Theory of System Level Efficiency in Health Care


In recent years there has been an increased interest in the notion of the health ‘system,’ the ultimate goal of which is to protect and improve the health of its population. The definition of the health system is contested, but a frequently invoked starting point is the World Health Report in 2000, which ‘‘… defines a health system to include all the activities whose primary purpose is to promote, restore or maintain health’’ (World Health Organization (WHO), 2000, p. 5). Systems level efficiency is concerned with understanding how well a specific system is using the resources at its disposal to improve health and secure related objectives. Identifying inefficiencies in either the system or in its component parts is important as it allows the same objectives to be attained with fewer resources (or alternatively it enables the system to produce more with the same resources). As spending on health care continues to rise remorselessly in all developed countries, this issue has become increasingly relevant for policy makers seeking ways to pursue health objectives at the same time as containing cost pressures.

Although the core idea of efficiency is easy to understand in principle – maximizing valued outputs relative to inputs – it becomes more difficult to make operational when applied to a concrete situation, particularly at the system level. It is, for example, quite conceivable that there are efficiently functioning components operating within an inefficient broader health system. Furthermore, efficiency is not strictly determined by the relationship between the physical quantities of inputs and outputs, but by the value attached to those outputs. Indeed, by analogy with the first law of thermodynamics, which postulates that energy cannot be created or lost, the ratio of all physical outputs to all physical inputs will necessarily remain unchanged. What will differ, according to the structures, processes, and systems in place, is the ratio of valued outputs to inputs.

The general assumption in a great deal of the health economics literature is that the objective of the health system and its component parts is to increase the length and health-related quality of life of the population. This is most famously embodied in the notion of a ‘quality-adjusted life-year’ (QALY). However, there may be other very important objectives attached to a health system, such as reducing disparities in health, protecting citizens from the financial consequences of illness, and improving the responsiveness of health services to personal preferences.

Valuations attached to different health system outputs can vary because of variations in individual preferences, the decision-making perspective being used, or even because of the level of analysis being applied. As a result, a number of sometimes conflicting definitions for ‘efficiency’ exist in the economics and policy literature, and even within health economics itself (Table 1).

Although each definition attempts to clarify the nature of inputs and outputs, the variety of perspectives illustrates that there is no consistent approach. In particular, there is considerable variation as to what the valued outputs are, including: Volume of care, quality of care, levels of quality, ‘performance’ and health improvement; and this reflects the lack of clarity as to the concept of ‘valued outputs.’ Throughout this article the authors generally adopt the assumption that ‘health improvement’ is the valued health system output. However, on occasions reference to some of the other legitimate objectives that society may attach to the system shall be made.

One terminological issue needs to be addressed: The productivity literature usually refers to the products of a production process as ‘outputs.’ In health care, it has become conventional to refer to the physical products (such as an episode of hospital care) as an output, but to the health benefits achieved as ‘outcomes.’ Thus, health outcomes can be thought of as the ‘value’ attached to an output. Throughout this article the authors use the term ‘outputs’ and where necessary ‘valued outputs’ unless it is specifically necessary to refer to the health benefits achieved.

Although there appears to be more consistency regarding system inputs, specifications are often quite vague, referring simply to ‘costs’ or ‘resources.’ Only a few of the definitions in Table 1 identify particular inputs, such as ‘‘The relative quantity, mix and cost of clinical resources’’ (Pacific Business Group on Health, 2006, p. 2). The lack of clarity about the concepts of ‘valued outputs’ and inputs reflects a wider ambiguity about the organizations and production processes of the health system. In particular, it is often not clear which resources and health outcomes are considered to fall within the responsibility of the health system. This article therefore begins by discussing the health system definition and its relationship to health system efficiency. Key concepts relating to efficiency such as productivity, technical and allocative efficiency, and their relationship to the production frontier are considered. These theoretical concepts are then related back to health policy to indicate the types of questions that might be considered in any analysis of technical or allocative efficiency.

What Is The ‘Health System’?

