Strachan of the Audit Com-mission:

The system is being distorted to meet those targets inthe sense that money that was intended for longerterm purposes, like buying medical equipment,buying computers simply maintaining the buildings,that’s being diverted in order to be able to meetwaiting time targets. (Panorama (BBC), ‘Fiddling theFigures’, June 2004).

The impact of competition on health-care

outcomes

Many market based health-care reforms seek toincrease the amount of competition between provi-ders, on the grounds that policy makers believe thiswill be beneficial. The current Labour administra-tion in the UK, for example, has re-introduced theidea that users of healthcare should have choice ofhospitals, which is essentially introduces competi-tion between hospitals for patients.

The argument that competition will improveoutcomes in healthcare draws heavily on thegeneral argument that competition is beneficialfor the rest of the economy. Yet, in fact, predic-tions from theoretical models of competition inhealth-care markets tend to be ambiguous: compe-tition may decrease price, but not quality, or it mayincrease both price and quality, or price maydecrease and quality rise. The effect on price andquality will depend on the sensitivity of demand toprice relative to the sensitivity of quality, and onthe precision of price and quality measures.

So the outcome of competition between provi-ders will depend on the precise nature of themarket into which competition is introduced andon the amount and quality of information avail-able to buyers. For example, competition is likelyto have different outcomes in markets wherecompetition is primarily on price from marketswhere price is fixed and sellers compete on quality[18–20].

Empirical evidence. Empirically, there are marketswhere greater competition has been associatedwith higher quality and higher prices. The classicexample of this is the ‘medical arms race’ in the USprior to the 1990s, where due to the high levels ofinsurance of consumers, hospitals did not compete



on price to attract patients, but rather on qualityand facilities in order to attract physicians.Analysts of the US market have argued thatchanges in the US market post-1990 have resultedin competition leading to both lower prices andhigher quality. This result is, however, subject toconsiderable debate and appears to depend con-siderably on whether buyers and sellers negotiateon both price and quality or only on the latter.

The 1990s UK internal market also providesevidence on the relationship between competitionand prices and costs on one hand, and quality onanother. In the internal market sellers and buyersnegotiated on both price and quality. However,while price information was relatively freelyavailable (so that a buyer could compare acrosshospitals), quality information was very limited inquantity (hospital performance tables were notpublished, for example, until 1999 – 2 years afterthe end of the internal market) and was notreliable (basically because it was hardly used).Given this institutional set-up, it might be expectedthat competition would be associated with lowerprices but also lower quality. Propper et al. [21]tested this hypothesis using data from hospitals inthe internal market and found that hospitalslocated in more competitive markets had poorerquality for heart attack treatment.

The implications

All these examples indicate that health-caresuppliers do respond to incentives – financial andotherwise. But as doctors, nurses and adminis-trators will respond in ways that maximise theirown benefits, incentive design is crucial. Given thathealth-care suppliers have many tasks to under-take and that many of these may be difficult tomeasure, there is a real danger that strongincentives to do one activity will lead to health-care suppliers focusing on meeting the targets forthis activity at the expenses of less easily measuredor observed, but not necessarily less importanttasks. In such cases, economic analysis suggeststhat incentives should not be too ‘high powered’ –no single activity should be rewarded too highly.

Conclusion

Economists, in the field of healthcare, are oftenstereotyped as being interested only in the costs of

certain activities. But economic analysis is farbroader than simply counting the costs of activitiesin hospitals or that of new drug development. Theidea that individuals make trade-offs, based on thebenefits and the full prices of competing activitiesis central to understanding why we are gettingfatter, why nurses fiddle the figures in A and Edepartments, and why hospitals may collude. Onthe future research agenda are such topics asunderstanding whether restricting fast-food outletswill curb the growth in obesity, whether bans onsmoking in public places will stop people startingsmoking, and whether the new market reforms inhealthcare in the UK will deliver better healthoutcomes.

Acknowledgements

My thanks are due to Alistair Munro and HeidiAndrews for assistance in finding and preparing materialand to Lucy Hancock for assistance in presenting tablesand figures. Simon Burgess and Deborah Wilsonprovided very helpful comments on an early draft.Any errors are my responsibility.

