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Public Hospitals
in Developing Countries
A World Bank Book

Public Hospitals
in Developing Countries
Resource Use,
Cost, Financing
Howard Barnum
and
Joseph Kutzin
Published for the World Bank
The Johns Hopkins University Press
Baltimore and London

( 1993 The International Bank
for Reconstruction and Development/The World Bank
1818 H Street, N.W., Washington, D.C. 20433, U.S.A.
All rights reserved
Manufactured in the United States of America
First printing April 1993
The Johns Hopkins University Press
Baltimore, Maryland 21211, U.S.A.
The findings, interpretations, and conclusions expressed in this publication
are those of the authors and do not necessarily represent the views and poli-
cies of the World Bank or its Board of Executive Directors or the countries they
represent.
The material in this publication is copyrighted. Requests for permission to re-
produce portions of it should be sent to the Office of the Publisher at the ad-
dress shown in the copyright notice above. The World Bank encourages
dissemination of its work and will normally give permission promptly and,
when the reproduction is for noncommercial purposes, without asking a fee.
Permission to copy portions for classroom use is granted through the Copy-
right Clearance Center, 27 Congress Street, Salem, Massachusetts 01970, U.S.A.
The complete backlist of publications from the World Bank is shown in the
annual Index of Publications, which contains an alphabetical title list and in-
dexes of subjects, authors, and countries and regions. The latest edition is
available free of charge from Distribution Unit, Office of the Publisher, The
World Bank, 1818 H Street, N.W., Washington, D.C. 20433, U.S.A., or from
Publications, The World Bank, 66 avenue d'Ina, 75116 Paris, France.
Library of Congress Cataloging-in-Publication Data
Barnum, Howard.
Public hospitals in developing countries: resource use, cost,
financing / Howard Barnum and Joseph Kutzin.
p. cm.
"Published for the World Bank."
Indudes bibliographical references and index.
ISBN 0-8018-4532-7
1. Hospitals-Developing countries-Finance. 2. Hospitals-
Developing countries-Cost control. I. Kutzin, Joseph.
II. International Bank for Reconstruction and Development.
[II. Title.
[DNLM: 1. Developing Countries. 2. Financial Management,
Hospital. 3. Hospitals, Public-economics. 4. Hospitals, Public-
utilization. WX 157 B263p]
RA971.3.B37 1993
338.4'336211 '091724-dc2O
DNLM/DLC 9249341
for Library of Congress CIP

Contents
Foreword vii
Adetokunbo 0. Lucas
Acknowledgments viii
1. Introduction I
The Scope of the Book 2
The Issues 3
Organization of the Book and Overview of the Findings 4
2. Patterns of Hospital Resource Use 11
Distribution of Resources within the Government
Health Sector 13
Distribution of Resources within Hospitals 27
Distributional Equity of Hospital Use 33
Cost-Effectiveness of Hospital Services 48
Summary 61
Appendix 2A. Resource Use 67
3. Hospital Costs and Efficiency 79
Accounting-Based Cost Studies 82
Service Statistics, Efficiency, and the Demand
for Hospital Care 90
Efficiency of Input Use 108
Statistical Cost Studies 114
Summary 133
Appendix 3A. Step Down or Cost Center Analysis
of Hospital Costs 135
Appendix 3B. Use of Service Indicators for Rapid
Assessment of Relative Performance of Indonesian
Type C Hospitals 137
v

vi Contents
4. Hospital Financing Alternatives 143
Health Financing Objectives 144
Altemative Policies 152
Summary 165
Appendix 4A. Optimal Prices for Hospital Services 167
5. Hospital Financing Experience 179
Revenue Performance 180
Fee Policy in Selected Countries 194
Insurance Financing of Hospitals 229
The Effect of Alternative Hospital Financing Programs
on Efficiency and Equity 239
Summary and Recommendations 254
6. Reallocating Hospital Resources to Improve Health Services 259
Changing Hospital Referral Pattems 262
Using Hospital Resources to Support Primary
Health Care 274
Altematives to Inpatient Hospital Care 284
Summary 294
Appendix 6A. Quality and the Market for
Health Services 295
7. Conclusions 299
Hospital Resource Use 299
Hospital Costs 301
Hospital Financing 303
Suggestions for Future Research 305
References 311
Index 327

Foreword
Hospitals consume the largest share of government health resources, yet
until recently, they have not been a focus of health policy research in
developing countries. The attention paid to community-based and other
nonhospital primary care interventions was appropriate, of course, be-
cause of the cost-effectiveness of these measures compared with those
delivered in hospitals. But this should not have led to analytical neglect
of hospitals. It is precisely because hospitals account for such a large
share of health expenditure that improvements in their efficiency can
yield tremendous benefits for the entire sector. Moreover, strong hospi-
tals at the first referral level are vital inputs to the success of an integrated
primary health care strategy. For example, the strengthening of surgical
and special obstetric services at the referral hospital is a key component
of the strategy for reducing maternal deaths in developing countries.
Most of the studies that are discussed in this book date back only to
1987, and data and analyses presented herein will prove useful to both
researchers and policymakers. The cases reviewed in this book illustrate
analyses that hospital managers in developing countries should carry
out in their own institutions. In addition, the authors highlight a number
of unanswered questions that can form the basis for further studies,
either national or cross-national.
By improving the efficiency of hospitals in developing countries, a
greater number of persons can be served with available resources. By
ensuring that hospitals provide appropriate support to the primary care
level and that they are well integrated into national health systems, their
effectiveness can be much enhanced. This is of vital importance in this
era of worldwide fiscal constraints.
I commend this book to all engaged in improving the health of people
living in developing countries.
Adetokunbo 0. Lucas
Director, International Health Programs
Department of Population and International Health
Harvard School of Public Health
vii

Acknowledgments
This book owes much to the interaction, help, and encouragement of
many colleagues during a period of years. At an early stage in our
formulation of the research effort, when hospitals were a comparatively
neglected topic of research in the health sectors of developing countries,
the support and interest of Nancy Birdsall, Anthony Measham, and Dean
Jamison were invaluable. In order to identify the issues and establish a
manageable focus, we began our research with a set of background
papers prepared in 1986 and 1987 by Kenneth Chomitz (1986), David
Dunlop (1986), Julio Frenk, Enrique Ruelas, and Avedis Donabedian
(1989), Andrew Green (1987), DominiqueJolly (1987), Anne Mills (1990a
and 1990b), and Godfrey Walker (1986). As indicated in the References,
some of these studies have since been published and are generally
available. Our examination of these broad overviews was followed by
studies in specific countries: China (Barnum 1989), Ethiopia (Bitran-
Dicowsky and Dunlop 1989), Indonesia (Djuhari and others 1988; Bar-
num 1987b), Malawi (Mills 1991), and the Dominican Republic,
Honduras, and Jamaica (Lewis 1990). The section on statistical cost
functions in chapter 3 is based partly on ongoing research we are
conducting with Adam Wagstaff on the characteristics of hospital cost
fumctions.
In addition to the activities commissioned specifically for this book,
the findings and recommendations are based on a detailed survey of the
relevant literature, both published and unpublished. Sector work con-
ducted under World Bank auspices has contributed greatly to our re-
search. Although we have drawn information from many World Bank
reports, the work managed by John Briscoe and William McGreevey in
Brazil, Richard Bumgarner in China, Nicholas Prescott in Indonesia, and
Hazel Denton in Nigeria deserves specific mention. Many non-Bank
studies were also used. Of particular note is the work carried out under
two activities funded by the United States Agency for International
Development: the Health Care Financing in Latin America and the
Caribbean (HCF/LAC) project, managed by Dieter Zschock; and the Re-
sources for Child Health (REACH) Project, managed by Gerald Rosenthal.
viii

Acknovledgments ix
In May 1989, a workshop entitled "Hospital Resource Use and Cost
Containment" was held at the World Bank. Presentations on hospital
costs, financing, and health service alternatives were made by Ricardo
Bitran-Dicowsky, David Dunlop, Charles Griffin, Maureen Lewis, Anne
Mills, Germano Mwabu, Julia Walsh, Annemarie Wouters, and Mary
Young. Jose-Luis Bobadilla, Richard Bumgarner, Philip Musgrove,
Mead Over, and Donald Shepard added greatly to the discussion of these
issues. Following the workshop, we began work on this book.
Many people reviewed parts or all of earlier drafts of the manuscript,
some on several occasions. We are most grateful for their written com-
ments as well as contributions made during meetings held to discuss the
first draft in August 1990 at the World Bank. Special acknowledgment is
due to Martha Ainsworth, Ricardo Bitran-Dicowsky, Jos&Luis
Bobadilla, John Briscoe, Richard Bumgarner, Guy Carrin, Andrew
Creese, Carlos Cruz-Rivero, Hazel Denton, David Dunlop, Guy Ellena,
Julio Frenk, Willy de Geyndt, Fred Golladay, Charles Griffin, Davidson
Gwatkin, Salim Habayeb, Jeffrey Hammer, Jean-Louis Lamboray, Mau-
reen Lewis, Patricio Marquez, Jo Martins, Anthony Measham, William
Newbrander, Mead Over, Donald Shepard, Anne Tinker, Louis Vas-
siliou, Adam Wagstaff, Julia Walsh, Marcia Weaver, Vivian Wong, and
Annemarie Wouters. The exacting readings given the manuscript by
four anonymous referees commnissioned by the World Bank's Office of
the Publisher were also invaluable and resulted in imnportant revisions.
Any remaining omissions and errors are our responsibility.
We are grateful to Joanne S. Ainsworth for a splendid job of editing
this book and to Leonila Jose, who provided excellent secretarial assis-
tance throughout all stages of preparation of the manuscript.

1. Introduction
This book examines economic and financial issues of hospital resource
allocation with the objective of contributing to policies that will improve
the use of public sector funds by hospitals. More specifically, the book
concerns (a) the allocation of health sector resources between hospitals
and nonhospital alternatives, (b) the internal efficiency of hospital oper-
ations, and (c) effective and equitable cost-recovery policies for hospitals.
Hospital operating expenses are at the core of the growing gap be-
tween required and available resources in the health sector of many
countries. Hospitals receive the lion's share of public recurrent resources
in health. Although the actual percentage varies from country to country,
it is common for 50 to 80 percent of public sector health resources, in
money and trained personnel, to be used in hospitals. The remaining
resources are used for preventive care, infectious and parasitic disease
control programs, nonhospital maternal and child health programs, and
other services that have been identified as generally more cost-effective
than hospital care in countries with limited health resources. Reviews of
the health sector in many countries suggest that these large recurrent
expenditures on hospitals involve a great waste of resources because of
the inappropriate allocation of funds within the health sector and the
technical and managerial inefficiency within hospitals.
Notwithstanding the large share of government health resources allo-
cated to hospitals, much of health research has focused on maternal and
child health programs and first-line services at the periphery rather than
on hospitals and higher-level curative care. The emphasis on nonhospi-
tal interventions reflects the limited results produced by capital-inten-
sive hospital projects. The avoidance of capital expenditure on hospitals
in health sector projects has been, and generally continues to be, desir-
able, but the neglect of hospitals in sector research has been unfortunate,
because research can be influential in changing the role of hospitals and
the flow of resources in the sector. In addition, the emphasis on non-
hospital interventions may have overshadowed the important potential
contribution of hospitals to the integral health system.
1

2 Public Hospitals in Developing Countries
Just five or six years ago there was relatively little information on
hospital economics in developing countries. Recent studies, however,
sponsored by ministries of health in collaboration with such donors as
the World Health Organization (WHo), the United States Agency for
International Development (UsALD), and the World Bank, have begun to
fill the void in hospital research. Although our knowledge of hospital
costs, finance, and resource use remains incomplete, the new research
provides important data that are needed to develop improved hospital
policy. This book draws widely on this research to support the analysis
presented.
The Scope of the Book
The overarching viewpoint of this book is economic. Thus we examine
the main questions of hospital efficiency within the framework of the
economics of production and costs. Full answers to these questions must
also involve the fields of hospital management, organization, and per-
sonnel planning, but to keep the book manageable we have restricted
the scope to economic and financial issues. Economic analysis can help
to identify the areas in which changes are needed even though im-
plementation of the changes ultimately requires noneconomic analysis.
Also, some important policy areas, especially those related to incentives
and pricing, directly involve economics and finance.
The economic view of hospitals provides an important perspective,
but it is not all-encompassing. This perspective is subsumed by a broader
public health view of hospitals, which considers hospitals in relation to
the epidemiology of the population and the structure of other health
services. Public health policy will reflect the way in which health author-
ities attempt to meet health needs, as determined by a population's
epidemiology and demographic structure. The level of preventive activ-
ities, the emphasis on basic care provided in health centers and through
outreach programs, referral policies, and the choices made by consumers
of health services all act to determine the case mix faced by a given type
of hospital. Treatment norms within the hospital (and in the medical
community in general), administrative policies, and staff composition
and incentives determine the procedures used for cases of a given type.
Although we discuss many aspects of public health policy in our eco-
nomic approach to hospitals, we do not attempt an in-depth analysis of
all aspects of the health system. The policy recommendations reached
from the economic analysis of hospitals, however, do have implications
for the entire health sector.
The scope of this book is limited primarily to public hospitals and to
public programs that finance hospital care, irrespective of whether such

Introduction 3
care is delivered by governmental or private providers. This limitation
is consistent with the objective of the book, which is to contribute to
public sector efficiency. It also has kept the book within manageable
bounds by restricting the information needed to the relatively more
accessible public hospital data. Information on private sector hospitals
is difficult to obtain because very few countries have any system of
regular reporting to a central authority on the details of private sector
hospital operations. Nevertheless, nonprofit hospitals operated by non-
governmental organizations (NGos) as well as profit-seeking hospitals
play an important role in the provision of services in most developing
countries. Public and private sector hospitals inevitably interact in the
market for services, and this interaction is taken into account in the policy
discussion.
The Issues
Correcting the problems with hospital resource use does not simply
mean allocating a greater proportion of development funds at the mar-
gin to nonhospital projects. In order to control hospital expenditures and
improve the efficiency, management, and role of hospitals in the health
sector, we need a better understanding of the issues underlying the
allocation of health sector resources to hospitals. Research on questions
of hospital economics and finance is needed to gain this understanding
and help formulate strategies for more effective hospital resource use.
Some of the questions that must be answered follow:
& What share offinancial and personnel resources do hospitals absorb? Who
uses hospitals? Given an appropriate criterion, such as maximum health
benefit, is the share of public health sector resources absorbed by hospitals
optimum?
The actual share of resources going to hospitals is not clearly known
in many countries, but aggregate government data, together with
special detailed studies in some cases, do suggest substantial differ-
ences among countries in the allocation of public sector health re-
sources. The amount of health sector resources absorbed by hospitals
in contrast to that taken in by nonhospital programs can have im-
plications for the success of primary health care and the overall
effectiveness of the public health sector. The provision of hospital
services also has implications for the distribution of benefits from
public resources.
* What are the levels of hospital average and marginal costs in selected
regions and countries? How can these unit costs be measured? What are the
relations among unit costs, occupancy rates, length of stay, and quality of

4 Public Hospitals in Developing Countries
services? What are the determinants of hospital unit costs? To what extent
can hospital unit costs be reduced and efficiency increased through adjust-
ments to factor mix and changes in length of stay? How does efficiency vary
with type and size of hospital?
Knowledge of unit costs is needed to assist planning for recurrent
budgets, as an indicator of efficiency, and to inform pricing of services.
Costs are not known with any accuracy for most hospitals in develop-
ing countries. Recent studies have demonstrated the feasibility, how-
ever, of reconstructing hospital expenditures to obtain estimates of
unit costs. This information can be used to suggest means of increasing
hospital efficiency through adjustments to factor mix, changes in
length of stay, and improved use of the referral system.
* Is cost recoveryfeasibleanddesirable in hospitals? Whatprinciples should
determine the level of hospital fees? Can practical guidelines be developed?
Should risk-sharing mechanisms be used to finance hospitals? What institu-
tional features should be included in insurance programs?
Decreased availability of government recurrent revenues has put new
pressure on government health officials to look for alternative sources
of funds. Cost recovery has been promoted by donors and by govern-
ment ministries but with little practical guidance on how to set fees
and for what services. Cost recovery in health could start most readily
with the use of fees for hospital services, where, because of adminis-
trative capacity and concentration on curative care, the use of fees is
more practical than it would be for lower-level services. The appropri-
ate level of these fees, however, is open for discussion.
* Can thefunctioning of the referral system be improved in order to increase
access to care and the economic efficiency of the health sector? Are there
practical, lower-cost alternatives to the delivery of health care now delivered
through secondary and tertiary hospitals?
The high cost of technically complex hospital services has motivated
a search for less complex alternatives that could provide acceptable
care at lower cost. Some of the possibilities considered have included
redefining the role of district-level hospitals, use of home care, and
greater reliance on short-term stays and outpatient care.
Organization of the Book and Overview of the Findings
The organization of the book flows directly from the issues set out
above. The magnitudes of hospital use of public sector health resources
and hospital unit costs are identified, and then possible financing and
health sector service alternatives are considered. A brief overview of the
book is given below. More detailed summaries are provided at the end
of chapters 2-6. Chapter 7 recapitulates our principal findings and

Introduction 5
recommendations and concludes with suggested topics for future re-
search.
Hospital Resource Use
The magnitude and patterns of hospital resource use are examined in
chapter 2. As expected, we found that in almost all countries hospitals
receive the largest share of government health resources and that, within
the hospital subsector of many countries, tertiary hospitals receive a
large share of both financial and skilled personnel resources in relation
to that received by district hospitals. Furthermore, we found that hospi-
tal services are used disproportionately by urban populations, and there
is evidence (although less clear) to suggest that hospital services are used
less by the poor. Another finding is that not only do adults and the
elderly use hospitals more than their share of the population would
indicate, but they are also more expensive to treat. Thus as the popula-
tion ages, pressure on hospital resources will increase if services continue
to be delivered in the current manner. Finally, the chapter includes a
survey of available studies on the cost-effectiveness of individual health
interventions. These studies confirm that, in low-income economies,
nonhospital interventions are more efficient in dealing with the preva-
lent health conditions. Although not surprising, these findings are im-
portant because they emphasize the continuing potential problem of
extensive use of health sector resources in hospitals.
In addition to these more evident results are some findings that lead
to less evident conclusions. One surprising result is the lack of a clear
inverse correlation between the hospital share of resources and success
in achieving primary health care objectives. In countries that have
achieved important gains in reducing infant mortality during the last
twenty years, such as Sri Lanka and China, both a high absolute level of
support for the health sector and the involvement of district-level hos-
pitals in a broad sectoral strategy have contributed to the success of
primary health care programs even though hospitals absorb more than
60 percent of public recurrent health spending.
More important than the share of public health resources absorbed by
hospitals is the use of the resources within the hospital subsector and the
overall composition of health programs. In countries with successful
primary health care programs, there is an emphasis on district-level
hospitals rather than large tertiary facilities. Additionally, as the level of
income increases, the relative importance of hospital services increases.
Thus, the optimum proportion of health sector resources absorbed by
hospitals must be determined by assessment of the epidemiological
needs and the available personnel skills, the financial resources, and the
structure of the hospital subsector of individual countries.

6 Public Hospitals in Developing Countries
Hospital Costs
Hospital unit costs and their implications for policy are discussed in
chapter 3. This section relies both on accounting-based studies and on
statistical estimation as complementary tools to examine internal effi-
ciency issues and to generate a cost basis for planning and cost-recovery
policies. The book does not give full answers to all the questions raised
above. Information is provided on the magnitude of costs, the method-
ologies for measuring costs, and the relationships between the various
service indicators. But answers to the questions of the relation of hospital
cost to efficiency remain tentative, primarily because of the difficulty in
measuring the quality of hospital services. Quality issues have not
received satisfactory treatment in the literature on hospital cost and are
an important topic for future research. With the caveat concerning the
issue of quality, we can summarize some of the chapter's findings.
An important fact demonstrated by the survey of accounting studies
of average costs is that such studies are feasible in low-income countries.
Collection and analysis of the data required to calculate average costs
can be made a routine hospital activity with the objective of improved
planning, management, and budgeting. The estimated average costs
demonstrate that tertiary-level hospitals have substantially higher costs
per patient than do more basic hospitals. This situation is to be expected,
but the treatment by tertiary facilities of cases not requiring specialized
care reflects a waste and misuse of resources. The difficulty, of course, is
in providing credible services at the district level that can support a more
rational use of referral facilities. In chapter 3 (and chapter 6 as well) we
discuss the importance of improving the quality of district facilities.
There have been very few statistical studies of developing-country
hospital costs, and it is thus premature to generalize from their findings.
The cost functions discussed in chapter 3 do not show evidence of
long-run economies of scale or of economies of scope.' These findings
are consistent with similar studies of hospital costs in industrial coun-
tries. Clearly, however, more examples from developing countries are
needed to improve our understanding of the hospital production process
in this context.
Many relations between service statistics and efficiency have been
identified. A cross-country survey reveals that occupancy rates, bed
turnover rates, and average lengths of stay vary considerably across
countries and among levels of hospitals.
2
Low turnover and occupancy
rates, especially among lower-level facilities, are often attributable to the
poor quality of services caused by insufficient drugs and other supplies
and a lack of skilled staff. Analysis suggests that, with plausible demand
response, higher occupancy and possibly lowered average cost can be
compatible with greater expenditures on facilities to improve quality.

Introduction 7
Another finding is that low turnover and long average lengths of stay
contribute to high costs per case treated. Much of this problem is mana-
gerial and requires careful studies if solutions are to be proposed in
individual cases. Some potential causes are poor scheduling of diagnos-
tic services or surgery, outmoded treatment protocols, and misuse of
secondary and tertiary facilities for extended care or convalescence. The
discussion in chapter 3, as well as in chapters 4 and 5, also suggests that
poor hospital performance, as revealed by service statistics, can relate to
adverse incentives provided by the structure of hospital financing.
Financing
Hospital cost recovery is considered in chapters 4 and 5. In these chapters
we build on the unit cost discussion and examine efficiency, equity, and
revenue implications of the use of fees and insurance for hospital ser-
vices. Chapter 4 provides a general framework for the analysis; here we
review the deficiencies in the private market that lead to public interven-
tion and set out the efficiency, equity, and revenue objectives of financing
policy. In chapter 5 we review current cost-recovery policies in a variety
of country settings.
Chapter 4 contains some principles for setting hospital prices: (a) fees
should be consistent with ability to pay, (b) fees should provide signals
that promote economic efficiency, (c) fees and the quality of services
should be linked, (d) fees should be subsidized for services that have
externalities, are public goods, have associated informational deficien-
cies, or are merit goods.
3
A full answer to the question of how to set fees
requires information on both sides of the market-household demand
and the hospital cost of supplying services. Studies of hospital unit costs
provide an important supply-side component to help determine appro-
priate fees, whereas studies of service use response to income and price
levels provide required demand-side information. Application of recent
public enterprise economics integrates demand- and supply-side infor-
mation to allow the development of guidelines for fee determination that
make explicit the roles of costs and demand response. Briefly, prices
should reflect price and income elasticities as well as costs. Services that
are more income elastic (that is, a given percentage increase in income is
accompanied by an even greater percentage change in the quantity of
service demanded) should have a greater proportion of costs reflected
in their price than services that are income inelastic. The benefits of
applying this rule are improved equity and efficiency.
The application of pricing rules must be tempered according to the
institutional setting in which financing takes place. The use of fees,
risk-sharing arrangements, management and organization, and the
overall structure of the health system all greatly affect client and pro-

8 Public Hospitals in Developing Countries
ducer incentives and performance in individual countries. In chapter 5
we review the systems used to finance health care in several countries
and set forth some practical additions to the pricing principles outlined
above. These additions can be abbreviated here: timely fee adjustments
should be an integral part of the system, fee structures should be simple,
and exemptions should be limited to those granted on equity grounds
or for services that provide benefits well beyond the patient. The chapter
also includes some suggested guidelines for risk sharing: cost contain-
ment requires active involvement by the insuring institution to encour-
age providers to behave in a cost-effective manner; cost sharing is needed
in all risk-sharing schemes to provide consumer incentives for efficiency
(but these appear to be less effective than provider incentives); prepaid
capitation schemes (for example, health maintenance organizations) are
practical in circumscribed communities. Publicly sponsored provision
of insured hospital services for only a small proportion of the population
should be done with great caution to avoid inequitable distributional
consequences.
Health Sector Alternatives
Lower-cost alternatives to hospitals are considered in chapter 6. In this
chapter we examine the role of hospitals in the wider network of health
service providers and suggest that there is ample scope for improving
the overall cost-effectiveness of the sector through a reallocation of
resources in favor of relatively low-cost providers. The suggested ap-
proach is to begin with an epidemiological picture of the population,
delineate several viable packages of interventions for meeting health
needs, and cost the alternative packages. The alternative that would
yield the maximum health benefit for the available resources should be
chosen. It is expected that a choice made in this manner would result in
a network of providers and an allocation of resources that would encour-
age treatment of frequently occurring, low-cost conditions in the least
expensive, yet capable, setting. Alternative treatment settings would
indude care in the home and community and noncomplex facilities such
as health centers, which are often considered to be important compo-
nents of a health referral system. Innovative alternatives not typically
thought of in this manner, such as outpatient surgery facilities, could
also be included if they are found to be cost-effective. As a result of the
use of these alternatives, the case mix of hospitals of varying complexity
would change so that, for example, tertiary hospitals would primarily
treat patients requiring highly specialized care rather than using sub-
stantial resources for patients who could be cared for in less expensive
facilities.

Introduction 9
Practical ways in which the development of alternatives to hospital
care can be supported are discussed in the chapter. It is most important
to improve quality at lower-level facilities so that the population will not
bypass them in favor of hospitals. To do this would require reallocating
resources in favor of noncomplex facilities, perhaps away from hospitals.
Another suggested policy is to coordinate the management of all provid-
ers at the district level, including the district hospital. The district hospi-
tal can also support primary care provided in lower-cost settings with
training programs, assistance with logistics, and provision of credible
diagnostic backup. Finally, we discuss alternatives to expensive hospital
inpatient care that may be useful in many developing countries. These
include treatments that can substitute for hospitalization and the use of
lower-level facilities for treatment and palliation of chronic diseases.
Notes
1. See chapter 3 for definitions of these and other characteristics that can be
derived from statistical cost functions.
2. See chapter 3 for definitions of these measures of service performance.
3. These terms are all aspects of market failure. A discussion of market failure
and definitions of these terms are given in chapter 4.

2. Patterns of Hospital
Resource Use
A change in health policy can affect the balance between services pro-
vided by hospitals and those provided by nonhospital facilities, and it
can alter the share of government health sector resources used by hospi-
tals. Interest in the share of health sector resources used by hospitals is
motivated by the need to determine whether the allocation of resources
within the health sector is economically efficient. An allocation of health
sector resources among alternative activities is economically efficient if
there is no possible reallocation that will improve health status. Unfor-
tunately, appropriate measures of health status are not easily defined for
the health sector in general and are especially hard to define for hospitals
with their complex multiple outputs. Although hospitals are an essential
part of any health system, the optimum allocation of resources is not
obvious but is open to debate. Considerable analysis and discussion
during the last twenty years have led to a rough consensus about the
cost-effectiveness of primary curative care and preventive services com-
pared with that of hospital services. Health planners generally agree that
in countries with low levels of per capita gross national product (GNP)
and high rates of mortality, the most effective allocation of resources
would result in a lower share of public resources committed to hospitals
than in countries with high GNP and low mortality.
Accordingly, the share of government health resources going to hos-
pitals is a rough indicator of the structure and emphasis within the health
sector. A relatively low share suggests an emphasis on primary health
care and concern with reaching rural populations, and a high share
suggests an emphasis on curative care and concern with urban health.
This interpretation of the hospital share, however, should be applied
cautiously to any specific country because the types of facilities defined
as hospitals vary across countries and, apart from definitional issues, the
absolute level of resources flowing to the health sector and the quality
11

12 Public Hospitals in Developing Countries
of health services are also determinants of the structure and effectiveness
of the health sector.
Despite the consensus that a greater share of public sector health
resources should be allocated to nonhospital activities than is currently
the case in many countries, the level of the appropriate percentage is not
obvious. The provision of better quality and increased quantity of pri-
mary health care services need not conflict directly with the existing
allocation of resources. Primary curative care is one type of service
currently provided in many hospitals, and as discussed in chapter 6,
hospitals can also provide a variety of preventive, palliative, and reha-
bilitative services and be structured so that they integrate with and
provide support for nonhospital services. Hospitals are relatively high-
cost institutions, especially with regard to investment, but primary
health care outreach activities, although relatively low cost in terms of
investment, can entail large recurrent costs. What is important is to
obtain a balance of services throughout the health sector, with each
investment being examined on the margin for its cost-effectiveness and
contribution to sectoral efficiency.
Interest in the share of public sector health resources going to hospitals
is also motivated by a concern with equity. There is no universal defini-
tion of equity because it is a normative concept that is defined in the
context of prevailing social and moral values. But again based on a
consensus view, equity might be defined as equal access across popula-
tion and income subgroups to health services covering basic health
needs. Using this minimum definition, equity could be enhanced with a
progressive distribution of the burden of payment across income groups.
Just what is included in basic health needs is only roughly defined, but
at a minimum it encompasses safe childbirth, prevention and treatment
of the main child health problems, protection from common tropical
diseases, and access to first aid for accidents. Hospitals are not the most
effective way to deal with many of these needs. In addition, hospital
facilities are commonly distributed unequally across geographic areas
and used unequally by different income groups. Thus, a relatively
inequitable allocation of health sector resources is suggested by a very
high percentage of recurrent health expenditures being absorbed by
hospitals.
This chapter is largely descriptive of observed patterns of government
resource allocation in the health and hospital sectors. The data are too
variable in definition across countries to support strong policy prescrip-
tions. Also, policies to reallocate sectoral resources in a particular coun-
try should be supported by detailed studies addressing the specific
institutional issues of the setting. For these reasons we confine ourselves
to identification of broad characteristics of hospital resource use and the
potential policy implications of these patterns.

Patterns of Hospital Resource Use 13
In the first two sections of this chapter we review cross-country
information on the use of resources by public hospitals, first, with regard
to the distribution of resources within the health sector and, second, with
regard to the distribution of resources within hospitals. In the third
section we assess data on the use of hospital services across income
groups, geographic location, age, and disease types and consider the
implications of existing use patterns for equity and future resource costs.
In the fourth section of the chapter we review information related to the
consensus view on the cost-effectiveness of hospital services. The chap-
ter thus describes the resources used by hospitals and then turns to a
normative evaluation of hospital resource use. The final section summa-
rizes the principal findings of the chapter.
Distribution of Resources within the Government Health
Sector
Hospitals compete with other health facilities and programs for both
recurrent and capital resources. The amount allocated to hospitals must
be further redistributed among different levels and types of hospitals.
These allocational issues are described below.
Recurrent Resources
In most developing countries the distribution of recurrent resources
within the government health sector strongly favors hospitals. Quanti-
tative comparisons across countries are difficult because of variation in
the definition of hospitals and a lack of comprehensive information
available from the private sector and from different levels of government
within the public sector. Broadly, the available data do reveal that a high
percentage of government health resources are assigned to hospitals.
Among the twenty-nine developing countries listed in table 2-1, over
half spend more than 60 percent of recurrent health budgets on hospitals,
and about two-thirds spend 50 percent or more. Only four countries
distribute less than 40 percent of public sector health resources to hospi-
tals. However, the implications of the hospital share for the success of
primary health care (PHC) programs and for national health indicators
are not clear and must be analyzed at the country level. Nepal, which
has the lowest hospital share of any country in table 2-1, has a low level
of absolute support for health services and notable problems in im-
plementing quality primary care programs (World Bank 1989). It also
has a low level of health status, reflected in an infant mortality rate (IMR)
of more than 125 per 1,000 live births in 1987. Indonesia, also a low-
income country, has been more successful at implementing primary care
programs (Prescott 1991) and has a higher overall level of support for

14 Public Hospitals in Developing Countries
Table 2-1. Share of Hospitals in Total Public Recurrent Health Expenditure
(percent)
Country Hospital share Year Source
Bangladesha 61 1987 Griffin 1989
Botswana 49 1984
Brazil 68 1984
Burundi 66 1986
Chinab 61 1987
Colombia 67 1984
Cote d'IvoireC 46 1984 Vogel 1988
El Salvadord 62 1985 Fiedler 1987
Ethiopia 49 1983-84
The Gambia 45 1985-86
Indonesia 37 1985-86
Jamaica' 72 1986-87 Kutzin 1989
Jordan' 75 1987
Kenya 73 1985-86
Lesotho 74 1986-87
Malawig 81 1985-86
Mexicoh 58 1986
Mozambique! 36 1987
Nepali 25 1987-88
Niger 30 1988 Budd 1989
Papua New Guinea 45 1986 Newbrander 1987
Philippinesf 71 1985
Senegal 50 1982 Vogel 1988
Somalia 70 1989
Sri Lanka 70 1986 ADB 1987
Swaziland 52 1983-84
Turkeyk 63 1987
Ugandal 43 1982-83
Zimbabwe'l 54 1987
OECD meann 54 1980s OECD 1987
a. Includes Upazila Health Complexes (primary-level hospitals).
b. Includes all expenditures by central and provincial governments on hospitals, hos-
pitals of traditional Chinese medicine, and township hospitals.
c. Percentage reflects mean of 40-51 percent range reported by Vogel.
d. Percentage may reflect hospitals as a share of all faclity-related health expendi-
tures, rather than of total public sector health expenditure.
e. Includes mental health hospital and the share of drugs and other medical supplies
allocated to hospitals from central administration.
f. Excludes health expenditures by public sector other than Ministry of Health.
g. Percentage reflects share of expenditure devoted to "curative" services, which over-
states the hospital share to some extent.
h. Includes capital and recurrent public health expenditures.
i. Recurrent budget estimates.
j. Total (capital and recurrent) budget devoted to secondary and tertiary care and to
hospitals with fewer than fifty beds; excludes amounts budgeted for military and mis-
sion hospitals.

Patterns of Hospital Resource Use 15
k. Includes expenditures by the social insurance organization.
1. MOH expenditures (uncertain if capital included) with medical stores proportionally
reallocated to faclities (may understate hospital share); some health center services in-
cluded.
m. Includes health expenditures by MOH and municipal or local government health
authorities; excludes central government health expenditures by other ministries.
n. Institutional health care, includes nursing homes, does not include ambulatory care.
Source: World Bank sector reviews and appraisal reports, except as noted above.
health services. Indonesia's imR was 70 in 1987. At the other extreme,
eight countries in table 2-1 devote 70 percent or more of public health
resources to hospitals; among them Lesotho, Malawi, and Somalia have
IMRs of more than 100, and Jamaica, Jordan, the Philippines, and Sri
Lanka have IMiRS below 50 (see the appendix table at the end of the
chapter for IAR data).
The use of beds per capita as a measure of the intensity of hospital
resource use is common but is fraught with difficulties. The definition of
a hospital bed varies across countries. Most developing countries do not
distinguish between acute beds (used for short-term stays of less than,
say, thirty days) and long-term beds, although some countries do distin-
guish long-term specialty hospital beds, such as those for tuberculosis,
leprosy, and psychiatric care. Even more troublesome are occasional
large differences between the number of beds officially installed and the
number of operational beds. A breakdown between acute and chronic
beds, and confirmation that the beds given are operational, would add
greatly to the interpretation of the comparative bed ratios, but this
information is not available for many countries. Thus, bed ratios give
only a gross measure of the availability of hospital services.
Generally, there is a strong relation between the availability of hospital
beds per capita and the level of per capita GNP (figure 2-1). The number
of beds per capita increases by about 4 percent for every 10 percent
increase in per capita income.' The structure of the health sector in terms
of the balance of resources between hospitals and other health service
alternatives, however, is not as easily explained as the overall availability
of hospital beds.
Despite the consensus that poorer countries should devote a larger
share of public sector health resources to nonhospital interventions,
available evidence suggests that there is no clear relation between the
hospital resource share and the level of per capita national income. This
lack of relationship is dear in the scatter of points relating the hospital
share of government health expenditure on the Y axis and GNP per capita
on the X axis in figure 2-2, which indicates that there are a number of
poor countries with relatively high hospital shares. The high hospital
shares of some poor countries may be explained (in part) by the nature

16 Public Hospitals in Developing Countries
Figure 2-1. Hospital Beds per 1,000 Population
Beds per 1,000
9
High income (38) S
8
7
6 * Upper-mniddle income (26)
5
4
3 * Lower-middle income (52)
2
* Low income (47)
1
0 2 4 6 8 10 12 14 16
Per capita GNP (thousands of 1989 US dollars)
Source: World Bank data, 163 countries; most recent year, 1970-89.
of hospitals as high-cost institutions. A considerable share of the total
health resources of a small country may be taken up by one large referral
hospital because of that hospital's high cost and the country's limited
resources. In Lesotho, for example, one hospital, the national referral
facility, absorbed 42 percent of total Ministry of Health (MOH) expendi-
ture in 1986-87 (United Medical Enterprises 1988). Reducing that share
without significantly increasing the absolute level of resources in the
health sector may imply drastically changing hospital functions or re-
ducing government responsibility for its financing. Both of these actions
are the subject of later chapters.
Some of the cross-country variation in hospital share may be attribut-
able to differences in the definition of a hospital. In China, for example,
if small township hospitals (which largely provide primary care) are not
included with secondary and tertiary care facilities, the 1987 hospital
share drops from 61 to 44 percent. The figures reported in table 2-1 reflect
varied definitions of what constitutes a hospital in individual countries.
This variation can mask the potential inequity and inefficiency resulting

Patterns of Hospital Resource Use 17
Figure 2-2. Relation between the Share of Public Health Spending
Devoted to Hospitals and per capita GNP, 1982-89
Percent
90
80 -* Malawvi
Kenya .@ Lesotho * Jamaica * Jordan
70 -Somalia 0 0 Philippines
Burundi * Sri Lanka * Colombia * Brazil
60 -* * China * El Salvador 0 Turkey
Bangladesh
Senegal * Zimbabwe Mexico
50 Etipia Sngl0 Swaziland
* TheGambia Cote d'lvoire * Botswana
4 * gandia * Papua New Guinea
40 * Uganda
* Mozambique 0 Indonesia
30 - Niger
* Nepal
20
10
0 I
0 500 1,000 1,500 2,000
Per capita GNP (1980 US dollars)
Source: World Bank sector reviews, project reports; see also table 2-1.
from a large proportion of resources being allocated to large urban
tertiary hospitals as opposed to smaller district and rural hospitals.
Cross-country differences in the definitions of hospitals and in the
share of recurrent hospital expenditures devoted to a few large tertiary
hospitals compared with many smaller hospitals limit the usefulness of
the overall public sector hospital share as an indicator of the priority
given to various health programs. Comparing hospital with nonhospital
expenditures is not equivalent to a comparison of primary care with
secondary and tertiary care because hospitals provide a considerable
amount of primary curative care. Therefore, as suggested above, the data
for hospital share alone do not support definitive conclusions regarding

18 Public Hospitals in Developing Countries
a country's level of support for primary health care or the effectiveness
of primary, secondary, or tertiary care programs. Country-specific anal-
ysis is required for such conclusions.
Figure 2-3 indicates that there is a tendency for higher hospital shares
to be associated with a greater number of doctors per capita. This relation
is strongest for middle- and high-income countries. An examination of
GNP per capita and doctors per capita as multiple determinants of the
hospital share for twenty-nine low- to middle-income developing coun-
tries produces results that are not very strong but are consistent with this
observation.
2
The statistical pattern in a cross-section of countries sug-
gests that a 1.6 percent increase in the hospital share accompanies a 10
percent increase in the number of doctors per capita. Interestingly, the
Figure 2-3. Relation between the Share of Public Health Spending
Devoted to Hospitals and Physicians per 1,000 Population
Percent
90
Malawi
80 -
Lesotho Kenya Jordan
* / Philippines Jamaica O
70 * * Sri Lanka Colombia Brazil
Somalia 5
60 - 0 Bangladesh * El Salvador Turkeyo China
Swaziland S
I * Zimbabwe Mexico
50 ** - Senegal
's0 * * *0 Botswana
**The Gambia-Ethiopia
* * Papua New Guinea
40 Uganda c C^ote d'Ivoire
S * Indonesia
Mozambique
30 -Niger
* Nepal
20
10
0 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1
Physicians per 1,000 population
Source: See figure 2-2.