To understand and measure efficiency, it is first necessary to define the scope of the entity under scrutiny. Health is the product of numerous determinants, some that can be directly influenced in the short term by factors in the health services (e.g., improving medical care), others that require long-term action of factors not directly associated with health services (e.g., environmental policy), and yet others that depend primarily on the actions of individuals and their families (e.g., diet). If the health system is assumed to be comprised only of health services, then actions that may have a greater impact on health are excluded (such as education or employment). Thus under a narrow definition of the health system, confined to health services, an analysis of system level efficiency may not consider the possible efficiency gains that could be secured by allocating resources differently between areas such as health care, education, and housing. However, a broader analysis can rapidly lead to lack of clarity of the boundary of the system, and associated difficulties with measurement and attribution.

Table 1 Alternative definitions of efficiency in a health care context

For example, Figure 1 illustrates the potential production process of a health system, with examples of costs and physical inputs put into the system and a selection of outputs and consequent outcomes that are produced. The different shades represent different boundaries of the health system, starting from a consideration of only medical care and extended to consider all factors that influence health. Across these boundaries, many of the outcomes of the system do not change – for example, health improvement and risk protection are outcomes arising from medical care, public health and health promotion, intersectoral action, as well as from economic growth and public sector investment. However, the physical inputs that contribute to the attainment of these outcomes will differ markedly depending on the choice of system boundaries.

In an evaluation of health system efficiency it is important not only to consider the physical inputs that correspond to the health system as defined, but also to ensure that the outcomes being assessed also represent only the contribution attributable to those particular inputs. For example, if the efficiency of medical care were to be assessed it would be crucial to isolate the contribution of medical care to health improvement, and to adjust for any contribution of other activities such as public health, development, and education.

A particular issue that sometimes arises is whether to scrutinize only publicly owned or financed institutions, or to include also the private and not-for-profit sector in an analysis of health system efficiency. The position of the World Health Organization is clear on this – they assign accountability to the government for the entire health sector, however, organized (World Health Organization (WHO), 2000). Under this formulation, the regulation and performance of privately funded healthcare should be included in any analysis. This reflects the WHO emphasis on governments as ‘stewards’ of population health.

In defining the health system, it is therefore important for analysts to be clear about what allocation of resources needs to be considered, what parties will be affected, and who will be making the decisions regarding allocation. Ideally the definition should be aligned with the factors under the control or influence of a responsible person or organization, such as the health minister. The scope of this accountable entity may therefore vary depending on a country’s institutional arrangements. In other words, the definition of the health system should reflect a country’s accountability arrangements. Whatever definition is chosen should then determine the scope and perspective of the analysis. It is then crucial that all definitions of inputs, outputs, and exogenous influences on attainment are aligned with that choice. This may lead to methodological challenges when attempting to compare one country with another where there exists no universal agreed categorization of diseases, health care procedures, health care organizations, or even health systems (Cylus and Smith, 2013).

Figure 1 Selected inputs and outputs of the health system at different boundaries.

Efficiency At Different Levels

Reflecting the wide range of potential perspectives, economists and policy makers have adopted different conceptualizations of efficiency when analyzing different levels of the health system. At the formal organizational level, definitions usually refer to the extent to which health service objectives have been achieved compared to the maximum that could be attained, given the resources available and the external constraints on attainment. The conventional concepts of allocative, technical, and economic efficiency are then used to describe efficiency at this level (see section The Elements of Efficiency).

However, the concept of efficiency may change if the perspective changes. It is possible to take a broader view of sector level resource allocation, for example, by considering the level of resources devoted to the health system relative to other sectors that can also provide a positive contribution to health or indeed to broader welfare. The Organization for Economic Cooperation and Development refers to this broader conceptualization of efficiency as macroeconomic efficiency (Hurst and Jee-Hughes, 2001). In principle, the size of the health sector should be determined by its marginal contribution to welfare, relative to other sectors. Work on macroeconomic efficiency might therefore examine whether healthcare expenditure has reached levels where marginal spending on medical services contributes less to welfare than if it were directed at other sectors, such as education, housing, the environment, or private consumption.

At the other extreme, resource allocation can be considered at the very micro level, for example, by guiding the decisions of individual clinicians on how to distribute healthcare resources across treatment options in order to maximize valued outputs. Study of this type of efficiency often takes the form of a systematic analysis of the effects and costs of alternative methods or programs for achieving the same objective (e.g., improving quality of live, extending year of life lived, or providing services). These methods include cost-effectiveness analysis (CEA), comparative effectiveness analysis, cost-benefit analysis, and cost utility analysis. In principle, these techniques can be crafted to reflect different personal pReferences:, although in practice they usually produce guidance on the basis of a uniform set of pReferences:.