Notes

a. Taxes on tobacco have risen by 164% between 1980and 2001 [6].

b. In industrial nations, the relationship betweentobacco consumption and income appears to havereversed. Studies in the US, for example, using datafor before the 1980s concluded that cigarette smokingwas a normal good, while more recent research hasconcluded that cigarette consumption has become aninferior good, with that the likelihood of smokingdeclines as income rises.

c. Laibson D. Intertemporal decision-making. EncyclCognitive Sci, forthcoming.

d. These models are comparable to the demand for aconsumer durable, where current demand depends on(depreciated) consumption in the past. In estimationof smoking, current consumption is modelled asdepending not only on prices but also on the stock ofpast consumption. Addiction is indicated if con-sumption depends on the stock positively.

e. Dusheiko et al. [15] ask the same question using theending of fundholding as the experiment.

References1. OECD. OECD Health Data Base. Organisation for

Economic Cooperation and Development: Paris, 2004.

C. Propper996


2. National Audit Office. Tackling obesity in England.Report by the Comptroller and Auditor General.The Stationary Office: London, 15 February 2001.

3. Philipson T, Posner R. The long run growth inobesity as a function of technological change. NBERWorking Paper 7423, 1999.

4. Lakdawalla D, Philipson T. The growth of obesityand technological change: a theoretical and empi-rical investigation. NBER Working Paper 8946,2002.

5. Culter DM, Glaeser EL, Shapiro JM. Why haveAmericans become more obese? J Econ Perspect2003; 17(3): 93–118.

6. Chou S-Y, Grossman M, Saffer H. An economicanalysis of adult obesity: results from the behaviouralrisk factor surveillance system. NBER WorkingPaper 9247, 2002.

7. Chaloupka FJ, Warner KE. The economics ofsmoking. In The Handbook of Health Economics,vol. 1B, Culyer AJ, Newhouse J (eds). North-Holland: Amsterdam, 2000.

8. Schelling TC. Ergonomics, or the art of self-management. Am Econ Rev 1978; 68: 290–294.

9. Gaynor M, Vogt WB. Antitrust and competition inhealth care. In The Handbook of Health Economics,vol. 1B, Culyer AJ, Newhouse J (eds). North-Holland: Amsterdam, 2000.

10. Sloan F. Not-for-profit ownership and hospitalbehaviour. In The Handbook of Health Economics,vol. 1B, Culyer AJ, Newhouse J (eds). North-Holland: Amsterdam, 2000.

11. Propper C, Wilson D. The use and usefulness ofperformance measures in the public sector. OxfordRev Econ Policy 2003; 19(2): 250–267.

12. Scott A. Economics of general practice. In TheHandbook of Health Economics, vol. 1B, Culyer AJ,Newhouse J (eds). North-Holland: Amsterdam, 2000.

13. Rochaix L. Financial incentives for physicians: theQuebec experience. Health Econ 1993; 2: 163–176.

14. Propper C. Agency and incentives in the NHS inter-nal market. Soc Sci Med 1995; 40(12): 1683–1690.

15. Dusheiko M, Gravelle H, Jacobs R. The effect ofpractice Burgdtes on patient waiting times: allowingfor section bias. Health Econ 2004; 13(10): 941–958.

16. Propper C, Croxson B, Perkins A. Do doctorsrespond to financial incentives: UK family doctorsand the GP fundholder scheme. J Public Econ 2001;79: 375–398.

17. Croxson B, Propper C, Shearer A. Waiting times forhospital admissions: the impact of GP fundholding.J Health Econ 2002; 21: 227–252.

18. Gaynor M. Competition and quality in health caremarkets: what do we know? what don’t we know?Mimeo, Paper commissioned by the Federal TradeCommission, Department of Public Policy, CarnegieMellon University, Pittsburgh, 2004.

19. Dranove D, Satterthwaite M. The industrial orga-nization of health care markets. In Handbook ofHealth Economics, Culyer AJ, Newhouse JP (eds).North-Holland: Amsterdam, 2000.

20. Burgess S, Propper C, Wilson D. Choice. Will morechoice improve outcomes in education and health? Theevidence from economic research. Mimeo, Universityof Bristol CMPO, March 2005.

21. Propper C, Burgess S, Green K. Does competitionbetween hospitals improve the quality of care?Hospital death rates and the NHS Internal Market.J Public Econ 2004; 88: 1247–1272.



Documents

Why economics is good for your health. 2004 Royal Economic Society Public Lecture