Patterns of Hospital Resource Use 19
coefficient on per capita GNP becomes insignificant when per capita
physician supply is included in the regression. A country's income level
would still seem to be an important factor, however, because high-in-
come countries tend to have greater availability of physicians per capita
(see the appendix table A2-1).
In any case, the relation between the hospital share of health sector
resources, the number of doctors per capita, and GNP per capita suggests
that policies to limit the future supply of doctors (for example, redirect-
ing subsidies for medical education to the training of other types of
health professionals) might have an effect in the medium to long term
on reducing the share of health resources absorbed by hospitals. Also,
the correlation between physicians per capita and hospital share may
indicate that the medical curriculum is oriented too much toward the
practice of high-technology Western medicine and does not correspond
to the health needs of the population. To a certain extent the transition
in disease mix-away from the diseases of childhood and toward
chronic disease and the diseases of adulthood-that accompanies
growth in per capita income can require more hospital resources. A
conclusion that is reached from a consideration of the cost-effectiveness
of health sector alternatives later in the chapter is that primary health
care services continue to have the greatest effect on health status per unit
of expenditure even for countries that have advanced to middle-income
levels.
Despite national and international calls for an emphasis on primary
health care in the years since the 1978 World Health Conference held in
Alma-Ata, the share of recurrent resources going to hospitals increased
in many countries but remained about constant or decreased in other
countries during recent years (table 2-2). The support that the data in the
table lend to conclusions regarding a country's ability to reallocate
resources is limited by the varying lengths of time between observations
of the hospital share, but the data do suggest clear trends in some
countries. The rate of annual increase of recurrent expenditures on
hospitals compared with total health sector expenditures was 2.8 percent
in Brazil (including nonhospital curative care), 6.6 percent in the Philip-
pines, and 1.5 percent in Kenya, to pick some representative countries.
In several other countries, the hospital share remained relatively con-
stant, which may reflect the inertia of a historically based budgeting
process (see Fiedler 1987 for a discussion of such a process in El Salva-
dor). In some other countries, the hospital share decreased, usually as a
result of deliberate govemment policies to control hospital expenditures
and protect PHC programs. Mexico, The Gambia, and Zambia exemplify
countries in which such policies have been translated into resource
allocation decisions. In The Gambia, for example, the health plan
adopted for the period 1981 to 1986 emphasized a village-based PHC
strategy and described the shift in resources implied by this policy.

20 Public Hospitals in Developing Countries
Table 2-2. Changes in the Share of Public Recurrent Health Expenditures
Allocated to Hospitals, Selected Countries and Years
(percent)
Hospital Average annual
Country Year shlare clhange Source
Botswana 1979 42
1984 49 3.0
Brazil' 1975 70
1982 85 2.8
Chinab 1980 38
1987 44 2.2
Colombia 1974 65
1984 67 0.3
El Salvador 1981 62
1985 62 -0.2 Fiedler 1987
The Gambia 1979-80 67
1985-86 45 -6.2
Jamaica 1983-84 73
1986-87 72 -0.5 Kutzin 1989
Jordan 1982 80
1987 75 -1.2
Kenya 1978-79 66
1985-86 73 1.5
Lesotho 1970-71 64
1981-82 71 0.9
Malawi 1976-77 73
1985-86 81 1.2
Mexico 1982 64
1986 58 -2.6
Papua New Guinea 1975 46
1987 45 -0.3 Newbrander 1987
Philippines 1981 55
1985 71 6.6
Swaziland 1976-77 69
1983-84 52 -4.0
Turkey 1981 68
1987 63 -1.4
Zambiac 1975 33
1981 30 -0.5
a. Percentages reflect the share absorbed by "curative" services (includes hospital and
nonhospital).
b. Includes only upper-level hospitals and hospitals of traditional Chinese medicine.
c. Percentages reflect the share absorbed by the four largest hospitals only.
Source: World Bank sector reviews and appraisal reports, except as noted.
Although there were severe cuts in the real level of governrment health
expenditure during the final three years of the plan period, the policy
was adhered to, as evidenced by the data reported in table 2-2.

Patterns of Hospital Resource Use 21
The recurrent resource needs of a country's health sector can interact
dynamically with the decline of real public revenues that results, for
example, from a fall in the prices of primary products coupled with
softening economies in industrial countries and thus a drop in demand
for these products. Nonhospital programs can therefore be placed in
special jeopardy during times of economic difficulty, and a gap can be
created between maintenance requirements and actual expenditures for
hospitals. Declining public revenues have affected the quality and quan-
tity of social sector outputs, although there has been no clear trend across
countries as to whether these sectors have been affected dis-
proportionately. Grosh (1990) found that, for eight countries from Latin
America and the Caribbean between 1980 and 1988, declines in public
spending on health exceeded declines in total government recurrent
expenditures by an unweighted average of 25 percent. Public sector
health expenditure, however, fell by less than total public spending in
five of these eight countries, and total social sector spending (including
education and social security) declined at only half the rate of total public
spending.
The way the burden of the reduction in health revenue is shared across
programs differs greatly among countries. The fear of many public
health specialists is that, contrary to the example of The Gambia reported
above, as the real value of revenue allocations for health services de-
clines, health ministries, faced with a painful choice in allocation be-
tween hospital and nonhospital services, will favor hospitals, which
have more visible and larger capital stock, over nonhospital programs,
in which capital expenditures are less obvious and smaller. In the Phil-
ippines, for example, during a decline in real government expenditure
between 1983 and 1985, the allocation to the Department of Health (DOH)
was reduced to a greater extent than the overall decline in public spend-
ing. Within DOH expenditures, however, the share spent on hospitals
increased, whereas expenditures on preventive programs declined rap-
idly (Intercare 1987). But some countries have reacted to decreasing
health revenues by protecting or even increasing primary health care
programs while reducing hospital recurrent expenditures. In Zambia,
for example, a decline in copper prices put pressure on public resources
available in the health sector in the late 1970s, and the share of tertiary
hospital recurrent expenditures was reduced by 3 percent from 1975 to
1981 as the real value of health expenditures declined by 13 percent
(World Bank 1984).
Investment
Hospital investment is by its nature lumpy and irregular, and the hospi-
tal capital stock produced by the investment has a life of two or more

22 Public Hospitals in Developing Countries
decades. For this reason hospital investment expenditure for any given
year can be a misleading indicator of the proportion of development
funds absorbed by hospitals; the current size of the hospital sector results
from much earlier health policies. Mills (1990a) contrasts selected data
on the share of hospitals in investment in the 1960s with expenditures in
the 1980s and notes the considerably higher share of capital expenditures
spent on hospitals in the earlier period. For example, in Tanzania the
hospital share of total health sector investment was reduced from 80
percent in 196142 to less than 32 percent in 1978-79. The high early
figures result from large-scale hospital construction programs started in
the 1960s, whereas the recent lower figures reflect the more limited donor
funds now available for hospital construction and the greater priority
given to primary health care.
One cause of imbalance between recurrent resource availability and
capital expenditures is that, in many countries, health ministries are
largely responsible for recurrent budgets, whereas donors fund a large
proportion of capital expenditures. Somalia provides an example of a
very poor country in which both the recurrent cost and the investment
cost of primary health care programs have been heavily supported by
donors, but hospital recurrent costs are left to be supported almost
strictly from government revenues (World Bank 1985). There is evidence
that in recent years some health ministries have favored hospitals in their
marginal recurrent resource allocation decisions and have focused on
primary care in their capital investment decisions, which are largely
donor-determined. Underfunding of the recurrent resource require-
ments of these projects may in part be the result of the unwillingness of
health ministries to adjust their marginal recurrent resource allocation
decisions from an earlier hospital bias. Kenya provides an example of
public sector health authorities' unwillingness or inability to shift recur-
rent resources in favor of primary care investments. A comparison of
Ministry of Health recurrent budgets with actual expenditures from 1982
to 1989 reveals that for curative services (mostly hospitals), annual
budgets were overspent by an average of 7 percent and actual allocations
to preventive and promotive programs and rural health services were
17 percent and 19 percent less, respectively, than the amounts budgeted.
This evidence of actual resource allocation runs counter to the ministry's
stated policy, as reflected in MOH budgets, of giving priority to rural,
preventive, and promotive health services (World Bank 1991). A similar
-pattern existed in Jamaica from 1983-84 to 1986-87; expenditures on
hospital services were consistently above the amount budgeted (by an
average of 16 percent for these four years), whereas primary health care
expenditure averaged slightly less than the amount budgeted (Kutzin
1989).
Hospital investment and recurrent expenditures are linked closely but
with substantial lags. Present recurrent expenditures on hospitals result

Patterns of Hospital Resource Use 23
from the cumulative hospital capital stock produced in the 1960s and
1970s and in many cases, especially in Africa, during an earlier colonial
era. Consistent procedures are needed to assist planners in projecting the
recurrent costs of project proposals and then incorporating these projec-
tions into alternative budget scenarios. Ultimately, a careful project
analysis by component and expenditure category needs to be made.
Recurrent-capital cost (RCC) ratios provide a convenient alternative,
however, prior to a more detailed analysis. Projections of recurrent
expenditures based on RCC ratios are not reliable for a detailed analysis
of the recurrent cost implications of specific investments because the
relation between variable costs, fixed costs, and outputs that underlies
the ratios may not be stable across countries, projects, and levels of
output. Nevertheless, RCC ratios can be a valuable method of making
quick first estimates of the recurrent costs associated with a contem-
plated investment strategy. It is instructive to compare the recurrent cost
ratios reconstructed from a number of more detailed sources. Using
accounting-based analyses of existing hospitals or analyses of new pro-
jects to estimate recurrent costs, the studies summarized in table 2-3
show RCC ratios varying from 0.10 to 0.40 and averaging roughly 0.20.
Some of the cross-country variation results from methodological differ-
ences described in the "Comments" column of the table (for example,
inclusion of depreciation in recurrent costs), and some probably results
from differences in budgeting conventions. Despite what may be char-
acterized as these artificial sources of cost variation, most of the esti-
mated RCC ratios in table 2-3 are dustered around the mean value of 0.20.
These ratios are substantially lower than for projects that are less capital
intensive, such as primary health care outreach programs, which can
entail ratios in excess of 0.5 (Heller 1979; Over 1981).
Allocation of Resources by Level of Hospital
The scope and complexity of hospital services vary greatly within coun-
tries. To sharpen the discussion it is necessary to categorize hospitals by
the level of services offered.
Definition of hospital levels. Differences in case mix, technical capacity,
and skills differentiate hospital levels. These differences may also imply
different sizes of facilities, roughly measured by the number of opera-
tional beds, upper-level facilities often having a larger size. Bed size is
not the definitive difference between levels of facilities, however, and
there are many examples of facilities in which bed sizes run counter to
the expectation of size based on level. It is difficult to distinguish between
levels of facilities when one set of criteria is used for all countries. For
convenience, three levels of general hospital facilities are distinguished
here, not on the basis of bed size but on the basis of service characteristics.

24 Public Hospitals in Developing Countries
Table 2-3. Recurrent Cost Ratios for Selected Hospital Projects
Level of RCC
Country hospital Year ratio Source Comments
China Central 1986 0.22 Barnum Comparison of
Provincial 0.22 1989 reported operating
District 0.40 costs and
replacement cost.
Indonesia Central 1986 0.16 Barnum Based on
Provincial 0.12 1987 accounting
District 0.12 analyses for
existing hospitals
compared with
new project costs.
Jamaica District 1989 0.16-0.18 Kutzin Based on
1989 accounting
analysis for new
project.
Kenya Unspecified c. 1970 0.10-0.30 Heller
1979
Malawi District 1988 0.14 Mills Based on
1991 accounting
analyses for
existing hospital
compared with
replacement cost.
Malaysia Provincial 1971 0.18 Heller
District 0.11-0.30 1975
Papua Central 1988 0.27 jsI 1990 Comparison of
New Base 0.27-0.40 recurrent costs
Guinea Provincial 0.22-0.33 (including
depreciation) and
estimated capital
replacement cost.
Rwanda Central 1987 0.18 Based on studies
Provincial 0.13 of similar facilities
District 0.14 plus data gathered
locally.
Uganda Unspecified 1970 0.25-0.30 Dunlop
1973
Zambia Central 1981 0.30-0.40 MOH accounts
Provincial 0.16 compared with
estimated capital
replacement cost.
Source: World Bank sector reviews and appraisal reports, except as noted in table.

Patternis of Hospital Resource Use 25
The classification fits a pyramidal conception of a health service referral
system, ranging from level I, the most technically complex, to level III,
the most basic.
3
The levels can be described as follows:
Level 1: These hospitals have the most specialized staff and technical
equipment. The clinical services are highly differentiated by function,
including, for example, cardiology and specialized imaging units.
More than ten clinical specialties are not unusual in large referral
centers. The staff-to-bed ratios are the highest in relation to other
hospitals. Hospitals at this level are often, but not exclusively, associ-
ated with a medical school. As befitting their location at the top of the
referral pyramid, level I hospitals are also called "central"- or "terti-
ary"-level hospitals. Bed size, as suggested above, varies; depending
on the size of the population to be covered, it ranges from 300 to more
than 1,500 beds.
Level II: Although lacking the most technical services available in level
I hospitals, level H hospitals are also highly differentiated by function,
with five to ten clinical specialties. Staff-to-bed ratios are intermediate
between the highest and lowest level of hospitals. Level II hospitals
are occasionally associated with medical schools. Bed size ranges from
200 to 800 beds. Level HI hospitals are often referred to as "provincial"
hospitals.
Level III: Level m hospitals have many fewer specialists than the
higher-level hospitals. The availability of skill levels within this cate-
gory is varied. Some entry-level hospitals may have specialists in
internal medicine, obstetrics-gynecology, pediatrics, surgery, or radi-
ology, whereas others may have only general practitioners. Limited
laboratory services are available for general but not specialized patho-
logical analysis. Staff-to-bed ratios are low in relation to the upper-
level hospitals. Level Ill hospitals are often referred to as "district" or
"first-level referral" hospitals.
These definitions are by necessity very approximate and meant only
to be suggestive. The actual differences between referral levels depend
greatly on the resources available, the extent of health sector develop-
ment, and the standards of service within a given health system. Addi-
tional levels could conceivably be distinguished. Level III is particularly
large and, for example, includes both class "C" and class "D" hospitals
in Indonesia, "county" and "township" hospitals in China, and district
hospitals in Malawi.
Hospital level and resource use. Higher-level (level I and II) hospitals
absorb a large share of total public expenditure on hospitals, despite the
small number of these facilities in comparison with the number of level

26 Public Hospitals in Devoelopinig Coun1tries
III hospitals in most countries. The greater case mix complexity in
higher-level hospitals and their more intensive input use commonly
translate into much higher operating costs per unit (see chapter 3) than
at lower levels. Hospitals that have a teaching function also tend to have
higher operating costs. This difference is expected on the basis of func-
tion, and thus it is expected that level I and II hospitals will absorb a
greater proportion of total hospital resources than simply their numbers
would indicate. The extent to which resources are concentrated in these
facilities, however, often goes beyond that which might be justified in
order to fulfill their tertiary functions. In Zambia, for instance, the three
large central hospitals use 30 percent of Ministry of Health resources and
an estimated 45 percent of total MOH hospital resources, leaving the
remaining 55 percent to cover thirty-nine lower-level hospitals (World
Bank 1984). Similarly in Indonesia (Barnum 1987), the nineteen largest
public hospitals (out of more than three hundred) used 53 percent of total
recurrent hospital expenditure in 1985. In Kenya (World Bank 1991),
Kenyatta National Hospital used almost 20 percent of recurrent MOH
expenditure for curative services in 1986-87. Belize City Hospital in
Belize (Raymond and others 1987) used 69 percent of recurrent MOH
hospital expenditure in 1985. Finally, in Zimbabwe (Hecht 1992), 45
percent of MOH recurrent hospital expenditure in 1987 was for four
central hospitals.
This concentration of resources may have undesirable implications for
overall sectoral resource use and equity. In each of these cases a relatively
modest proportion of total hospital expenditures remained to finance
the services of district hospitals, which are intended to serve as first-level
referral facilities for most of the population. Excessive centralization of
resources in a small number of tertiary hospitals is not consistent with
the performance of crucial first-line functions by district hospitals, be-
cause these smaller hospitals are relatively starved of inputs. Such
centralization may result in poor-quality services at these first-level
referral centers, possibly causing patients to bypass them in favor of the
tertiary hospital. The end result is inefficiency in the overall network of
health services. The importance of maintaining a reliable supply of
services with an acceptable level of quality to enable district hospitals to
perform their first-level referral role is examined in greater detail in
chapter 6.
Distribution of Resources within Hospitals
The distribution of hospital expenditures by line item category reflects
the input mix used in the production of services. Depending on manage-
ment incentives, hospital input mix may be determined by many influ-
ences in addition to input prices, including centrally determined

Patterns of Hospital Resource Use 27
personnel staffing quotas and nationally acceptable medical practices.
In any case, relative prices will strongly influence the share of expendi-
ture on different inputs. In more industrialized countries, labor inputs
(wages and salaries) commonly absorb a high proportion of operating
expenditures, because wages and salaries tend to be high in relation to
nonlabor inputs (Mills 1987). In contrast, in developing countries salaries
and wages tend to be lower in relation to nonlabor inputs, and thus it
might be expected that labor cost would be a smaller proportion of total
expenditures. This expectation could be disappointed to the extent that
economic incentives lead to substitution of equipment and other non-
labor inputs for labor in high-wage countries and the reverse in low-
wage countries, but accepted standards of care and medical procedures
provide limits on this substitution.
Data on labor shares for a selection of hospitals in a cross-section of
countries support the expectation that the share of labor increases with
income, at least up to the middle-income levels indicated in figure 2-4,
in which the percentage of labor in hospital recurrent costs is compared
with GNP per capita.
4
Limits on the substitution of nonlabor inputs are
also created by rigidities in employment policies and the setting of wage
rates. The share of total hospital expenditure devoted to personnel has
increased in many countries as a result of a decreased availability of
public sector revenues and an inability or unwillingness to reduce the
size of hospital staff, possibly because of civil service constraints on the
hiring and firing of staff.
Even though in low-income countries the share of total expenditures
absorbed by labor tends to be less, labor remains an important input. The
data in table 2-4 show that in African countries labor costs are 33 to 79
percent of total expenditures. In Indonesian hospitals, personnel costs
are about 40 percent of total expenditures, and in Jamaica and Belize,
personnel costs range from about 50 percent to 74 percent of total
hospital expenditures.
In China labor costs are 23 to 26 percent of total expenditures. In part,
this unusually low personnel share may be caused by the exclusion of
the value of nonmonetary or budgeted benefits from hospital accounts.
Still, the low personnel share also results from a deliberate policy to
emphasize nonlabor inputs, especially pharmaceuticals, in inpatient and
outpatient hospital services. This latter factor is related to China's
method of financing hospitals through user charges; drugs are priced at
profitable levels, thus encouraging their use by providers. Largely be-
cause of this situation, drug fees are the leading source of hospital
revenues.
Drugs and medical supplies vary greatly as a percentage of total
hospital expenditures. These are often largely acquired in intemational
markets with foreign exchange and at intemationally determined prices.

28 Public Hospitals in Developing Countries
Figure 2-4. Relation between the Share of Labor in Hospital Recurrent
Costs and per Capita GNP, 1978-90
Percentage of labor in hospital recurrent costs
80
* Nigeria
70 - 0 Colombia
Papua New Guinea * St. Lucia
Botswana * * Tunisia * Belize
* Zambia
60 -
* Ethiopia
Morocco *
* Jamaica
50 - * Turkey
* Tanzania
Benin So Rwanda
40 - * Indonesia
* Niger
S Malawi
30 -
* China
20 l
0 500 1,000 1,500 2,000
Per capita GNP (constant 1980 U.S. dollars)
Source: See table 2-4.
Thus the expenditure on drugs and medical supplies does not reflect
local prices to the same extent as labor costs. If the relative quantities of
drugs and labor used per bed-day in countries with low wages were
similar to those used in higher-wage countries, the share of expenditures
on drugs would be higher. Central ministry pressures (in addition to
relative prices) may dictate, however, that a lower quantity of medical
supplies be used per unit of labor in low-wage countries. This may be a
rational response to prevailing relative prices, providing allocational
efficiency (as at point A in figure 2-5, where total output is 1,000 bed-
days), or it may be a suboptimal response, forcing an economically

Table 2-4. Hospital Recurrent Costs by Line Item Category
(percent)
Number
Level of Total recurrent cost of hospitals
Country Year hospital Personniel Drugs Other Total in study Source
Belizea 1985 II 56 - 44 100 1 Raymond and others 1987
III 74 13 13 100 6
Beninb 1986 II 43 13 44 100 1 Pangu and others 1987
Botswana 1978 All 64 17 19 100 All MOH BMOH 1979
Colombiab 1978 I-II 71 15 14 100 8 PRIDES 1980
China 1986 I 23 38 40 100 8 Barnum 1989
II 26 43 32 100 11
III 24 50 26 100 7
1 Ethiopia 1983-84 Urban 56 17 27 100 9 Donaldson and Dunlop 1987
Rural 59 17 24 100 11
Indonesia 1985 1 33 - 67 100 2 Barnum 1987
II 42 - 58 100 15
III 39 - 61 100 296
Jamaica 1985-86 1 55 10 36 100 2 Kutzin 1989
II 49 12 39 100 2
III 55 11 34 100 1
MalawiC 1987-88 III 33 30 37 100 6 Mills 1991
Morocco 1987 All 54 24 2 100 All public Bennis and others 1990
Niger 1986 I 38 34 28 100 1 Wong 1989
Nigeria 1986 III 79 16 5 100 2
Papua New Guinea 1988 I 73 9 18 100 1 js 1990
11 63 9 28 100 4
III 64 9 27 100 8
(Table continues on thefollowing page.)

Table 2-4 (continued)
Number
Level of Total recurrent cost of hospitals
Country Year hospital Personnel Drugs Other Total in study Source
Rwanda 1987 I 43 - 57 100 1 Shepard 1988
St. Lucia 1986 11 69 8 23 100 1 Russell, Gwynne, and
Trisolini 1988
Tanzania 1979 All 46 35 19 100 All MOiH Dunlop 1984
Tunisiad 1990 1 65 12 23 100 22
Turkeyb 1987 I 50 30 20 100 3
Uganda 1968 All 63 14 23 100 All MOH Dunlop 1973
Zambia 1981 I 60 - 40 100 3
11, III 63 - 37 100 All MOH
a. "Drugs" includes medical and nonmedical supplies.
b. "Drugs" includes all medical supplies.
c. Total amount includes some nonhospital district health expenditures.
d. Figures reflect amount budgeted for a combination of teaching hospitals and specialized institutes.
-Not available.
Source: World Bank sector reviews and appraisal reports, except as noted in table.

Patterns of Hospital Resource Use 31
inefficient solution (as at point B in figure 2-5, where output is 800
bed-days even though the budget remains constant).
In poorer countries, drug shortages are common and absolute expen-
ditures on drugs are limited, so that even though wages are low, drugs
as a percentage of total costs may not be high. Many analysts have argued
that the shortage of drugs forces technical inefficiency on the hospital
sector. This is particularly true if rigid personnel policies make substitu-
tion of supplies for personnel difficult. It is the combination of drug and
supply shortages (and other manifestations of recurrent cost constraints,
such as insufficient maintenance) and rigid personnel policies that cre-
ates the technical inefficiency. Improved hospital information systems
coupled with management policies and training could lead to greater
flexibility by central authorities, hospital administrators, and physician-
managers with respect to input substitution. Such reforms would be
positive steps toward reducing this source of suboptimal hospital per-
formance. The potential gains are limited, however, by operational
constraints on managerial choice of inputs that may be unaffected by
these reforms (lack of drugs or equipment, for example).
One possibility for improving the internal efficiency of hospitals may
be to change the mix of labor inputs in the production of hospital
Figure 2-5. Underfunding of Supplies
Supplies
Budget constraint
/~~~
1,000 bed-days
B 800 bed-days
Labor
hours

32 Public Hospitals in Developinig Countries
services. Many hospitals in developing countries are organized and
staffed based on industrialized country models. The different resource
endowments and epidemiological profile of low-income countries sug-
gest that such a model may not be appropriate here. Very little informa-
fion is available on hospital staff mix in developing countries, and
microeconomic-level studies are needed to examine the scope for im-
proving the cost-effectiveness of hospital services through the realloca-
tion of staff and the creation of new staff categories. This is a sensitive
issue because medical (and in some cases, nursing and paramedical)
professionals may perceive such reallocation as a threat to the positions
they have worked hard to attain. Also, the internal organization of large
hospitals (Harris 1977) leads to a bifurcation of labor between hospital
support services (for example, laundry, pharmacy, blood bank) and
direct medical care. Input mix and labor allocation on the medical side
may be viewed as determined by scientific standards. These standards,
however, are often determined in industrial countries. The medical input
mix should not be viewed as fixed (Harris 1977). Training and opera-
tional research can improve staff flexibility and increase medical
decisionmakers' awareness of substitution possibilities. Consideration
of alternative staffing patterns is particularly critical for those countries
that are suffering severe shortages of skilled staff. Some substitution
examples follow:
* Substitution of nonphysician- for physician-managers. Physicians in
hospitals commonly perform management functions that could be
more effectively and cheaply filled by trained managers who are not
physicians. The use of professional hospital managers is common in
industrial countries but rare in rniddle- and low-income countries. The
principal reason for this is the strong tradition in the medical profes-
sion of physician control of hospitals. In many countries the lack of
appropriate training and internship programs is a severe constraint
on the development of a cadre of career hospital managers.
* Substitution of nursing for physician time. Wider use of nursing staff
could reduce the use of physician time in the hospital. Monitoring of
patient condition, basic diagnosis, obstetrics, and simple curative
intervention for trauma are possible areas in which nursing training
and activities could be extended.
* Substitution of clerical stafffor registered nurse time. In some countries,
registered nurses (RNs) are widely used for clerical tasks and in some
cases (primarily in Africa) for nontechnical nursing activities. Many
of the tasks performed by RNs there could be adequately carried out
by less-well-trained persons. Clerks could perform some clerical func-
tions, and assistant nurses could perform some patient care and other

Patterns of Hospital Resource Use 33
ward-related activities. The use of alternative staff could free RNs to
focus their efforts on activities that make the best use of their skills.
Distributional Equity of Hospital Use
With a cross-country mean of about 60 percent, hospitals absorb a
substantial percentage of public recurrent health expenditures. The
share of health resources devoted to hospital services is believed to be
inversely related to the equity of overall health service provision; the
greater the share devoted to hospitals, the less is left for primary care
programs and facilities that have the potential to provide relatively
low-cost basic curative and preventive services to a broadly dispersed
population. Thus, within the health sector, the share of resources ab-
sorbed by hospitals has implications for the equity of the service delivery
system.
The characteristics of hospital services themselves may have a pro-
found effect on equity in many poorer countries in addition to the effect
the share of government health resources devoted to hospitals may have
on the availability of primary care services. Hospitals use a large part of
the total public sector health budget but can provide benefits to relatively
few. Even with existing large expenditures only a limited number of beds
can be provided, and inpatient service remains necessarily restricted to
a small number of people. Hospital bed ratios per 1,000 population in
low-income countries are commonly less than two, in contrast to means
of more than four beds per 1,000 in middle-income and more than eight
beds per 1,000 in high-income countries (see figure 2-6). In this section
we describe the distribution of hospital expenditure and use across
income groups, geographic location, age, and disease categories. In
addition, we assess implications of projected demographic and epidemi-
ological changes for the distribution of hospital services among popula-
tion subgroups.
Hospital Use across Income Groups
Little recent research has been conducted on the income characteristics
of hospital users. However, the analyses of individual hospitals in sev-
eral Asian countries suggest that hospitals are used unequally by differ-
ent socioeconomic groups within designated catchment areas. A survey
of inpatient income from a sample of seventeen hospitals in Malaysia
showed that only 21 percent of hospital inpatients were from households
below a specified poverty criterion compared with 39 percent of the
general population (Heller 1975). Upper-income groups used a substan-
tially greater share of total inpatient services than would be expected
from their proportion of the population. Using 1978 data from the Bicol

34 Public Hospitals in Developing Countries
Figure 2-6. Distribution of Hospital Beds per 1,000 Population
in 163 Countries, Most Recent Year, 1970-89
Percentage of countries from each group
100
80
60
40
20 ......
0
Less than 2 2-4 4-6 6-8 More than 8
Hospital beds per 1,000 population
Low income (47) l.Middle income (78) High income (38)
Mean = 1.45 Mean = 4.12 Mean = 8.60
Source: World Bank data.
region of the Philippines to examine the distribution of public health
subsidies across income groups, Ching (1986) found that, for public
hospitals, the per capita subsidies to the poorest three quintiles of the
population were below the regional mean, whereas those to the wealth-
iest two quintiles were above the regional mean. In fact, per capita
subsidies were greatest to families in the richest quintile. A household
survey in Indonesia revealed that households in the lower 40 percent of
per capita income distribution accounted for only 16 percent of hospital
service use, whereas households in the upper 30 percent accounted for
63 percent (Meesok 1984). Hospital-based surveys conducted in 1985 in
the Nusa Tenggara Barat province of Indonesia had similar findings.

Patterns of Hospital Resource Use 35
Patients from the richest 9 percent of the province's income distribution
accounted for 32 percent of inpatients and 56 percent of outpatients.
Conversely, the poorest 55 percent of the population accounted for only
32 percent of inpatients and 18 percent of hospital outpatients (Gish,
Malik, and Sudharto 1988). Thus, persons in the highest income groups
benefited disproportionately from Indonesia's subsidies to public hos-
pitals, with a greater degree of regressivity involved in the use of hospital
outpatient care.
A study of the characteristics of patients at one African tertiary hospi-
tal had results similar to these Asian studies. Surveys of patients at
Niamey National Hospital in Niger showed that inpatients had a median
income that was comparable to or slightly higher than other urban
residents (who had, in turn, higher incomes than rural residents), and
outpatients had a higher median income than inpatients (Weaver,
Handou, and Mohamed 1990b). The pattern suggested by this and the
above studies is that government subsidies to public hospitals are not
well targeted to the poor and that this regressivity is magnified for
hospital outpatient services, perhaps because of their more discretionary
nature.
Not all the available information (particularly studies from Latin
American countries), however, confirms inequitable use across income
groups. Selowsky (1979) used household survey data in conjunction
with public sector and social security expenditures on health services to
analyze the distribution of public subsidies for health across income
groups, facilities, and regions in Colombia in 1974. He found that, in
public sector hospitals, the lowest-income quintile received the greatest
subsidy for inpatient care and that this share declined monotorncally for
higher-income groups. McGreevey (1990) cites information for five
South American countries (Argentina [1980], Costa Rica [19821, Chile
[1982], the Dominican Republic [1980], Uruguay [1982]) that
demonstrates that the benefits from social security expenditures on
health, much of which is used for public hospital services, are inversely
related to income. In those few countries in which social security covers
most of the population, as in Brazil, the overall distributional effect of
public hospital services is to improve equity. One possible explanation
for the better equity effects of public hospital subsidies in Latin American
countries is the existence of a strong modern private sector serving the
wealthiest population groups, leaving lower-income groups to use the
public (ministry of health or social security) hospitals.
Similar studies in other countries are needed, especially ones distin-
guishing between the use of public and the use of private hospital
services by socioeconomic group. When there are perceived quality
differences between public and private services, either material differ-
ences related to health outcome or differences in amenities, high-income

36 Public Hospitals in Developing Countries
groups will favor private services. In Sri Lanka, for example, the value
of per capita use of public services by low-income households far ex-
ceeds the expenditure by such households on private care, whereas the
value of government services received by the highest-income group is
about one-half that group's expenditure on private medical care (Al-
ailima and Mohideen 1984).
Geographical Distribution
Hospitals are located primarily in urban areas, and even when they are
intended to provide a referral service for a broad geographical popula-
tion base they serve in actuality a disproportionately urban clientele.
Because urban populations generally have higher incomes than those of
rural areas, the urban location of most hospitals affects income equity as
well as geographic equity. The urban bias provided by hospital services
extends even to China, which has decreased mortality in rural areas
during the last four decades and is widely perceived to have focused on
equity. Other factors, such as improved nutrition and education, have
probably been at the root of China's improved health status in this
period. In a study of the distribution of health care resources, Prescott
and Jamison (1985) noted that the fall in mortality has not been achieved
through a more equitable distribution of health resources. There is a
wide variation in the availability and distribution of hospital beds, health
workers, and health expenditure among Chinese provinces. They found
that the distribution of health resources is strongly related to the degree
of urbanization in the province and to urban income. In their study, a 1.0
percent increase in urban income is associated with a 1.5 percent increase
in the ratio of medical doctors to population, a 2.5 percent increase in the
general hospital bed ratio, and a 3.0 percent increase in recurrent expen-
diture. These increases are also likely correlated with the extent of health
insurance coverage, which is associated with greater health care use and
expenditure, as well as with greater income.
Similar inequalities in the availability of hospital beds and in the
distribution of hospital expenditures are documented in health sector
assessments of other countries. Evidence from a few representative
studies can be cited. The number of hospital beds per thousand popula-
tion in Indonesia varies from 0.2 to 1.2 across provinces, and the variation
again is related to levels of urbanization and income (Barnum 1987); the
income elasticity of hospital beds is 1.0 (Prescott 1991) and, given that
hospital beds located in more heavily urbanized and high-income areas
tend to be staffed and equipped more intensively, the income elasticity
of hospital expenditure is even greater.
5
In Malaysia (Heller 1975) and
Papua New Guinea (Baker 1977), hospital expenditure per capita varied
more than twentyfold across provinces. In Brazil, expenditure per capita

Patterns of Hospital Resource Use 37
by the social security health system in the lower-income northeastern
region in 1986 was less than half of those of the higher-income states in
the southeast (World Bank 1988), and the availability per capita of
hospital beds in the north and northeast was about half of that in the
south and southeast in 1984 (Briscoe 1990). In Colombia the average
government health subsidy per urban household in 1974 was more than
twice as large as that received by rural households (Selowsky 1979). In
many African countries probably at least equal variation exists because
of the predominantly urban location of hospitals and the largely rural,
dispersed populations.
The above examples are not intended to constitute an argument for
establishing hospitals in rural areas to meet equity concerns but to
highlight the importance of improving the reliability of lower-level
facilities that serve more widely dispersed populations. The examples
also draw attention to the importance of improving transport and, more
generally, the referral network to widen access to hospital services. The
"bias" of hospital services toward urban dwellers is to be expected from
the nature of hospitals as institutions with high fixed costs. It would not
make sense to establish large hospitals in sparsely populated areas or
rural areas with a widely dispersed population; a network of low-cost
primary care that included smaller district hospitals would seem to be
more appropriate for these areas. Other risks are associated with using
hospital investments in poor geographic areas as a means of improving
equity, such as the creation of a two-tiered medical system, in which poor
quality and stigma are associated with the facilities serving poor com-
munities. It is logical for hospitals to be located in areas with a concen-
tration of population high enough to keep the relatively large amount of
resources (staff, equipment, supplies) occupied. Ensuring that those not
living near these areas have access to hospital care when needed is the
function of the referral system.
In concept, referral within the health system is supposed to provide a
wider distribution and appropriate use of health services, entry being
gained at the bottom of the referral pyramid through primary care
facilities and other providers. In practice, self-referral-often resulting
from the perception or fact of poor quality primary care services because
of a lack of drugs or personnel-and poor administrative, transport, and
communications linkages between levels of care, frequently defeat the
intended purpose of the referral system. Many referral studies have
revealed that hospital entry is a matter of proximity, rather than the
appropriateness of the classification, and that most inpatients in upper-
level hospitals in the most urbanized areas are admitted directly. This
situation is to be expected in the absence of barriers to easy admission,
when, for many urban dwellers, the nearby hospital is the closest source
of primary care. A sample of hospitals in Indonesia revealed that more

38 Public Hospitals in Developing Countries
than 50 percent of inpatients come from less than 5 kilometers away from
the hospital and more than 80 percent of outpatients come from less than
1 kilometer away (Barnum 1987). Cumper, WaIlker, and MacCormack
(1985) concluded that much of the variation in hospital admission rates
across census constituencies in Jamaica (from 13 to 92 per 1,000) could
be explained by hospital location. The referral system is discussed in
greater detail in chapter 6.
Distribution of Hospital Use by Age
Both the overall level of demand for hospital services and the specific
services required are affected by the age and disease profiles of the
population. As the economic development of a country proceeds, both
profiles change in what is commonly characterized as demographic and
epidemiological transitions. The demographic transition refers to the
change in the population age structure that accompanies the fall in
fertility and mortality as economic and social development occur. The
epidemiological transition refers to the changes in age-specific death and
illness rates that result in reduced infant and child mortality and longer
expected life span. Interaction of these two transitions results in an aging
population that is characterized by a lower prevalence of infectious
disease and a higher prevalence of chronic disease (Jamison and Mosley
1990). The implications of this transition for hospital resource use can be
derived from the experience of specific countries.
Hospital inpatient services are used primarily by adults, both because
they comprise the largest proportion of the population and because
children, after they survive their first year of life, are much less likely to
need hospitalization (for epidemiological reasons) than they will in later
life. For example, according to samples from hospitals in the countries
concerned, adults comprise 88 percent of hospital admissions in county
hospitals in China (Over and others, 1992); 87 percent in Papua New
Guinea (Jsi, 1990); 84 percent in Belize (Raymond and others 1987); and
approximately 70 percent in Malawi (Mills 1991), Niger (Wong 1989),
and Uganda (Over and others, 1992). The lower percentages of adult use
of hospitals in the African countries reflect the smaller percentage of
population that is more than fifteen years of age. Significantly, however,
it also reflects the reduction in child mortality and the increase in the
relative importance of chronic diseases in China and Papua New Guinea
during the last twenty years.
This pattern of use is apparent in more detail in figures 2-7a and 2-7b,
which present comparisons of the age distribution of the population
with the age distribution of hospital admissions in Jamaica and the
Republic of Korea.
6
The figures indicate that, in both countries, the
distribution of hospital admissions by age corresponds closely with the

Patterns of Hospital Resource Use 39
Figure 2-7a. Distribution of Population and Admissions by Age Group,
Jamaica, 1985
Percentage of total
60 56
50-
40-
30-
24
20-
2< n 110 12lW l i i1 X
10~~~~~~~~~~~~~21
6 98 60
36
0
0 1-4 5-14 15-44 45-64 65+
Age
Population Admnissions
Source: GOJMOH 1987.
Figure 2-7b. Distribution of Population and Admissions by Age Group,
Korea, 1986
Percentage of total
60 54
50
40
30
20 1 7 16 8
10 7 6 7
0
0 1-4 5-14 15-44 45-64 65+
Age
Population Admnissions
Source: FKMIS 1987.