Thus, health system efficiency can be characterized in very broad terms at different levels of analysis, as adapted from Chung et al. (2008):

  • Physician level: How to distribute resources between interventions in order to choose a treatment strategy that maximizes the patient’s value or utility given existing resources.
  • Organizational level: How to distribute resources within a healthcare organization and across health care processes in order to maximize aggregate health gain and satisfaction.
  • Systems level: How to distribute resources within the broad components of the health system (such as prevention, primary care, secondary care) so that production of healthcare maximizes citizen health and welfare.
  • Societal level: How to distribute resources between sectors of the economy (education, health, public goods, etc.) such that health and broader welfare within society are maximized.

These issues are addressed in the section Allocative and Technical Efficiency as Applied to Health Policy.

The Components Of The Health System

The different levels of the health system are profoundly interdependent, as actions at one level will often influence behavior and outcomes elsewhere. Bringing together findings from studies at the different levels can provide fundamental tools for understanding how an entire system is managed and sustained. The interconnectedness of the separate areas of study of a health system can be illustrated by the distinct areas of health economics set out in Alan Williams’ ‘plumbing diagram’ reproduced in Figure 2 (Williams, 1987).

Each box in the diagram represents one of the sub-disciplines of health economics. The various fields are connected to one another by ‘pipes’ with the arrows indicating the direction of the relationship. Each of the boxes, discussed briefly in Figure 2 involves both positive and normative issues and different societal preferences (Maynard, 2007). In relation to the discussion of efficiency, Boxes A, B, C, and D represent the key factors that determine the initial allocation of resources by society and what inputs and outputs are available and valued within health systems. These factors create the framework for the analysis of efficiency at the patient, organization, and system level represented in Boxes E, F, G, and H.

Box A models the determinants of health, focusing particularly on social and behavioral determinants that lie beyond the immediate control of the health system. These will be important when considering the system boundary issues discussed in the sections What is the ’Health System’? and Efficiency at Different Levels. It is important to understand what is meant by ‘health’ and how it is valued by individuals and society. Thus, Box B represents the study of perceptions of health as well as the valuations of its different states and life. These are important to the study of efficiency in order to be able to assign value to the outputs being produced at the patient, organization, system, and society levels, and inform decisions on the allocation of resources.

Boxes C and D consider the demand for and supply of health care respectively. In any market, supply and demand will determine how the market allocates resources from producers to consumers. In health services, demand is driven by patients seeking health care to improve their health status and longevity. This can be influenced by information asymmetries between patients and providers, or providers and third-party payers, barriers to care such as cost, distance or culture, and externalities of care. Supply of health care considers a wide range of factors including the use of private and public suppliers, the behavior of institutions and providers, the skill mix and structures available to provide health, the financing structures in place to provide funds, as well as the organization of service delivery. It is important to understand the factors that influence demand and supply in order to be able to interpret how the market allocates resources and how this can be influenced to correct inherent market failures and associated inefficiencies.

Figure 2 Williams’ Health Economics Plumbing Diagram. Reproduced with permission from Williams, A. (1987). Health economics: The cheerful face of a dismal science. In Williams, A. (ed.) Health and economics, pp. 1–11. London: Macmillan

Boxes E, F, G, and H represent the application of core economic principles, including the study of efficiency at different levels. Box E is concerned with the microeconomic evaluation at treatment level, and reflects the impact on efficiency of ‘physician level’ decisions outlined in the section Efficiency at Different Levels. This area of health services research involves conducting microevaluations such as CEA or cost utility analysis to inform rationing and reimbursement choices. They require information on clinical effectiveness of treatments, as well as the measurement of costs and value added.

Box F addresses the issue of market equilibrium, where market demand equals market supply. Private and public markets will in general clear at different levels, depending on factors such as pricing of goods and services, restrictions of benefit packages, rationing, and waiting times. This area of research encompasses issues of organizational level efficiency, where different production processes, input prices, and willingness to pay influence decisions of what and how much of different goods and services should be produced.

