Prices and Protocols in Public Health Care

This article addresses the problem of how to determine the optimal allocation of public expenditure in the health sector. The first part poses the question: How should the set of services provided in the public health care system and the fees charged for them be chosen to maximize the health status of the population with a fixed budget? First, the findings show that policy reform should take into account the response of the private sector. Substituting for a reasonably well-functioning private sector is not as valuable as providing services the private sector cannot. Second, the assumptions needed to justify the cost-effectiveness of medical interventions as a criterion for setting priorities are so restrictive as to make this method usable in few, if any, circumstances. Third, prices for any one service should be set to balance the conflicting goals of encouraging its use and of conserving the budget for more effective services. The second part broadens the objective of policy to cover the standard welfare economics concerns of utility and market failure, the latter being extensive in the health sector. It reexamines welfare maximization rules to show that only the market failure components of shadow prices are needed to calculate the welfare gains from public investments.