40 Public Hospitals in Developing Countries
age distribution. Exceptions are the group age five through fourteen,
which makes least use of hospitals compared with that group's share of
the population, and infants (less than one year), who make most use of
hospitals in relation to their population share. The elderly also tend to
use hospitals disproportionately, as would be expected.
The wealth of data available on insured patients from Korea provides
a better look at inpatient resource use by age group. In figure 2-8 the
population distribution of the insured is compared with the age distri-
bution of inpatient expenditure. In Korea, most inpatient care is pro-
vided by private hospitals that are financed through a combination of
insurance reimbursement, copayments, and user fees. Therefore, expen-
diture data provide a good proxy for measuring resource use. Conclu-
Figure 2-8. Population and Inpatient Cost for Insured Patients by Age
Group, Korea, 1986
Percentage of total
60
50 4
40
30 2
20 17
10 9 8
4 5 .....
0
0 1-4 5-14 15-44 45-64 65+
Age
Population Z Cost
Source: FKMIS 1987.

Patterns of Hospital Resource Use 41
sions drawn from this figure are similar to those from figures 2-7a and
2-7b, with the exception of the group age fifteen through forty-four,
which uses slightly less than its population share of inpatient resources,
though admissions for this group exceed its population share. This
suggests that the average cost per case for young adults is low in relation
to the mean across all age groups. This conclusion is supported by figures
2-9a and 2-9b, which depict mean expenditures per admission and per
patient-day for each age group in relation to their respective overall
means. The results confirm what would be expected: older adults and
the elderly are the most expensive to treat in the hospital. The implication
is that as a country's population ages, if there is no significant change in
the delivery of health care services, hospital costs will rise.
Diseases and Conditions Treated in Hospitals
Data on hospital admissions from six countries are summarized in table
2-5 by the primary headings of the International Classification of Dis-
eases (ICD). Conditions relating to pregnancy and childbirth were the
leading cause of admissions in five of the six countries. This is as
expected. A country's policy or the population's preferences regarding
hospital deliveries, however, are also important factors. Trauma care
related to accidents, injuries, and poisonings was among the top five
causes of admission in each country, reflecting both the relatively fre-
quent nature of serious accidents across countries at various levels of
development and the important role of hospitals in providing trauma
care. Other leading causes of admission are infectious and parasitic
diseases, respiratory diseases, and diseases of the digestive and genito-
urinary systems.
The causes of admission to hospitals can be reorganized into groups
to assess the broad epidemiological composition of inpatient use. Table
2-6 presents such a reorganization into five inclusive groups. The table
provides a snapshot of several countries at different stages with respect
to the epidemiological transition. The relative sizes of the communicable
disease and the chronic and noncommunicable disease categories are of
particular interest. The relative share of communicable diseases is great-
est in those countries (Nigeria and Malawi) with the highest infant
mortality rates and the shortest average life span (see table A2-1). Con-
versely, the countries with the lowest fMR and longest average life span
(Jamaica and Korea) have the greatest share of chronic and noncommu-
nicable admissions. These statistics are not simply a function of a
country's level of development, as measured by per capita GNP; Oman
has the highest per capita GNP, followed by Korea, Belize, Jamaica,
Nigeria, and Malawi. Communicable diseases are, in general, more
amenable to broad-based primary prevention efforts than are noncom-

42 Public Hospitals in Developing Countries
Figure 2-9a. Cost per Admission in Relation to the Population Mean,
Korea, 1986
Index value
0.6
0.4 -
0.2 -
0
-0.2-
-0.4-
0 1-4 5-14 1544 45-64 65+
Age
Source: FKMIS 1987.
Figure 2-9b. Cost per Patient-Day in Relation to the Population Mean,
Korea, 1986
Index value
0.6
0.4
0.2
0
-0.2 -
-.4
0 1-4 5-14 15-44 45-64 65+
Age
Source: FKvI4S 1987.

Table 2-5. Ten Leading Causes of Admission to Hospitals, Selected Countries
Rank Belize (1985)a Jamaica (
1985
)b Korea (1986)c Malawi (
1986)d Nigeria (1984) Oman (1984)e
I Pregnancy/ Pregnancy/ Pregnancy/ Pregnancy/ Parasitic/ Pregnancy/
childbirth (40.8%) childbirth (42.9%) childbirth (25.9%) childbirth (29.8%) infectious (31.3%) childbirth (30.2%)
2 Accidents/injuries Accidents/injuries Digestive (15.3%) Parasitic/ Pregnancy/ Parasitic/
(9.8%) (11.4%) infectious (26.9%) childbirth (23.1%) infectious (18.7%)
3 Parasitic/infectious Digestive (6.0%) Respiratory (9.8%) Respiratory (9.1%) Respiratory (9.8%) Respiratory (13.0%)
(8.6%)
4 Respiratory (6.8%) Genitourinary Parasitic/infectious Anemias (6.6%) Genitourinary Accidents/injuries
(5.9%) (7.0%) (5.8%) (8.1%)
5 Digestive (6.2%) Heart/circulatory Accidents/injuries Accidents/injuries Accidents/injuries Genitourinary
(5.9%) (6.9%) (5.0%) (5.3%) (5.8%)
6 Heart/circulatory Respiratory (5.2%) Neoplasms (6.6%) Endocrine/ Digestive (5.0%) Senility/ill-defined
(3.7%) metabolic (4.1 %) (4.7%)
7 Perinatal (3.0%) Parasitic/ Genitourinary Genitourinary Nervous/sensory Digestive (4.6%)
LQ infectious (4.8%) (5.8%) (3.3%) (3.3%)
8 Genitourinary Neoplasms (3.3%) Heart/circulatory Skin (2.9%) Anemias (3.0%) Heart/circulatory
(2.3%) (5.8%) (4.1%)
9 Endocrine/ Endocrine/ Nervous/sensory Nervous/sensory Endocrine/ Nervous/sensory
metabolic (2.1 %) metabolic (2.5%) (3.2%) (2.3%) metabolic (2.8%) (2.7%)
10 Skin (2.0%) Skin (1.6%) Perinatal (2.7%) Digestive (2.2%) Skin (2.4%) Skin (1.8%)
a. All public hospitals.
b. All public acute care hospitals except 200-bed children's hospital and 500-bed university hospital.
c. Data on those covered by Industrial Employment Medical Insurance, Medical Insurance for Government Employees and Private School Teachers, and
Compulsory Regional and Occupational Medical Insurance (99 percent of the insured and 46 percent of the total population in 1986).
d. All public hospital inpatients.
e. All MOI I facilities.
Source: Raymond and others 1987 (Belize); GOJMOH 1987 (Jamaica); FKMIS 1987 and KMIC 1987 (Korea); Mills 1989 (Malawi); World Bank data (Nigeria
and Oman).

44 Public Hospitals in Developing Countries
Table 2-6. Distribution of Causes of Hospital Admissions across Major
Categories of Conditions, Selected Countries
(percent)
Chronic
and non-
Pregnancy Commun- Commun-
and icable icable Accidents,
Country Year perinatal diseasesa diseasesb injuries Other c
Belize 1985 44 15 22 10 9
Jamaica 1985 44 10 30 11 5
Korea 1986 29 17 45 7 3
Malawi 1986 31 36 26 5 3
Nigeria 1984 23 41 22 5 8
Oman 1984 31 32 24 8 5
a. Infectious and parasitic diseases and respiratory diseases.
b. Noncommunicable diseases indude neoplasms; endocrine, nutritional, and meta-
bolic diseases; anemias; mental disorders; and diseases of the nervous system and sense
organs, circulatory system, digestive system, the skin and musculoskeletal system, and
the genitourinary system.
c. Congenital anomalies and ill-defined conditions.
Source: Raymond and others 1987 (Belize); GOJMOH 1987 (Jamaica); FKMIS 1987 and
KMIC 1987 (Korea); Mills 1989 (Malawi); World Bank data (Nigeria and Oman).
municable diseases, and thus the relative share of these diseases in total
hospital admissions in part reflects the effectiveness of a country's
primary health care (and specifically, communicable disease control)
policies, in addition to a country's underlying demographic and epide-
miological characteristics.
Countries that have been successful in controlling the spread of com-
municable diseases and that have experienced increases in the average
length of life of their citizens are faced with a new problem: a greater
percentage of persons with chronic and noncommunicable diseases than
existed previously. In figures 2-8, 2-9a, and 2-9b we showed that, in
Korea, the cost of treating a person over age forty-five was expensive
compared with the cost of treating a younger person. In figure 2-10 we
again use Korean insurance data to compare the percentage of total
admissions by category of condition with the percentage of total costs
for the same categories.
7
The figure indicates that communicable dis-
eases and pregnancy and perinatal conditions are relatively inexpensive
admnissions, whereas admissions for accidents and noncommunicable
diseases are relatively expensive. The cost data suggest that more than
70 percent of inpatient care resources are used for patients in these latter
two categories.
The distribution of admissions can be used to portray relative resource
use across disease categories if the percentages are adjusted for case mix

Patterns of Hospital Resource Use 45
Figure 2-10. Distribution of Admissions and Inpatient Costs
by Category of Principal Condition, Korea, 1986
Percentage of total
80
70
63
60-
50 -4.8
40-
30 25
20 17
13
:10 8 1
3 4
0 -] 8 1~ F--
Preg/ Communicable Accidents Noncommun- Other
Perinatal icable
Category of disease or condition
Admissions Costs
Source: KMIC 1987.
(that is, resource use per case of a particular type). The Korean data on
admissions and cost by disease categories were used to develop case mix
weights. These weights were applied to the distribution of admissions
by disease in selected countries to approximate relative resource use by
condition. The estimates are only indicative because they apply results
from one country to other countries. The weights were generated by
dividing the percentage of total costs for a disease category by the
percentage of total admissions for that same category. The percentages
of admissions for a country were then multiplied by the appropriate
weight for a disease or condition to generate a distribution of inpatient
resource use (corrected to sum to 100 percent). The results of this exercise
for six countries are presented in table 2-7.

46 Public Hospitals in Developing Countries
Although the results in table 2-7 are only indicative, they suggest two
important conclusions: (1) in all countries, a greater share of hospital
resources is devoted to treating patients with noncommunicable condi-
tions and for trauma care than is indicated by data on total admissions,
and (2) as the demographic and epidemiological transitions proceed, the
demand on hospital resources will increase as the mix of patients be-
comes more expensive to treat.
The implications of the epidemiological transition for the health sys-
tems of Mexico, Brazil, and China have recently been analyzed (Frenk
and others 1989; Briscoe 1990; and Bumgarner 1992, respectively), and
the findings are consistent with the conclusions reached above. In the
Mexico study, Frenk and his colleagues call for a transition in the health
system that involves proactive, innovative primary health care measures
to meet the changing pattern of service needs. In the Brazil study, Briscoe
warns that the demand for individual treatment of "post-transition"
diseases will escalate and may divert resources from preventive efforts
aimed at these as well as at communicable diseases, which will remain
Table 2-7. Distribution of Hospital Costs across Major Categories
of Conditions, Based on Case Mix-Adjusted Admissions, Selected Countries
(percent)
Chronic
and non-
Pregnancy Commun- commun-
and icable icable Accidents,
Country Year perinatal diseasesa diseasesb injuries Other c
Belize 1985 24 14 34 15 13
Jamaica 1985 23 9 44 17 7
Korea 1986 13 13 61 9 4
Malawi 1986 17 32 39 8 4
Nigeria 1984 12 35 34 8 11
Oman 1984 16 27 37 12 8
Case mix
weights 0.46 0.74 1.31 1.30 1.25
Note The percentage distribution of admissions for each country was first multiplied
by the appropriate case mix weight. The resulting percentages were then normalized to
sum to 100 percent for each country.
a. Infectious and parasitic diseases and respiratory diseases.
b. Noncommunicable diseases include neoplasms; endocrine, nutritional, and meta-
bolic diseases; anemias; mental disorders; and diseases of the nervous system and sense
organs, circulatory system, digestive system, the skin and musculoskeletal system, and
the genitourinary system.
c. Congenital anomalies and ill-defined conditions.
Source Raymond and others 1987 (Belize); GOJMOH 1987 (Jamaica); FKMIS 1987 and
KMIC 1987 (Korea); Mills 1989 (Malawi); World Bank data (Nigeria and Oman).

Patterns ofHospital Resource Use 47
important in many parts of the country. In his study of the health system
in China, Bumgarner conservatively estimated that, solely because of the
epidemiological transition, the annual rate of growth of per capita health
care costs will be 2 percent higher than that of per capita GNP. These
studies emphasize the need to allocate resources to chronic disease
prevention and control programs immediately as a means to avoid
future preventable loss of life and keep hospital treatment costs from
reaching completely unmanageable levels.
Cost-Effectiveness of Hospital Services
This section contains a brief review of the relative cost-effectiveness of
hospital and nonhospital health care services. Both hospitals and PHC
programs cover multiple and often overlapping activities, and it is
difficult to assess the effectiveness of all interventions collectively. "Pri-
mary health care" has become a particularly amorphous term, pervasive
in the literature but difficult to define in operational terms. The term is
nevertheless useful because its connotation of community-level delivery
programs contrasts with the connotation of hospital services delivered
through large facilities socially detached from the community. Primary
health care also connotes prevention rather than cure, although the term
does include simple curative care such as oral rehydration for diarrhea
and first-level curative contact for other health problems. In chapter 6
we argue that hospitals and PHC should be more integrated, and the
services provided by the health sector should be balanced and inter-
linked, from lower-level preventive and curative outreach programs to
upper-level facilities. The question remains, however, of the appropriate
balance of services within the integrated system. In order to provide one
dimension of an answer to this question, we discuss below the individual
activities carried out by hospitals and nonhospital programs.
Itis difficult to discuss the cost-effectiveness of health services without
a knowledge of the epidemiological and resource environment because
the relative effectiveness of services changes with the context. The dis-
cussion below distinguishes loosely between low-resource countries
with comparatively high mortality rates (say, lower-middle-income
countries and below that have infant mortality rates above fifty) and
high-resource countries with low mortality rates. Our interest encom-
passes mortality and morbidity for all age groups, but health status has
been found to correlate roughly with infant mortality. There are a few
exceptions, but generally, high-mortality countries have fewer health
resources, and low-mortality countries have relatively greater resources.
The exceptions-countries that have fewer resources but have neverthe-
less achieved lower levels of infant mortality-are instructive. For exam-
ple, China, Sri Lanka, and Costa Rica are low- and lower-middle-income

48 Public Hospitals in Developing Countries
countries that have achieved relatively low infant mortality rates
through innovative and encompassing PHC programs plus investments
in education, nutrition, clean water, and sanitation (Halstead, Walsh,
and Warren 1985).
If health planners working in poorer countries were asked to rank
health interventions by their efficiency in achieving decreased morbidity
and mortality, they would almost universally place primary health care,
especially basic services delivered through outreach or rural health
centers or health posts, near the top and large, urban-based institutional
facilities near the bottom, with regard to both cost-effectiveness and
equity. This consensus view derives from the fact that health problems
targeted by primary health care programs are epidemiologically the
most important, especially to low-income groups, in low- and middle-
income countries.
Table 2-8 contrasts the epidemiological pattern of diseases in Ghana,
China, Mexico, and the United States as examples of high- and low-mor-
tality countries. Ghana (1979) provides an example of an epidemiological
environment typical of many low-income and high-mortality countries.
Table 2-8. Total Days of Life Lost by Major Category of Disease in Selected
Countries
(percent)
Ghana China Mexico United States
Category (1979) (1985) (1985) (1988)
Infections, respiratory 58 25 22
and digestive diseases,
malnutrition
Chronic and 21 34 19a 39
cardiovascular diseases,
malignancies,
psychiatric disorders
Newborn, pregnancy, 15 9 14 6
gynecological
complications
Injuries, accidents, 5 27 23 31
homicide, suicide
Other 1 5 22 24
Total 100 100 100 100
-Not available.
a. Malignancies and cardiovascular only.
b. Includes infectious diseases, which represent approximately 5 to 10 percent of total
days lost.
Source GHAT 1981 (Ghana); People's Republic of China 1986 (China); Hijar-Medina
1990 and Cavazos-Ortega and others 1989 (Mexico); Centers for Disease Control 1989
(United States).

Patterns of Hospital Resource Use 49
The leading causes of morbidity in Ghana and other high-mortality,
low-resource countries are upper respiratory illness, diarrhea, parasitic
diseases, and accidents. The leading causes of mortality are vaccine-
preventable diseases, respiratory diseases, malnutrition, diarrhea, and
accidents. With the exception of accidents, hospitals do not play a
dominant role in reducing lost years of life from these causes. Accumu-
lating studies (see, for example, Barnum, Tarantola, and Setiady 1980;
Feachem 1986; and Shepard, Brenzel, and Nemeth 1986) demonstrate
that preventive measures, such as immunization and prenatal care, and
simple curative measures, such as oral rehydration, can be delivered
efficiently through rural health post and outreach programs and are only
a fraction of the cost of the alternative inpatient care where it is available.
The epidemiological picture in China in 1985 illustrates the pattern of
diseases in a low-mortality country. After earlier success at reducing
mortality from infectious diseases and lowering fertility, chronic dis-
eases have emerged as a significant health problem. Accidents and
injuries have also become important sources of morbidity and mortality.
Increasingly, with a lowering of overall mortality, the pattern of diseases
can be expected to resemble that in the industrial countries (the 1988
pattern in the United States of years of life lost is given for reference in
the last column). Hospitals play a somewhat larger role in addressing
the problems of chronic disease than in treating infectious diseases.
Prevention and primary health care programs, however, still have a
central role in determining the disease pattern of low-mortality coun-
tries.
Hospitals do play an essential role in the delivery of a program of
coordinated health services and provide an essential backup and credi-
bility for primary health care programs in both low- and high-mortality
countries. In particular, as we will argue in more detail in chapter 6, more
effort to integrate lower-level hospitals could greatly increase the effec-
tiveness of outreach and community-based programs. Central-level hos-
pitals can also provide technical support for lower-level services and a
focus for training of skilled manpower. Nevertheless, as routinely ap-
plied, hospital services, especially in upper-level hospitals, are less cost-
effective in reducing mortality or morbidity than many alternative uses
of health sector resources, as shown below.
The cost-effectiveness of an array of alternative health interventions
for primary and secondary prevention and treatment is summarized in
tables 2-9a and 2-9b. The effects are measured, depending on the study
and availability of data, by years of life gained (YLG) from prevention of
premature mortality or, if the required additional morbidity data are
available, by healthy years of life gained (HYLG) or, if an index of the
quality of health status has been constructed, by quality-adjusted life
years (QALY).

Table 2-9a. Approximate Cost-Effectiveness of Selected Primary and Secondary Prevention Activities in Health
(percent of GNP per capita)
Low-income, hig&l infant mor-tality countriesa Higli-iticome, low infanit mortality countriesb
Cost per Cost per Cost per Cost per
° Intervention discounted YLG discounted HYLG discounted YLG discounted QALY
Primary prevention activities
Immunization
EPI packageC 3 2
Measles (alone) 5 5
Polio (alone) 120 21
Hepatitis B 20
Cholera 16 14
Diarrhea prevention
Weaning education 9 8
Breast-feeding 7 6
Prevention of new smoking starts 2 2

Tropical disease vector control
Malaria 22 12
Schistosomiasis 46 26
Onchocerciasis 85
Secondary prevention activities
Prenatal screening and high-risk delivery
(maternal death only) 19
Cervical cancer screening 25 26
Breast cancer screening
Physical exam 12
Mammography added 150
Hypertension screening
cr Mild hypertension (90-110 mm Hg) 140
Moderate hypertension ( 110 mm Hg) 70
Hypercholesterolemia screening (drugs) 500
Note: All notes appear at the end of table 2-9b.

Table 2-9b. Approximate Cost-Effectiveness of Selected Treatment Activities in Health
(percent of GNP per capita)
Estimated foreign
Low-income, high infant mortality countriesa High-inicome, low infatt mortality countriesb cotntent in lower-
Cost per Cost per Cost per Cost per middle income
Intervention discounted YLG discounted HYLG discounted YLG discounted QALY countryC (proportion)
Diarrhea treatment
Oral rehydration 5 5
Intravenous therapy 37 33
Tuberculosis treatment
> Outpatient (rifampicin) 6 6
Inpatient-outpatient 16 15
Hospital treatment 40
Neonatal intensive care:
1,000-1,499 grams 400d 70 0.3
500-599 grams
3
,
000
d 500 0.5
Cancer treatment
Cervix 40 10 0.2
Breast 40 11 0.2
Colon and rectum 140 50 0.2
Lung 1,300 220 0.5
Stomach 2,700 460 0.5
Liver 4,000 660 0.5

Hip replacement 50d 12 0.5
Hemodialysis
Hospital
1,
000d 300 0.7
Home l,oood 200 0.7
Coronary treatment
Pacemaker 60d 12 0.7
Valve replacement 80d 15 0.7
Coronary bypass
Severe angina (left vent.) 90d 25 0.7
Moderate angina (2 vessel)
300d 60 0.7
Note: The estimates should be regarded as approximate. The intention is to allow an order of magnitude comparison among broad categories of interven-
tions. Local conditions may cause great variance in actual cost-effectiveness across countries. Cost is expressed as a percentage of GNP per capita. The pur-
U pose of using the percentage of per capita GNP rather than monetary units is to reduce program costs across countries to roughly comparable units. The
U measure is deficient in that it primarily adjusts for labor cost differences among countries but does not account well for differences in foreign supply costs
or productivity. The deficiences are offset, however, by the convenience of the measure. Sources for the GNP and exchange rates are various years of the
World Bank, World Development Report, and IMF, International Financial Statistics.
Many of the sources are reviews of cost-effectiveness rather than primary sources. If several studies gave the cost-effectiveness of an intervention, as was
the case for oral rehydration therapy or immunization, an average was taken and outliers were excluded. Basic information in the literature is reported
variously as cost per undiscounted or discounted years of life lost, per healthy years of life lost, or per death prevented. Several procedures were used to
convert the information to the comparable measures used in the table. Undiscounted results or results reported using a different discount rate were con-
verted to discounted units using a 3 percent discount rate. Deaths prevented were converted to years lost using life expectancies for the original time and
place of the study and information on average age of death from the Ghana or China data sets summarized in table 2-8. Ratios of years of life lost from
death to total healthy years lost in the Ghana study were used to convert years of life lost to healthy years in other studies.
a. IMR >50.
b. IMR <50.
c. The foreign exchange proportion is approximate. The foreign exchange requirements of hospital services are expected to vary with the size and level
of development of the country. No studies have specifically examined the foreign exchange content of hospital services by function in low-income coun-
(Table continues on thefollowing page.)

Table 2-9b (continued)
tries. In a study of hospitals in Tanzania, Dunlop (1984) estimated that 40 percent of total government hospital costs entailed foreign exchange expenditures in
1979. This is an average, however; basic services would have a smaller foreign exchange content and more technically complex services would far exceed 40 per-
cent because of the need for special skills and training.
u, d. Estimated cost per discounted QALY based on results for high-income countries.
Source: Barnum, Tarantola, and Setiadi 1980; Robertson 1985; Shepard, Sanoh, and Coffi 1986 (immunization). Feachem 1986; Horton and Claquin 1983; Shepard
Brenzel, and Nemeth 1986 (diarrhea). Barnum and Greenberg 1991 (smoking). Barlow and Grobar 1986 (malaria, schistosomiasis). Prost and Prescott 1984
(onchocerciasis). Herz and Measham 1987 (prenatal screening). Barnum and Greenberg 1991 (cervical cancer screening, breast cancer screening). Torrance 1986 (hy
pertension screening, coronary treatment, neonatal care, dialysis, hip replacement). Williams 1985 (coronary treatment, neonatal care, dialysis, hip replacement).
Barlow 1976 (general hospital treatment). Mills 1985; Mills and Drummond 1987; Drummond 1985 (additional sources).

Patterns of Hospital Resource Use 55
The three measures are not strictly comparable. The HYLG measure
primarily has been applied to prevention, whereas the QALY measure has
been applied to treatment. For any given preventive intervention, an
ordering of the magnitude of the measures will, by definition, give
HYLG 2 YLG.
8
In contrast, for a given treatment, an ordering of the
magnitudes will, by definition, give, YLG 2 QALY.
9
Thus if the cost per
QALY or YLG for a first intervention is less than the cost per HYLG for a
second, the cost-effectiveness of the first is evidently greater even though
different measures have been used in reporting the effects. In any case,
if the cost per unit measure of a first intervention is an order of magni-
tude greater than the cost per unit measure of a second (that is, the
difference is sufficiently great that it cannot be due to differences in the
technical definition of the measures), then the cost-effectiveness of the
first can be accepted as a practical conclusion.
Costs are measured as a percentage of the GNP per capita (percent
GNPN) at the time and in the country of the study. The purpose of using
the percentage of per capita GNP rather than monetary units is to facilitate
comparisons across countries. Cost as a percentage of GNP gives an
intuitively clear measure of the cost of the intervention in terms of the
resources used in relation to the productive capacity of the country. The
measure adjusts primarily for differences in labor costs and local supply
costs between countries, however, and does not account well for differ-
ences in foreign supply costs or productivity. Thus, the degree of com-
parability of the cost-effectiveness estimates expressed in percent GNPN
is limited; differences in technical capacity and in productivity are
substantial between countries, and there are important technical inter-
ventions such as complex surgery in high-income countries that can be
replicated in poorer countries only at a substantially greater cost in termns
of per capita GNP because of the need to use imported materials and
technical training. The use of common monetary units, such as dollars,
is even more problematic because differences in resulting cost estimates
may reflect differences in exchange rates and wage rates more than the
content of services. Conceptually, the separate components of interven-
tion costs could be corrected for price differences across countries, but it
would be difficult to do so because of the lack of appropriate indexes
across the range of countries and dates in the cost-effectiveness studies
surveyed.
In recognition of this problem in comparability, tables 2-9a and 2-9b
are divided into two sections; the first two columns give the results of
studies from low-income countries and the third and fourth columns
show the results of studies carried out in high-income countries. The
results in table 2-9a, for primary and secondary prevention, respectively,
are not greatly affected by this distinction because most of the studies on
which the table is based were carried out in developing countries, and

56 Public Hospitals in Developing Countries
the foreign exchange costs for these interventions is low. For neonatal
intensive care, cancer, hip replacement, hemodialysis, and heart treat-
ments, the original studies on which table 2-9b is based were carried out
in industrial countries. For these interventions an estimated cost for
hospital procedures in percent GNPN for an average lower-middle-in-
come country has been computed based on the estimated foreign ex-
change component in the last column and calculation of a weighted sum
of the foreign and local costs.1
0
The general order of magnitude of the difference in cost-effectiveness
between hospital services and primary health care programs can be
established, and the dominance of lower-level interventions, especially
prenatal care, diarrhea control, and immunizations is clear from the
tables. Looking first at diseases that are of primary importance in high-
mortality countries, we see that the cost per year of life gained from the
expanded program of immunization (EPI) package or measles vaccina-
tion varies from 3 to 5 percent GNIPN, and for diarrhea control using
weaning, breast-feeding, or oral rehydration therapy, the cost per year
of life gained varies from 5 to 9 percent GNIPN.
Obstetrics and neonatal care are of particular importance because of
the relatively large share of total hospital resources used for delivery in
high-fertility countries. In low-resource countries, routine delivery in
hospitals is not cost-effective compared with health center or attended
home delivery (see, for instance, the analysis in Barnum and others 1980).
Neonatal intensive care at 400 percent GNPN for births of 1,000-1,500
grams is very expensive, and for births of less than 1,000 grams the cost
of wide coverage would be prohibitive. Much of the need for neonatal
care could be prevented by prenatal care programs, especially with early
detection of pregnancy (see the discussion in Rao 1990). A potentially
cost-effective use of hospital services is for high-risk deliveries, with an
estimated cost per year of life gained of about 20 percent GNPN. Few
countries, however, currently have an effective screening program for
high-risk deliveries or adequate transportation to provide access, and
the ability to mount such a program depends crucially on the develop-
ment of the supporting primary health care infrastructure.
Cesarean deliveries are not mentioned in the tables but have great
implications for the misuse of hospital resources. When performed in
conjunction with high-risk screening, cesarean deliveries can be an
important component of programs to reduce maternal mortality. Rapid
growth in the number of cesarean deliveries in some middle-income
developing countries (Bobadilla and Walker 1991), and in industrial
countries (OECD 1987), has raised the question of inappropriate use. In
selected countries in which medical training and the financial reimbur-
sement system provide adverse incentives, the proportion of total deliv-
eries that are cesarean has become a potential hazard to maternal health

Patterns of Hospital Resource Use 57
and an unwarranted financial burden on the health system. Brazil pro-
vides a dramatic example. The cesarean rate (1981) is 17 percent for
low-income households and climbs to 58 percent for upper-income
households, with an overall average of 31 percent for the country (Saxenian
forthcoming). Clinically, less than 15 percent of all deliveries, on average,
can benefit from a cesarean section. For routine, normal deliveries, which
comprise more than 85 percent of births, cesarean sections are of greater
mortality and morbidity risk for the mother than normal vaginal deliv-
ery. A World Bank country study (Saxenian forthcoming) estimates the
cost of unwarranted cesareans in Brazil to be US$53 million per year.
In countries that have experienced the epidemiological transition from
high to low infant and child mortality, the cost-effectiveness of hospital
services increases, but not dramatically. As noted earlier, increased life
expectancy greatly shifts the mix of diseases with which the health
system must contend, and problems of adult ill health, especially acci-
dents and chronic diseases, become even more important than they
already are. Columns three and four of tables 2-9a and 2-9b summarize
the cost-effectiveness of a number of health interventions in high-
resource countries. Selected hospital services are relatively cost-effective,
but preventive measures remain crucially important.
Primary prevention programs for smoking are clearly dominant
among interventions for noncommunicable diseases, and hepatitis con-
trol is also a priority area compared with the application of hospital
resources to lung, stomach, or liver cancers. At an estimated cost per year
of life saved of 2 percent GNPN, antismoking programs are much more
cost-effective than the use of hospital resources to treat the associated
lung cancer or heart ailments over the lifetime of the disease. Treatment
of lung cancer or heart disease costs 200 percent GNPN per year of life
saved and 25 to 60 percent GNPN per QALY in a high-income country and
1,300 percent GNPN per year of life saved and 90 to 300 percent GNPN per
QALY in a low- or middle-income country. Similarly, hepatitis B im-
munization in a high-prevalence country at 20 percent GNPN per year of
life saved is more cost-effective than the 660 percent GNPN per year of
life saved from treating the associated primary liver cancer.
Secondary prevention programs, such as those for cervical and breast
cancer and tuberculosis, can also be cost-effective if the incidence of the
targeted diseases is high and sufficient hospital infrastructure is avail-
able for follow-up. Several important secondary prevention programs
(for example, prenatal care, screening for high-risk delivery, and screen-
ing for breast and cervical cancer) require the use of hospital resources
for follow-up treatment of those who test positive. In fact, the cost and
effects of screening and treatment are intertwined, and in some cases it
is difficult to isolate screening and treatment for separate cost-effective-
ness evaluation.

58 Public Hospitals in Developing Countries
Cervical cancer provides a good example. The low cost per year of life
saved from cervical cancer treatment is an effect of the long existence of
screening programs in industrial countries. These programs have re-
sulted in earlier detection and, if treatment is undertaken, improved
survival. Thus, the estimated cost-effectiveness of treatment, which is
based on improvement in survival rates, is increased for cervical cancer.
As a complement, the secondary prevention program is cost-effective
partly because treatment for cervical cancer involves simpler and less
costly procedures when the cancer is detected early. The relation of
secondary prevention and the appropriate design of a referral system is
considered further in chapter 6.
Unfortunately, most studies on the cost-effectiveness of hospital ser-
vices have been of technical procedures, such as dialysis, that have
generated controversy in industrial countries. Most of these procedures
are clearly not cost-effective in developing countries and are performed,
if they are performed at all, primarily in larger provincial or central
facilities. Only a few studies, such as that carried out by Barlow (1976)
in Morocco, have addressed the general cost-effectiveness of relatively
basic services provided in hospital facilities. Recast in percent GNPN, the
cost per year of life gained for hospital services in the Morocco study was
40. This cost, although higher than many nonhospital interventions, is
an average of high- and low-cost hospital activities and suggests that
more detailed analysis of less technically complex hospital interventions
in low-income countries could demonstrate their relative cost-effective-
ness.
Marginal Cost-Effectiveness of Hospital Resources
The marginal cost-effectiveness of a given activity can be defined as the
change in the number of discounted healthy life years gained with a
change in the expenditure on the activity. The studies cited in the
discussion above do not distinguish between marginal and average cost-
effectiveness. Allocational efficiency requires that the marginal cost-ef-
fectiveness of interventions be equal, and the use of average
cost-effectiveness introduces bias into the comparisons. This bias can be
especially important in comparing interventions in environments of low
mortality and high resources, because the marginal cost-effectiveness of
any intervention falls as the incidence of its related disease falls and the
level of coverage by the given intervention as well as other interventions
increases. In evaluating health care interventions in countries with low
levels of resources and high disease rates, the difference between
resource allocations based on average and marginal effects is not great.
The distinction may be important, however, in resource environments
in which the coverage with more basic interventions may be high.

Patterns of Hospital Resource Use 59
A study of the optimum use of resources to improve child survival
demonstrated that marginal cost-effectiveness can change rapidly as the
coverage and use of interventions increases, with the result that the
optimum intervention mix changes at alternative resource levels (Bar-
num and others 1980). At low-resource levels and with an imR greater
than 100, the activities with the highest marginal cost-effectiveness in
improving child survival are outreach programs promoting nutrition,
breast-feeding, antidiarrheal measures, prenatal care, and attended
home delivery. At middle- to upper-resource levels, hospital outpatient
programs and inpatient delivery become increasingly cost-effective.
Only at upper levels of resources, as the IMR falls well below fifty, does
inpatient care become cost-effective, and then only for selected uses. The
principle remains sound and can be extended to resources used by adults
as well as children and to morbidity as well as mortality. Preventive and
primary curative programs should be maintained at all resource levels,
but hospital inpatient care becomes increasingly cost-effective as the
general mortality level falls and greater health resources become available.
If a country were following an optimum allocation strategy as the
health sector developed, the marginal cost-effectiveness of any given
primary health care intervention, even ones with as high an average
cost-effectiveness as the diarrhea prevention activities listed in table
2-9a, would decrease with each additional unit of resources until at some
point it fell below inpatient hospital care. The principle is illustrated in
figure 2-11. If we follow the two lines depicting the marginal cost-effec-
tiveness of diarrheal disease prevention and inpatient care for the case
in which a country has initially invested only a limited amount of
resources in hospitals, we can see how the required investment in
hospitals might change as increasing resources become available. The
change in the number of years of life gained with, say, an additional
expenditure on diarrhea prevention or hospitals is measured on the
y-axis and the level of resources used is given on the x-axis. A low level
of resources used for diarrhea prevention results in great marginal
cost-effectiveness compared with an equivalent expenditure on inpa-
tients. As the resources used for diarrhea prevention activities increase,
the marginal cost-effectiveness of the activities decreases until at some
point (at high resource levels) diarrhea prevention becomes less cost-ef-
fective than an additional unit of inpatient care.
In most resource-poor countries, however, the health sector invest-
ment program has not followed an optimum path, and the countries
have already invested heavily in hospitals even though the level of
sectoral development is low. Investments in nonhospital health care
programs are vastly more cost-effective in these countries. This situation
is depicted in figure 2-12. As diarrhea prevention activities increase, the
relative cost-effectiveness of hospitals nevertheless remains low. In these

60 Public Hospitals in Developing Countries
Figure 2-11. Change in Marginal Cost-Effectiveness with Low Initial
Investment in Hospital Services
Marginal cost-effectiveness
Diarrhea
prevention
Health resource level
countries it becomes especially important to release public resources for
more cost-effective programs by finding ways of diminishing the
government's financial responsibility for hospitals. In practice it is often
politically or technically difficult actually to reduce recurrent expendi-
tures on hospitals and transfer the funds to nonhospital programs.
Changes must be made at the margin by altering investment patterns;
this strategy can have significant effects in time. An alternative method
would be to alter the function of existinghospitals to integrate them more
fully into primary care programs.
Summary
In this chapter we have surveyed the use of hospital resources in devel-
oping countries with respect to their distribution within the government
health sector, their distribution within and across hospitals, their dis-

Patterns of Hospital Resource Use 61
Figure 2-12. Change in Marginal Cost-Effectiveness with High Initial
Investment in Hospital Services
Marginal cost-effectiveness
Diarrhea
Inpatient care
Health resource level
tributional equity, and their cost-effectiveness. We have arrived at the
following conclusions:
* In nearly all countries, the largest share of public sector health
expenditure is for hospitals, regardless of a country's health status and
income level.
* Within the hospital subsector in many countries, tertiary hospitals
use a very large share of public resources in relation to district-
level hospitals. The relatively limited resources available for
district-level hospitals can be detrimental to service quality and im-
pedes the function of district hospitals as the institution of choice for
first referral.
* The benefits of hospital services are not distributed equitably
throughout the population but instead are received disproportionately
by residents of urban areas. There is also limited evidence to suggest
that hospital services are used less by the poor, with the possible

62 Public Hospitals in Developing Countries
exception of hospital services covered by social security in those
countries in Latin America where such coverage is high.
* Nonhospital interventions are both more cost-effective and more
equitable as a means of improving health status for most of the
prevalent health conditions in low-income countries.
These conclusions are not surprising and are consistent with widely
held views of hospital resource use. Nevertheless, the discussion leading
to the conclusions is important because it marshals available evidence to
sustain the prevailing consensus and underlines the importance of find-
ing solutions to the problem of heavy hospital resource use. Within these
broad and obvious conclusions the chapter reveals a number of less ob-
vious details that have implications for health sector resource planning.
Distribution of Resources within the Health Sector
The large share of recurrent resources going to hospitals is only indica-
tive of the actual priority placed on other health programs or sector
strategies. The hospital share does not, in itself, demonstrate a country's
level of support for primary health care or the effectiveness of its primary
health care strategy. Although exceptionally large expenditures for hos-
pitals are competitive with PHC programs, lower-level hospitals can
provide substantial primary health care services directly as well as
support to nonhospital aspects of PHC programs, as will be brought out
in chapter 6. For these reasons a comparison of hospital share with health
status indicators, such as the infant mortality rate, related to the goals of
primary health care reveals only a modest inverse pattern with many
significant exceptions. Thus, an examination of tradeoffs between hos-
pital resource use and PHC requires country-specific analysis.
The hospital share of recurrent resources can be changed by deliberate
government policies affecting either the short-term or long-term alloca-
tion. In the short term, the share may change during periods of fiscal
difficulties when fewer public resources are available. Some countries
have acted to protect primary care programs in the face of declining
availability of recurrent resources for the entire sector, whereas others
have concentrated a greater share on hospitals. Policymakers should be
especially careful during periods of acute fiscal adjustment to protect the
recurrent resource needs of basic health care programs.
In the long term, although the number of physicians in relation to the
population appears to affect the hospital share, a more worthwhile
activity than simply limiting physician supply may be to alter the
medical curriculum to place a greater emphasis on primary health care
and less emphasis on technically complex curative techniques. Perhaps
physicians could spend more training time at district hospitals and in