Finally, Box G represents the evaluation of the whole system, concerned with understanding how inputs are used to achieve the key objectives of the health system. This includes the area of system level efficiency. Box G will be influenced by planning, budgeting and monitoring mechanisms represented in Box H. All three of boxes F, G, and H can embrace regulatory mechanisms intended to correct market failures and maximize the optimum allocation of resources in order to meet society’s health system goals.

Although each box constitutes a separate area of study, the ‘pipes’ between the eight boxes show some of the linkages between the different areas, indicating their interdependence. For example, the operation of the hospital would be best considered in Box F. Yet the hospital’s market equilibrium in Box F would be influenced by the supply and demand for health care (Boxes D and C) as well as the severity of patients being treated (Box A), and the acceptable forms of treatment administered (Box B). Moreover, although the hospital could be perfectly technically efficient at the organizational level, it could be operating in a very inefficient health system, represented by Box G, if the overall health improvements made at the system level are below what could be achieved if current health expenditures were reallocated – say between hospital and preventive services. This may be related to the mechanisms in place for planning and budgeting, represented in Box H, for example, if too much money is being allocated to secondary care as opposed to primary care.

The health system is complex to analyze, because of people’s heterogeneous health needs, the enormous scope for market failures, and the interdependencies illustrated in Figure 2. The assessment of efficiency is therefore also challenging. In the next section the authors set out some basic building blocks needed for the successful examination of health system efficiency.

The Elements Of Efficiency

The underlying aim of efficiency analysis is to understand how inputs are translated into valued outputs. In this section the authors seek to clarify some of the different general concepts of efficiency as they apply to the health system.

Productivity and efficiency are often used interchangeably, but they refer to slightly different concepts. Productivity refers to the ratio of a (possibly partial) measure of output to a (possibly partial) measure of input. In contrast, efficiency seeks to assess the attained level of output in relation to the maximum that can be produced, given the inputs used, system constraints and available technology. Efficiency will often be calculated taking into account constraints (such as scale) that inhibit improved productivity. Ideally, efficiency will express the outputs being produced in terms of their value to consumers or society. Thus, there is an implication that efficiency is a more comprehensive and normative tool than productivity.

Fundamental to the study of efficiency is the concept of production function, which models the maximum possible level of outputs for given levels of inputs, given current technology. Alternatively, it is sometimes convenient to model production possibilities in the form of a cost function, which models the minimum feasible cost of producing a given set of outputs. In reality, for most production processes, there are both multiple inputs and multiple outputs, and it is more accurate to think in terms of a production possibility frontier, which maps the maximum levels of output attainment for any mix of inputs. Whether a production function or cost function perspective is adopted usually depends on the specific focus of the study. In what follows the focus is mainly on the production function.

Whatever perspective is adopted, efficiency analysis can be considered broadly as the study of two main questions:

  1. Are resources being used so that the maximum level of chosen outputs is produced given the available inputs? (or are resources being used so that the minimum level of inputs are used to produce the chosen outputs?) That is, is the entity located on the production frontier, rather than inside it?
  2. Is the ‘right,’ or most valued, mix of outputs being produced, given society’s valuation of those outputs. Or conversely, is the ‘right,’ or minimum cost, mix of inputs being used, given the chosen outputs. That is, is the entity located at the maximum value (or minimum cost) point on the production frontier?

These two questions relate respectively to technical and allocative efficiency, which are now considered in turn.

Technical Efficiency

Technical efficiency indicates the extent to which an entity is producing the maximum level of output for a given level of inputs under the prevailing technological process, therefore addressing the first question of efficiency analysis posed in the section The Elements of Efficiency. To identify whether the health system is technically efficient, it is thus necessary to determine four key characteristics:

  1. What are the inputs of the health system?
  2. What are the outputs of the health system?
  3. What is the maximum level of health system output that can be produced for different levels of input?
  4. What are the external constraints that may limit the ability of the health system to be technically efficient?

The discussion in the section Efficiency at Different Levels illustrated the challenges involved in defining the boundaries of the system under scrutiny and identifying relevant inputs and outputs. In particular, the chosen definition of the health system will determine whether factors such as public health, health promotion, and socio-economic determinants of health are considered in the analysis. The choice of boundaries will be crucial in determining first what resources make up the health system inputs, and second what are considered uncontrollable exogenous constraints on attainment.

With regard to health system outputs, a key challenge relates to the differences in stakeholder perceptions about what the health system should be producing. International and national health system frameworks identify a number of potential health system objectives, some of which are almost universally recognized (such as health improvement) and others where views differ (such as the extent to which a system offers patients choice of provider). Many definitions of efficiency require some measure of quality as well as volume of outputs (Table 1), yet notions of what constitutes quality of care are sometimes vague and conflicting (Papanicolas, 2013).

Once inputs and outputs have been identified, it is necessary to identify the maximum level of health system output that can be produced for different levels of inputs, using the concept of the production frontier. Any unit lying on the production frontier will be technically efficient. Inefficient units lie strictly within the frontier. In the context of health systems, therefore, a technically efficient system will be one that produces the maximum achievable level of valued outputs (in the form perhaps of health outcomes) given its inputs (or uses minimum level of inputs, given its outputs). Although this tool serves well in understanding the theory of systems level efficiency, it poses many practical challenges in the empirical estimation of the production function.

A central concern in estimating the production function is the identification of external constraints – the uncontrollable influences on attainment that limit the production of desired outputs. At the health system level such constraints might include: the underlying health of the population, the configuration of provider organizations, and the skills and size of the workforce. In the short term, many of these factors can be considered genuinely exogenous influences on levels of attainment, and so should be included as constraints in the analysis. In the longer term, it might be expected that the health system should be responsible for addressing some of the constraints. So, for example, an inefficient scale of providers might be an acknowledged handicap in the short run, but should not be considered as an ‘excuse’ for poor attainment in the longer run. However, some constraints, such as the physical terrain of a geographical area, might be considered truly exogenous.

A final key consideration that is rarely modeled satisfactorily is the dynamic nature of the health system. Outputs measured at one point in time will have been influenced by inputs of a previous time period, and similarly inputs in a current time period will to some extent influence outputs in a future time period. Ignoring dynamic aspects of efficiency may incorrectly attribute all current performance to current actions and hold stakeholders accountable for past actions for which they may not have been responsible. In principle, the proper approach to longer term investments in (say) disease prevention is to treat them as a capital investment, the benefits of which accrue over several time periods. They can either be treated in the same way as more conventional investments in physical capital, or by using proxies for the future benefits of current investments (e.g., expected QALYs gained per person immunized). By properly including a time dimension, analysis of efficiency may even provide improved incentives for policies with long-term effects, as future benefits will be recognized even in the short term.

Allocative Efficiency

Technical efficiency examines the extent to which the unit is failing to reach the production frontier, as expressed in the cost or production function. In contrast, allocative efficiency examines whether production is allocated across either inputs or outputs so as to maximize the value to society. This principle can be interpreted in a number of ways. However, the common theme is that allocative efficiency refers to the extent to which a socially optimal point on the production frontier has been reached. In a conventional market, market prices can be indicative of the value of goods and services according to the trade-off consumers or society are willing to make between them. In input space this is readily transferred to health systems, where allocative efficiency can be interpreted as the extent to which the minimum cost of inputs is being used, given the market prices of those inputs. For example, to what extent is the right mix of clinical skills, physical inputs and medical products being used to secure system objectives, given prevailing wage rates, property prices, product prices, and so on.

However, in health systems, there are rarely market prices for outputs. It therefore becomes more difficult to define the relative value of outputs, as a guide to identifying the ‘right’ mix of outputs. As a result, in output space a number of definitions of allocative efficiency have arisen. Roberts et al. (2008) are, however, representative in defining allocative efficiency as whether a nation is producing the right mix of outputs to maximize attainment of its overall goals.

Thus, technical efficiency refers to the question of how goods are produced given certain inputs, meaning that a technically efficient point is one that lies anywhere on the production possibility frontier. At such a point a provider can produce more of one output only by reducing production of another. Allocative efficiency, however, refers to the question of what inputs are used or what outputs are produced, and suggests that there is a unique point on the production frontier that maximizes societal values relative to all other attainable sets. To do this it is (in principle) necessary to specify a ‘social welfare function,’ which aggregates societal preferences into a single measure of the benefits to society of a social program.