Patterns of Hospital Resource Use 63
primary care outreach programs. A by-product of such a change may,
in the medium to long term, be a reduction in the hospital share of public
sector health expenditure.
The long-term balance of recurrent resource use between hospitals
and other health programs is obviously affected by past and current
investments, but health sector plans often fail to project the implications
of recurrent costs. Recurrent-capital cost ratios can be used to generate
a rough order-of-magnitude estimate of the recurrent cost implications
of current capital expenditures until project-specific financial analysis is
available for more accurate projections. Whatever projection methodol-
ogy is used, governments should act on the projections to coordinate
government and donor investment in the sector to achieve the intended
long-term balance of recurrent resource use.
Allocation of Resources within the Hospital Subsector
Tertiary-level hospitals absorb a large share of total public expenditure
on hospitals. Tertiary hospitals are intended for patients with complex
conditions, who are more costly to treat. It is likely that many, if not most,
of the patients treated in large urban tertiary hospitals could be treated
in less costly facilities but are not because the referral system is not
functioning effectively and because viable alternative urban treatment
centers are not available for the population living relatively close to the
hospital. If concentration of funds on tertiary hospitals leads to un-
derfunding of first-level referral hospitals, the quality of these low-level
facilities is likely to deteriorate, and people who are able will tend to
bypass them and seek out the nearest tertiary center. Therefore, excessive
concentration of funding on a few facilities will feed on itself and result
in an increasingly inefficient and inequitable allocation of hospital re-
sources.
There appears to be a positive correlation between the share of labor
in hospital recurrent expenditures and a country's level of income,
though there are several exceptions. This correlation is expected on
economic grounds as long as the technical possibilities for substitution
between personnel and other inputs, especially drugs and supplies with
relatively fixed real prices across countries, are relatively limited. Al-
though there may be a greater relative quantity of labor used per unit of
output in low-wage countries, it is not enough to cancel out the price
effects of imported inputs on the relative expenditure shares. As a result,
drugs and medical supplies absorb a larger share of total recurrent
expenditures than in high-wage countries. This high-cost, low-produc-
tivity environment leads to a recommendation that hospitals in low-in-
come countries should not pattern themselves after those in high-income
countries; rather, emphasis needs to be placed on research to develop

64 Public Hospitals in Developing Countries
productive, alternative, labor-using technologies for delivering hospital
services in developing countries.
In contrast to the majority of low-income countries that have, as
expected, relatively low (40 to 60 percent) personnel shares, some low-
income countries have very high labor shares. Examination of the hos-
pitals in these countries reveals the cause of this discrepancy: in the face
of declining resource availability in the public sector and civil service
constraints on reducing the number of employees, there are very few
funds available for nonpersonnel inputs after the staff has been paid. The
result is extremely low productivity, because the staff then has very few
nonlabor inputs available with which to produce hospital services.
Greater health sector funding and more flexibility in assigning staff to
nonhospital programs within the health sector are needed to increase
productivity.
Distributional Equity of Hospital Use
The use of hospital resources is important for the relative welfare of
different population groups distinguished by income, geographical lo-
cation, and age. Given that hospitals absorb a large share of health sector
resources but can provide services to relatively few persons, these dis-
tributional implications are of great importance in setting policy. Sur-
prisingly little information is available on this question, and there is a
great need for additional research, possibly based on household surveys
or comparisons of the characteristics of patients discharged from hospi-
tals with wider demographic and income information. The limited in-
formation on hospital use by income groups indicates, but not
conclusively, that bias in favor of high-income groups exists. Stronger
evidence exists of geographical bias and of greater use of hospital
outpatient and, to a somewhat lesser extent, inpatient services by urban
populations than rural. This evidence suggests that there are distributional
biases that favor high-income regions and urban populations. Hospitals are
necessary as part of the overall health system, and economic logic dictates
that they be located in areas with the highest population. The key equity
issue raised by the geographical bias is whether the health needs of rural
persons are being met by the services available to them, and whether the
existing referral system provides them with access to more complex services
when needed.
Consideration of the distribution of hospital services by age and
disease or condition raises issues of future resource use related to the
epidemiological and demographic transitions. Limited data from devel-
oping countries indicate that infants and the elderly comprise a greater
share of admissions than they do of the population, whereas the five-
through-fourteen age group comprises fewer admissions than its popu-

Patterns of Hospital Resource Use 65
lation share. The available empirical evidence supports the hypothesis
that greater resources are used per admission and patient-day for adults
over age forty-five than for younger persons. This suggests that older
people use more services and are more expensive to treat. An implication
of the demographic transition is that as populations age, if services are
organized and delivered as they are currently, hospital costs will rise.
This implication is made stronger by the fact that specific disease
categories require greater hospital resources. The current leading causes
of admission relate to pregnancy and communicable (infectious-para-
sitic and respiratory) diseases. These cases, however, have a relatively
low average cost per admission, and noncommunicable conditions and
accidents consume a far larger share of hospital resources than is indi-
cated by the admissions data. It is difficult to disentangle the separate
effects of the demographic and epidemiological transitions, but it is clear
that as they occur their combined effects will lead to a more costly
hospital case mix, further straining available resources, assuming health
services continue to be financed and delivered as they are today. World
Bank studies from Brazil and China stress the need to reallocate re-
sources immediately in favor of chronic disease prevention and control
programs in order to avert future high hospital costs that will arise when
patients with these conditions present themselves at hospitals. This
condusion is applicable (to varying degrees) to many developing coun-
tries.
Cost-Effectiveness of Hospital Services
Understanding the relative cost-effectiveness of hospital services helps
to determine the appropriate levels of hospital and nonhospital services
that should be provided in an integrated referral system. Because of
different resource endowments and relative prices across countries, a
ranking of interventions by their relative cost-effectiveness may be dif-
ferent in different countries. Despite these differences, however, it is
likely that the leading causes of morbidity and mortality in low-income,
high-mortality countries are conditions that can be treated or prevented
most cost-effectively through nonhospital interventions. In a low-mor-
tality country, in which chronic disease is more important, hospital
services become relatively more cost-effective, although primary care
and prevention remain very important.
To recapitulate the conclusions of the chapter: hospital services have
a role in providing referral services to support and complement non-
hospital health programs, but in resource-poor countries the magnitude
and diversity of hospital services to be provided should be limited. In
most countries the resources going to hospitals appear to exceed the

66 Public Hospitals in Developing Countries
amount required for allocational efficiency. Thus, to reduce the use by
hospitals of public sector resources and to make additional resources
available for nonhospital programs, it is important to find ways of
increasing internal efficiency in hospitals, to find mechanisms to reduce
the dependence of hospitals on public finance, and to develop low-cost
alternatives to hospitals. The next four chapters address these problems.

Patterns of Hospital Resource Use 67
Appendix 2A. Resource Use
The table on following pages provides indicators of health resource
availability and health status for a cross-section of countries. Information
is also provided for total health spending and government spending on
hospitals. This latter information is available for only a limited number
of countries.

Table 2A-1. Selected Health Indicators, Most Recent Estimates
Infant Health Hospitals as a
Per capita Life mortality spending as a percentage of
GNP a expectancy (per 1,000 Health inputs per 1,000 population percentage public health
Country (U.S. $) at birtha live births) a Physiciansb Nursesc Hospital bedsd of GNP spendinge
Low-income countries
Mozambique 81 49 137 0.03 0.17 1.09 4.4 36
Tanzania 120 49 112 0.04 0.18 1.38 3.2
Ethiopia 122 48 133 0.01 0.19 0.30 3.6 49
Somalia 170 48 128 0.06 0.65 1.43 - 70
Malawi 173 47 147 0.09 0.32 1.54 2.7 81
Nepal 175 52 124 0.03 0.21 0.17 1.4 25
LaoP.D.R. 175 49 105 0.73 1.88 0.93 - -
Bangladesh 182 51 106 0.15 0.11 0.28 1.7 61
Guinea-Bissau 183 40 147 0.14 0.89 1.86 - -
Chad 188 46 127 0.03 0.29 1.31 - -
Bhutan 195 48 125 0.10 0.33 0.71 2.0 -
Sierra Leone 209 42 149 0.07 0.92 1.21 3.0 -
Burundi 218 49 70 0.05 0.23 0.68 - 66
Madagascar 220 51 117 0.10 0.58 2.50 9.2 -
The Gambia 236 44 138 0.09 0.46 1.67 - 45
Zaire 244 53 94 0.08 0.56 1.65 - -
Nigeria 249 51 100 0.16 1.18 0.73 7.8 -
Uganda 250 49 99 0.05 0.49 1.52 2.1 43
Mali 260 48 167 0.04 0.74 0.71 0.8 -
Niger 292 45 130 0.03 2.18 0.50 - 30
Burkina Faso 313 48 135 0.02 0.59 0.57 - -
Rwanda 320 49 118 0.01 0.23 1.67 3.5

India 347 59 95 0.40 0.59 0.77 4.3 71
China 356 70 30 0.99 0.71 1.98 4.0 61
Haiti 359 55 94 0.14 0.44 0.72 - -
Equatorial Guinea 359 46 122 - 0.80 - - -
Kenya 364 59 68 0.10 1.55 1.65 2.3 73
Pakistan 365 55 106 0.34 0.20 0.59 3.5 52
Sao Tome and Principe 373 66 71 0.50 3.55 - - -
Central African Republic 379 51 100 0.04 0.45 1.55 - -
Benin 382 51 112 0.06 0.57 1.13 4.1
Ghana 383 55 86 0.05 0.60 1.57 2.4
Togo 394 54 90 0.11 0.90 1.43 - -
Guyana 407 64 53 0.16 1.13 3.33 4.4
Zambia 412 54 76 0.14 1.34 3.53 5.6
Maldives 417 61 73 0.07 1.63 - - -
Sudan 428 50 104 0.10 0.79 0.88 6.0
Sri Lanka 433 71 20 0.18 0.78 2.94 2.3 70
Lesotho 437 56 96 0.05 0.26 1.67 2.0 74
Guinea 442 43 140 0.02 0.19 1.53 - -
Comoros 456 55 94 0.08 0.45 2.10 - -
Indonesia 503 61 64 0.11 0.79 0.55 2.4 37
Mauritania 505 46 123 0.08 0.85 0.78 - -
Solomon Islands 577 64 49 0.13 1.69 5.68
Low-income countries with
missing GNP data
Afghanistan - 42 170 0.16 0.11 0.27 - -
Cambodia - 50 121 - 0.73 1.08 - -
Liberia - 54 137 0.11 0.73 1.67 - -
Myanmar - 61 66 0.27 1.18 0.85 3.2 33
Viet Nam - 66 43 1.06 1.68 3.70 - -
(Talile continues on thefollowing page.)

Table 2A-1 (continued)
Infant Health Hospitals as a
Per capita Life mortality spending as a percentage of
GNP a expectancy (per 1,000 Health inputs per 1,000 population percentage public health
Country (U.S. $) at birtha live births)a P,lysiciattsb Nursesc Hospital beds" of GNP spendinge
Middle-income countries
Angola 604 45 132 0.06 0.99 2.72 - -
Bolivia 628 54 106 0.65 0.44 2.00 2.3
Arab Republic of Egypt 639 60 68 1.30 1.28 2.09 - -
Republic of Yemen 650 48 125 0.15 0.58 0.45 6.0
Senegal 654 48 82 0.08 0.49 1.25 3.1 50
Zimbabwe 654 64 45 0.14 1.39 2.01 4.2 54
Kiribati 702 55 59 0.51 4.40 4.80 - -
Philippines 714 64 42 0.15 0.37 1.70 2.4 71
Western Samoa 722 66 48 0.28 2.45 4.36 - -
Cape Verde 778 66 41 0.19 1.40 2.19
Dominican Republic 781 67 61 0.57 0.83 2.50 - -
C6te d'lvoire 788 53 92 - 0.49 1.16 5.4 46
Morocco 878 61 69 0.21 0.95 1.24 1.2
Papua New Guinea 892 54 59 0.16 1.14 4.81 3.8 45
Swaziland 896 56 114 0.05 0.95 3.37 5.5 52
Tonga 907 67 24 0.60 1.83 3.56 - -
Honduras 909 65 66 0.66 1.49 1.25
Guatemala 916 63 55 0.46 1.17 1.67 -
People's Republic of the
Congo 943 54 115 0.12 1.73 4.59 9.4
Syrian Arab Republic 963 66 44 0.77 1.12 1.13 -
Vanuatu 981 64 71 0.19 2.18 6.08 -
Cameroon 995 57 90 - 0.51 2.50 7.1

Ecuador 1,023 66 61 1.22 1.64 2.50 3.4
Namibia 1,027 57 101 - - - 4.4
Paraguay 1,032 67 32 0.69 1.20 1.67 -
Peru 1,061 62 79 0.96 0.99 1.69 - -
El Salvador 1,063 63 55 0.35 1.75 2.00 - 62
Colombia 1,212 69 38 0.80 1.52 1.65 4.9 67
Thailand 1,224 66 28 0.16 1.42 1.54 3.8 58
Tunisia 1,261 66 46 0.46 2.73 2.13 4.5 70
Turkey 1,368 66 61 0.73 0.98 2.08 3.0 63
Jamaica 1,400 73 16 0.49 2.50 3.33 4.6 72
Botswana 1,603 67 39 0.14 1.43 2.37 3.3 49
Jordan 1,640 67 52 0.90 0.79 0.94 6.8 75
Fiji 1,675 67 19 0.49 2.36 2.75 3.8 -
Belize 1,720 68 46 0.45 2.17 3.32 - -
Panama 1,764 72 22 1.00 2.57 3.33 5.6 -
Dominica 1,764 75 17 0.32 1.88 4.44 5.3 -
Chile 1,771 72 19 0.81 2.70 3.41 6.1 -
Costa Rica 1,773 75 17 1.04 2.22 3.41 -
Poland 1,774 71 16 2.05 5.35 7.64 3.7 -
St. Lucia 1,810 71 20 0.26 1.90 5.07 5.0 -
Mongolia 1,824 62 64 9.81 4.72 11.35 - -
Grenada 1,891 69 32 0.47 - 5.95 7.0 -
Mauritius 2,017 70 21 0.53 1.71 3.33 9.0 -
Mexico 2,079 69 40 0.80 1.14 1.25 3.4 58
Argentina 2,103 71 30 2.68 1.19 5.59 7.1 -
Malaysia 2,136 70 22 0.52 0.99 2.50 3.5 59
Algeria 2,287 65 69 0.43 3.30 2.63 5.4 -
Uruguay 2,448 73 22 1.95 5.29 3.25 6.4
(Table continues on the following page.)

Table 2A-1 (continued)
Infant Health Hospitals as a
Per capita Life mortality spending as a percentage of
GNP a expectancy (per 1,000 Health inputs per 1,000 population percentage public health
Country (U.S. $) at birtha live births)a Physiciansb Nursesc Hospital bedsd of GNP spendinge
Venezuela 2,449 70 35 1.43 2.71 2.60
South Africa 2,470 61 68 - 2.43
Brazil 2,496 66 59 0.93 0.83 5.00 5.6 68
Hungary 2,585 71 16 3.26 5.76 9.17 5.4 -
Bulgaria 2,662 72 14 3.63 6.44 11.14 - -
Yugoslavia 2,937 72 24 1.82 3.93 5.98 - -
Gabon 2,992 53 98 0.36 3.67 1.25 - -
Suriname 3,006 67 40 0.79 3.62 8.90 - -
Islamic Republic of Iran 3,007 63 90 0.34 0.87 1.52 - -
Trinidad and Tobago 3,338 71 15 1.05 3.98 5.00 - -
Czechoslovakia 3,453 71 12 3.60 6.91 12.45 - -
Seychelles 4,226 70 18 0.46 5.03 4.98 - -
Portugal 4,249 75 14 2.42 1.59 5.00 6.4 44
Republic of Korea 4,400 70 23 0.87 1.72 1.68 5.1 33
Oman 5,217 65 36 0.91 2.55 1.81 3.4
Libya 5,308 62 77 1.44 2.85 4.83 -
Greece 5,346 77 12 2.85 2.24 6.16 5.3 33
Malta 5,832 73 10 1.14 8.84 10.00 - -
Countries believed to be
middle income, but with
missing GNP data
Antigua and Barbuda - 74 20 - 3.07 6.53
Djibouti - 48 117 0.24 1.98 3.60

French Guiana - 73 - 1.40 16.65 12.15
Gibraltar - - 5 - - -
Iraq - 63 67 0.55 0.58 1.85
Lebanon - 65 47 1.49 1.59 4.34
Macao - 72 11 1.80 2.35 5.49
Martinique - 76 10 1.42 - 10.06
Montserrat - 71 30 0.42 - -
New Caledonia - 69 33 0.66 2.41 -
Nicaragua - 64 57 0.67 1.87 2.50
Pacific Islands Trust
Territories - 72 20 - -
Reunion - 72 13 - 3.62 8.66
Romania - 71 24 1.76 3.65 8.77 3.0 53
St. Kitts and Nevis - 69 38 0.46 7.94 8.65 - -
St. Vincent and the
Grenadines - 70 25 0.23 1.48 4.99
Highi-incomie countries
Saudi Arabia 6,020 64 67 1.35 2.90 1.46 - -
Barbados 6,346 75 13 0.89 4.49 8.53 - -
Bahrain 6,380 69 33 1.22 2.71 3.31 - -
Cyprus 7,040 76 11 1.34 3.67 5.55 - -
Ireland 8,713 74 8 1.47 7.16 9.71 7.5 73
Spain 9,329 77 8 3.17 3.87 5.20 6.0 48
Israel 9,787 76 11 2.90 9.37 5.00 - -
Singapore 10,352 74 7 0.76 2.96 4.05 - -
Hong Kong 10,372 77 7 0.93 4.15 4.89 - -
The Bahamas 11,119 68 24 0.94 4.85 4.40 - -
New Zealand 12,067 75 10 1.74 12.39 10.13 6.8 66
Australia 14,357 77 8 2.29 8.73 12.00 7.6 56
(Table continues on the following page.)

Table 2A-1 (continued)
Infant Health Hospitals as a
Per capita Life mortality spending as a percentage of
GNP a expectancy (per 1,000 Health it1puts per 1,000 population percentage public health
Country (U.S. $) at birtha live births)a Physiciansb NursesC Hospital bedsd of GNP spendinge
United Kingdom 14,612 76 9 1.64 8.34 9.33 6.0 57
Italy 15,118 77 9 4.28 4.00 10.59 7.3 52
Qatar 15,833 70 29 1.74 4.48 2.54 - -
Netherlands 15,923 77 7 2.22 5.96 12.53 8.4 65
Kuwait 16,153 74 15 1.57 4.94 4.14 - -
Belgium 16,223 76 9 3.02 9.26 9.38 7.3 23
Austria 17,303 76 9 2.57 5.43 11.14 8.4 18
France 17,821 77 7 3.13 9.51 7.22 8.6 55
N United Arab Emirates 18,414 71 24 0.98 2.56 2.96 - -
Canada 19,032 77 7 1.96 8.25 9.88 8.6 59
Iceland 20,411 78 6 2.30 11.49 - 7.9 70
Germany 20,442 75 8 2.65 4.42 11.50 8.1 43
Denmark 20,453 75 8 2.51 16.43 9.68 5.9 76
United States 20,910 76 10 2.12 13.58 5.85 11.1 59
Sweden 21,574 77 6 2.59 1.48 14.81 9.1 75
Finland 22,121 75 6 2.26 16.92 15.54 7.5 51
Norway 22,294 77 8 2.22 17.50 15.00 7.4 74
Japan 23,811 79 5 1.51 5.43 11.58 6.9 42
Luxembourg 26,217 75 9 1.81 4.14 11.84 7.2 29
Switzerland 29,883 78 6 1.44 7.74 11.16 7.7 56
Countries believed to be
high income, but with
missing GNP data
American Samoa - - - 0.83 0.51

Bermuda - - - 0.76 - 9.31
Brunei Darussalam - 75 9 0.55 3.78 3.11
Channel Islands - 77 8 1.52 - 10.60
Faeroe Islands - 74 23 - - 8.13
French Polynesia - 72 21 1.25 2.35
Greenland - 63 29 1.14 - 14.35
Guadeloupe - 74 15 1.39 1.90 11.14
Guam - 73 11 1.18 4.75
Isle of Man - - 16 - -
Netherlands Antilles - 77 13 - - 9.12
Puerto Rico - 75 13 - -
Virgin Islands (U.S.) - 74 18 - -
@ Other economies
Albania - 72 26 - 5.25 7.10
Cuba - 76 12 1.89 3.51 4.62
Democratic People's - 70 27 2.38 -
Republic of Korea
Former U.S.S.R. - 70 24 3.70 5.90 10.97
-Not available.
a. Data are for 1989.
b. Most estimates are for 1985 or later.
c. From about 1985.
d. From about 1980.
e. For OECD countries, measured as the share of public inpatient expenditures in total public sector health expenditure.
Source: OECD 1990 and World Bank data.

76 Public Hospitals in Developing Countries
Notes
1. The relationship of the number of beds per capita (Beds/Pop) to GNP per capita
(GNPN) using the data in figure 2-1 is
Log (Beds/Pop) = -9.416 + 0.477 [Log (GNPN)I
(-35.47) (13.45)
R
2
= 0.57 n = 139
(t-statistics are given in parentheses).
2. The log-linear relationship explaining the hospital share (HOSP%oEX) is
Log (HOSP%EX) = 1.230 -0.068 [Log(GNPN)] + 0.159 [Log(MD/Pop) ]
(1.23) (-0.76) (2.71)
R = 0.29 n = 29 (developing countries)
(t-statistics are given in parentheses.)
3. A pyramidal conceptualization of a health system is discussed in chapter 6.
4. The relationship of the personnel share in total hospital cost to GNP per capita
(using the data from table 2-4), controlling for the level of hospital (D = 1 for
district-level hospitals, 0 for other levels) is
Personnel Cost Share (%) = 36.5 + 0.020 GNPN + 7.30 D
(7.31) (3.48) (1.57)
R
2
=033 n= 31
(t-statistics are given in parentheses).
5. The income elasticity of hospital beds gives the percentage change in
hospital beds in response to a percentage change in per capita income.
6. The Jamaican data include admissions to all acute care public hospitals. The
Korean data relate to those covered by Industrial Establishment Medical Insur-
ance, which represented 60 percent of the insured population and 32 percent of
the total population in 1986.
7. These data are for insured government employees and private school
teachers and staff (and all dependents), who made up 10.4 percent of the
population in 1986.
8. The number of healthy years of life gained (HYLG) is the sum of years of life
gained from prevention of mortality (YLG) and years gained from avoidance of
disability. Polio provides an example. Using the data for Ghana provided by the
Ghana Health Assessment Team (GHAT 1981), we find that a total of 3.3 HYLG per
thousand people per year are gained from elimination of polio. Of this total 0.6
is gained from elimination of mortality (YLG) and the remainder, 2.7, is gained
from elimination of disability. Thus, in this example, the number of YLc is
substantially less than the number of HYLG.
9. A QALY is, literally, a quality adjustment to a year of life gained (YLG). The
adjustment yields a fraction of a year of life with full health. In the example given
by Williams (1985), coronary artery bypass surgery on a patient with severe

Patterns of Hospital Resource Use 77
angina and disease of the left main vessel gives a gain of 6 years compared with
no surgical intervention. Adjusting these years for the loss of quality of life from
the treatment and from continued chronic disability gives a gain, measured in
QALYS, of 3.5 years.
10. Given an original cost expressed in U.S. dollars of C$ in a high-income
country and foreign exchange costs as a proportion, f, of total costs in a lower-
middle-income country, the estimated cost as a proportion of GNPN in a low-
income country is:
C GNPN H f*C H + (I-f)CH
L ~~~$ $
GNPN L GNPN H
= FOREIGN + LOCAL
COMPONENT COMPONENT
The superscript indicates whether the cost is measured in $ or GNPN, and the
subscript indicates a high-income (H) or low-income (L) country.

3. Hospital Costs
and Efficiency
In this chapter we provide estimates of recurrent hospital costs and
consider the relation of costs to services. Our immediate objective is to
provide information on the determinants of hospital costs that can be
used to formulate policy recommendations concerning efficiency and
financing. Related benefits that can arise from an understanding of costs
include estimates of the potential savings from improved referral pat-
terns, the relative cost-effectiveness of alternative programs, and projec-
tions of future recurrent resource requirements of current and proposed
facilities.
The methodology and findings of studies that use two very different
methods of cost analysis are reviewed in this chapter. The first method
makes use of accounting information and reanalysis of hospital service
records to examine hospital costs and performance. The second one
makes use of statistical procedures to infer the relation of hospital costs
to services provided. The accounting method can be applied usefully to
a single hospital and can involve a labor-intensive, detailed examination
of hospital accounts, staffing patterns, and admissions. It is also possible,
although somewhat less accurate, to derive hospital accounting costs by
using aggregate government budgets or expenditure data. Less detailed
data are needed in the statistical method, but it requires observations of
costs and service use for many hospitals. Statistical studies provide
insights into cost issues-the relation between marginal and average
cost, and the degree to which hospitals exhibit economies of scale and
scope-that accounting studies do not reveal as readily. Ideally, the
information used for the statistical analyses would be derived from a
large number of detailed and well-documented observations. In actual-
ity this is not often possible, and the lesser quality of data in a statistical
analysis must be compensated for by inferring a general pattern of costs
from a large number of observations. Thus, the accounting and statistical
methods yield different but complementary views of costs.
79

80 Public Hospitals in Developing Countries
Whichever method of costing is used, the unit of analysis (such as
patient-days, admissions, or outpatient visits) and consideration of both
average and marginal costs are important, because the use of any single
output or cost measure may produce misleading results. The reasons for
this can be seen in figure 3-1, which provides a schematic description of
the nature of inpatient hospital costs. As depicted in the figure, recurrent
inpatient costs are considered to have three components:
* Overhead costs. These costs remain essentially constant regardless
of whether a bed is occupied. Typically, they include items such as
heating and maintenance, but for many public hospitals in developing
countries, personnel may be a large component of overhead costs,
because it may not be possible for staff to be reduced in the short run
during periods of low occupancy. The magnitude of overhead costs is
related to hospital size.
* "Hotel" costs. These are costs, such as catering, laundry, and linen,
that are incurred for each patient-day in the hospital. They tend to be
constant for each day of a patient stay, though there will be some
variation related to diagnosis and patient characteristics.
* Treatment costs. These are case-dependent costs associated with the
particular diagnostic, therapeutic, and other treatment services pro-
vided to the patient. As depicted in figure 3-1, these costs tend to peak
in the first few days of a patient stay, when, for example, there might
be an operation, and then diminish thereafter. The actual pattern of
treatment costs in any hospital will vary depending on the clinical
management of inpatients.
Figure 3-1 illustrates the importance of using various units of analysis
when interpreting cost data. The figure posits that marginal costs per
day equal average costs per day for overhead costs and per patient-day
for hotel costs but differ for treatment costs during the period of the
patient stay. If the case were the only unit of analysis, the changing
nature of marginal treatment costs during a stay would not be observed.
Cost comparisons between two hospitals based solely on the number of
inpatient days, however, would not account for the differences in aver-
age costs per case arising from differences in the average length of stay
(ALOS). The hospital in which the length of stay of patients was longer,
other things equal, would tend to have a lower average cost per day
because the treatment costs for the additional days would be likely to be
far below the average for the case. The extra day's stay in the hospital
would probably contribute little to the improvement of the patient's
condition, and thus the lower average cost would actually mask ineffi-
cient hospital performance.
The figure illustrates the potential use of hospital service statistics in
understanding the efficiency implications of unit cost estimates. Knowl-

Hospital Costs and Efficiency 81
Figure 3-1. Inpatient Cost Profile
Cost per day
Length of stay Length of stay
Turnover
Hotel costs interval
Overhead costs
Days
Source: Adapted from Forte, 1985.
edge of the average length of patient stay, the bed occupancy rate
(percentage of beds occupied by patients), and the annual bed turnover
rate (average number of inpatients per bed during one year) can help in
explaining variation in inpatient unit cost measures. Assuming that the
treatment cost profile is similar, high occupancy rates tend to result in
lower average costs per patient-day because overhead costs are spread
over beds that are usually filled. If high occupancy results from relatively
few admissions but very long stays, however, hotel costs will be high in
relation to the number of patients and average cost per admission will
be high. The expected marginal cost per bed-day will be low because the
treatment costs at the end of a long hospital stay tend to be minimal.
Alternatively, if the bed turnover rate is high, average cost per admnission
is apt to be lower because hotel costs are spread over a larger number of
patients, whereas the marginal cost per day will be relatively high.
Increasing the bed occupancy rate through a greater number of admis-

82 Public Hospitals in Developing Countries
sions per bed rather than longer stays will allow more patients to be
served and thus improve hospital productivity.
The service units to which costs are compared in this chapter-admis-
sion, patient-day, and outpatient visit-are intermediate output or pro-
cess measures. Ideally, efficiency in the use of health sector inputs should
be assessed in relation to health outcomes (for example, quality adjusted
years of life gained, as discussed in chapter 2) rather than process
measures. Unfortunately, a massive level of resources would be needed
to conduct empirical studies of hospital costs per QALY or other outcome
measure for all hospital services, and we are unaware of any such studies
having been done. Therefore, we are left to focus on these process
measures for analysis of hospital efficiency.
The analysis of hospital costs and efficiency in developing countries
is a relatively new phenomenon. Although a few accounting studies of
average costs were performed in the 1970s and early 1980s (see, for
example, the work on Malaysia by Heller [19751 and reviews of earlier
studies in Robertson 1985, and Mills 1987), hospital costing has received
increased attention in more recent years. Of the studies reviewed in this
chapter, only one precedes 1987. The relative newness and dearth of
hospital cost studies circumscribes the contribution of this chapter. On
the one hand, the chapter pulls previously widely dispersed information
together for the first time and insight is thus gained into economic
functioning of hospitals in developing countries; on the other hand the
data base for the chapter is relatively small compared with what is
available in industrial countries, which underlines the need for further
cost studies.
Accounting-Based Cost Studies
In this section we review cost estimates derived from a selection of
accounting-based studies. Such studies are often termed "unit cost"
studies to indicate that they provide estimates of the average cost of a
unit of service. Unfortunately, the term "unit cost" has evolved in the
language of health planners to refer ambiguously to both average and
marginal costs per unit. To a certain extent the ambiguity in the use of
the term "unit" has practical roots. By separating costs into relatively
fixed components (utilities and some categories of staff, for example) and
variable components (examples are drugs, medical supplies, and food),
we can approximate marginal costs by average variable cost using
accounting methods. Also, if it is reasonable to assume that average cost
is invariant for the relevant scale of production, then marginal and
average cost will be equal and estimates of change in cost with projected
output can be based on the "unit" cost estimates. Thus, average costs can

Hospital Costs and Efficiency 83
be used with care to approximate the marginal cost needed to project the
recurrent costs of existing and planned hospitals.
There are a number of additional reasons for measuring average cost.
Perhaps the foremost is that an examination of the levels and determi-
nants of costs holds out some possibility of providing useful insight into
the relative efficiency of hospital operations. Comparisons of average
costs between hospitals with similar roles in a country's health system
may be useful for assessing individual hospital performance and iden-
tifying hospitals whose average costs are far from the norm. Compari-
sons of average costs of performing the same activity among different
levels and categories of hospitals may help to determine hospital devel-
opment policy and give an approximation of the potential saving (or
increased availability of services) to be derived from improving the
referral system. A closely related use of average costs in planning is to
provide information that can be used to compare the cost-effectiveness
of alternative health sector interventions or to provide information
needed to calculate the cost of treating particular diseases and the
expenditure avoided by prevention. Average costs also provide infor-
mation that can be used in justifying budgets when the level of govern-
ment subsidies is set for public hospitals or when reimbursement is made
to nongovernmental organizations. Finally, knowledge of recurrent op-
erating costs is needed for the formulation of economically efficient
hospital cost-recovery policies.
Methodology of Accounting-Based Studies
We have divided accounting-based average cost studies into two cate-
gories. The first develops detailed cost information for individual hos-
pitals using allocational assumptions in what is sometimes designated a
"step down procedure" to distribute aggregate costs across departments
and functions. The second makes less detailed estimates of hospital
average costs based on aggregate central ministry information or aggre-
gate reported hospital statistics and accounting records.
Step down analyses. Until recently, detailed average cost studies were
not available for hospitals in developing countries. Such analyses were
seen as too difficultbecause of the lack of general accounting information
and not useful because of the probable imprecision of the results. This
view was not correct; a number of studies, many employing variations
on the step down costing methodology, have recently demonstrated the
feasibility and usefulness of doing cost studies in a variety of economic
and developmental environments. To date, this costing method has been
applied only as an exception. The experience from these applications

84 Public Hospitals in Developinzg Countries
suggests, however, that it would be possible to institutionalize this type
of accounting methodology at the hospital, regional, or ministerial level.
Step down cost accounting is a disaggregated method of analyzing the
costs associated with specific hospital outputs. It is based on scrutiny of
the hospital production process to enable the best assignment of costs to
the outputs to which they are related. All hospital expenditures are
attributed to specific departments (cost centers), and then allocational
criteria, such as time use, are employed to distribute all costs (including
overhead and the cost of intermediate outputs) to final service categories.
A summary of the step down procedure is given in appendix 3-1.
Our focus is on the final cost estimates derived from step down cost
analyses, but it is worth noting that the analytical process can be as
important as the final estimate. In itself the process of attributing costs
to cost centers gives hospital managers considerably more useful infor-
mation than the line item accounting information with which they
typically operate. The cost center method enables managers at the hos-
pital and departmental level to know the level of resources they have
available to produce services, and this information can be used with
measures of departmental output (in the dietary department, for exam-
ple, a comparison can be made between the number of meals served and
expenditures in this cost center) to develop benchmarks against which
performance can be measured through time and across facilities. The use
of cost centers, thus, also promotes financial accountability of depart-
mnental managers. The process of allocating costs across intermediate
and overhead departments to the final patient service departments
yields much greater understanding of resource flows within the hospital.
Finally, a comparison of fully allocated costs with service statistics
produces average cost estimates of important performance indicators,
such as cost per patient-day and cost per outpatient visit. Average cost
estimates derived from hospital step down cost studies are included in
the top half of table 3-1.
Other accounting cost studies. An accounting alternative to step down
analysis is the use of aggregate data, either for individual hospitals or
for groups of hospitals. The calculation of meaningful average costs from
aggregate data requires that cost and service information be related with
respect to time and institutional and geographic coverage. Although
studies based on aggregate data require much less analysis than do step
down studies, the importance of data coverage, accuracy, and complete-
ness remains the same. Making an informed assumption of the resource
use of other outputs (such as an outpatient visit) from a single output
measure (such as an inpatient-day) simplifies the process of relating cost
and service information to produce average cost estimates. For example,
such a study for Rwandan hospitals (Shepard 1988) assumed that the

Hospital Costs and Efficiency 85
resources consumed in four outpatient visits equaled that of one patient-
day. A single measure of hospital output, the day-equivalent, was cre-
ated as the sum of patient-days and one-fourth of outpatient visits. Unit
cost per patient-day was calculated as the total cost divided by day-
equivalents, and cost per outpatient visit was one-quarter of this.
Cost studies based on aggregate hospital information can be per-
formed in less time but provide fewer details and insights than do the
step down studies that allow functional analyses. Nevertheless, the
information provided from more aggregate studies can be useful in
making comparisons among similar hospitals, or different levels of
hospitals, and can serve as a basis for making budgetary allocations to
hospitals. Aggregate studies should be supplemented by step down
studies that give more details on the relative average cost of inpatient
and outpatient services to inform the choice of a day-equivalent mea-
sure. The aggregate studies can then be used for a quick approximation
of average costs for a comparatively large number of hospitals. Average
costs based on aggregate accounting studies are cited in the lower half
of table 3-1.
Caveats on the Interpretation of Average Costs
Information on average costs provides one useful input needed for
assessing hospital performance. Average cost data alone, however, are
not sufficient for reaching definitive conclusions regarding hospital
efficiency within a country, and even greater caution is warranted in
interpreting results from cross-country studies. Differences in the com-
pleteness of the data used in each study and in the health, institutional,
and economic environment underlying the estimates place limitations
on comparisons. Under ideal circumstances, a study comparing the cost
per unit of output for several hospitals would tell us which one provided
services with the greatest efficiency (technical or economic). The follow-
ing conditions would have to be met, at a minimum, however, for the
results to be unequivocal:
* The quality of services provided in each facility would have to be
the same (or adjusted for) so that costs per an equivalent unit of output
were being compared.
* The clinical composition of the patients (the case mix) at each of the
facilities would have to be the same (or adjusted for).
* For economic efficiency, the cost information would have to mea-
sure the social opportunity cost of resources used, not merely the
amounts reported to have been spent.
1
Without an understanding of differences in quality and case mix
across hospitals, the efficiency implications of variation in average costs

Table 3-1. Hospital Recurrent Average Cost Estimates from Accounting Cost Studies, Selected Countries, Selected Hospitals
(1988 U.S. dollars)
Inpatient cost Number
Level Per Per Outpatient of hospitals
Country and year of data of hospital patient-day admission Per bed cost per visit in study Source
Step down studies
Belize, 1985a If 60.4 370 15,075 1 Raymond and others 1987
III 42.3 126 4,714 6
China, 1986 1 9.1 260 3,223 1 Chen 1988; Chen 1987
11 4.4 87 1,446 1
c Indonesia, 1987 II 15.5 6.2 2 Djuhari and others 1988
III 8.1 2.3 30
Jamaica, 1985-86 1 30.7 327 9,419 12.6 2 Kutzin 1989
11 20.9 140 6,646 8.7 2
III 23.0 176 6,699 9.0 1
Malawi, 19
87-
88b III 3.0 27 1,264 0.6 6 Mills 1991
Niger, 1986-87c I 6.6 93 2,090 15.9 1 Wong 1989
Papua New Guinea, 1988 1 28.7 286 8,384 6.2 1 js1 1990
11 25.8 276 7,549 2.5 4
III 26.7 364 5,822 5.3 8
St. Lucia,
1986-
87d if 43.9 311 11,907 19.4 1 Russell, Gwynne, and Trisolini 1988
Other accounting studies
China, 1986e 1 8.7 218 2,993 2.2 8 Barnum 1989
II 5.7 103 1,807 1.4 11
III 4.3 57 1,489 1.1 7

Colombia, 1978 I, II 56.9 421 16,526 14.2 8 PRIDES 1980
Indonesia, 1985f 1 18.6 174 5,102 4.6 2 Barnum 1987
II 14.6 127 3,647 3.7 15
III 7.0 41 1,384 1.8 296
Rwanda, 1984k 1 16.1 5,146 4.0 2 Shepard 1988
II 13.8 4,218 3.5 1
III 7.6 1,572 1.9 17
Turkey, 1987g 1 39.8 372 10,649 3 World Bank 1990
Zimbabwe,
1987
h 1 28.0 219 9,123 10.6 4 Hecht 1992
II, III 17.9 109 4,366 1.9 90
United States, 1988' All acute 581.1 4,194 5,579 AHA 1989
Note: Current estimates in local currency were converted to U.S. dollars by exchange rate in that year. The U.S. consumer price index was used to adjust
to 1988 terms.
a. For level Im hospitals, attribution of inpatient and outpatient costs was based on relative amounts estimated for Belize City Hospital.
>, b. Outpatient department unit cost relates to new outpatients (unit cost across all outpatients would be lower).
c. Intermediate service (for example, laboratory) costs were attributed to inpatient and outpatient services for comparability with other studies.
d. Radiology, laboratory, operating theater, and physiotherapy costs were attributed to inpatient and outpatient services for comparability with other
studies.
e. Cost data identified more than 50 percent of expenses as either inpatient or outpatient. For the remainder, expenditures were attributed on the assump-
tion that the cost of four outpatient visits was equal to that of one patient-day.
f. Day equivalents assume that the cost of four outpatient visits equal that of one patient-day.
g. Total hospital recurrent costs were divided by inpatient statistics; no attempt was made to apportion costs between inpatient and outpatient.
h. Estimates were based on Hecht's assumption that 80 percent of total hospital costs were attributable to inpatient services. The category "I, 1Hi" in-
cludes provincial, district, and small rural hospitals, plus health centers.
i. Estimates exclude the value of staff time of physicians who are not salaried employees of hospitals.
Source: As noted in table.

88 Public Hospitals in Developing Coun tries
cannot be properly interpreted. For example, high average costs may
reflect high quality, poor efficiency, or the characteristics of the patients
at one institution in relation to another. Low average costs may be a
result of an inadequate provision of drugs, and thus would represent
poor quality, not greater efficiency. If information on the quality of
services and the case mix of patients is added to cost data, the efficiency
implications of average cost information become clearer.
Conclusions from Accounting Studies
With these caveats in mind, it is still possible to glean useful information
from table 3-1. Perhaps the most striking aspect of the table is the
magnitude of cross-country variation in the average cost estimates. The
level of average costs is associated with per capita GNP, because the richer
countries in the table (Belize, St. Lucia, Turkey, and Jamaica) have the
highest unit costs, and Malawi and Niger, the poorest nations, have the
lowest unit costs. Given that personnel usually comprises the largest
component of hospital costs (see discussion in chapter 2) and that wage
rates are associated with per capita income, this finding is not surprising.
It suggests that the appropriate technological mix of inputs in a poor
country's hospitals is probably different, that is, would use relatively
more personnel, from that which is appropriate in a richer country's
hospitals. The extent of the difference depends on the feasibility of
substituting labor for nonlabor inputs.
Cross-country variation in recurrent average costs may also reflect
differences in the quantity of recurrent inputs used, which may suggest
qualitative differences in hospital outputs across countries. These differ-
ences between outputs across countries may mean that, for example, a
hospital day in St. Lucia bears little resemblance to a day in a Chinese
hospital of the same level. Therefore, comparison of the cost of produc-
ing a patient-day in each country is difficult to interpret because the
outputs may be qualitatively different. Detailed information on the
prices and quantities of inputs is needed to interpret more meaningfully
the relative cost-effectiveness of hospital services across countries.
A study by Lewis, Sulvetta, and LaForgia (1990) of one tertiary hospi-
tal in the Dominican Republic sheds some light on the relation between
quality and average costs. The authors collected information on specific
clinical practices in the hospital and compared them with norms of
clinical treatment established by Dominican physicians that described
the inputs needed to provide adequate quality of care for selected
diagnoses. Price information gathered during the study was used to
estimate the cost of achieving these norms. To reach the norms, current
expenditures for the appropriate diagnostic tests and drugs would each
have to increase tenfold. This suggests that current estimates of average

Hospital Costs and Efficiency 89
costs at this hospital are measures of the resources used to provide care
of low quality. Although this finding is only suggestive because it
assesses quality as a process rather than as an outcome, it has important
implications for the interpretation of average cost estimates. The devel-
opment and costing of country-specific norms and their comparison
with estimated average costs would go a long way toward enabling a
hospital's average costs to be adjusted for quality so that the cost per
equivalent unit of output could be compared across facilities.
Data in table 3-1 show that, within a country, tertiary hospitals tend
to have the highest average costs and that the less technically complex
district-level hospitals have the lowest. There are several possible expla-
nations for this. First, the teaching role of most tertiary hospitals contrib-
utes to higher costs. Second, tertiary hospitals are intended for treatment
of patients with the most complex and severe conditions. Therefore,
higher costs per patient might indicate different case mixes across facil-
ities. Such differences reflect appropriate use of tertiary facilities and are
not, in themselves, cause for concern. Third, higher average costs in
tertiary hospitals might also result from their having more equipment
and other resources available than lower-level facilities have. This may
lead to the use by tertiary hospitals of a more expensive mnix of inputs to
treat cases of similar complexity and severity to those in provincial or
district hospitals. Such use of resources might be inappropriate and
require corrective action with respect to referral policy. Treatment norms
and analyses of hospital case mix are needed to inform such policy
decisions. Each of these factors-teaching function, case mix complexity,
and costlier input mix-contribute to the higher average costs found in
tertiary hospitals, with the relative contribution of each varying by
hospital.
A common finding of the step down studies was that official govern-
ment budgetary information and even the financial reports of individual
hospitals understate expenditures (and, to a greater degree, costs) by and
on behalf of public hospitals. Although this finding has implications for
future cost studies (particularly for more aggregate-level analyses), per-
haps a more important finding is that those within the hospital who are
responsible for allocating resources do not have a complete picture of
their available revenues. For example, if the hospital's budget does not
indude services provided by a regional maintenance unit, hospital ad-
ministrators will find it difficult to manage maintenance services. These
detailed studies point to the need for greater transparency in public
hospital accounting systems, so that managers have an accurate depic-
tion of the level of resources with which they are working.
The data in table 3-1 allow an indirect comparison of the step down
studies with those that use aggregate data. Although the studies were
performed on a different set of hospitals, the estimates of cost per day

90 Public Hospitals in Developing Countries
for Chinese hospitals and for Indonesian hospitals were similar under
the two methods, which suggests that reasonably accurate results can be
achieved through use of aggregate costs and day-equivalents when
available resources do not allow for step down studies. In the case of the
Indonesian studies, however, there are greater differences with regard
to outpatient costs between the step down and accounting results.
The three studies that used the day-equivalent method-China (Bar-
num 1989), Indonesia (Barnum 1987), and Rwanda (Shepard 1988)-
each assumed that, for line item categories for which the direct cost was
unknown, the cost of one inpatient day was equal to the cost of four
outpatient visits. For China, a separate linear regression of total cost on
inpatient bed-days and outpatient visits gave a rough confirmation of
the 1:4 ratio. For Indonesia, Djuhari and others (1988) gave a rough
confirmation of the same ratio for lower-level hospitals but suggested a
ratio closer to 1:3 for upper-level hospitals. With few exceptions, how-
ever, the step down studies found the cost of an outpatient visit to be
greater than one-fourth the cost of an inpatient day. This finding sug-
gests that it may be worthwhile for countries with large numbers of
hospitals to perform a few step down studies on hospitals of each type
to generate the appropriate day-equivalent measure.
Table 3-2 presents the average costs from table 3-1 as a percentage of
each country's per capita GNP to show hospital costs in relation to the
level of income in each country. The percent GNPN measure is a good
indicator of the burden of hospital costs on the overall economy of a
country. For example, this table indicates that, compared with other
countries, the average cost of a hospital day and the annual cost associ-
ated with a hospital bed in Rwanda and Zimbabwe are high in relation
to the overall level of resources. Alternatively, it is evident that in the
United States, where the absolute level of hospital costs is high (table
3-1), costs per discharge in relation to this country's level of resources
are lower than in many poorer countries.
Service Statistics, Efficiency, and the Demand for Hospital
Care
The above discussion suggests that although average cost studies yield
useful results, accurate interpretation of the implications of the calcu-
lated level of average costs requires data on service indicators. In this
section we examine data from a number of countries on three interrelated
hospital service indicators-bed occupancy rate, average length of stay,
and the bed turnover rate-and describe a methodology developed by
Pab6n Lasso (1986) for assessing hospital performance based on the
simultaneous analysis of these statistics. Table 3-3 presents data on these
indicators (plus an additional indicator showing the relative use of

Hospital Costs and Efficiency 91
hospitals for outpatient services) from hospitals in a number of develop-
ing and industrial countries.
The bed occupancy rate measures the percentage of total available
beds that are occupied by patients.
2
The average length of stay ALOS is
the mean number of days from admission to discharge for each inpa-
tient.
3
The bed turnover rate is the average number of inpatient admis-
sions or discharges per bed.
4
Each of these indicators is usually (but not
necessarily) defined on an annual basis and can refer to a particular
ward, inpatient department, entire hospital, or group of hospitals. Any
one of these indicators provides useful information that can help de-
scribe the performance of a hospital's inpatient services, but their explan-
atory power is multiplied when they are used together. Because they are
interrelated, knowledge of any two indicators defines the third. In the
following subsections we consider each of the service statistics individ-
ually and then present a graphical technique using the indicators simul-
taneously to examine the relative efficiency of hospital performance.
Occupancy and Turnover Rates
The data in table 3-3 indicate that occupancy and turnover rates vary
greatly from country to country and between levels of hospitals. For the
most part, occupancy rates decrease as the level of the hospital decreases.
There are exceptions, such as China and Malawi, where occupancy rates
are high at the district level, but in most developing countries low
occupancy rates at the district level are an important reflection of eco-
nomic inefficiency in the hospital sector. Annual bed turnover rates do
not show a consistent trend according to the level of hospital. In many
countries, turnover is higher in middle- and low-level hospitals than in
tertiary hospitals. In these countries, low- and middle-level hospitals are
serving a greater number of patients per bed than tertiary facilities. Even
if this is the case, however, there may still be room for improving sectoral
efficiency by encouraging more patients to use lower-level rather than
tertiary hospitals.
Low occupancy rates are a commonly observed problem in many
countries, especially in lower-level facilities. Individual facilities have a
level of services, usually somewhere in the neighborhood of 85-90
percent occupancy, at which they have been designed to operate most
efficiently. In the short run, a relatively small percentage of hospital costs
can be varied; most costs are fixed and determined by the scale of the
facility and the personnel establishment (the overhead costs shown in
figure 3-1). In chapter 2 it was reported that personnel costs, which make
up the bulk of fixed cost, represent a range of about 35 to 75 percent of
total recurrent costs. The effect of low occupancy is to spread the cost of
personnel and other fixed inputs over a smaller number of service units

Table 3-2. Hospital Recurrent Average Cost Estimates fromn Accounting Cost Studies, Measured as a Percentage of per Capita GNP
Inpatient cost Number
Level Per Per Outpatient of hospitals
Country and year of data of hospital patient-day admission Per bed cost per visit in study Source
Step down studies
Belize, 1985a II 4.9 30 1,231 1 Raymond and others 1987
ill 3.5 10 385 6
China, 1986 I 3.2 90 1,119 I Chen 1988;
II 1.5 30 502 1 Chen 1987
Indonesia, 1987 II 3.6 1.4 2 Djuhari and others 1988
ill 1.9 0.5 30
Jamaica, 1985-86 1 3.7 40 1,148 1.5 2 Kutzin 1989
11 2.6 17 810 1.1 2
ill 2.8 21 817 1.1 1
Malawi,
1987-8
8b III 1.9 17 806 0.4 6 Mills 1991
Niger, 1986-87c I 2.2 32 710 5.4 1 Wong 1989
Papua New Guinea, 1988 1 3.3 33 962 0.7 1 jsi 1990
II 3.0 32 866 0.3 4
III 3.1 42 668 0.6 8
St. Lucia,
1986-8
7d II 3.0 21 808 1.3 1 Russell, Gywnne, and Trisolini
1988
Other accounting studies
China, 1986e 1 3.0 76 1,039 0.8 8 Barnum 1989
11 2.0 36 627 0.5 11
III 1.5 20 517 0.4 7

Colombia, 1978 I-II 3.4 25 985 0.8 8 PFRDES 1980
Indonesia, 1985f 1 2.8 26 756 0.7 2 Barnum 1987
11 2.2 19 540 0.5 15
III 1.0 6 205 0.3 296
Rwanda, 1984f 1 5.2 1,667 1.3 2 Shepard 1988
11 4.5 1,366 1.1 1
III 2.5 509 0.6 17
Turkey,
1987g I 3.1 28 816 3 World Bank 1990
Zimbabwe, 1987h 1 4.3 33 1,393 1.6 4 Hecht 1992
II, III 2.7 17 667 0.3 90
United States, 19881 All acute 2.0 15 5,579 AHA 1989
Note: Percent GNPN cost figures derived by dividing current year average cost estimates by the country's per capita GNP for that year, both measured in
local currency.
a. For Level III hospitals, attribution of inpatient and outpatient costs was based on relative amounts estimated for Belize City Hospital.
4 b. Outpatient department unit cost relates to new outpatients (unit cost across all outpatients would be lower).
c. Intermediate service (for example, laboratory) costs were attributed to inpatient and outpatient services for comparability with other studies.
d. Radiology, laboratory, operating theater, and physiotherapy costs were attributed to inpatient and outpatient services for comparability with other
studies.
e. Cost data identified more than 50 percent of expenses as either inpatient or outpatient. For the remainder, expenditures were attributed on the assump-
tion that the cost of four outpatient visits was equal to that of one patient-day.
f. Day equivalents assume that the cost of four outpatient visits equal that of one patient-day.
g. Total hospital recurrent costs were divided by inpatient statistics; no attempt was made to apportion costs between inpatient and outpatient.
h. Estimates were based on Hecht's assumption that 80 percent of total hospital costs were attributable to inpatient services. The category "ll, 1I" in-
cludes provincial, district, and small rural hospitals, plus health centers.
i. Estimates exclude the value of staff time of physicians who are not salaried employees of hospitals.
Source: As noted in table.

Table 3-3. Hospital Service Statistics, Selected Countries, Selected Hospitals
Occupancy Bed turn- Mean Outpatient Number
Level rate over rate length visits per of hospitals
Country and year ofdata ofhospital (%) per year ofstay bed-day in study Source
Argentina, 1980 Acute public 66 20.0 12.0 - All
Belize, 1985 II 68 40.7 6.1 1.3 1 Raymond and others
III 31 37.3 3.0 - 6 1987
China, 1986 I 94 13.7 25.1 2.1 8 Barnum 1989
II 86 17.6 17.9 3.6 11
III 95 26.1 13.3 3.3 7
Colombia, 1980 I 73 37.8 7.2 - 9 Pab6n Lasso 1986
II 61 38.7 6.0 - 20
III 55 42.8 5.2 - 44
t Ethiopia, 1983-85 Urban 47 14.7 11.8 1.7 6 Donaldson and Dunlop
Rural 59 29.7 7.2 2.4 13 1987
Fiji, 1987 1 83 42.5 7.2 2.7 3
III 46 47.9 3.5 4.2 19
Indonesia, 1985 I 75 29.2 9.4 2.5 2 Barnum 1987
II 68 28.7 8.7 1.8 15
III 54 33.6 5.9 2.2 296
Jamaica, 1985 1 79 35.2 8.2 1.0 5 GOJMOH 1986
II 84 43.2 7.1 0.6 4
III 61 28.6 7.8 0.6 13
Jordan, 1986 All MOH 71 66.0 3.9 1.7 -
Korea, 1986 All 60 17.8 12.3 2.3 546 FKMIS 1987
Lesotho, 1985 I 125 50.7 9.0 0.7 1
III 129 54.9 8.6 1.1 7
Mission 56 19.2 10.7 1.0 9

Malawi, 1987-88 III 116 47.4 9.0 1.3 6 Mills 1991
Morocco, 1987 All Public 57 20.2 10.3 - - Bennis and others 1990
Niger, 1986-87 I 87 22.5 14.1 0.3 1 Wong 1989
Papua New Guinea, 1 80 29.4 9.9 1.4 1 jsi 1990
1988 II 80 28.1 10.4 2.2 4
III 60 16.9 12.9 1.8 8
Rwanda, 1984 1 88 - - 0.9 2 Shepard 1988
II 83 - - 0.5 1
III 57 - - 2.0 17
St. Lucia, 1986-87 II 74 38.8 7.0 0.6 1 Russell, Gwynne, and
Trisolini 1988
Tanzania, 1989 Mission 81 33.3 8.9 1.5 43 CMBT 1991
Tunisia, 1989 1 76 27.6 10.1 1.0 9
Turkey, 1987 I 73 28.7 9.3 - 3
All MOH 46 25.3 6.6 --
All hospitals 50 25.5 7.2 -
Zirnbabwe, 1987 MOH I 89 41.7 7.8 0.7 4 Hecht 1992
MOH II 91 54.5 6.1 1.4 8
MOH III 76 40.8 6.8 1.9 31
OECD mean, 1980-83 All 81 16.4 17.9 - - OECD 1987
Finland, 1982 All 85 13.9 22.2 - - OECD 1987
France, 1983 All 73 18.9 14.1 - - OECD 1987
Ireland, 1982 All 80 32.5 9.0 - - OECD 1987
Spain, 1981 All 75 18.6 14.6 - - OECD 1987
United Kingdom, 1981 All 81 16.0 18.6 - - OECD 1987
United States, 1981 All 79 29.0 9.9 - - OECD 1987
United States, 1988 Acute 65 33.2 7.2 1.2 5,579 AHA 1989
-Not available.
Source: World Bank sector reviews and appraisal reports, except as noted in table.

96 Public Hospitals in Developing Countries
and raise the average cost of services. Even if hospital inputs are being
used with technical efficiency, low occupancy implies economic ineffi-
ciency.
A high bed occupancy rate does not necessarily indicate better hospital
performance. Indeed, bed occupancy rates can be too high, in the sense
that the volume of services is above the design level of the facility. The
implications of high occupancy for average costs and hospital efficiency
are ambiguous without information on the other service indicators. The
reason for this is that a high occupancy rate may reflect a relatively
efficient situation, as when many patients with modest lengths of stay
are served (that is, the hospital has a high bed turnover rate), or an
inefficient situation, as when the high proportion of filled beds largely
results from long lengths of stay. The latter situation is signaled by a low
average cost per day but a relatively high average cost per admission.
Consider, for example, the level I hospitals (from the non-step down
studies in table 3-1) in China and Indonesia. The Chinese hospitals have
a lower cost per day but a higher cost per discharge. From table 3-3 it is
clear that the Chinese hospitals have a higher occupancy rate, yet the
mean length of stay figures suggest that this high occupancy rate does
not reflect an efficient situation. A comparison of the turnover rates
shows that, at each level, Indonesian hospitals are serving more patients
per bed than Chinese hospitals.
There are other reasons why a high occupancy rate does not by itself
imply a relatively efficient hospital. For example, with high occupancy
rates, scheduling of individual service activities, maintenance, and man-
agement becomes more difficult and more costly. The measured average
costs from accounting-based studies do not provide sufficient evidence
to support or reject the hypothesis that average costs are regularly lower
for hospitals with extraordinarily high occupancy rates. More likely is
that the quality of services is compromised as staff attention and labora-
tory and ancillary services are divided among a greater number of
admissions that exceeds the hospital's design capacity. In addition, very
high occupancy rates may reflect overcrowding, which can facilitate the
spread of hospital-acquired infections.
In general, conditions treated in lower-level facilities require simpler
interventions and may require shorter lengths of stay than more complex
cases seen in tertiary facilities. In those countries where turnover rates
are highest in tertiary hospitals, the likelihood is that a large percentage
of the cases treated in these hospitals are basic cases not requiring tertiary
care. Although the hypothesis needs to be tested in future research, there
is a presumption that turnover at tertiary facilities that is high in relation
to turnover at lower-level hospitals may be an indicator of sectoral
inefficiency.

Hospital Costs and Efficiency 97
Quality and Hospital Use
The determinants of low hospital turnover and occupancy rates are not
well understood and need careful empirical research to establish statis-
tically confirmed causes. Field experience and qualitative analysis do,
however, suggest some likely hypotheses. Possible causes include de-
mand-side factors affecting use that are not within the control of central
health authorities, for example, underlying morbidity patterns, reflected
in a high proportion of communicable diseases that require less hospi-
talization than the mix of diseases in higher-income areas, and education
and cultural factors, specifically, the lower inclination of poorer and
less-educated people to look to hospitals for care. Supply-side factors
that interact with demand, however, are probably at least as important
and are more amenable to policy intervention. These include cash prices,
in the form of user fees, for services and drug charges; nonmonetary
prices of access, for example, the value of time spent in gaining access,
which is inversely related to the proxirnity of the hospital to patients in
the catchment area, plus the availability and monetary cost of transport;
and the quality of services with respect to the adequacy of drugs and
other medical supplies, staffing, and the availability of critical special-
ties.
Quality has both supply- and demand-side characteristics. The critical
demand issue is perceived quality: the consumer's assessment of the
relative quality of different health care providers. Differences in per-
ceived quality, with a basis in fact, provide an important explanation of
why some people bypass district facilities and refer themselves directly
to provincial or central tertiary facilities despite the greater price in time
and money that use of these facilities often entails. Adequate staff and
supplies are obvious supply-side factors affecting actual quality of ser-
vices that are important in affecting perceived quality. Thus, demand for
services can be responsive to policies on the supply side to improve the
availability of key inputs at lower-level facilities.
Availability of drugs and supplies. In low-income countries, a sporadic
supply of drugs and supplies, especially in lower-level facilities, is
commonplace. Foreign exchange constraints severely limit the purchase
of drugs by central ministries, and poor distribution systems further
restrict the regular availability of drugs at lower-level facilities in outly-
ing areas. The correlation between drug availability and use of services
is quite clear to local hospital managers and is revealed by the variation
in occupancy and outpatient visits during the course of a year-when
drugs are available service use is high and when drug supplies are
limited service use is low. This expected effect of drug availability on
perceived quality and thus on demand is supported by a World Bank

98 Public Hospitals in Developing Countries
study of health facility demand in Nigeria's Ogun State, which found
that facility use increased with the percentage of time during the year
that drugs were available (Akin and others 1991).
Important to note is that the shortchanging of drug and supply expen-
ditures in hospitals may not result in lower average costs but quite the
opposite. The elasticity of service demand with respect to drug availabil-
ity is probably well above, say, 0.3 at low levels of drug provision, so that
a 10 percent fall in drug availability is accompanied by a more than 3
percent fall in service demand. In this case a simple calculation will show
that, if drugs make up 30 percent of total hospital unit costs, average costs
will increase as the availability of drugs decreases even though drug
costs are reduced.
5
Lack of skilled staff. A similar deficiency in demand is associated with a
lack of trained personnel and skilled functions in lower-level hospitals.
Because of greater opportunities for private practice, better opportuni-
ties for advancement, better amenities, and training that emphasizes
Western medical practices and the use of modern technology, medical
doctors often resist assignments to rural areas, preferring to be posted in
large urban areas. The lack of skilled staff for basic services such as
high-risk obstetrics, radiology and laboratory diagnostics, surgery, and
pediatrics undermines patient confidence in lower-level facilities. A lack
of skilled staff may also indicate an overall insufficiency of other inputs,
such as equipment, and an overall inferior quality of services.
Indonesia offers an appropriate context to examine the relation be-
tween low occupancy rates and the quality of hospital services. There is
wide variation in the occupancy rates in the 296 lower-level hospitals
(designated C and D in the Indonesian classification system). Among all
class C and D hospitals, half have bed occupancy rates under 50 percent,
and one out of six has rates lower than 25 percent. Some insight into the
cause of this variation is given by an analysis (reported in the study
edited by Prescott [19911) of the relation between inpatient use and a
number of variables, including staffing characteristics. Inpatient use is
weakly related to district population size, is higher for urban hospitals,
lower outside Java, and is higher when there is a large proportion of the
population covered by the compulsory insurance system for govern-
ment employees (ASKES). But the most important result is the extremely
strong effect of staffing, used as a proxy for service quality. Hospitals
that offer surgical services had 42 percent higher inpatient use than
similar hospitals that do not offer surgery. Adding a specialist doctor
(not necessarily a surgeon) would boost use by 83 percent.
These results suggest a strong conclusion: perceived service quality as
measured by physician availability is a key determinant of the level of
hospital use in Indonesia. Adding a specialist doctor and providing basic

Hospital Costs and Efficiency 99
surgical facilities in the lower-level hospitals could increase service
quality and quantity dramatically. The total costs in the hospitals would
rise, but average costs could fall if use increased. Health system costs
may not increase much if physician staff is transferred from urban to
rural facilities. Clearly, the problem in implementing this policy is that
it is difficult to attract specialist doctors to small outlying hospitals: the
financial opportunity cost to specialist doctors at present levels of public
sector salaries levels is too great because of the lack of effective demand
for supplementary private practice in poor, remote areas. But this anal-
ysis strongly suggests that it might be worthwhile to offer a salary
supplement to attract specialists to these hospitals. Without a physician
and basic facilities the hospital is little more than an empty shell, and the
fixed operating costs and sunk investment costs are substantially
wasted. Paying market wages for specialists and providing necessary
facilities might yield a high payoff. Alternatively, smaller hospitals with
very low occupancy rates could be converted into health centers or
clinics that provide primary care. Any excess staff or supplies that may
result from this conversion could be reallocated to other facilities.
Average Length of Stay
Average length of stay is an important indicator of the efficiency of
hospital resource use. There is no reason to conclude that longer stays
contribute to higher-quality care; in fact the steady decline during the
last thirty years in lengths of stay in most countries belonging to the
Organisation for Economic Co-operation and Development (OECD) has
occurred at the same time that the technical quality of care in hospitals
has improved. Without information about case mix and severity it is
difficult to use length of stay as a direct indicator of efficiency for
individual hospitals, but stays that are unusually long raise questions
regarding efficiency and should provoke a closer search for an explana-
tion of the cause. Differences in the average length of stay among a large
number of hospitals of comparable type imply differences in prevailing
treatment practices across countries, but again, case mix must be taken
into account. Although average length of stay varies across countries, it
appears that stays are generally shorter in developing countries than in
Europe and are roughly comparable to the average lengths of stay in the
United States (see table 3-3). High fertility, however, may bias the
average length of stay in developing countries toward short-term con-
finement, whereas the higher chronic disease rates in the United States
and Europe impart the opposite bias. Thus, average lengths of stay
adjusted for case mix may actually be higher in many developing coun-
tries in relation to industrial countries than is indicated by the aggregate
data of table 3-3. The problems arising from cross-country differences in

100 Public Hospitals in Developing Countries
the definition of a hospital must be noted in comparisons of average
lengths of stay. Whether hospitals include long-term as well as acute care
beds is particularly relevant to this issue.
China, with extremely long average stays at all hospital levels, is an
important example of instances in which a long ALOS reflects technical
inefficiency in hospital resource use. In two general hospitals in Shang-
hai, average stays in 1986-87 for many conditions (for example, hyper-
tension, bronchitis, malignant tumors) were about two to three times as
great as in the average OECD hospital in 1980 (Chen 1987 and 1988; OECD
1985). There are many possible reasons for the longer confinements in
China, including a lack of alternatives for long-term care, poor schedul-
ing for diagnostics or surgery, and a poor recovery environment in
posthospital home care.
The means by which inpatient services are financed can have a direct
effect on average length of stay. If patients do not face a monetary price
for each day that they stay in the hospital, they have no financial
incentive to minimize their length of stay. From the hospital's perspec-
tive the financial incentives can be powerful. If a hospital is reimbursed
for the costs of an inpatient stay on the basis of a constant per diem fee,
they have an incentive to keep patients for lengthy periods. This incen-
tive can be strong; it was shown in figure 3-1 that the last days of a patient
stay have low marginal costs, thus making these days the most profitable
under this method of hospital reimbursement. Korean and Chinese
hospitals are financed in this way. In Korea, the average length of stay
was 10.9 days in 1986 (FKMIs 1987) and in China the average length of
stay was 19.1 days in 1989 (from a sample of twenty-six hospitals;
Barnum 1989). The lower average length of stay is expected in Korean
hospitals because the Korean health insurance system includes substan-
tial per diem cost sharing by beneficiaries, whereas most Chinese cov-
ered by health insurance have no copayment requirements. A study (Yu
1983) comparing insured with uninsured patients in a Korean hospital
from 1978 to 1980 found that the average length of stay was significantly
higher for insured patients.
Alternatively, hospital reimbursement policies can serve to limit
length of stay. This is the most likely cause of the short average lengths
of stay in the United States, where hospitals are increasingly being
reimbursed a case-related prospective price for inpatient stays (by pri-
vate as well as public payers). Under this system, which was im-
plemented in 1984 for the publicly funded Medicare program (serving
the acute care needs of the population age sixty-five and older), patients
are categorized-according to their diagnosis, procedures received, and
other characteristics-into Diagnosis Related Groups (DRGs), and hospi-
tals are reimbursed a fixed price based on the DRG. If the costs of a patient
stay are less than this price, the hospital profits. If they are not, the

Hospital Costs and Efficiency 101
hospital loses money on that patient. Clearly, under this system hospitals
have had an incentive to reduce length of stay (and, some have argued,
other resource inputs) per case and to maximiuze the number of profitable
admissions. The average length of stay in nonfederal acute care hospitals
for Medicare beneficiaries fell from 10.7 days in 1980 to 8.6 days in 1987
(NCHS 1989). This 20 percent decline bears out the strength of these
incentives.
Developing countries have had little experience with case basis pric-
ing, and it is premature to evaluate or recommend policies of this type
for low- or middle-income countries. Case-based pricing as it operates
in the United States (the DRG system) requires continual updating and
monitoring of payment rates and a massive amount of data collection
and reporting. These features of the system limit its use in low-income
countries at present. Nevertheless, because of the growing need to
control costs, less administratively complex versions of case-based pric-
ing may have application. Simplified adaptations of case-based pricing
should be evaluated on a pilot basis, particularly in large university or
central hospitals. Brazil's social health insurance system has recently
begun to reimburse hospitals on a procedure-oriented prospective price
basis, and thus one would expect its average length of stay to have fallen
since the implementation of this system. Unfortunately, such informa-
tion is not available (Rodrigues 1989a). In Zaire's Bwamanda Health
Zone, the reference hospital is reimbursed a fixed amount per case, with
different payment rates for each of sixteen case categories (Shepard,
Vian, and Kleinau 1990). As in Brazil, however, no data are yet available
to assess the effect of this payment system on ALOS.
Apart from differences in case mix and methods of financing, cross-
national variation in average lengths of hospital stay may result from
differences in the role of hospitals across countries. In the United States,
for example, acute care hospitals rarely provide extended care to those
in need of such care. Separate facilities exist to provide long-term care;
therefore, the reported mean length of stay of hospitals is not biased by
the long stays of those treated in extended care facilities. In many
developing countries, separate extended care facilities do not exist, and
hospitals must often be a source of long-term as well as acute care (see
discussion of extended care, below). In some countries, hospitals also
serve other social functions, such as orphanages and as nursing homes
for the elderly. These factors must be considered before drawing conclu-
sions regarding the efficiency implications in comparisons of cross-na-
tional mean length of stay.
Reducing the average length of stay in upper-level facilities with high
occupancy rates would enable turnover rates to increase and thus allow
hospital benefits to be extended to a greater number of people, dimin-
ishing the pressure for capital investment in new hospital capacity. In

102 Public Hospitals in Developing Countries
both upper- and lower-level facilities, even where occupancy rates are
low, the reduction of excessive ALOS would increase the cost-effective-
ness of services by reducing the average cost per admission of specific
treatments, although the cost per day may rise from the reduction in
relatively inexpensive days. Many factors subject to management inter-
vention have been identified as contributing to long ALOS and are dis-
cussed below.
Scheduling. Poor scheduling of diagnostic and therapeutic care contrib-
utes to longer stays, especially in upper-level hospitals. In many hospi-
tals it is common for patients to be admitted to inpatient care for
diagnostic tests and then confined until results are received. Similarly,
patients receiving therapy are often kept in the hospital between treat-
ments rather than treated in short stays or as outpatients. Dramatic
examples are the use of scarce high-technology therapies, such as kidney
dialysis and radiation treatment, but elective surgery and antibiotic
therapy and basic laboratory tests are also poorly scheduled. Blanpain
(1987) notes that a selection of Chinese hospitals had waiting periods of
three to eleven days from the conclusion of preoperative diagnostics to
the day of actual surgery. In the context of figure 3-1 the hospital incurs
hotel costs prior to as well as after the principal treatment activity.
Insufficient equipment does not fully explain the scheduling bottlenecks;
often the same hospitals that report long diagnostic waiting periods have
uneven use of special facilities, excess capacity being observed during
particular times of the day or week.
Physicians who divide their time between public hospital service and
private practice are another source of scheduling problems, although the
efficiency of outpatient services may suffer more than that of inpatient
services. Many hospitals provide scheduled specialist or nonspecialist
services in outpatient clinics. Physicians who maintain a private practice
in addition to public employment may experience conflicts in schedul-
ing, which result in their lateness for or absence from scheduled public
clinic appointments. It is critical for hospitals to work out arrangements
with their physicians to ensure that such conflicts are minimized.
Problems in diagnostic services. These problems often manifest them-
selves as scheduling problems but result specifically from equipment
failures or shortages of supplies or staff needed to conduct diagnostic
tests. Lack of recurrent resources to fund maintenance, supplies, and
staff adequately is at the root of these problems, which then spill over
into delayed testing and, further, into extended lengths of stay. A short-
age of reagents often presents itself as a cause of delays in performing
and analyzing laboratory tests. Parallel problems arise in radiological
services. For example, lack of staff and equipment failure were cited as

Hospital Costs and Efficiency 103
the primary reasons behind scheduling delays for radiological exams in
Jamaica's public hospitals (GOJMOH 1987).
Extended care. The provision of extended care services in acute care
hospitals is sometimes considered an inefficient use of hospital re-
sources. In Europe and the United States, patients convalescing or suf-
fering from long-term degenerative or chronic diseases are often kept in
nonhospital facilities (nursing homes, rehabilitation facilities, convales-
cent homes, or their own homes), where less resource-intensive but more
appropriate care is available. Transportation and logistics problems,
however, plus shortages of trained staff and other resources, make it
difficult to replicate this array of providers in developing countries.
Given shortages of recurrent resources for hospitals, many countries
probably do not consider the creation of separate facilities for extended
care to be feasible. Even though some staff can be reallocated, the
additional overhead costs that must be incurred may be prohibitive.
Home care, provided reliable outreach support is made available, may
be a feasible lower-cost alternative.
The unsatisfactory health environment, poor sanitation, and inade-
quate housing into which convalescing patients are discharged is often
cited by local hospital administrators as a reason to keep patients beyond
their direct need for hospital care. Patients or their families may also be
a source of demand for longer hospital stays for convalescence or chronic
diseases.The extent to which hospitals are used for these purposes
probably varies greatly between urban and rural areas and by income
level, the poorer and more rural patients using hospitals for extended
care to a much lesser extent. Nonhospital alternatives for extended care
are discussed further in chapter 6.
Standard treatment practices. Treatment protocols for the same causes of
admission vary among countries and through time. After considerable
professional controversy concerning the effect of early discharge and the
use of ambulatory care on the quality of outcomes, physicians in the
industrialized countries concluded that dramatic reductions in length of
stay were possible without compromising, and perhaps increasing, the
quality of outcome. From 1960 to 1980, the average length of stay was
reduced from twenty-one to ten days in the United States (all hospitals;
OECD 1987). The reduction was achieved, in part, by changing the stan-
dard practice for specific causes of admission. Physicians exert ultimate
control over the way in which the treatment plan involves hospitals,
including diagnostic and treatment procedures used and lengths of stay.
Medical school training and commonly accepted professional practice
are determinants of physicians' choices and affect the rate at which new
standards are adopted.