One therefore needs information on the relative value to society of different health system outputs. There are many possible approaches to identifying those values, based on competing theories of justice. Various types of market mechanism, technical analysis, and political process seek to address this challenge. Moreover, even if there is agreement on which approach to adopt, individuals will always hold different values about what are the ‘right’ outputs to be produced. This diversity in normative perspectives and individual values relating to the allocation of health resources often makes it difficult to agree on a common starting point.

Nevertheless, if policy makers had knowledge of individual utility functions and preferences, they could in principle specify a social welfare function that aggregates the utilities across members of society. One could then examine the problem of efficiency as one of welfare maximization – that is, finding the feasible allocation of resources that maximizes a chosen concept of social welfare. This approach has been labeled ‘welfarism.’

However, in practice construction of a social welfare function is extremely challenging, and systematic aggregation of individual preferences is infeasible. Yet – given the importance of health care in society – policy makers must make allocation decisions, and they have therefore used criteria other than traditional welfarism to inform resource allocation, such as potential health gain, need for treatment, demand for treatment, or simply cost. This approach is often referred to as extra-welfarism. This school of thought rejects the notion of using only utility as the outcome of interest, but seeks to consider broader factors such as an individual’s capabilities: the goods and services that enable individuals to flourish. The dominant application of extra-welfarism in health economics has been concerned with aggregate health maximization, an approach that allows the aggregation and comparison of individual benefits.

Allocative And Technical Efficiency As Applied To Health Policy

To illustrate the points raised in the section The Elements of Efficiency, Table 2 considers the outputs, inputs, and trade-offs that might be considered in an analysis of technical or allocative efficiency within the health system. The provider (micro) level considers an individual seeking treatment where the inputs being considered are the money spent on treating the patient, and the output is the heath gain. The most efficient point of provision hinges on the choice of treatment. The intention is to treat the patient with the most cost-effective treatment (allocative efficiency), with maximum effectiveness (technical efficiency), within budget constraints. The choice of the allocatively efficient point should in principle consider the patient’s preferences for types of treatment (e.g., attitudes toward pain and risk aversion), and offer the treatment that (subject to expenditure constraints) maximizes the expected value of the treatment to the patient. Given the lack of information about potential outcomes for many (if not most) treatments and the practical difficulty of crafting treatment choices specific to each patient, lack of information, and knowledge of medical care and types of treatment, clinical guidelines and payment mechanisms set at a higher organizational level may be very important in ensuring a technically and allocatively efficient distribution of resources.

At the organization (meso) level, assuming the only goal of the health system is to maximize health, the technically efficient point would be where expected health gain is maximized within each organization, by offering an optimal mix of cost-effective treatments to patients with different conditions. To achieve the allocatively efficient point mix of outputs, there needs to be a way to measure health gain across different potential treatments that the organization could provide, perhaps in the form of the QALY. Note that the ‘mission’ and design of organizations may constrain the range of output options available – for example, a hospital may not be capable of delivering a health promotion program. To overcome organizational boundaries, a correct allocation of resources must be made at the higher (system wide) level.

Macro concerns are represented in Table 2 by the system level and the societal level. The system level considers how resource allocation decisions are made to maximize health within the health system, and the societal level considers how resources are allocated between health and other sectors of the economy. For the system, a technically efficient point might be one that allocates resources across health services so as to maximize health gain. The allocatively efficient point is the one that provides the combination of health services that maximizes aggregate health gain across all services. At the societal level, the problem is analogous, but the health gain can be from different sectors of the economy, such as education or housing. Addressing this intersectoral allocation problem in principle requires consideration of the relative value of nonhealth objectives of other sectors, especially if these are produced jointly with health-enhancing programs.