104 Public Hospitals in Developing Countries
Older standards of care and medical protocols may contribute to the
longer hospital stays in some countries. To the extent that shorter stays
require the use of high-cost modern technology, such change might not
be desirable; however, much of the reduced length of stay in OECD
countries has been achieved with changed standards based on a better
understanding of disease and recovery, changed financial incentives,
and widely available modern pharmaceuticals. Through physician re-
training programs, government information and management guid-
ance, and appropriate financial incentives (see chapters 4 and 5),
practices contributing to shorter stays could be encouraged by govern-
ment policy choice.
Hospital-acquired complications. Hospital infections and accidents add to
extended lengths of stay, but reliable data on rates of hospital infection
and their effect on average lengths of stay in developing countries are
lacking. Overcrowding, poor sanitation, limited use of disposable items,
inadequate use of pressurized steam sterilizers, the misuse of antibiotics,
and the use of contaminated blood products all contribute to hospital-
acquired medical problems and consequent longer hospital stays. Wide-
spread inadequate maintenance is an important cause of conditions
leading to accidents and infection. Policy intervention is also needed to
provide explicit guidelines on infection control and to enforce standards
of care. A survey of twenty-one hospitals in China measured an overall
rate of nosocomnial infection of 8.4 percent, with rates as high as 13.2
percent in surgery and 10.3 percent in orthopedics (Blanpain 1987).
Despite these seemingly high rates, China's hospital environment may
be better than in many other countries.
Matching Facilities to Patient Care Needs
The large average cost differences between high- and low-level hospi-
tals, the inverse relationship between hospital level and occupancy rates,
and the scope for further increases of the turnover rate at low-level
hospitals indicates that there are economic gains to be obtained from
improving the match between patient care needs and the type of facility
at which patients seek treatment. An indication of the potential gain from
successfully encouraging patients to use low-level rather than middle-
level facilities is suggested in table 3-1. Using the averages for the sample
of hospitals in Indonesia, and assuming that all cases are of the same
complexity and that marginal cost equals average cost, we calculate that
the saving (measured in 1988 U.S. dollars) per inpatient bed-day and
outpatient visit would be $7.60 and $1.80, respectively. Similarly in
Rwanda, the savings per inpatient bed-day and outpatient visit would
be $6.20 and $1.60. There are two reasons why these figures provide only

Hospital Costs and Efficiency 105
a rough estimate of the potential saving to be gained by such shifts in
facility use. First, the average treatment cost of the patients shifted to
lower-level facilities is likely to be somewhat less than the average for all
patients at mid-level hospitals because the goal is to shift the patients
needing basic care toward lower levels, and the average treatment cost
of these patients is likely to be less than the average for all patients at
mid-level hospitals. The second reason, which perhaps offsets the first,
is that marginal costs are likely to be greater than the average cost in
mid-level hospitals with high occupancy rates, whereas marginal costs
are likely to be lower than average costs in low-level hospitals, which
often have lower occupancy rates. Despite these provisos, if patients
needing basic care are shifted and appropriate treatment can be pro-
vided, they will be treated in facilities with lower overhead costs, and it
is likely that a less costly combination of inputs will be used for treat-
ment. This systemwide efficiency gain would provide savings that could
be translated into the provision of services to a greater number of clients.
If the patients who have less severe conditions are moved out of
tertiary facilities, the remaining case mix in these hospitals will be more
costly, on average, than previously, so average costs will probably rise.
This is desirable, however, because these hospitals will then be able to
concentrate their efforts on the complicated cases for which they were
intended. It is expected that average costs in lower-level hospitals will
fall, as considerable underused capacity (as evidenced by low occupancy
rates) is activated. The magnitude of some of the calculated average cost
differences between types of facilities in a country is probably a function
of the level of resources available at each level. Successfully encouraging
consumers to use lower-level facilities would probably entail increasing
the supply of drugs and staff to these hospitals, which might increase
their average costs, though they would still likely be less than those in
large urban facilities.
6
Nevertheless, a shift of less severely ill patients
from crowded urban tertiary hospitals into lesser-used secondary facil-
ities would represent an improvement in resource allocation in the
sector.
There is some evidence that self-referral becomes an increasing prob-
lem as economic conditions, education, transportation, and communica-
tions improve, because these improvements increase the accessibility of
higher-level facilities. This phenomenon will occur as long as nothing is
done to alter the perception of the quality of services available in basic
facilities.
Mechanisms for improving the referral system are related to the
quality of services at lower levels and to the financing of services pro-
vided at each level. Most important, an effective referral system requires
the availability of lower-level services in which consumers have confi-
dence. The means by which services at each level are financed can serve

106 Public Hospitals in Developing Countries
to encourage or discourage appropriate use of the referral system.
Achieving a balance between demand and service availability at each
hospital level depends on a system of relative prices, fee penalties for
nonreferred entry at upper levels, and enforcement of referral that is in
balance with the quality of services. Implementation of imnproved refer-
ral policies is facilitated by a district and regional health management
structure that includes both primary and secondary care under a com-
mon administrative and financial unit responsible for all health facilities
and programs in the region.
Simultaneous Use of Hospital Service Indicators to Assess Efficiency
Pab6n Lasso (1986) devised a graphical technique to summarize the three
inpatient service indicators-occupancy rates, turnover rates, and
ALOS-for similar levels of hospitals within a country in order rapidly to
assess their relative performance. In figure 3-2 we adapt his graphical
technique to describe performance measures across countries. The data
represent either the average of a sample of hospitals or the average for
all hospitals in the selected countries. The x-axis is the average bed
occupancy rate, and the y-axis represents the annual bed turnover rate.
Because of the mathematical relationship among these three indicators
of hospital performance, a ray drawn from the origin that passes through
any point on the graph represents a constant average length of stay, and
this measure increases monotonically from left to right across the top
and down the right-hand side of the graph.
7
The graph is divided into four regions by two intersecting lines drawn
from the mean values of the bed occupancy and turnover rates (which
in turn identify the mean value of the average length of stay). Alterna-
tively, normative values of at least two of these three indicators of
hospital performance could be used as the basis for subdividing the
graph. Within countries, the division of the graph into four quadrants is
useful to identify hospitals that are outliers and demand specific atten-
tion. Among countries it is useful to give some idea of the relative
performance of the hospital subsector. (The cross-country interpretation
needs to be made cautiously because country averages disguise large
internal variations.) Pab6n Lasso (1986) describes some of the character-
istics that could be expected to be found in hospitals falling in each
region. As they apply to figure 3-2, hospitals in the countries of region I
may be characterized by excess bed availability, low demand for hospi-
talization in relation to installed capacity, and possibly demand that has
been reduced by patients being diverted to other institutions. Hospitals
in the countries of region II may have some or all of the following
characteristics: excess bed availability, unnecessary hospitalizations,
many beds used for patient observation, and a predominance of normal

Hospital Costs and Efficiency 107
Figure 3-2. Indicators of Hospital Performance, Selected Countries
Bed turnover rate Average length of stay (days)
60 4.5 5.8
6.6
7.1
50 II Jordan Sr 7.
-7.8
* Fiji * Zimbabwe
409.
4 Belize . ; 190.
,Jamaica 10.3
Indonesiag U.-. 11.5
30 1? 3
Tunisia *
Turkey,* 14.1
.TurkeyX * , - ,apua New Gunea
20 .thiopia a * -,iger .
.' .'. .- * -'. -Argentima 19.1
Korea China
IV
10 .
0 ,, .- l l I
0 10 20 30 40 50 60 70 80 90 100
Average bed occupancy (percent)
Source: See table 3-3.
(as opposed to complicated) deliveries. Region III countries have hospi-
tals that are performing relatively well, on average (though perhaps not
compared with normative concepts of what occupancy rates and aver-
age lengths of stay should be). They are characterized by a relatively
small proportion of unused beds. Hospitals in countries in region IV tend
to exhibit some or all of the following: a high proportion of severely ill
patients, a predominance of chronic cases, and unnecessarily long inpa-
tient stays.
For international comparisons, this graphical technique is more useful
for descriptive than for policy purposes. Figure 3-2 merely describes
countrywide averages; it does not suggest specific problems to be ad-

108 Public Hospitals in Developing Countries
dressed. As an operational tool, it can be applied on a national level as a
quick identification guide to hospitals that seem to be performing poorly
or very well (see appendix 3-2 for an application to Indonesia). Some of
the caveats that apply to the interpretation of unit cost information,
however, are also relevant here, especially the need to consider case mix.
For example, it would be expected that a tertiary hospital would be
clinically composed of more severe cases than would a district hospital
and that a greater average length of stay in the tertiary hospital would
be one manifestation of this greater severity. The effect of differences in
case mix across hospitals can be mitigated somewhat by grouping hos-
pitals according to type and creating one graph per hospital type, as in
appendix 3-2. Outliers could then be identified and investigated as to
whether they deviate from the norm because of differences in case mix,
quality of care, or other "legitimate" reasons, or because of differences
in technical or economic efficiency.
Efficiency of Input Use
Inefficiency of input use can lead to high costs per unit of service
delivered to patients. In chapter 2 we defined two important sources of
inefficiency. The first is technical inefficiency, in which output is less than
is technically possible with the mix of inputs used by the hospital (that
is, if the institution is operating on the "frontier" of its production
possibilities). The second is economic inefficiency, in which the institu-
tion may be technically efficient but is not economically efficient in the
sense that it is not using the least expensive combination of inputs for its
given production of services.
Technical Inefficiency
Technical inefficiency in the use of staff, supplies, and equipment has
been cited in many studies of hospital operations. Defining staff assign-
ments too narrowly can restrict the full use of staff time in district-level
facilities that have insufficient demand for specialized skills. For exam-
ple, in a field study of six district hospitals in Malawi, X-ray technicians
were used only about half time in their specialty, yet their excess time
could not be used in other departments because they lacked qualifica-
tions or were unwilling to be reassigned on a part-time basis (Mills,
Njoloma, and Chisimbi 1989). This example comes from hospitals with
high occupancy, where the effect of technical inefficiency on the quality
of health services is likely to be greatest. Nevertheless, the problem of
staff inflexibility is more apparent in hospitals with low occupancy rates
and high ratios of staff per bed. Broadening the role of lower-level staff
to include more support for primary health care activities could add to

Hospital Costs and Efficiency 109
the productivity of both hospital and PHC operations. Extending the role
of lower-level hospital staff is discussed further in chapter 6.
Theft, bribery, and fraud are serious problems in the management of
medical and nonmedical supplies, such as pharmaceuticals and food, in
some countries. Security problems can occur at any point in the distri-
bution chain, but hospitals are particularly vulnerable to losses due to
petty theft by staff of items for personal use, diversion to the black
market, and private medical practices. Poor storage is also a source of
pharmaceutical loss in hospitals. Use of careful inventory and account-
ing systems and well-maintained and secure storage areas is a prerequi-
site for efficient drug and supplies management.
8
A large number of sources of technical inefficiency in drug use can be
identified. They indude extravagant prescribing (a less expensive drug
or generic could be used with comparable effect), overprescribing (the
drug is not needed or is taken in too large a dose or for too long a period),
incorrect prescribing (the wrong drug is prescribed for the diagnosis or
it is improperly prepared), multiple prescribing (two or more drugs are
used when one would have the same effect), and underprescribing (the
dosage or length of treatment is inadequate). The effect of these practices
is to increase unnecessarily the cost of effective treatment, as well as to
create deleterious health effects. Training, appropriate guidelines, and
management surveillance are needed to reduce technical inefficiency in
drug use.
Low levels of use and incorrect use of equipment are also sources of
technical (and economic) inefficiency at all levels of hospitals. In some
cases, especially in low- and middle-level hospitals, the equipment is
little used or misused because it is inappropriate. For example, in China,
radiological equipment at district and provincial hospitals and compu-
terized axial tomography (CAT) scanners, neonatal intensive care, and
dialysis machines at provincial and central hospitals are often unused or
inappropriately used (Banta 1987). Fluoroscopes are often used for rou-
tine examinations, although they should be reserved for specific prob-
lems not resolved by X ray. Expensive 500-milliampere X-ray machines
are used rather than the safer and cheaper WHO Basic Radiological
System (BRS) (Palmer 1985), which should be all that is needed at the
lowest level. In other cases there is a lack of trained personnel to make
adequate use of equipment. Ultrasound, for example, is inexpensive and
powerful and thus a tempting device to have at low- and middle-level
hospitals. Yet reading the ultrasound image requires experience and
more training (six months) than often is available.
Another source of technical inefficiency associated with equipment is
a lack of uniformity and consistency in supply. A country may receive
medical equipment from donations or under multilateral or bilateral
assistance programs. Frequently the result is a variety of items from all

110 Public Hospitals in Developing Countries
over the world and with considerably different technical specifications.
Acquiring spare parts and managing the maintenance of, for example,
ten different types of X-ray machines from different countries can be
extremely difficult. This is an area in which a health ministry must
actively manage its donors.
Because all these sources of inefficiency involve a technical waste of
resources, it is conceptually possible to obtain more hospital services
without any increase in input. Unfortunately, achieving this conceptual
possibility can provide a significant challenge; in most cases the increase
in output cannot be obtained without deliberate and potentially difficult
institutional changes. The inefficiencies that exist have arisen because of
the incentives inherent in the existing system of financing health ser-
vices, a lack of incentives for management or workers, a lack of manage-
ment skills, a lack of information, or a lack of forethought in investment.
Economic Inefficiency
The production of services, including those of hospitals, involves a
choice among alternative techniques and combinations of inputs. Even
if the hospital is operating with technical efficiency, hospital managers
and service providers are faced with a range of means of achieving a
given service level. Ideally, the choice will be economically efficient, that
is, the combination chosen to produce a certain quantity and quality of
output will have the lowest cost among the range of alternatives. The
problem of input choice can be stated as substituting one input for
another while keeping the output (quantity and quality of services) the
same. Input substitution will occur until the incremental value of ser-
vices from another unit of expenditure on an input is the same for all
inputs. Unfortunately, the lowest cost combination of inputs is often not
achieved. The failure to use the economically efficient combination
relates to many of the same reasons as the failure to achieve technical
efficiency. These include deficiencies in incentives, lack of necessary
training or skills, institutional constraints beyond the control of hospital
managers (for example, rigid budgetary policies that expressly disallow
input substitution), shortages in the flow of real resources to the hospital,
and failures in information or investment planning.
Overarching institutional constraints, such as civil service or budget-
ary regulations, and failures of information and planning must be ad-
dressed through coordinated and consistent national policies. Problems
of economic inefficiency are generally outside the control of individual
hospital managers. It is often at the level of the health ministry that the
issues of the appropriate types and quantities of facilities, staff, and
equipment must be answered. For example, the least-cost way to im-
prove service coverage may be to convert underused district hospitals

Hospital Costs and Efficiency 111
to health centers and reallocate staff. Alternatively, in rural facilities it
may be possible to install basic diagnostic equipment that can be oper-
ated by lesser-trained technicians and to reallocate more specialized
equipment and staff to larger facilities. Analysis of which alternative
would achieve the desired population coverage at least cost is not a job
for individual hospitals. Regional or national issues of economic effi-
ciency in the health sector involve decisions regarding many issues that
affect the performance of individual hospitals but are not within their
power to control.
Common problems with economic efficiency can be illustrated by an
examination of some substitution choices among important input com-
binations. In the next few paragraphs we consider the possibilities of
substitution between different categories of labor, between equipment
or pharmaceuticals and labor, and between maintenance and other
expenditure categories.
Substitution among categories of labor. Professional standards of care and
accepted practices provide restrictions on service tasks assigned to dif-
ferent categories of medical care staff in a hospital. Most affected are the
range of activities undertaken by nurses and paramedical staff compared
with the accepted role of medical doctors, as well as the roles within a
field or discipline (such as the role of registered nurses compared with
that of assistant nurses, or the role of professionally trained radio-
graphers compared with that of X-ray technicians). Possibilities for
substitution between and within these categories of staff exist, but they
are often limited by roles defined by professional associations.
The quantity of each type of staff person can be related to hospital size
and translated into ratios of staff to beds. There are no internationally
accepted norms for staffing ratios, and there probably should not be any
because staffing choices must be made in the context of local constraints
and wage levels. An examination of staffing ratios (table 34) reveals
cross-country variation in the total staff per bed and, for those countries
for which information is available, in the composition of staff. As ex-
pected, the limited data support the conclusion that higher-level hospi-
tals tend to employ more staff per bed than lower-level hospitals. In
particular, the table supports the observation that physicians are concen-
trated in large, tertiary hospitals. Nurses and paramedical personnel
make up the largest component of hospital staff, although in Indonesia,
Jamaica, and Niger the number of other (nonmedical) workers is sub-
stantial.
Staffing ratios per bed or bed-day are not an infallible proxy for quality
of services. Training and skill level, supporting technology, team work,
and the organization of services are all essential complementary co-de-
terminants of quality. In addition, expected differences in case mix

Table 3-4. Hospital Staffing Characteristics and Related Data, Selected Countries, Selected Hospitals
Staff per bed
Occupancy Nurses Nurmber
Level rate Bed-days and of hospitals
Coumtry and year of data of hospital ( per staff Physicians Parameds Other Total in study Source
Belize, 1985 11 68 218 0.1 0.9 0.1 1.1 1 Raymond and others 1987
III 31 225 0.1 0.4 0.0 0.5 6
Colombia, 1979 1,11 68 100 0.2 1.4 1.0 2.6 8 PRIDES 1980
China, 1986 1 94 177 - - - 1.9 8 Barnum 1989
11 86 172 - - - 1.8 11
III 95 232 - - - 1.5 7
Dominican Republic, 1989 1 - - 0.9 0.8 0.4 2.1 1 Lewis, Sulvetta, and
LaForgia 1990
Fiji, 1987a 1 83 225 0.2 1.0 0.1 1.4 3
III 46 176 0.1 0.8 0.1 1.0 19
Indonesia, 1985 1 75 97 0.6 1.0 1.2 2.8 2 Barnum 1987
II 68 118 0.4 0.9 0.9 2.1 15
III 54 197 0.1 0.6 0.4 1.0 297
Jamaica,
1985-
86
b I 84 160 0.2 1.4 0.4 1.9 2 Kutzin 1989
II 87 238 0.1 0.7 0.5 1.3 2
III 80 158 0.1 0.9 0.9 1.8 1
Niger, 1986-87 1 87 476 0.1 0.3 0.3 0.7 1 Wong 1989
Papua New Guinea, 1988 I 80 328 0.1 0.6 0.2 0.9 1 JSI 1990
II 80 276 0.1 0.6 0.4 1.1 4
III 60 287 0.0 0.4 0.3 0.8 8
-Not available.
a. Staffing data refer to number of established posts.
b. Staffing data refer to number of established posts as of August 1988.
Source: World bank sector reviews, except as noted in table.

Hospital Costs and Efficiency 113
between hospitals suggest that tertiary hospitals require greater staffing
intensity than district hospitals. Staffing ratios are, however, an import-
ant indicator of hospital performance, and low staffing ratios in district
hospitals remain an impediment to adequate service provision in rural
areas in many countries.
Substitution of equipment and pharmaceuticals for labor. One reason that
ratios of staff to beds vary considerably from country to country, even if
quality is roughly comparable, may be the flexibility in the choice of
input mix made possible by some forms of new hospital technology.
Monitoring equipment can be used in intensive care departments and in
wards to replace some nurses, freeing them for other patient care activ-
ities. Automated laboratory equipment, such as that for urinalysis and
hemoanalysis, can increase the effectiveness and productivity of labora-
tory workers. The kitchen and laundry can also involve capital-labor
substitution possibilities with the introduction of electric, gas, or steam-
driven appliances to replace wood fires and hand labor. The potential
for efficiency-improving input substitution exists, but it should not be
overstated. Although some technological breakthroughs can be charac-
terized as labor-saving, new technology often requires as much labor as
older equipment does, and often of a higher level of skill. Country-
specific conditions would determine the desirability of such substitu-
tion.
Pharmaceuticals can also reduce required staff or increase staff effi-
ciency. Psychiatric drugs render patients more controllable with fewer
workers and less-secure facilities. Drugs to reduce infection and increase
resistance after surgery can reduce length of stay. The use of drugs, for
example, rifampicin or ethambutol in tuberculosis treatment, sometimes
makes outpatient care possible for illnesses that previously required
long inpatient stays (Barnum 1986).
Substitution between maintenance and other expenditures. Poor mainte-
nance of buildings, equipment, and vehicles is a ubiquitous problem.
Maintenance as a share of total recurrent expenditures is often budgeted
at less than 4 percent of recurrent costs (for example, see Mills 1991). The
level of required maintenance depends on the operating environment
and the complexity of the facility, but an estimate of the desirable level
of maintenance expenditure for a secondary referral hospital is between
10 and 15 percent of annual recurrent cost.
9
Even if maintenance is
budgeted at this level, the actual expenditure is often less, as mainte-
nance is typically the first item to suffer cutbacks in the face of budget
shortfalls. Although technically classified as economic inefficiency, un-
derallocation to maintenance has important implications for the overall
technical efficiency of the hospital. For example, insufficient mainte-

114 Public Hospitals in Developing Countries
nance can lead to broken steam units or inoperable X-ray equipment or
vehicles, which contribute to the inefficiency of the remaining 96 to 97
percent of recurrent expenditures.
Conclusion. The examples of input substitution given above do not
constitute specific recommendations for change. No prejudgment
should be made of the appropriate factor mix because what is appropri-
ate will vary across countries and hospitals. For some hospital services,
substitution of equipment for labor may reduce diagnostic or therapeutic
errors; however, such substitution may also increase errors in other
services or in the same services in other hospitals. The choice should be
made on the basis of economic efficiency. Careful country-specific anal-
ysis needs to be carried out to determine the relative cost-effectiveness
of alternative mixes of factors.
Statistical Cost Studies
The minimum cost of providing a specified set of services when input
prices are given can be represented by a point on a cost function. The
cost function summarizes the economics of production and can be used
to determine the cost of both an additional unit of output (marginal cost)
and an average unit and to describe the possibilities of economies or
diseconomies of scale or scope. Although hospital managers do not, of
course, know the exact nature of their cost function or even of its
existence, by their choices through time they necessarily operate within
its confines and, if their incentives are sufficiently strong, they operate
on or near it. Knowledge of the cost function or at least the rough
magnitudes of some of its parameters is especially important for central
policymakers because it promotes the setting of policies that are consis-
tent with economic reality. By examining data for a large number of
hospitals we can hope to discover some of the characteristics of cost
functions. This section summarizes the findings from some statistical
cost functions for developing countries.
Modeling Hospital Cost
Accounting studies of costs, such as those reviewed in the first section
in this chapter, have an implicit underlying cost function, represented
by the sum of the products of the quantity of each input multiplied by
its respective price.
10
In fact, such an accounting cost function represents
the cost of production, at one point in time, on a cost function. The
accounting view of the cost function-sometimes referred to as a "pas-
sive" cost function-is rigid and does not allow management or techni-
cal responses to changes in input prices or quantities. Figure 3-3 depicts

Hospital Costs and Efficiency 115
Figure 3-3. Accounting Cost Function in Contrast to Actual Cost
Function
Cost
Actual cost function
(one of many possibilities)
g Accounting cost function
Output
the relation between an accounting cost function and one possibility for
the actual underlying cost function. An accounting study generates a
point estimate of total costs at the observed output, as at point A in the
figure, but does not tell much about what is likely to happen when the
price or quantity of an input changes. The only point we are certain that
the actual and accounting cost functions have in common, if the hospital
is minimizing costs, is the cost and quantity combination depicted at
point A. The implicit assumption of an accounting cost function is that
the underlying cost curve is linear and, thus, that marginal costs are
constant. This assumption may or may not be true and must be tested.
Econometric models of cost and production can be specified suffi-
ciently flexibly that they allow the assumption of constant marginal cost
and similar rigid assumptions inherent in the accounting model to be
tested. Econometric or statistical models also provide a better depiction
of how total costs change in response to differences in service mix,
inputs, input prices, and scale of operations. For example, the accounting
model would show a direct and simple relation between an increase in
a factor price and an increase in total costs; that is, total costs would rise

116 Public Hospitals in Developing Countries
by the increase in price multiplied by the quantity of the factor. The
econometric model would let total costs rise at a rate less than that of the
price increase, to allow for substitution of other factors and a reduced
quantity of the input for which the price rose. This cost function is
curved, not linear as in the accounting model.
In spite of the potential usefulness of econometric cost and production
studies, very few such studies of hospitals in developing countries have
been carried out thus far. Data deficiencies have been the primary
constraint. Few hospitals regularly collect the information needed for
such studies, and inconsistencies among hospitals limit the usefulness
of the data that are gathered. To a certain extent, statistical methods are
robust enough to allow data problems to be absorbed in error terms or
imprecision of estimates, but limits on this absorption of poor data
quality are soon reached, and the statistical confidence that can be placed
in most of the studies to date is low. Another important limitation in
econometric studies is that they are built largely on an economic model
that assumes the hospital is minimizing costs at some point along its
production frontier. Econometric studies also assume that it is fairly easy
for managers to change their factor input mix or their capital stock in
response to the economic environmnent. Furthermore, the means by
which hospitals are financed have specific implications for the behavior
of hospital managers and the characteristics of hospital costs, but the
econometric models formulated so far have not been able fully to incor-
porate the influence of finance. In reality, hospital managers may be
insufficiently motivated to operate on the production or cost frontier and
instead may be operating comfortably and placidly inside. Or, even if
sufficiently motivated, managers may be severely constrained by poli-
cies set outside their influence. Finally, as with accounting-based studies,
econometric studies suffer from the difficulty of controlling for the
quality of output. Thus, the results of the studies to be discussed below
are interpreted with caution.
Estimation of hospital cost functions is made difficult by the lack of a
clear model of hospital behavior that can be used to interpret the relation
between cost and output (service) data. The difficulty of developing an
economic view of the hospital lies in the inadequacy of the conventional
profit maximization model of the competitive market to explain the
incentives, and thus the objectives and behavior, of hospital managers.
Many alternative views of hospitals as economic entities have been
proposed, ranging from the appealing simplicity of the model suggested
by Newhouse (1970)-which proposes that hospitals achieve least-cost
production as they strive to maximize a combination of quantity and
quality of output constrained by a budget-to a complex, but institution-
ally apt, model suggested by Harris. Harris (1977) suggests that many
hospitals can be characterized as actually composed of two firms-the

Hospital Costs and Efficiency 117
first consisting of the medical staff, which delivers the services, and the
second consisting of the administrative staff. The input mix, determined
in advance by the administrative staff, defines the capabilities of the
hospital to meet the demand identified by the medical staff. This view
of a hospital may not be appropriate for many hospitals in developing
countries, in which the administrative staff and service staff often over-
lap considerably. It is useful, however, because it recognizes that the
demand for services is controlled by the service staff, especially physi-
cians, with resource constraints imposed by managers (centrally or
locally). A not uncommon institutional arrangement is that medical staff
income is dependent, at least partly, on the volume and type of services
offered by the hospital. Thus, this model replaces as a hospital objective
the profit maximization of the conventional economic model with the
income maximization of physician cum manager.
Still other models have been proposed to explain the incentives of
managers in nonprofit organizations in general or hospitals in particular.
Pauly (1987) reviews many possible specifications of hospital objectives
and notes that, with the current econometric formulations now in use,
these models cannot be distinguished from each other. He condudes that
the differences in the models may be important for policy decisions
involving incentives and hospital pricing behavior, but the models have
similar behavioral implications with regard to cost.
A complete review of possible models is potentially large. Indeed,
there is no one model that would be appropriate across the tremendous
diversity of institutional settings that exist in developing (or industrial)
countries. To indicate the variety, a partial list of alternative behavioral
models can be given:
* Maximization of output (patient admissions), given a fixed budget
* Maximization of some function of output and quality of care (as-
suming a tradeoff between the two)
e Minimization of cost, given an exogenous demand for admissions
e Maximiization of some function of profit and output
e Maximization of institutional prestige, which is a function of hos-
pital size, facilities, and the prestige of associated physicians
* Nonmaximization-so-called "satisficing" models of behavior-in
which managers and staff only hope to achieve some level of output
and quality within a fixed budget that will satisfy their own expecta-
tions and those of higher-level managers.
Extending Pauly's observations, all these alternatives, with the possi-
ble exception of the last two, are consistent with a close empirical relation
between total costs and hospital output. The last two models can lead to
behavior that obscures the cost-output relationship but, more likely, they

118 Public Hospitals in Developing Countries
coexist with budget constrained behavior circumscribed by a cost func-
tion. Our expectation is, therefore, that even in the absence of an under-
lying maximization objective that is universally applicable, a functional
relation exists between observed hospital costs and output. The rela-
tively close fits of the econometric functions estimated below sustain that
expectation.
During the last twenty years, estimation of cost functions for hospitals
in industrial countries has become commonplace. Reviews by Cowing,
Holtmann, and Powers (1983); Wagstaff (1989a, 1989b), and Breyer
(1987) document the progress. The earliest attempts to estimate cost
functions using data from hospitals in industrial countries employed
specifications of the regression equation that used composite measures
of hospital output (for example, Cohen 1967), used average or unit costs
of inpatient-day or admission as the dependent variable (Feldstein 1968),
and included a variety of interrelated explanatory variables such as
occupancy rates, patient flow, length of stay, and capacity as explanatory
variables (Mann and Yett 1968). The primary reason the authors of these
studies adopted the average cost formulation was to avoid the potential
problem of error terms with a nonuniform variance (heteroscedasticity)
in the estimated regression. (When total rather than average cost is used
as the dependent variable, there is some potential that the error term may
be correlated with the size of the hospital.) In these estimates, the
functional form used in the specification is not derived from a structure
based in theory but is generally defined for convenience of estimation as
either log-linear or additive-linear.
In more recent attempts, authors have specified a functional form and
included variables that are consistent with a theoretical production
structure (for example, Cowing and Holtmann 1983; Grannemann,
Brown, and Pauly 1986; and Vita 1990). They have generally estimated
total cost (rather than average cost) functions with multiple outputs and
have employed flexible functional forms. Although the total cost speci-
fication can present the problem of heteroscedasticity, this can be dealt
with if it arises through the proper selection of an estimation procedure.
Some advantages of the more recent work compared with the earlier
work are (a) the multiproduct nature of the hospital is explicitly recog-
nized, (b) an economic interpretation of functional form and induded
variables is provided, (c) econometric problems created by using output
(inpatient bed-days) on both sides of the estimating equation are
avoided.
Authors of recent cost studies have also been more careful to distin-
guish between short- and long-run cost functions. This distinction is
important for the identification of economies of scale, which is a long-run
concept. In empirical applications the distinction between long- and
short-run cost functions is related to the specification of the time period

Hospital Costs and Efficiency 119
and the inclusion of a scale or capital proxy as an independent variable.
If the hospital cannot adjust the capital stock within the period of time
defined by the data, as would commonly be the case if the cost and
output data refer to a one-year accounting period, then a short-run
variable cost function is appropriate. It is possible to examine the behav-
ior of the variable cost function with changes in the capital stock (in this
case the number of beds) and derive a long-run function (see Vita 1990).
The importance of this is that it is then possible to derive an index of
long-run economies of scale from an estimated short-run variable cost
function.
For heuristic purposes (though it may not be descriptive of the actual
shape of a given estimated function), we show in figure 3-4 a general
graphical description of the relation between long- and short-run cost
curves, presented in average cost format, for a single output. With
reference to the figure, we can distinguish between the short- and
long-run behavior of cost with changes in output by differentiating
between returns to scale (a long-run concept) and returns to the variable
factor (a short-run concept).
Looking first at different locations along the long-run average cost
function (LRAC), we see that the hospital with the short-run average cost
(SRAC 1) curve is at an optimum plant size and can be characterized as
having constant returns to scale when producing the long-run minimum
cost output at A. To the left of A on the LRAC, average cost falls with
increases in hospital size (increasing returns to scale). To the right of A,
average cost increases with hospital size (decreasing returns to scale).
Looking at locations on a short-run average cost function, for example,
SRAC 2, we see that, given the fixed scale, the hospital is at its most
efficient level of output at B and is above this short-run optimum at, say,
C. At C, the cost of an additional unit-the marginal cost (MC)-is above
the average cost. At point B the hospital is at a point of constant returns
to the variable factor. To the left of B, short-run average cost decreases
with greater output, yielding increasing returns to the variable factor,
and to the right of B, say at C, there are decreasing returns to the variable
factor. Thus we distinguish between movements along the short-run cost
curve by discussing returns to the variable factor and movements along
the long-run cost curve by discussing returns to scale. This distinction is
not always carefully made in the literature on hospital cost functions.
Vita (1990) has recently pointed out that failure to make this distinction
has led to errors in estimating economies of scale and that such failure
is caused by applying long-run formulas to short-run empirical cost
functions. To avoid this problem we explicitly define short- and long-run
formulas.
Our central interest in estimated cost functions is in obtaining infor-
mation on the magnitude of average and marginal cost, on returns to the