Table 2 Examples of allocative and technical efficiency in health systems

Finally, Table 2 also considers possible decision mechanisms that can be used to determine what mix of outputs will be produced. For example, at the provider level the optimal mix of outputs will be informed by cost constraints within the system and individual preferences for treatment. The decision processes at the organizational level, such as a hospital, will be informed by the priority setting system in place. This priority setting system may differ across health systems, and may be based on factors such as the needs of the population being treated, the costs of inputs, the cost-effectiveness of treatments, or historical trends in purchasing. At the macro level, the resource allocation decision mechanisms in common use attempt to reflect the preferences of society, often through political processes. At the systems level, where the budget must be allocated to resources across the entire health system, the decision mechanism will often be made by bureaucratic processes overseen by elected representatives. At the societal level, decisions arise from a mix of private markets and political decisions about how to spend public finances, typically arising from some sort of election process.

Although Table 2 may help to conceptualize what seem like abstract notions, it takes a highly simplified view. It assumes an extra-welfarist perspective, in the sense that the only valued output of the health system is health gain. In practice, the health system often has broader objectives, and in principle a comprehensive analysis would examine the impact of allocations on broader social welfare. The market for health care makes it inherently prone to inefficiency if left to its own devices. Key market failures include: The lack of competition, especially for the provision of health services; the information asymmetries between patients and physicians, and between physicians and third-party payers; and externalities that are not reflected in prices (such as the spillover benefits offered by vaccinations). These market characteristics may, in the absence of corrective mechanisms, result in highly inefficient allocations of resources. The last column of Table 2 therefore indicates the sort of mechanisms necessary to promote allocative and technical efficiency at the different levels of analysis, given such market failures. This is particularly important for allocative efficiency, where the structure of a particular health system will determine what potential there is at each level of analysis for the provider to decide what mix of outputs should be produced.


There is increasing awareness that the design of the health system has a fundamental impact on the health and broader welfare of the population. Improved system efficiency is an important consideration because it enhances the capacity to produce valued outputs and the consequent sustainability of the system. However, the conceptualization of efficiency in health systems is far from straightforward. The first fundamental challenge is assigning ‘value’ to outputs (and also possibly inputs). Definitions of efficiency differ across institutions with no consistent reference to valued outputs and inputs. In practice, different definitions in use cover a range of valued outputs such as ‘overall’ performance, quality of care, health gain, or volume of treatment.

The challenge of identifying a set of valued outputs has implications for the conceptualization of both technical and allocative efficiency. To determine the technically efficient points of production, it is necessary to identify the outputs of the production process. Similarly, in order to determine what bundle of health services to provide, and thus identify the ‘allocatively efficient’ point of production, it is necessary to understand the preferences of the population being served. This will require consideration of whose preferences to consider, whether they should reflect the utilities associated with consumption of health care or the capabilities created by the consumption of health care, and the aggregation of preferences across society.

The second conceptual challenge refers to the difficulties associated with defining the boundaries of the entities under scrutiny. Determining the boundaries of a health system is one of the key areas of debate in health services research. The central point of discussion arises from the recognition that health outcomes are the result of numerous determinants, many of which might lie outside the direct influence of health policy makers. How narrowly or broadly the boundaries are set will influence judgments about the causal responsibility for improving health, thus influencing assessments of the level of ‘efficiency’ of the defined health system. A clear definition of relevant boundaries will facilitate the specification of objectives and the valued outputs and inputs for different areas of the health system.

The third challenge in conceptualization of efficiency for health systems relates to the intertemporal nature of the health system. All health systems are dynamic entities; performance in one period will influence performance in later periods. Health outcomes are the result not only of factors in the time period being measured, but also a product of behavior over the lifecycle as well as previous efforts of the health system. The physical resources such as hospitals and medication available in a current period are a result of investments made in previous years, and will in part contribute to future attainment. Any definition and metric of efficiency should in principle attempt to capture the dynamic processes that make up the health system.

In conclusion, the above discussion summarizes a burgeoning literature and policy debate on the theory of health systems efficiency. The challenges at the system level identified amount to an extensive research agenda, the purpose of which should be to create a clearer understanding of the health system and how it can be used to the best effect in line with societal objectives. Although these challenges may appear daunting, considerable progress has been made in addressing many of these issues at the micro level, through the literature of CEA. Research in such analyses has secured major progress both in the theory and use of economic thinking, and has had a fundamental impact on health policy. It is to be hoped that similar progress can now be made at the other levels of analysis.


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Efficiency of Resource Allocation Funding Formulae
Welfarism and Extra-Welfarism