120 Public Hospitals in Developing Countries
Figure 3-4. Relation of Short- and Long-Run Average Cost Functions
Cost
LRAC
~~~~~ ~~SRAC2/
Output
variable factor, and on the importance of economies of scale and scope.
These concepts can be defined in terms of a general specification of a
short-run cost function, C = ftBeds,Yl, Y2,.. .Yn), where Beds identifies
the scale of the short-run function, C is the total cost of hospital opera-
tions, and the Yi are the hospital's n outputs. We then have the following
definitions.
For the short run:
1. The marginal cost of producing an additional unit of the ith output:
MC, = aC/aYi.
2. The average incremental cost of the ith output:
AIC = [C -C (Yn -i) ]/Yi
where Yn-i is the total cost of production with the exclusion of the ith
product. The average incremental cost is the average added cost per unit

Hospital Costs and Efficiency 121
of producing the ith product in comparison with producing all products
except the ith.
3. Short-run returns to the variable factor:
SRVF = C/1YiciYi.
The index of short-run returns to the variable factor measures the
effect on costs of a general increase in output when the output mix and
bed size remain fixed. If the SRVF is greater than one, the level of output
is below optimum efficiency. If the SRVF is less than one the level of
output is above maximum efficiency.
4. Short-run product-specific returns to the variable factor:
SPRVF = A1C/MC,.
The indexes of product-specific returns to the variable factor measure
the effect on costs of a proportional increase in all inputs on the output
of the ith product while the level of output of all other products remains
constant. Product-specific returns to the variable factor are said to exist
if the SPRVF is greater than one.
5. Economies of scope:
SCOPEs = [C(YJ) + C(Yn _ -C(Y) ]/C(Y).
Economies of scope exist when it is cheaper to produce selected
outputs jointly than to do so separately. Economies of scope between a
subset of outputs (Y,) and all other outputs (Yn-s) exist when SCOPE S is
greater than zero.
In addition to these definitions, we have for the long run:
6. Economies of scale:
With beds included as a proxy for scale, the measure of long-run
economies of scale (EOS) is
EOS = (1 -aCBeds)/ GCyi
where Gab indicates the elasticity of a with respect to b. The index of
economies of scale measures the effect on cost of a general increase in
output when the output mix remains unchanged and all inputs are
allowed to vary.
1
' If the EOS is greater than one, economies of scale are
said to exist, if less than one, diseconomies exist.
We now turn to estimated cost functions for developing countries and,
where possible, apply these formulas to derive estimates of marginal
cost, returns to the variable factor, and economies of scale and scope.

122 Public Hospitals in Developing Countries
Five Studies of Developing Countries
The literature on developing countries follows much the same evolution-
ary pattern as that for industrial countries, but in this case there are only
a handful of studies. In chronological order the studies known to us
cover hospitals in Kenya (Anderson 1980), Ethiopia (Bitran-Dicowsky
and Dunlop 1989), Nigeria (Wouters forthcoming). In addition to these
we add our own analyses of data for Colombia and China. It is evidence
of the relatively recent emergence of this topic that only one of the studies
(Anderson's) was obtained from the published literature.
12
Individually,
several of these studies suffer from data inadequacies that cloud an
interpretation of results; collectively, however, the studies indicate the
variation in the magnitude of some critical cost parameters across differ-
ent countries and different health system environments. We first review
the five studies and then briefly discuss the general implications of the
findings.
Kenya. The study of hospital costs in Kenya is in the tradition of the
earliest studies done in industrial countries and uses an average cost
specification:
I = aO [365.4' [-16 j [jAT B4 ZFSZ
where C/I = Costs (C) per inpatient bed-day (1),
I/(365-B) = Occupancy Rate, B represents beds,
0/1 = Outpatient visits (0) per inpatient bed-day,
I/A = Length of stay, A represents admissions,
ZF = Weighted index of the number of associated subhospital facilities,
ZL = Level of hospital, 1 = province, 0 = district.
The results of the Kenyan study are clouded by the fact that hospital
costs include the costs of related subcenters (health centers and health
posts) as well as those of the specified hospital, and it is not possible to
match the estimated coefficients clearly with the hospital services per se.
An attempt was made to correct for this problem by including a
weighted average (ZF) of the number of subcenters as an explanatory
variable. The data set included fifty-one provincial and district public
hospitals. Natural logs were taken of all variables before regression so
that the estimated coefficients could be interpreted directly as elasticities.
The ordinary least-squares estimates of the coefficients are given in table
3-5.
Anderson does not use the estimated equation to calculate the mar-
ginal cost of services, and the mean values for the variables employed in
the analysis are not reported. He interprets the significant negative
coefficient on beds (B) to imply long-run economies of scale with regard

Hospital Costs and Efficiency 123
to hospital size, but the specified equation does not yield a direct estimate
of economies of scale because of the unit cost formulation and the several
places in the specified cost function that inpatient bed-days (I) occur.
Additionally, Anderson's interpretation of the coefficient on beds is not
strictly correct; the estimated function is a short-run cost function, and
allowing bed size to change will account for movements from one
short-run cost curve to another, keeping output constant, but will not
give movements along the long-run cost curve.
By multiplying through by I and rearranging terms, however, we can
put the estimated equation in a total cost form. The rearranged equation
can be used to derive the elasticities with respect to output and beds that
are needed to obtain a measure of long-run economies of scale (EOS
above). Following this method, we arrive at 1.5 as the estimate of the
index of economies of scale. The policy implications are that, if additional
capacity is to be constructed, moderate cost savings could be obtained
by expanding existing facilities instead of building new small-scale
hospitals. This is, of course, only one of several factors, such as accessi-
bility, that planners would take into account in planning hospital con-
struction.
The function rearranged in total cost form yields an estimate of the
index of general short-run returns to the variable factor of 2.0 as well as
an estimate of the elasticity of unit cost with respect to inpatient bed-days
of -0.8. This would seemingly indicate that Kenyan hospitals can be
characterized by decreasing cost with greater output. It would be diffi-
cult to reach the conclusion, however, that greater efficiency would be
achieved by increasing hospital use and occupancy rates. Anderson
points out that many Kenyan hospitals at the time of the study already
had occupancy rates in excess of 100 percent and increased use would
further compromise quality. Perhaps greater throughput could be
achieved by shortening the length of stay; the coefficient on length of
Table 3-5. Cost Function for Selected Hospitals in Kenya
Variable Coefficient t-statistic
Constant 6.57
I/B -0.44 -4.17
0/i 0.29 2.45
I/A -0.07 -0.69
B -0.20 -2.97
ZF 0.19 8.23
ZL 0.29 2.37
2 =0.75 n=51
Source: Anderson 1980.

124 Public Hospitals in Developing Countries
stay (I/A) is negative but not statistically significant. It was not possible
to calculate economies of scope. A further finding, however, was the
significantly greater unit cost for provincial hospitals than for district
hospitals. This probably reflects a mix of more severely ill patients in
provincial hospitals or a greater allocation of resources per patient to
provincial hospitals than to district hospitals.
Ethiopia. As do recent studies of industrial countries, the study of
Ethiopian hospitals uses a flexible functional form and estimates a
short-run variable total cost function. The specification used is quadratic
in outputs:
C = e(ao +aB) eYX)
where
f(Y,X) = bjI + b
21
2
+ b
30 + b
40
2
+ b,
5I 0 + b
6Del + b7Surg + b8Lab.
All variables remain as defined previously with the addition of the
number of deliveries, laboratory tests, and surgical operations repre-
sented by Del, Lab, and Surg, respectively. The data set included a
pooled cross-section-time-series data set of thirty-eight observations for
fifteen public hospitals. Ordinary least-squares estimates of the coeffi-
cients are given in table 3-6. The coefficients on outpatients and the
square of bed-days are not statistically significant. Taken together, the
high R
2
and large standard errors of the estimated coefficients suggest
that multicollinearity is a problem. The sign on the square of bed-days
is incorrect and implies an inverted U-shaped average cost curve for
bed-days. The peak of the implied average cost curve, however, is well
outside the range of the data; throughout the range of the data, average
cost increases slowly with increases in output.
The main findings are that, at the sample average, marginal costs are
only slightly above average costs for inpatient bed-days and for deliver-
ies and laboratory services. Given the statistical variation in the sample
it cannot be clearly established that marginal and average costs differ for
inpatient services, and the sample of hospitals is best characterized by
nearly constant (slightly decreasing) short-run returns to the variable
factor. The study also identifies mild economies of scope between inpa-
tient and outpatient services. Bitran-Dicowsky and Dunlop (1989) do not
report estimated results for hospitals of different sizes but note that the
output structure varies between large and small hospitals. They suggest
that with additional data it would be important to disaggregate the
sample by hospital size. Equally important would be a disaggregation
by functional level.

Hospital Costs and Efficiency 125
Table 3-6. Cost Function for Selected Hospitals in Ethiopia
Variable Coefficient t-statistic
Constant 5.45 22.51
B 4.71 E-3 8.89
I 2.18 E-5 3.44
12 -1.65 E-12 -0.02
0 1.91 E-6 0.08
02 1.42 E-10 0.26
I 0 -7.50 E-10 -2.42
Deliv 1.68 E4 5.39
Surg 3.21 E-5 0.11
Lab 7.63 E-6 7.97
i2 =0.96 n =38
Source: Bitran-Dicowsky and Dunlop 1989.
Nigeria. The analysis in Nigeria covers twenty-four health institutions
in Ogun State, of which eight are health centers with ten to twenty
inpatient beds each, seven are maternities (about seven beds each), and
nine are dispensaries. Three of these facilities (one health center and two
maternities) are privately owned. For our purposes the lack of facilities
classified as hospitals limits the applicability of the results. Interpretation
of the results is also clouded by the small sample size. In spite of these
limitations the study is of interest because it gives some information on
the behavior of costs of inpatient care in small facilities and because it
uses an econometric specification that explicitly recognizes that facilities
may not be operating efficiently. In this technique the production func-
tion, designated a frontier production function, is estimated as an enve-
lope of observed points. Wouters (forthcoming) estimates a production
function for outpatient visits to compute the marginal products of health
workers and non-health workers and compares the ratio of marginal
products with the ratio of wages to derive an efficiency index (a value of
one represents optimum economic efficiency). The efficiency index is
then used in a multiproduct cost function as a technically neutral shift
variable. The estimated equation is log-linear. The specified cost equa-
tion is,
C = aO
0
a
1zaa i, W a ' expfA,B)
where
f(A,B) = bo + b
1A* + b
2B* + b
3D
and all variables remain as defined previously with the addition of

126 Public Hospitals in Developing Countries
Z = an index of drug availability as a measure of quality,
WH = wage of health workers,
WN = wage of a non-health worker,
E = Efficiency index based on first stage estimate of a production function,
D = dummy variable set to 0 if facility has no beds,
* indicates a Box-Cox transformation (2 = 0.1) of the variable.
The results of the cost function estimation are given in table 3-7. The
main finding from the production function estimate (not reported here)
is that the Ogun State facilities use substantially greater numbers of
non-health workers than is economically efficient; the ratio of the mar-
ginal product of non-health workers to that of health workers is about
two-thirds of their ratio of wages. The main findings from the estimated
cost function are short-run returns to the variable factor for admissions
and approximately constant returns with respect to outpatient visits for
the group of small facilities included in the analysis. That is, the marginal
cost of admissions is substantially less than the average cost, whereas
marginal and average costs for outpatient services are approximately
equal. The study also indicates slightly decreasing short-run returns to
the variable factor with respect to a neutral expansion of facility produc-
tion. Long-run economies of scale were not calculated.
Colombia. The Colombian cost function is derived from data given in a
special survey (PRIDES 1980) evaluating the financial management of
eight class I and II hospitals (hospitales de referencia) distributed through-
out the country. The costs, given in 1975 constant pesos, and service data
cover the period 1975 to 1978 and provide a pooled cross-section and
time series data set of thirty-five observations. The function estimated is
a short-run variable cost function and includes beds as a measure of
Table 3-7. Cost Function for Selected Health Facilities in Ogun State, Nigeria
Variable Coefficient t-statistic
Constant 1.628 0.58
B 0.093 0.44
A' 0.011 0.25
0 0.597 5.28
z -1.361 -2.06
WH 0.586 2.46
WN 0.387 2.08
E -0.160 -0.88
D 0.221 0.62
R
2
=0.91 n=24
Source: Wouters forthcoming.

Hospital Costs and Efficiency 127
scale. A functional form similar to that used by Grannemann, Brown,
and Pauly (1986) was adopted for the analysis. The specified function is
cubic in outputs:
C=e e(a° + a,B) .,P(Yx)
where
f(Y,X) = b,I + b21
2
+b
31
3
+ b
40 + b502 + b
60
3
+ b
71. 0
and all variables remain as defined above.
A preliminary estimation of this equation gave coefficients on the
squared and cubed number of outpatient visits that were not statistically
significant and of the wrong sign. Cubic equations often provide diffi-
culty in estimation because of multicollinearity and the magnified effect
of outliers on the squared and cubed terms. Reestimation of the cost
function omitting the power terms on outpatients gives the results
presented in table 3-8. The significance of the coefficient on outpatients
remains low, but the sign and magnitude are plausible.
With regard to inpatient costs, the findings are similar to those for the
Ethiopian study. At the sample average, marginal costs for inpatient
services are approximately equal to average costs, and the sample of
hospitals exhibits constant short-run returns to the variable factor. With
regard to outpatient services, marginal costs are again very close to
average costs and there appear to be constant returns to the variable
factor, although in this case the statistical weakness of the coefficient on
outpatients reduces the confidence that can be placed in this result. The
estimated equation also does not confirm the existence of economies of
scope between inpatient and outpatient services. Calculated at the
Table 3-8. Cost Function for Selected Hospitals in Colombia
Variable Coefficient t-statistic
Constant 2.76 10.34
B 3.96 E-4 1.16
1 1.73 E-5 3.27
12 -6.42 E-1 1 -1.74
13 8.78 E-17 1.44
0 3.34 E-06 1.28
I 0 -7.01 E-12 -0.39
R
2
= 0.91 n = 35
Source Authors.

128 Public Hospitals in Developing Countries
means of the data, the estimated value of EOS is close to 1 and suggests
constant returns to scale.
China. As a final study, a short-run variable cost function was esti-
mated for the sample of thirty Chinese hospitals summarized in the
discussion of accounting unit cost. The sample includes cost and service
data for three years, 1984 through 1986. Cost data were converted to
constant 1986 yuan. After exclusion for missing observations, the total
sample size was seventy-two. Again, a flexible cost function similar to
that used by Grannemann, Brown, and Pauly (1986) and cubic in outputs
was used for the estimating equation,
C e(ao+a,B) AjYAX)
where
f(Y,X) = bil + b
20 + b3I2 + b41
3
+ b
50
2
+ b6O3 + b
71- 0 + bgDg
4+ b
9D85.
The variables remain as previously defined with the addition of
dummy variables, D
84and D
85, set to 1 for years 1984 and 1985. After an
analysis of the residuals, a maximum likelihood estimate of a frontier
production function specification was rejected in favor of an ordinary
least-squares estimate (see Aigner, Lovell, and Schmidt 1977). Also, the
residuals were not found to be heteroscedastic with respect to bed size
(Goldfield-Quandt test). The ordinary least-squares estimates are sum-
marized in table 3-9. The main findings are diseconomies of scale and
only mild economies of scope and short-run inefficiencies in the level of
operation with respect to bed-days and outpatients.
It is of interest to examine the returns to the variable factor and
economies of scale and scope for different levels of hospitals. Table 3-10
gives the marginal cost, short-run returns to the variable factor, and
economies of scope and long-run economies of scale for low-, middle-,
and high-level Chinese hospitals. The estimates were obtained by sub-
stituting the means for the groups in the estimated cost function. The
short-run returns to the variable factor of 0.9 for lower-level hospitals
and 0.7 for upper-level hospitals indicate that low- and middle-level
hospitals are operating at or slightly above efficient volumes of output,
whereas larger hospitals are clearly above an efficient volume of output.
The index of long-run scale economies indicates that increases in the size
of hospitals is not warranted and that, particularly in the upper level, a
smaller scale would be more efficient.
These results are consistent with the high levels of occupancy rates in
most of the hospitals included in the sample (and in Chinese hospitals
in general). Occupancy rates in China are very high, so output takes place

Hospital Costs and Efficiency 129
Table 3.9. Cost Function for Selected Hospitals in China
Variable Coefficient t-statistic
Constant 12.93 71.54
B 6.12 E-4 0.72
1 2.03 E-5 4.63
12 -6.04 E-11 -1.90
13 1.16 E-16 1.56
O 2.01 E-6 1.49
02 -9.65 E-13 -0.35
03 14.72 E-18 0.83
1 0 -11.51 E-11 -2.71
D84 -0.166 -2.23
D
85 -0.111 -1.53
2 =0.89 n = 72
Source Authors.
well to the right of the optimum output on the cost function, in a region
where marginal cost is greater than average cost. A mechanical conclu-
sion would be that unit costs could be reduced by using a larger number
of institutions and reducing the average occupancy slightly. This inter-
pretation, however, fails to acknowledge the inordinately long stays in
Chinese hospitals. The long stays are largely responsible for high occu-
pancy rates, which would be much more modest if length of stay were
managed more efficiently. In fact, the productivity of hospital beds in
regard to the number of patients treated (reflected in the turnover rate)
in Chinese hospitals is lower than in the hospitals of many other coun-
Table 3-10. Marginal Cost and Economies of Scale and Scope by Level of
Hospital from Cost Function for a Sample of Chinese Hospitals
(1986 yuan)
Lower level Middle level Upper level
Marginal cost
Bed-day 16.2 20.3 40.1
Outpatient visit 1.5 3.2 1.8
Indices of scale and output
Short-run SRVF 0.9 0.9 0.7
Long-run EOS 0.8 0.7 0.5
Economies of scope
Bed-days and outpatient visits 0.4 0.3 0.2
Note: Marginal costs are calculated from the estimated cost function in table 3-9 with
all variables set at the means of the indicated group.

130 Public Hospitals in Developing Countries
tries, despite generally much higher occupancy rates in China (see table
3-3). Given the long stays, reducing the cost per day through expanded
bed capacity should not be the focus of policy. Reducing length of stay
would be likely to increase costs per day slightly (because relatively less
expensive days toward the end of the stay would be reduced), yet there
would be overall efficiency gains because more patients would be ac-
commodated and the cost per admission would be sharply reduced. The
shortened length of stay could also result in a more efficient level of
inpatient use.
Discussion of Statistical Cost Functions
The small number of cost function studies for developing countries that
are available for the survey above precludes any clear generalization of
results. The great variation in results demonstrates that the conclusions
must remain country-specific. In addition, it is important to avoid a
mechanical interpretation of the statistical results, such as the finding of
inefficiency in high Chinese occupancy rates implied by marginal cost
that exceeds average cost. The statistical functions are useful only if one
has a knowledge of the context.
The scope of the survey could be expanded to include results from
industrial countries, but such an expansion should only be done with
caution. The greatly restricted budgets of hospitals in developing coun-
tries and the limited capacity for training skilled personnel in medical
and nursing schools constrain the production technology choices to a
much smaller range of activities than in industrial countries, and the
underlying production functions are probably very different, especially
in low- and middle-level hospitals. Furthermore, hospital managers will
respond differently according to the manner in which hospital services
are financed. The results from analyses of industrial countries might be
of more relevance in the higher-income South American economies and
in the emerging countries of the Pacific rim.
Some similarities in the findings between industrial and developing
countries do, however, appear indicative. An important debate running
throughout the literature of industrial countries concerns the extent of
economies of scale. Significantly, the earlier literature, using the single
product, unit cost specification, commonly identified significant econo-
mies of scale or, strictly speaking, of size. But these findings were
criticized, as we noted earlier, because of the poor theoretical specifica-
tion of the models upon which they were based. The view of economies
of scale changed substantially with the introduction of the more flexible
estimation forms and the use of total cost, multiproduct specifications.
In particular, some of the later studies found constant or mildly dimin-
ishing returns to scale, especially for larger hospitals. The general con-

Hospital Costs and Efficiency 131
clusion of Cowing, Holtmann, and Powers (1983, p. 276) in their survey
of industrial country studies is that "economies of scale may exist for
small hospitals but that moderate and large size hospitals can generally
be characterized by constant returns to scale."
The results from the five studies of developing countries surveyed
here are consistent with the literature concerning industrial countries.
With regard to long-run economies of scale, Anderson, using a unit-cost
specification in his study of Kenyan hospitals, found economies of scale.
However, we used flexible cost functions in our analyses for Colombia
and China and found either diseconomies of scale or constant returns to
scale at the sample averages. Table 3-11 summarizes the results from the
four flexible function cost estimates. With regard to short-run returns to
the variable factor, with the exception of the returns to admnissions in the
small facilities with low occupancy rates included in the Nigerian study,
the four studies found either decreasing or constant returns at the sample
averages.
In two of the three studies in which the functional form allowed an
index to be computed, there was no clear evidence of economies of scope.
The Colombian and Chinese data yielded an index value of 0.2 or less
between outpatient and inpatient services. The Ethiopian data suggested
that some economies of scope may exist between bed-days and outpa-
tient visits. Computation of the scope index for separate levels of hospi-
tals in the Chinese data set (see table 3-10) suggests that the index
increases inversely to the level of hospital and that low- and middle-level
hospitals with an index value of 0.3 or more may have slight economies
of scope in providing both outpatient and inpatient care. Despite the
slight variation found in the Ethiopian data and the Chinese middle-level
hospitals, the overall results indicate that economies of scope are not an
important factor in planning hospital activities.
These results are also consistent with the literature on industrial
countries, although in medium to large hospitals some diseconomies of
scope have been identified. In their analysis of U.S. hospitals,
Grannemann, Brown, and Pauly (1986) found that there were some
diseconomies of scope between outpatient visits and inpatient care-
hospitals with larger numbers of inpatients also had a higher unit cost
of outpatient visits. Their explanation for this phenomenon may be
useful in understanding the interaction of inpatient and outpatient costs
in large hospitals in developing countries. They state that the difficulty
of coordinating a greater range of services may contribute to higher costs.
Also, larger hospitals may have outpatient visits of greater complexity
that give rise to longer or more costly inpatient stays. They did not
suggest, but it may also be, that larger hospitals have more trained
personnel and available techniques that are applied to outpatient ser-
vices independently of case complexity. In other words, the "quality" of

132 Public Hospitals in Developing Countries
Table 3-11. Marginal Cost and Economies of Scale and Scope from
Statistical Cost Functions
Study
Item Ethiopia Nigeria China Colombia
Marginal cost
In 1988 U.S. dollars
Bed-day 1.4 7.6 22.0
Outpatient visit 2.9 0.5 9.9
Admnission 4.2
Delivery 89.8
As a % of per capita GNP a
Bed-day 0.9 1.8 2.7
Outpatient visit 0.3 0.1 1.2
Admission 0.4
Delivery 55.9
Indexes of scale and output
Short-run SRVF 0.8 0.9 1.1
Long-run Eos 0.7 0.9
Product returns
Bed-day 1.0 0.7 1.0
Outpatient visit 0.8 0.5 0.8
Admission 2.6
Deliveries 0.9
Economies of scope
Bed-days and outpatient visits 0.4 0.2 0.1
a. In year of data.
Source: Bitran-Dicowsky and Dunlop 1989 (Ethiopia); Wouters forthcoming (Nigeria);
authors (China and Colombia).
outpatient care in larger hospitals in terms of resources used per patient
may be better (although it is not clear that the health outcome for
noncomplex cases is superior; that is, qualitatively different inputs are
used, which may or may not lead to qualitatively different health out-
comes).
The general lack of marked economies of scope for all hospitals and
possible diseconomies of scope for larger hospitals removes an economic
argument for expanded outpatient departments in large hospitals.
Taken at face value, the estimated results imply that limiting, or perhaps
eliminating, the outpatient department of large hospitals and shifting
the burden of outpatient care to lower levels of facilities would improve
the efficiency of the hospital subsector. Much more detailed study is
needed before such a far-reaching policy conclusion is recommended,
however. Hospital outpatient services are quite diverse, ranging from
emergency trauma care to scheduled specialty treatment and consulta-

Hospital Costs and Efficiency 133
tion services. It is unlikely that large hospitals could divest themselves
of their casualty and emergency departments, nor is it likely that highly
specialized outpatient care requiring expensive equipment and person-
nel could be moved from a hospital setting, as both the capital and
recurrent costs of opening separate outpatient facilities are likely to be
prohibitive. A much more feasible policy conclusion is that lower-level
facilities should be upgraded to provide basic outpatient services to
general outpatients requiring nonspecialized care and to provide follow-
up ambulatory services to patients who have received specialized inpa-
tient or outpatient care at a tertiary facility. In other words, first-level
referral hospitals should be capable of playing a dual role: that of
referring patients to more specialized care and that of providing pallia-
tive and follow-up care to these patients after they receive specialized
services and are referred back down the provider pyramid to their local
institutions.
Summary
The growing number of accounting analyses of hospital costs
demonstrates both the feasibility of such studies, even in situations in
which information on cost and use is ostensibly lacking, and the useful-
ness of such analyses. Within countries, the studies can be used to
develop performance standards, assist with projections of future
resource requirements as demand for hospital services increases, and
identify hospitals that require special management attention to improve
efficiency. Cost studies can be supplemented by examination of service
statistics through use of the technique suggested by Pab6n Lasso (1986)
to provide further identification of hospitals with substandard perfor-
mance. Once such hospitals are identified, the analysis of specific effi-
ciency issues can quickly move beyond the realm of economics and into
management, organization, and personnel planning. Problems with low
turnover and occupancy rates, inappropriate length of stay, and ineffi-
cient use of personnel and technical inputs may be solvable if direct
changes are made in administrative rules or management decisions. But
if inefficiency is widespread, it is probable that corrective policies will
involve changing the incentives that guide the behavior of management,
physician, and client.
The average cost estimates reviewed in the first section of the chapter
show the remarkable similarity across countries in the average cost of a
bed-day when measured as a percentage of per capita GNP. With few
exceptions the cost per bed-day in a middle-level hospital varies from
about 1.3 to 3.0 percent GNPN. The actual constant dollar cost varies by
considerably more, however, and this variation is undoubtedly accom-
panied by broad differences in quality. The variations in quality impede

134 Public Hospitals in Developing Countries
cross-country comparisons in efficiency of service delivery. Two facts do
stand out, however. First, the average cost of lower-level hospitals is
nearly always substantially less than that in higher-level referral institu-
tions. The waste of resources resulting from the inappropriate use of
provincial and central facilities to treat cases that do not require more
specialized technical care can be large. The difference between upper-
and lower-level facilities in cost of services gives a rough measure of the
resource benefits from improved referral policies, although one must
keep in mind that some of the cost variation is likely to be attributable
to case mix and quality differences. Second, lower-level hospitals are
characterized by low occupancy and turnover rates in many countries.
These low rates are commonly related to services that are perceived to
be and actually are of low quality. Increased use cannot be achieved
merely by new written guidelines for a patient referral system; rather,
an adequate supply of inputs at lower levels to improve quality is needed
to stimulate demand.
The results of statistical studies performed to date are too limited to
provide definitive guidance for policy. Most of the studies have been
carried out on small or poorly specified data sets that obscure the
conclusions. The potential usefulness of such studies is established,
however, by the illumination they could shed on the relation between
marginal and average cost and between economies of scale and econo-
mies of scope. The setting of hospital prices can be done more efficiently
with a knowledge of marginal costs, and economies of scale and scope
should be included in hospital design and organization. As experience
grows with statistical analysis of hospitals in low-resource environments
and with larger hospital data bases and improved specifications, the
studies will be of increased usefulness for setting prices and planning
hospitals. The individual studies surveyed in this chapter demonstrate
the variability that can be expected across countries and the need for
doing country-specific studies before assuming constant cost. The pas-
sive accounting view of the cost function can be taken as a good first
approximation of the relation between output and cost and is certainly
preferable to basing planning decisions on rough assumptions. The
accounting and true cost functions, however, can be expected to diverge
for policies that carry output far from prevailing levels.
The findings in this chapter complement the policy discussion in the
subsequent three chapters on pricing and hospital service alternatives.
Pricing should be intimately related to costs, which constitute half of the
information required for determining optimum pricing levels. The next
chapter will add demand and income distribution information to cost
information to build suggested guidelines for hospital pricing. With
regard to hospital alternatives, the discussion of cost and efficiency in
this chapter has suggested that improving referral patterns by directing
patients to lower-level hospitals and nonhospital alternatives might pro-

Hospital Costs and Efficiency 135
vide savings without sacrificing health status. Chapter 6 outlines inno-
vative and practicable lower-level hospital and nonhospital alternatives.
Appendix 3A. Step Down or Cost Center Analysis
of Hospital Costs
Anyone who does detailed step down recurrent cost studies faces two
significant problems. The first is a problem that all authors of cost studies
must address: cost data may not be directly available for individual
hospitals. Multiple sources of budgeting (for example, central as op-
posed to district-level expenditures) and assorted means of making
payment for different line items (for example, the salaries of physicians
and nurses may be paid by the central health ministry, other salaries may
be paid at the district level or directly by the hospital) make the recon-
struction of actual expenditures laborious. The second problem, of par-
ticular importance for step down studies, is that cost information may
be available only on an aggregate basis for the hospital. The need to
reconstruct hospital cost data from multiple sources provides some
insight into the problems of resource allocation that confront hospital
managers. Often, because of institutional constraints and multiple budg-
etary sources, they do not have a complete picture of their costs or the
level of resources that will be available to them over a period of time.
The first requirement of the estimation process is to get as complete a
picture of total recurrent hospital costs as is possible. This means sup-
plementing the hospital line item expenditure data with information on
resources used that do not appear in the hospital's budget or financial
statement. For example, it is common that the financial statements of
public hospitals do not include most expenditures on drugs and medical
supplies or on maintenance services provided to the hospital. It is
necessary to get such information from central medical stores or other
central or regional distributional agencies. It is also necessary to estimate
nonfinancial costs, such as depreciation and the value of donated goods
and services. Next, because most hospital or health ministry budgets are
in a line item format (typical line items are salaries, drugs, other supplies,
public utilities, and so on), line item costs must be attributed to cost
centers, which reflect specific hospital departments. The specific cost
centers vary from study to study, but typically three categories of cost
centers are used:
* Overhead. These cost centers produce only those services that are
consumed by other departments (cost centers) of the hospital, not by
patients. Examples include Administration, Housekeeping, Mainte-
nance, and Utilities.

136 Public Hospitals in Developing Coun tries
* Intermediate. These cost centers produce services that are used by
other departments but also provide services directly to patients. Ex-
amples include Laboratory, X ray, Operating Theater, and Physiother-
apy.
* Final. These cost centers provide services directly to patients, not
to other departments. Examples are Inpatient and Outpatient, with
some studies disaggregating these broad categories into specific de-
partments, such as Medicine, Surgery, Obstetrics-Gynecology, and
Pediatrics.
Step down costing can be depicted algebraically as follows:
Let Cio = direct costs in Overhead cost center i;
Cj, = direct costs in Intermediate cost center j; and
CkF = direct costs in Final cost center k.
The direct costs are the costs attributed to each cost center prior to their
allocation to the cost centers associated with hospital outputs. After the
direct costs of each cost center (that is, all of the Cio, Cji, and CkF) are
identified, the step down method is applied to allocate all costs to final
cost centers. The basis for allocating specific proportions of each cost
center's costs to other departments should reflect the consumption of the
source department resources by the receiving department (as an example,
the distribution of dietary [source] costs among inpatient departments
[receiving] would typically be based on the proportion of total patient-
days in each inpatient department). First, direct overhead costs are
allocated to all other departments. The bases of allocation of costs from
each overhead cost center to the other cost centers are proportions that
can be represented as:
aij = the proportion a of Overhead cost center i's costs "used" by
Intermediate cost center j;
cxik = the proportion a of Overhead cost center i's costs "used" by Final
cost center k;
pjk = the proportion p of Intermediate cost center j's costs "used" by
Final cost center k;
where
p= 1.
In the first step the overhead costs are allocated to intermediate and
final cost centers using the allocational proportions cic and xik, resulting
in the first step allocated costs, C 'jI and C 'kF.1
3
Explicitly,

Hospital Costs and Efficiency 137
C 'I, = C,, + -a,i C,
0
C 'kF = CkF + Yak* CiO
where
C 'J = fully allocated costs of Intermediate cost center j; and
C 'kF = partially allocated costs of Final cost center k.
Then, in the second step, the allocated ("indirect") costs from the
intermediate cost centers in the first step are allocated among the final
cost centers using the proportions pfk. Explicitly, the fully allocated costs
are
C "k = C 'k + CPk /1
where
C "kF = fully allocated costs of Final cost center k.
After all costs are fully allocated to each of the final cost centers,
average costs are calculated by comparing fully allocated costs to the
relevant use statistics. For example, if the only final cost centers are
simply Inpatient and Outpatient, statistics on total patient-days and
discharges can be compared with fully allocated inpatient costs to gen-
erate measures of the average cost per day and per discharge. In a similar
manner, the average outpatient cost per visit can be calculated. Average
costs of intermediate services can also be calculated if service statistics
are available.
Appendix 3B. Use of Service Indicators for Rapid Assessment
of Relative Performance of Indonesian Type C Hospitals
Each point in figure 3A-1 (in accord with the method described by Pab6n
Lasso [1986]) represents one of seventy-eight Indonesian type C hospi-
tals (eighteen on Sumatra, forty-three on Java, and seventeen on the other
islands). The points are defined by the rates of bed occupancy and
turnover for each hospital; these rates in turn define the average length
of stay (shown for its mean and extreme values across the top and down
the right side of the graph). The dotted lines are one standard deviation
(plus and minus) from the means of the occupancy and turnover rates.
Hospitals that lie outside the central rectangle formed by the intersecting
dotted lines (with the intersecting solid lines in its center) are considered
outliers and merit further investigation to understand their deviation
from the norm.

138 Public Hospitals in Developing Countries
The most striking aspect of the figure is the apparently poor perfor-
mance of Sumatran hospitals compared with those of Java and the other
islands. Most of the outliers in region I are Sumatran. Hospitals in this
region have the least desirable characteristics-low use and poor pro-
ductivity. This region is characterized by low demand for hospital beds
in relation to installed capacity, either because of a generalized low
demand for inpatient care or because alternatives to type C beds are
preferred by the population. The data in the figure suggest that an
Figure 3A-1. Indicators of Hospital Performance in Indonesia,
Type C Hospitals, 1985
Turnover rate Average length of stay (days)
3.5
70 -
60 _ - 6.2
5 .' * 0
50 II 61*11 II
~~~~~~~~~~~~~~~~~~~~~~~1 2.
40
30 0 -3
E+
Averag bedoccupancy(perce eIV )14.2
20 + t v .a
10 + 1+97
0 10 20 30 40 50 60 70 80 90 100
Average bed occupancy (percentage)
+ Sumatra 0 Java Other islands
Source: Bamnum 1987.

Hospital Costs and Efficiency 139
investigation should be made to explain this situation and develop
possible remedies:
* It should be determined whether poor performance is a function of
low medical staffing ratios, low budgets per bed, management defi-
ciencies, or overbedding in Sumatra.
* Since demand for type C inpatient services in Sumatra is low, it
may be cost-effective to consolidate inpatient services in a smaller
number of facilities and to convert some facilities into strictly ambu-
latory centers. These changes would enable reallocation of staff and
allow remaining type C facilities to become more productive.
* If it is determined that demand for inpatient care at a type C
hospital is low because the population bypasses this hospital to reach
a higher-level (type B) hospital, it may be possible to improve the
quality of services visibly at the type C hospital (for example, by
transferring resources, such as one or several physicians, from higher
levels to the type C) in order to change the population's preferences
and improve the referral system. Alternatively, if this is not feasible,
it may be better to curtail the inpatient services of the type C hospital.
* The reasons for the relatively good performance of the Javanese
hospitals that are outliers in region IJI should be assessed.
Because of expected variation in case mix, staffing, and possibly other
characteristics across hospitals of different types, for example, tertiary in
contrast to district, this methodology for assessing hospital performance
is most appropriate when applied to facilities that are similar in nature
(as in this example). Upon detailed investigation, however, one may find
that, even among a group of similar hospitals, deviations from the norm
are caused by case mix or other factors that do not necessarily imply
differences in relative efficiency across hospitals. Nevertheless, this
graphical means of identifying performance outliers among a group of
similar hospitals is both quick and effective. Once identified, these
outliers can be required to explain their deviations from the norm. By
itself, then, this graphical technique does not answer the question of
whether a given hospital is performing efficiently. It does, however,
enable one to focus attention on those specific hospitals whose perfor-
mance varies considerably from the norm.
Notes
1. Existing prices may not reflect the true scarcity of certain items in the
economy. For example, public sector wage rates may understate the value of
physician or nursing services, or an overvalued exchange rate may result in the
domestic prices of imported pharmaceuticals being artificially low. Cost esti-
mates should adjust for these distortions, or, at a minimum, note their existence
and their approximate magnitude.

140 Public Hospitals in Developing Countries
2. The occupancy rate (occ) is calculated as:
occ = I / (365-B), where
I = Annual number of inpatient days, and
B = Average number of available hospital beds during a year.
3. The average length of stay is defined as:
ALOS = I / A, where
I = Annual number of inpatient days, and
A = Annual number of inpatients (admissions or discharges).
4. The turnover rate (C) is calculated as:
T= A / B, where
A = Annual number of inpatients (admissions or discharges), and
B = Average number of available hospital beds during a year.
5. Let drug availability be measured as drug expenditure (prices are constant)
and write total costs as C = F + D, where D is drug expenditure, and F is all other
costs (assumed fixed in the short run). Define the elasticity of service use with
respect to drug availability (expenditure) as EQD = (aQ/aD)-(D/Q) and the elas-
ticity of costs with respect to drug availability as ECD = (dC/aD)-(D/C). Average
costs can be written c = C/ Q. Then the change in average cost with a change in
drug expenditure is
&/aD = ac CaQ]/D2.
Multiplyingby D/D, C/C, Q/Qand rearranging gives theelasticityof average
cost with respect to drug availability,
Tcd = (ac/aD) (D/C) = (Q/D2)- [(aC/aD)- (D/C) -(aQQ/aD)- (D/Q)]
or
TlcD = (Q/ID2) .[ECD -EQD] = (Q/D
2
) [DIC -EQDI
where the two terms in the brackets on the right-hand side are the elasticities of
total cost and quantity with respect to drugs. If the expression in brackets has a
negative absolute value the effect of a reduction in drug availability will be to
increase average costs. This highlights D/C and EQD as the appropriate param-
eters to estimate for an empirical study of the effect of drug availability on
demand and average costs. Typically D/C is about 0.3 so that EQD merely has to
be greater than 0.3 for a drug shortage to result in increased average costs.
6. The increase would depend on the values of the elasticities in the previous
note.
7. On the graph, national mean values of thebed occupancy and turnover rates
define a point. Because the average length of stay is defined as
ALOS = I/A,

Hospital Costs and Efficiency 141
knowledge of the occupancy and turnover rates identifies the average length of
stay:
I = (occ)(B)(365),
and
A = (T(B),
therefore
ALOS = (occ)(365) / T.
8. A careful analysis of inefficiencies and remedies for drug supply is given in
Quick 1982.
9. In a modestly equipped referral facility, equipment may be 30 percent of
total construction cost (about 40 percent of the cost of the building construction).
Using a rule of thumb that annual maintenance expenditure should be 1.2 to 2
percent of the capital cost of the building and 7 percent of equipment cost,
maintenance should be about 3 percent of total capital cost (0.012 x 0.7 + 0.07 x
0.3 = 0.029). If the recurrent cost ratio (see chapter 2) is between 0.2 and 0.25,
maintenance will be between 12 and 15 percent of the recurrent cost
(0.03/0.2 = 0.15).
10. The accounting view of the cost function can be written as
C = F + lWi Li + lq BDj,
i i
where F is fixed cost, Wand L are the wage and quantity of the ith type of labor,
and q and D are the price and quantity of the jth type of other nonlabor inputs.
11. The index of short-run returns to the variable factor, SRVF, set out above
could be appropriately interpreted as an index of long-run general economies of
scale if applied to a long-run cost function in which costs include the cost of
capital and the data are defined for a time period that is sufficiently great so that
all inputs, including capital stock, can vary. The estimated cost functions pre-
sented later in the chapter are all short-run cost functions (as, indeed, are most
econometric hospital cost functions). When applied to a short-run variable cost
function, the SRVF provides a measure of short-run returns to the variable factor,
as we note above, but does not measure economies of scale because scale is fixed.
If the function estimated is a short-run variable cost function the appropriate
index for economies of scale is the EOS as set out above (Vita 1990).
12. Four of these studies were done to provide background for recent World
Bank research. The Ethiopia, Colombia, and China research efforts were done as
background studies for this chapter, and the Nigeria study was carried out to
support the Nigeria health sector analysis reported in Akin and others (1991).
13. It is also possible to allocate the costs from one overhead cost center (for
example, Administration) among other overhead cost centers (for example,
Housekeeping). The step down procedure is closely related to input-output
analysis of the firm, and it could be formulated in terms of matrix algebra. For
an example of step down hospital cost study with a detailed description of
methodology, see Russell, Gwynne, and Trisolini 1988.

4. Hospital Financing
Alternatives
A growing number of countries have implemented, or are considering,
alternatives to government budget allocations for financing health ser-
vices. Because of the individual nature of the services provided and the
importance of hospitals in the total health sector budget, hospitals are a
focus for the practical application of these alternatives. Although donors
and ministry of finance officials have been supportive and, in some cases
promotive, of the use of fees and insurance schemes in the health sector
(see, for example, Akin, Birdsall, and de Ferranti 1987), the support has
in most cases fallen short of specific guidelines for pricing and revenue
collection. In this chapter we summarize the potential role of alternative,
nonpublic sources for hospital financing; present a brief outline of the
most important issues in financing alternatives; and suggest some gen-
eral criteria for setting hospital prices.
The impetus for adopting alternative financing policies in hospitals
comes from the difficulty of mobilizing sufficient funds for the health
sector from public general revenues alone and the inefficiency and
inequity of using public funds to support institutions or programs that
do not have wide benefits. In addition, problems in achieving or main-
taining acceptable quality within government budgets dictate a search
for alternative financing sources. Rapid hospital cost escalation has also
distorted the allocation of health sector resources between facilities and
programs. Financing mechanisms are intrinsically related to potential
solutions to these problems because, in addition to augmenting reve-
nues, they affect demand and supply decisions and the allocation of
resources.
Broadly, financing alternatives that respond to these problems in-
volve, either separately or in combination, public or private insurance
and direct charges to users of hospital services. User fees and insurance
are, in themselves, large topics that go beyond the scope of this study.
1
In this chapter and the next, we attempt to keep the focus narrowly on
143

144 Public Hospitals in Developing Countries
the financing mode and its effects on the use and provision of public
hospital services, although much of the discussion is applicable to other
health services as well. In order to clarify criteria for setting health
financing policy, we first set out the rationale for public sector involve-
ment in hospitals and identify the objectives of public sector health
financing, particularly as these objectives relate to hospitals. Then, in the
second section, we discuss alternative financing policies, provide broad
principles for designing cost-recovery programs, and briefly outline the
institutional characteristics of user fees and insurance as they relate to
hospitals.
Health Financing Objectives
Efficiency, equity, and revenue collection are the objectives of a health
financing policy. Problems of efficiency and equity in the delivery of
hospital services and insufficient funds for recurrent operating costs
have been emphasized in the preceding chapters. Hospital financing
policy can contribute to improved equity and efficiency of service use
and improved funding or, if ill-considered, can contribute to a worsening
of these problems. Efficiency, equity, and revenue collection, thus, are
criteria by which the performance of a financing policy can be assessed.
Efficiency
The need for public intervention in specific markets, either through
provision of goods and services directly by the government or through
market regulation, arises from market defects or failures that prevent the
achievement of an economically efficient outcome or that lead to ineq-
uities that are unacceptable. Not only does the existence of market
failures affect the choice of public services to provide, but it can affect
the appropriate choice of public financing. In this subsection we briefly
review the market failures that provide a rationale for government
intervention in the market for hospital services, and in the following
subsection we review failures related to equity.
Market failures that lead to allocational inefficiency and that require
government financing or provision of services are of great importance
for health markets in general and of moderate importance for hospitals.
Five general sources of market failure are commonly recognized-public
goods, externalities, economies of scale, inadequate consumer informa-
tion, and incomplete markets. Public goods are those goods whose con-
sumption by one person does not diminish the consumption by another
and from whose benefits it is not possible to exclude nonpaying consum-
ers if the good is provided at all. Externalities are benefits or costs that
accrue to persons other than the direct market participants. Economies of

Hospital Financing Alternatives 145
scale occur when the unit costs of production decline throughout the
range of production. Information failure exists when consumers or pro-
ducers (or both) lack information about the benefits or costs of consump-
tion or production that is needed for rational market participation.
Incomplete markets occur if uncertainty, the lack of contingent markets
(for example, consumer loans), or the lack of future markets prevents
consumers and producers from forming a market. Classification of some
services as Merit goods, is also given as an argument for public sector
activities (though this classification cannot strictly be defined as a market
failure). The argument for public support of merit goods is not based on
economic analysis but is a normative, extramarket, argument based on
a subjective evaluation by society (planners or voters) of the desirability
of providing and consuming specific goods or services.
Table 4-1 summarizes one view of the strength of each of these sources
of market failure as a rationale for government intervention in the
provision of selected broad categories of hospital services. The contents
of the table are not rigorously determined. The existence or absence of
market failure is a question of positive economics and is conceptually
Table 4-1. Strength of Rationale for Public Sector Involvement in Hospital
Services
Rationale
Econo- Informa- Incom-
Public Exter- mies of tion plete Merit
Type of service goods nalities scale failure markets goods
Inpatient
Communicable diseases .. ** .. **
Chronic diseases * ***
Accidents
Mental health * * **
Surgery * * *** *** ** Depends
Diagnostics * ** ** ** on social
Obstetrics and
Normal * * political
High risk .. * ** *** values
Outpatient
Communicable diseases .. ** ** *
Chronic diseases .. * *** *
Emergency and trauma * ** *
Preventive care * *** **
*** Strong.
** Moderate.
* Applicable but weak.
Of negligible importance.

146 Public Hospitals in Developing Countries
open to deductive reasoning and empirical validation. Still, there is
actually very little related empirical analysis on which to construct such
a table, and the importance of the various market failures could also
change in different settings. In addition, there is a wide variation of
services subsumed within each category. For all these reasons, the con-
tents of the table are open to debate. By citing specific service categories,
however, the table provides a concrete frame of reference to allow a
judgment of the overall importance of market failure in the case of
hospitals.
The first three types of market failures-public goods, externalities,
and, possibly, economies of scale-are of importance only in special
categories of hospital care. The last two-inadequate consumer informa-
tion and incomplete markets-are of greater importance. In addition, the
merit goods argument, though often implicit, is perhaps the strongest
rationale for the public sector provision of hospital services.
With the possible exception of the security provided by the existence
of emergency or trauma units, very few hospital services have the
characteristics of true public goods. Many hospital services have the
weak externality of greater labor productivity of individuals whose
health is improved by the services. In addition, a few services, especially
those involving communicable diseases, such as tuberculosis, have the
important externality of the improved health of others. In general,
however, hospital services are characterized by excludability in con-
sumption and the fact that the bulk of benefits accrue to the individual
(or household) receiving care. Thus, externalities and public goods are
not important in arguments for public provision of services or regulation
of the prices of services.
As found in the last chapter, economies of scale are not pronounced
in hospitals. When occupancy rates are low, the marginal cost of produc-
tion may be below average cost, but in hospitals operating at full capac-
ity, marginal cost is likely to be equal to or greater than average cost. It
cannot be convincingly argued that hospitals are a naturally declining
cost industry that universally require government production, but in
smaller communities, especially those in which transportation is limited,
an efficient scale of facility may have declining cost in the range of
production relevant to the local level of demand. Subsidized production
may be required in such communities if the service is to be provided. In
addition, some researchers in industrial countries (Grannemann, Brown,
and Pauly 1986) have found important economies of scale for emergency
care, and the high fixed cost of some diagnostic techniques can also
involve economies of scale.
From an efficiency point of view the most obvious reasons for public
provision or regulation of hospital care are the inadequacy of consumer
information and the incomplete market for hospital services in many

Hospital Financing Alternatives 147
settings, especially in rural and low-income areas. The inadequacy of
consumer information restricts the appropriate use of hospital services
and creates the opportunity for market exploitation through supplier-in-
duced demand. The consumer has little basis on which to judge the
appropriateness of producer-requested surgery, laboratory tests, or
other interventions. Public provision of services or private market regu-
lation, although not completely eliminating this problem, can subject
producers to greater control. Lack of consumer information may also be
an especially large problem in a setting in which the level of education
is low, because a failure to recognize the need for care and to seek services
at the appropriate time can restrict the demand for services.
On the consumer side of the market, the uncertainty of when diseases
will occur, information failure, and the long-term time horizon involved
in individual consumption decisions in health lead to incomplete mar-
kets for hospital services.
2
Incomplete markets are manifest in the failure
of contingency or futures markets to arise to finance private purchases
of hospital services. They are especially important in the failure of the
market to provide for less frequent and higher-cost medical services even
when consumers, if adequate financing were available, would pay to
protect against the risk of incurring the full cost of these services. On the
supply side of the market, capital market imperfections limit funds for
construction of hospitals in rural areas, and skilled labor shortages
restrict the operation of rural hospitals.
The market failures cited above prevent the private market from
financing an economically efficient allocation of resources directly. Pub-
lic sector involvement in the market for hospital services does not
automatically eliminate the efficiency problems posed by market failures
but instead introduces the new problem of selecting an appropriate
financing system. The financing system creates incentives for consumers
and hospital managers that affect the efficiency of resource allocation. In
general, efficiency is served if the price paid by the user reflects the
additional benefits to society from consumption of the service and the
additional cost to society of producing the service. The appropriate
pricing and financing system to achieve this is, however, not obvious.
All financing systems have potentially undesirable allocational effects.
Regulation or public sector provision of services may lead to nonmarket
inefficiency. Hospital services provided without charge may be con-
sumed beyond the point of economic optimality, that is, the marginal
cost to society may exceed the marginal benefit of the excess consump-
tion. Regulated prices, as set, for example, by a price control board, may
inadvertently provide socially adverse profit incentives for hospital
managers to produce particular services, such as CAT scans, and neglect
others, such as general wards for inpatients. Finally, unregulated private
provision may lead to a service mix that is not socially optimal because

148 Public Hospitals in Developintg Counitries
of a lack of consumer information and poorly functioning markets for
hospital services. Thus, among the range of choices, from free public
provision of the good, through regulated pricing of services provided
either by public or private institutions, to a laissez-faire private system of
service provision, there are associated potential welfare losses. This is a
sobering fact, for there are no pat answers to the hospital financing and
allocational efficiency problem. The best that health planners can do is
to remain aware of the importance of allocational efficiency as a criterion
and to attempt to achieve, not necessarily an optimal system, but prac-
tical improvements to existing arrangements that are clearly suboptimal,
as revealed in the preceding two chapters.
Equity
Evaluating the equity effects of a potential financing mechanism requires
identifying who pays, who benefits, and how much (Hoare and Mills
1986). Market failures contributing to a worsening of social equity are of
great importance for hospitals. Whereas most publicly provided health
care is intended to improve social welfare and involves a redistribution
of government revenues collected from a narrow base to provide health
services having broad-based benefits, hospitals are, in many countries,
an exception. The primarily urban location and the pattern of hospital
use by type and cost of service across income classes have equity effects
that are too often either neutral or even negative (see discussion of these
effects in chapter 2).
As with efficiency, the financing system creates incentives for consum-
ers and hospital managers that affect equity. Financing affects the inter-
action of supply and demand and thus the distribution of benefits from
resources devoted to hospital services. There are also direct implications for
equity that arise from government, NGO planning, and entrepreneurial
investment decisions. In general, equity is served if the financing system
promotes wider accessibility and use of services across income and risk
groups. Equity is further improved if the burden of payment is distrib-
uted progressively across income. Equity thus involves an interaction of
the risks of illness across different social groups, the availability and use
of services for the illnesses, and the ability of different groups to pay.
From an equity point of view, incomplete markets for services and the
inadequacy of consumer information provide even stronger rationales
for the public provision or regulation of hospital services than efficiency
does. Information failure is apt to be correlated with low education or
rural location, and incomplete markets attributable to limited access to
contingency financing are a greater problem for low-income households.
By locating in relatively poor geographic areas, using financing methods

Hospital Financing Alternatives 149
that promote the use of services by low-income groups, and providing
a referral network that is tied to outreach programs intended to increase
accessibility, public hospitals are meant to promote social goals.
In incomplete markets, hospital services are not made available, even
if demand would be sufficient to cover costs, because of a structural
imperfection that prevents a market from forming. Merit goods are a
somewhat different case in that a market with a socially acceptable price
and quantity of services cannot be established because of deficient
demand (perhaps a result of low household incomes) or the high cost of
production. In the absence of government intervention it is unlikely that
hospital services would be available and used in many rural areas and
among low-income groups in urban areas. Most countries recognize
health services as merit goods and provide some services through the
public sector, but the scope of the services included varies widely. In
some countries, free health services, including hospitals, are specified as
a social right. Other countries provide only basic hospital care to indi-
gents as a merit good. Economics does not directly determine what is
regarded as a merit good but does determine what is feasible to provide
given available resources. Many countries must face the conflict between
all that they would like to provide as a merit good and what they can
actually afford to provide.
Again, as was true for efficiency, the appropriate financing system to
achieve equity goals is not obvious, and all financing systems-whether
services are provided free or for fees by the public sector or are provided
through the private sector-have potentially deleterious (as well as
beneficial) equity effects. The provision of free hospital services by the
public sector is potentially the least deleterious, but does have the
possible adverse effect of using the public budget to pay for services that
do not address the greatest health needs of the poor (either locationally
or epidemiologically). Also, if the tax system is regressive and the
demand for hospital services is income elastic, the provision of free
hospital services may decrease equity. The introduction of fees carries
with it the obviously significant risks of damaging the accessibility of
health services to the poor. These risks can be reduced if targeting, fee
exclusion criteria, and differential pricing can be put into effect. Finally,
the equity risk of relying on the private (for profit) provision of services
is that such services will cater to the needs of higher-income groups and
be offered only where sufficient monetary incentives exist. Conversely,
however, each system also has potentially beneficial effects. It is more
illuminating to view alternative financing mechanisms not as purely
competing but as potential components in an eclectic system of balanced
public and private care that combines elements of free service provision,
the use of fees, and some form of risk coverage.

150 Public Hospitals in Developing Countries
Revenue
If we distinguish three levels of budgeting-central finance, the health
sector, and the hospital-then we can identify three competing revenue
goals that motivate administering agencies to use nongovernmental
sources of hospital financing. Conceptually, the three goals result from
the desire of the administrative agency at each level to maximize reve-
nues under its control and retain flexibility in allocation across budget
items within its jurisdiction. The three competing goals are:
* to supplement a hospital's resources derived from the government
budget, that is, to add to the hospital's budget;
* to substitute for the hospital's allocation from the health sector
budget and provide supplemental funds for other health activities,
that is, to add to the health sector budget and reallocate part of the
hospital budget to other programs; and
* to substitute for governmental sources of health revenues, that is,
to add to the central government budget.
Outcomes between supplementation and substitution are also possi-
ble. For example, a part of alternative collected revenues could be used
to supplement the hospital's budgeted resources, a second part could be
used to supplement other health activities, and the remainder could
provide a partial substitute for the government subsidy to health at
either the local or central level. Such a remainder would be analogous to
tax revenues and would yield an increase in government general reve-
nues.
These revenue goals and the efficiency and equity goals of cost recov-
ery are related. For analytical darity, the theory of public finance sepa-
rates the effects of revenue and expenditure policies, and to the extent
practical we attempt to keep this distinction. Yet in execution, revenue
and expenditure policies are often linked. The distinction between the
three goals above implies that such links are seen by government admin-
istrators and motivate revenue policy. If revenues are kept by the hospi-
tal and do not supplant existing subsidies, they make improved quality
of services or greater quantity of services possible, and the effects on
efficiency and equity are then determined by hospital policy. If revenues
are kept within the health sector at the local level, they may make
additional nonhospital services possible; depending on local health
sector policies there may then be cross-subsidization between hospital
and nonhospital services and attendant changes in efficiency and equity.
The accrual of proceeds of hospital financing alternatives at the central
level holds other possible benefits. In this case, the government can use
the resources to bolster the central-level program that is deemed to have
the greatest social benefit.

Hospital Financing Alternatives 152
Strictly interpreted, the theory of public finance leads to the conclusion
that the central level is the best locus for accrued revenues. If geographic
redistribution of the funds is needed to improve efficiency and equity,
the central government may be a more effective end user of new reve-
nues. Practically, however, accrual of revenues at the local level appears
to provide a good compromise between the flexibility of central govern-
ment accrual and the increase in quality made possible by hospital
accrual. In many practical situations, the retention of revenues at the
local level would provide the greatest possibility for effective use of the
funds. Local governments have the most immediate knowledge of alter-
native effective and equitable uses of funds and are most flexible in
response. Local officials also are more acutely aware of hospital funding
requirements. An unconstrained choice among program alternatives,
rather than restriction of choice to hospitals or a given sector, can result
in the greatest benefit.
Revenue stability. Achieving greater revenue stability for the health
sector can also be an objective that motivates administering agencies to
use nonbudgetary financing altematives. During economic recession,
brought on, for example, by a decline in the price of an important export
commodity such as oil in Indonesia or copper in Zambia, recurrent
financing in the health sector falls more or less in tandem with a decine
in government revenues. By providing an alternative source of funds
that is less sensitive to fluctuations in the government budget, the use of
alternative financing for hospitals can reduce the effect of economic
recession on health programs.
TIhe efficiency of revenue collection. There is a further relation between
these goals, the kind of nongovernmental financing, and the degree of
efficiency of collection of nongovernmental revenues (where efficiency
is measured as the proportion of potential revenues, given the defined
revenue policy, that are actually collected). Depending on the form of
financing, the collection of revenues may be more efficient at the central,
intermediate governmental, or institutional level. The revenue goals can
involve either partial or full recovery of hospital costs (or even the
generation of hospital profits). There is a link between the extent to which
actual revenue collection can achieve the intended proportion of cost
recovered and the kind of financing and institutional form and level of
collection.
As an illustration we consider the relation between the efficiency of
fee collection and government accrual policy. For any given level of
prices, potential levels of demand and revenues are determined. The
revenues actually collected from hospital user charges are generally less
than those that potentially could be collected if all users of hospital

152 Public Hospitals in Developing Countries
services paid the designated amount. The principal reason for this is that
lax enforcement of fee policy allows nonexempt patients to receive
hospital services and never pay for them. Comparing actual with poten-
tial revenues allows an assessment of the performance of alternative
financing mechanisms, given prices.
Anecdotal evidence (for example, see Collins 1990; Overholt and
others 1990; Vogel 1988) indicates that there is an inverse relation be-
tween the governmental level at which fees accrue and the efficiency of
fee collection. The general recommendation is to allow fees to accrue as
closely as possible to the collecting level in order to provide an incentive
for managerial surveillance and enforcement of fee policies. There is, of
course, no conflict between this recommendation and the revenue goals
if the intention is to allow supplementation at the institutional or local
level (the first two revenue goals listed earlier). Critically, even if the goal
of government fee policy is substitution at the central level (that is, the
third revenue goal), and, therefore, a reduction of the net government
subsidy after fee revenues returned to the central level are subtracted,
some retention of fees at the collecting level is needed to provide a
collection incentive.
3
Alternative Policies
Public sector hospitals in developing countries receive revenues from a
large variety of budgeted sources. Financing from government budgets
can occur at the central, local, or intermediate level, and at each of these
levels more than one agency budget may be involved. Sources of the
government budgeted revenues are in themselves based on a diverse tax
and financial base, perhaps including earmarked taxes and donor trans-
fers. Collectively, the hospital revenues derived from these sources are
a subsidy from the governmental budget allocation. In the next two
subsections we discuss fees and risk sharing as alternatives to subsidies
from governmental budget allocations that would shift a greater part of
the financing burden more directly to household or community sources.
Fees
Fees, if they are to be substantial enough to achieve revenue objectives
and cover a significant proportion of hospital costs, must be set with a
recognition of their effects on demand and user welfare. Conceptually,
fees can improve efficiency of resource use by reducing use of hospital
services for care with negligible benefits, removing demand in excess of
existing supply capacity, and providing appropriate allocational incen-
tives to both producers and consumers. Fees can also have adverse
effects on equity by impeding the access of the poor to needed services.

Hospital Financing Alternatives 153
The few studies that have been done of the demand elasticity of user
choice of services (table 4-2) suggest that users are not highly responsive
to changes in the price of health care. The low elasticities in these studies,
however, do not of themselves indicate either that the efficiency gain
from fees or the adverse equity effects of fees is low. First, all the
econometric studies on user fees cited in table 4-2 have been carried out
where fees are low or nearly negligible. It does not follow that one can
extrapolate from the results of these studies to estimate the quantity
response to substantial fees. Second, even if the price elasticity is truly
low, the welfare effect of fees can be significant because, in households
that have fixed incomes, increases in fees imply that the consumption of
other goods or services, possibly food or education, could be reduced.
Thus, the use of fees can have implications not only for revenue but also
for efficiency and equity objectives.
Pricing principles. Guided by the efficiency, equity, and revenue objec-
tives, we can elaborate a normative set of practical principles for a system
of health sector fees in government institutions.
4
These principles in-
clude considerations of (a) ability to pay, (b) fees as resource allocation
signals, (c) the relation between fees and quality, and (d) market failures.
Table 4-2. Price Elasticities of Demand for Health Services
Price range
Year of data Country Service (U.S. dollars) Price elasticity
1985 CUted'Ivoirea Clinic Free-$0.11 -0.32
$0.11-$0.22 -0.62
Hospital Free-$0.11 -0.38
$0.11-$0.22 -0.83
1985 Perua Clinic Free-$1.56 -0.46
$1.56-$3.12 -0.68
Hospital Free-$1.56 -0.41
$1.56-$3.12 -0.64
1984 Kenya Outpatient Free-$0.13 -0.05-0.20
1975 Malaysia Public outpatient - -0.15
Public inpatient - -0.00
1981 Philippines Prenatal care - -0.01
1985 Ethiopia Outpatient - -0.05-0.50
1990 Nigeria Outpatient - -0.04
1986 Sudan Outpatient care - -0.37
-Not available.
a. Arc elasticity was calculated in price ranges given and for middle-income group.
Sources: Gertler and van der Gaag 1988,1990 (C6te d'lvoire and Peru); Heller 1982
(Malaysia); Akin and others 1986 (Philippines); Donaldson and Dunlop 1987 (Ethiopia);
Mwabu and Mwangi 1986 (Kenya); Akin and others 1992 (Nigeria); Schwabe, n.d., as
quoted in Jimenez 1989 (Sudan).

154 Public Hospitals in Developing Countries
* Fees should be consistent with ability to pay and should not prevent essential
access to health care. A direct interpretation of this principle would sup-
port price discrimination among users on the basis of income. Some price
discrimination may be practical between urban and rural locations or
across geographical regions insulated by high travel costs, but within a
given geographic location or institution, price discrimination can be
difficult to enforce. In the appendix to this chapter, we show that indirect
price discrimination in which fees with differing profit or loss margins
for services consumed by different income groups can achieve consider-
able equity gains and can substitute for direct price discrimination.
Detailed price discrimination in which several price tiers are used may
be impractical, but some provision should be made to recognize and
exempt the very poor from the burden of fees. It may be feasible in
smaller institutions to base such exemptions on the judgment of local
officials. For larger hospitals, however, a system of formal identification
of income status is needed. Still, local control of the identification of the
indigent may be practical.
In setting equitable fees, it should be recognized that the actual fee
paid to the hospital or clinic is only a part of the true price to the user.
Transportation and out-of-pocket drug expenses can be large. In some
health systems patients or their relatives supply meals and bed linen.
Surveys of the cost of services to patients should inform the design of a
fee system. The system of fees needs to provide some limitation on the
out-of-pocket expenses of patients. Such a limitation is particularly
important for long stays in hospitals or extended outpatient treatment
of chronic diseases.
-Fees should provide correct signals for the direction of the use of health care
and health sector resources. One of the most commonly cited reasons for
imposing user fees is to provide signals that discourage unwarranted use
of services that have high costs but comparatively low benefits. The
system of fees is an essential component in establishing an efficient
referral network that avoids the loss of welfare that accompanies inap-
propriate use of services at upper referral levels by patients who ignore
the referral requirements. Patients who use upper-level services directly
can be viewed as using luxury services and be charged as such. One
possibility is to forgive part of upper-level charges for patients who are
appropriately referred.
* Fees and the quality of services should be linked. The introduction of fees
will result in consumer dissatisfaction and possibly unacceptable de-
creases in demand if the quality of services is not perceived to be
sufficiently high. Quality that is perceived as low at entry levels of
referral is the primary reason that clients attempt to avoid established
referral chains and go directly to more costly institutions. Several studies
have advocated tying increases in fees to increases in quality of services

Hospital Financing Alternatives 155
by using the revenues obtained to improve the availability of pharma-
ceuticals and provide other improvements in quality. A crucial empirical
assumption underlying this recommendation is that the decrease in
demand for services in response to the higher fee will be more than offset
by the increase in demand in response to the higher quality. A simulation
of the equity and efficiency effects of fee increases with accompanying
quality increases based on data from several hundred health units in
Kenya demonstrated a net increase in welfare (Mwabu and Mwangi
1986). Similarly, simulations based on estimated demand functions
demonstrate that quality increases more than offset the minimal reduc-
tion in demand that accompanied fee increases in Ogun State in Nigeria
(Akin and others 1991). These findings are particularly important with
regard to public hospital care at the district level; low usage at this level,
even when services are free, is often explained by the poor quality of
services and lack of availability of essential complementary inputs.
* Fees should be subsidized for services that have important externalities, are
primarily publicgoods, have low consumption due to informationaldeficiencies,
or are merit goods. As noted earlier, goods with externalities have benefits
that accrue not only to the individual receiving the service but to others
as well. The externalities involved in the consumption of many preven-
tive health services can be substantial and justify government interven-
tion, including subsidization, to achieve an economically efficient level
of use. It can be argued that obstetrics and some curative services, such
as tuberculosis treatment, have external benefits, but generally hospital
services do not have significant externalities. Also, as previously indi-
cated, public goods are characterized by the impossibility of excluding
nonpaying users from the benefits of consumption. Examples in health
are vector control and some of the community monitoring services of
public health laboratories. Hospital services have negligible public good
attributes. Inadequate consumer information, in contrast, is an import-
ant problem that affects the appropriate use of health care, including
hospital services. Without a good understanding of the benefits of a
potential service, the consumer cannot determine if or when consump-
tion is warranted. Subsidies are warranted if the lack of information
results in underuse of services.
Although merit goods do allow excludability in consumption, it is
considered necessary to subsidize them or provide them free to the
public because their consumption is deemed to have social merit or be a
social right. Public provision of merit goods is related to equity values
and political processes. Many countries implicitly consider hospital
services merit goods as evidenced by their heavy subsidization, given
that they do not qualify for broad-based subsidies on other grounds.
Merit goods need continued and careful justification for their public
provision, favorable pricing, or subsidization.

156 Public Hospitals in Developing Countries
Administrative feasibility of fee collection. The introduction of fees in a
hospital that has not previously charged for services, or in which the
charges have previously been minimal or sporadically collected, can
present potentially daunting problems of administration. The manage-
ment system and physical plant arrangements must provide checks
against theft, fraud, and uneven enforcement of exemption rules and
allow for accountability and monitoring of the flow of collected funds.
Installation and maintenance of a practical system of collection require
staff time, training, and even some minimal equipment, all of which have
an associated cost. The collected fees (together with the value of any
gains in economic or technical efficiency from the introduction of a price
system) must exceed the cost of collection in order to justify implementa-
tion of a user charge system.
In a survey of fee collection systems in West Africa, Vogel (1988) gives
some useful pointers for successful fee collection systems:
* Well-defined entrance points for the hospital
* The issuance of receipts, with duplicate copies, to serve as evidence
of payment
* A rigorously enforced system for determining those eligible for
exemption
* Training for all staff to confirm the importance of enforcing collec-
tion
* Periodic spot checks to establish that the above points are being
carried out by all staff
* Periodic audits of the financial transactions and flow of funds.
These elements are needed for successful collection with even the most
simply defined fee schedule. Daunting though this may seem, the prac-
ticability of fees in diverse settings is demonstrated by the existence of
active fee collection in nongovernmental, nonprofit hospitals, often in
geographic areas where governmental hospitals provide services with-
out charge.
Optimal pricing. A standard result of economics is the optimality, in the
sense of achieving the greatest welfare with a given set of resources, of
prices equal to marginal cost. This optimality holds for a competitive
equilibrium in markets that supply private goods (as opposed to public
or merit goods) to well-informed consumers and in which there is free
entry and exit of firms. Hospital services are not provided under these
conditions. The failure of the market for hospital services requires regu-
lation of provider behavior and may require subsidized provision of
services. Under these conditions the greatest welfare within the con-
straint of the public budget (or quasi-public institutional budget) can be

Hospital Financing Alternatives 157
achieved by prices that reflect the demand and equity characteristics of
the good as well as its marginal costs. The appendix to this chapter
reviews some rules of optimal pricing as they relate to the problem of
pricing hospital services. The rules provide an explicit specification of
prices that are consistent with the general thrust of the principles out-
lined above. Broadly, the rules contribute to equity goals by incorporat-
ing the distribution of income and setting lower prices for services
consumed disproportionately by the poor. The rules also contribute to
efficiency goals by setting prices that interfere minimally with private
preferences.
Detailed exploration of optimal pricing would carry the discussion too
far afield and into the realm of technical economics, but it is noted here
because it holds out some promise of being useful as a guide in setting
rational hospital prices that are consistent with planning objectives.
Optimal pricing is suggested in this context, not with the thought that
the principle should be applied rigidly, but that it can be used for
guidance, together with a less quantitative interpretation of the pricing
principles, to set prices that can achieve revenue and efficiency objectives
without sacrificing equity.
Price simulations for three broad categories of bundled services, which
can be interpreted as successively higher amenity levels of inpatient care,
are discussed as an example in the appendix to this chapter. The simu-
lations apply optimal pricing rules, using plausible ranges of required
information (on income distribution and distributional objectives, price
and income elasticities, budget and subsidy levels) to derive pricing
coefficients that are multiplied by the marginal costs of services to give
the optimal prices. Some broad implications can be derived from the
simulations.
First, the optimal prices are small, but positive, for services that would
be used by groups that have the lowest income. Given the plausible sizes
of income elasticities used in the simulations, the proportion of marginal
costs recovered is very small for the category with the lowest income
elasticity (this would correspond, say, to ward care) but substantially
higher for the category with the highest income elasticity (this would
correspond, say, to a private room with special amenities). In hospitals
with 80 percent of total cost subsidized from public revenues, the ratio
of the pricing coefficients of the highest to the lowest categories of care
is approximately 30:1.
Second, as the subsidy decreases, that is, as the proportion of total cost
to be recovered from patient fees increases, the ratio of the high- to low-
category pricing coefficients decreases markedly. Going from an 80 to 40
and then to 0 percent subsidy, the ratio falls from 30:1 to 12:1 and finally
to 4:1. Thus, as the subsidy is reduced the latitude for cross-subsidization

158 Public Hospitals in Developing Countries
is also reduced, with the lowest elasticity category taking on an increas-
ingly greater burden of the cost of services. Even at a zero subsidy,
however, the optimal pricing rules generate some cross-subsidization,
with the pricing coefficient remaining less than one for the lowest service
category but rising to above one for the highest categories.
Third, the pricing coefficients are moderately sensitive to the income
elasticities. A lower elasticity for a given service produces a lower pricing
coefficient on that service and a higher coefficient on other services. At
a 40 percent subsidy and with income elasticities of 0, 0.3, and 1.5 for the
three categories of services, the pricing coefficients are 0.12, 0.68, and
1.42, respectively. If the income elasticity for the highest category falls to
1.0, the pricing coefficients for the two lowest categories rise to 0.15 and
0.75, whereas the coefficient for the highest category falls to 1.20. This
sensitivity illustrates the importance of further empirical studies to
derive the demand characteristics of hospital services.
Fourth, the pricing coefficients are not highly sensitive to the income
distribution through a range of realistic values from recent household
surveys, but the coefficients are sensitive to the distributional objectives
guiding government pricing policy. A standard normative principle in
economics is that added income brings about increased welfare, but
successive additions to income bring ever-smaller increments in welfare
(this is the principle of diminishing marginal utility). The simulations
are based on the subjective assumption that a given percentage increase
in income is accompanied by an equal proportional decrease in the
increment to welfare. The effect of this assumption is sufficiently human-
itarian to lead to relatively aggressive redistribution objectives. If, in-
stead, government planners believe that the increment to welfare falls
faster (more slowly) than this assumption indicates, the extent of cross-
subsidization implied by the pricing coefficients increases (decreases)
markedly.
The actual pricing schemes in selected public hospitals in which there
is an attempt to mount more than a nominal cost-recovery program are
not greatly at variance with the implications of these simulations. An
examination of the pricing coefficients produced by the simulations and
the coefficients derived from the actual costs and prices for a level II
hospital in Indonesia serves to illustrate their similarity. Expressly stated
goals of Indonesia are to provide accessible hospital services for groups
with the lowest incomes and to institute a program of modest cost
recovery. On average, public hospitals in Indonesia subsidized about 80
percent of total cost, recovering the remaining 20 percent from user
charges. With an 80 percent subsidy the optimal-pricing coefficients
from the simulations are 0.03, 0.18, and 0.60, respectively, for the low-,
middle-, and high-amenity (low-, middle-, and high-income elasticity)
services. Based on the 1984 pricing guidelines of the Ministry of Health

Hospital Financing Alternatives 159
as implemented in a small level II hospital, the implicit price coefficients
for low-, middle-, and high-amenity services are 0.04, 0.30, and 0.51.5
Thus, the Indonesian coefficients are taken as consistent with the opti-
mum pricing simulation, and the pricing scheme used in the hospital is
in line with the relatively egalitarian equity goals as well as a revenue
objective of 20 percent cost recovery.
Risk Sharing
The high cost of hospital services, coupled with the randomness of many
health needs, is the primary reason for the importance of insurance as a
means of financing health services. The introduction of optimal pricing
as a means of achieving the equitable distribution of care will not fully
adjust for all the equity concerns that arise in the use of hospital services.
If the total revenues raised through fees are to offset a substantial part of
total costs, then the prices charged for all goods, even those demanded
by low-income groups, must be a high proportion of unit costs. Hospital
services are by far the most expensive health goods consumed and,
depending on the illness, the cost of a hospitalization can easily amount
to a multiple of per capita annual income. Modest fees for primary health
care services at and below the level of the health center may be absorbed
by the majority of the population without a risk of great financial loss,
but the introduction of substantial fees for hospital services adds a risk
of heavy financial costs to households and creates a need for insurance.
Some health needs occur randomly throughout the life of all individ-
uals and thus, within a narrow confidence band, are predictable. But
savings arrangements or contingent asset and credit markets may be
inadequate to finance these predictable costs. In addition, other, unusual,
health needs are unpredictable from the point of view of the individual.
The cost of adequate treatment for many unpredictable illnesses can
easily prove to be a catastrophic burden substantially affecting the
welfare of the household. Health insurance improves efficiency by pro-
viding a form of earmarked savings for predictable risks and can also
improve equity by spreading the risk of the cost of unpredictable illness
among all households.
The availability of health insurance varies among developing coun-
tries. In those in which health services are heavily subsidized, govern-
ment is implicitly covering individual risk, though this coverage is not
actuarially based. Interpreted in this light, government provision of free
services is a form of social insurance with no deductible and with zero
coinsurance rates. Such subsidization limits the demand for more ex-
plicit forms of health insurance. High administrative costs and a lack of
an institutional mechanism for collection in rural areas may also impede
the use of health insurance. Also, an actuarially adequate premium may

160 Public Hospitals in Developing Countries
be beyond the capacity of many households. For these reasons private
insurance markets that cover individuals are often not well developed,
and those that do exist usually cover only a small fraction of the popu-
lation. Informal insurance arrangements, in which the financial risk is
shared among the members of a community or extended family, may
exist in some areas, but such mechanisms are apt to function unevenly.
Employer plans providing either direct services or third-party risk cov-
erage are also not common and cover only selected parts of the popula-
tion. Government social insurance programs with a medical care
component are more prevalent in Latin America but are rare and gener-
ally cover only a small proportion of the population in most African and
Asian countries.
There is growing interest in government-provided insurance in many
emerging economies, but experience in Latin America and the industrial
countries demonstrates that adoption of social insurance must be done
circumspectly if the programs are not to have unintentionally adverse
effects. In many low-income countries the best choice may not be an
explicit program of government-sponsored health insurance. In spite of
the theoretical advantages of health insurance, specific schemes must be
formulated carefully if substantial positive equity and efficiency benefits
are to be realized.
Poorly devised health insurance schemes and those designed to ben-
efit only specific population subgroups can result in a deterioration
rather than an improvement in social welfare. For example, the use of
health insurance to cover subsets of the population, such as civil servants
or urban workers, in a partially monetized economy raises important
equity issues. This is especially true if, as is generally the case, govern-
ment revenues partially subsidize the superior quality and greater per
capita quantity of services consumed by the insured population.
Schemes can also create incentives to use resources inefficiently. Finally,
the use of insurance introduces problems of administrative feasibility
that are even greater than those brought about by the use of fees them-
selves because of the need for more careful accounting and administra-
tion, both in the collection of premiums and in the delivery of services.
This difficulty in administration has been an important reason that
insurance schemes have not been used more widely in poor economies.
In the next chapter, we review experience with a selection of schemes
and note potentially adverse effects in equity and efficiency. In the next
few pages, we briefly review the principles of some risk-sharing alterna-
tives and note salient aspects related to hospitals.
The type of insurance plan and efficiency. There are several possible ways
to design health insurance schemes, and within the general formulation
of each scheme there are many parameters that must be set correctly if

Hospital Financing Alternatives 161
the scheme is to have a positive effect on the overall welfare of the
population (Akin 1987). Broadly, we can classify insurance schemes into
two principal types: third-party retrospective reimbursement and pre-
paid health care organizations. Among the many parameters defining
the scheme, we focus our attention on the services to be covered, the
magnitude of the health event to be covered, the population groups
induded, and the size of the premium and copayment. The choice of
scheme and parameters closely affects the functioning of hospitals.
Critical to an appropriate insurance plan are the implications it contains
for client and provider behavior. Different reimbursement arrangements
can bring about marked differences in the kind and quantity of services
demanded by patients and given by hospitals.
In plans providing retrospective reimbursement on a fee-for-service
basis, the individual pays a periodic premium to cover possible expen-
ditures for specified services in the future. The premiums from different
individuals are pooled and only used to cover services as needed at
random by members. Hospitals are reimbursed retrospectively for the
cost of each service provided. This payment system gives hospitals an
incentive to add to revenues by maximizing the volume of services
provided per patient and providing the most costly services possible. As
is true of all insurance systems, patients have no incentive to be concerned
with the cost of care unless there are cost-sharing provisions. The effect
of this hospital reimbursement system is to increase health care costs.
One possible means of countering these adverse incentives is a regulatory
process whereby hospitals can be denied reimbursement for services
determined to be unnecessary. Of course, such a process is itself costly.
An alternative retrospective reimbursement plan reimburses the hos-
pital a fixed amount per case or admission, which is to cover all services
provided to the patient during his or her stay. The cost-containment
incentives are superior to those of fee-for-service reimbursement, as the
hospital is encouraged to minimize service inputs per admission. On the
other hand, the hospital may try to maximize the number of admissions
for which its margin of reimbursement above treatment costs is greatest
(that is, hospitals may try to choose healthier patients). To mitigate this
problem, diagnostic and other patient or procedural information may be
used to group patients into categories, each with its own case payment
rate (Fetter and others 1980). The difficulties of defining diagnostic
categories, establishing and periodically adjusting case reimbursement
rates, and policing and administering this type of plan can be formidable,
however. Case-based reimbursement raises concerns about quality of
care, given the incentives to minimize inputs per case. These concerns
can be addressed through some combination of quality-based competi-
tion among hospitals or insurers, and utilization review and other forms
of regulation.

162 Public Hospitals in Developing Countries
Finally, prepaid capitation provider plans (an alternative terminology
is health maintenance organization, or HMo) remove provider incentives
to increase the cost of care. In these plans, the provider is prepaid a fixed
amount to cover health care needs during a specified time interval and
then delivers services as needed without further reimbursement. This
arrangement focuses on the population rather than on the providers to
be reimbursed; therefore, a capitation health plan should involve all
levels of personal health services so that the care of individual patients
may be managed cost-effectively. One form of this model is direct
insurance, in which the provider and insurer are the same institution and
thus respond to the same incentives. In contrast to the retrospective
reimbursement plans, the capitation plan introduces provider incentives
to reduce both the total number of admissions and quantity of services
provided per case. With these incentives providers may lower the qual-
ity of care in order to reduce the cost of services. As in case-based
reimbursement, the means of mitigating such effects would be either
competition among prepaid plans or some form of regulation that would
ensure quality.
In all these schemes there is an incentive, termed "adverse selection,"
for high-risk patients, whose health needs will probably exceed the cost
of the average claim, to join and the converse incentive for low-risk
people. There is also an incentive, termed "selection bias," for insurers
to exclude high-risk persons from their risk pools in an attempt to
maximize the margin between premium income and claims paid. Ad-
verse selection can greatly increase the cost of an insurance program if
there are significant differences in relative risk across insurance groups,
and selection bias can create equity problems if high-risk persons are
unable to obtain insurance. The effects of adverse selection and selection
bias can be reduced by requiring enrollment in insurance plans across
broadly defined client groups or by organizing insurance plans around
other broadly defined groups.
Insurance can also create an incentive for clients to change their
behavior, which can affect the cost and quantity of services demanded.
Such changes occur because the clients are less concerned about possible
financial loss. For example, high-risk pregnancies and the use of hospital
services for delivery might increase if the cost of obstetrics is covered by
insurance. This phenomenon is called "moral hazard." The effect of
moral hazard can be reduced by limiting benefits or by requiring a
copayment or deductible from clients for part of the cost of services. The
argument for including cost sharing as part of an insurance scheme is
similar to that for instituting user charges in formerly free care systems.
Excess use of services resulting from moral hazard is equivalent to what
is often termed "unnecessary utilization," which arises in free care
systems. In both cases, the high demand is the rational response of
consumers faced with a very low priced good.

Hospital Financing Alternatives 163
Equity and government insurance. Government-sponsored health insur-
ance for specific employment groups such as civil servants has been
proposed as a means of transferring resources from urban to rural areas
and from high-income to low-income health service users. The argument
is that most high-cost hospital services are consumed in urban areas and
by specific employment groups whose income is higher than average,
and that the revenues obtained from insurance premiums and
copayments in urban areas can be used to cross-subsidize rural services
for poorer people. This is a valid argument as long as the revenues
obtained are greater than the cost of services provided; in this case the
cross-subsidization will go in the direction intended. Review of actual
experience, however, reveals that revenues seldom exceed the cost of
services. Instead, the government subsidy of urban hospital services
covered by insurance is often substantial and, depending on the source
of revenues, the equity effects are adverse. For example, the ASKES
insurance program provides free hospital care for Indonesian civil ser-
vants but reimburses hospitals only about 15-25 percent of the cost of an
average inpatient stay. Furthermore, the hospitalization rate for ASKES
beneficiaries is about five times the national average (Prescott 1991).
Thus, moral hazard magnifies the negative impact on equity of provid-
ing insurance coverage for subsidized hospital services to a part of the
population that is relatively well off. Government health insurance
plans, therefore, need to be established in conjunction with a careful
choice of services covered, a knowledge of unit costs, and premium and
copayment levels that will achieve the desired distributional objectives.
One possible way to reduce the adverse equity problem is for the
government-sponsored plan to include only a defined minimum benefit
package covering amenity levels and services that provide adequate care
for the average consumer, to charge fees for services excluded by the
benefits package, and to leave the provision of additional coverage to
private insurance.
Prepaid plans and hospitals. Prospective payment plans can be organized
on a modest scale and provide a means of increasing revenues for specific
hospitals or groups of hospitals within a community. Through use of a
prepayment plan, rural communities served by district hospitals can
achieve greater financial autonomy and reduced dependence on central
budget sources. Such plans can also yield improved efficiency in the use
of providers if the prepayment amount covers all personal health ser-
vices for plan members, not just hospitalization. In this case, providers
have the incentive to steer enrollees in the plan to the least costly service
delivery setting.
The advantages of a prepaid plan are that they reduce the incentives
for excessive consultations, excessive diagnostic tests, and higher drug
use and surgical rates that are reported to exist with a retrospective

164 Public Hospitals in Developing Countries
payment system (Shimmura 1988). The administrative costs of prepaid
plans are less than those of reimbursement schemes because of the
reduced need for billing information and records, and the requirements
by management for information within the hospital are less than those
in retrospective payment schemes. As is the case for retrospective plans,
however, a copayment may be needed to reduce demand for less neces-
sary treatment and to improve economic efficiency.
Type of service covered. There is a conflict between the need to cover only
catastrophic losses to reduce the cost of an insurance plan and the need
to include broader, noncatastrophic coverage to avoid the introduction
of spurious overuse of higher-cost hospital services. This conflict exists
under both retrospective and prospective plans, although it is most
relevant for retrospective plans because coverage under such plans is
often narrow, whereas prepaid plans commonly provide broad coverage
of services. Some authors (for example, Griffin 1989) have recommended
that only catastrophic costs be covered. The difficulty lies in defining the
basis and limits of the coverage. Perhaps the best possibility would be to
set the limits of the coverage on the basis of individual annual health
expenditures or (slightly less desirable) on the basis of an individual
health event. Insurance would become applicable only above a certain
absolute amount. This arrangement would place a burden on the con-
sumer of keeping records and then filing claims as justified. The require-
ments for literacy, numeracy, and organization may be too great,
however, for low-income groups in many countries. A second possibility
would be to define "catastrophic" in terms of specific services to be
covered, such as inpatient care of more than a certain number of days,
emergency services, or specific diseases. This arrangement, although
more practical in terms of recordkeeping and administration, could
greatly distort the use of hospital services by encouraging providers to
use unwarranted services in order to claim insurance coverage. Control-
ling such misuse of services would probably require regulation and
monitoring.
Limiting insurance to catastrophic coverage also results in a loss of the
efficiency gain provided by the credit or savings function that comes
from covering the cost of subcatastrophic random care. By extending
coverage to selected services provided by health centers and hospital
outpatient departments, copayment levels for the lower referral levels
can be set so that patients are encouraged to use these less costly settings.
The cost of the services can then be offset from the insurance fund
composed of accumulated premiums.

Hospital Financing Alternatives 165
Summary
In this chapter we have outlined the principal cost-recovery alternatives
to the financing of hospitals from public sector budgets. All the alterna-
tives have potential effects on the use and provision of services that are
both beneficial and detrimental to welfare. The planner's dilemma is to
weigh the benefits and costs associated with the alternatives in order to
design a scheme that is most suitable for a given environment. Many of
the effects can be attributed to the incentives created by the financing
mechanism for consumers and providers. Responses to these incentives
may differ across institutional and cultural environments. For example,
the behavior of providers depends on whether they are motivated by
quantity, revenue, or profit maximization; cost minimization; quality
objectives; or some combination of these. The behavior of consumers is
affected by their education, income, and perception of the quality of
facilities; the range of providers from which to choose; and the degree of
practical control the consumer has over treatment.
There are dozens of variations on the basic fee and risk-sharing alter-
natives. Table 4-3 provides a very general summary of the incentives
inherent in six broad financing options, ranging from high fees and no
insurance through high fees and partial insurance to capitation pay-
ments for managed health care. Some of the options, such as high user
charges and no insurance, clearly create incentives that adversely affect
equity. Other options, such as free public provision of services or,
equivalently, full insurance coverage without cost sharing, create incen-
tives that encourage inefficient use of resources. Practical systems that
avoid or control these adverse effects through exemptions, partial cov-
erage, capitation, or price discrimination are apt to vary and be tailored
to the situation in a given country or geographic area. In the next chapter,
we examine the actual experiences of hospitals in recovering costs with
the financing options outlined above.

166 Public Hospitals in Developing Countries
Table 4-3. Summary of Incentives Inherent in Alternative Financing Policies
Incentives
Policy Providers Consumers
High user charges Maximize billable Incentive to reduce use,
(fee-for-service) services, possibly but without insurance,
constrained by access to expensive
awareness that services is difficult for
consumers' ability to many
pay is limited
Fee-for-service plus Maximize billable FoT the insured
third-party insurance services; producer is population, quantity
with no cost sharing virtually unconstrained demanded is the same as
by consumers' ability when money price is
to pay zero; no cost
consciousness
Third party fee-for- Maximize billable Some cost consciousness,
service insurance with services but demnand still greater
cost sharing than if consumers faced
full prices
Insurance coverage Minimize costs per Extent of cost
using prospectively patient, maximize consciousness depends
determined admissions of patients on existence and
reimbursement whose treatment costs magnitude of cost-
rates per case are less than sharing provisions
reimbursement amount
(that is, shift case mix);
report diagnoses or
procedures for
ambiguous cases that
maximize reimbursement
High fees plus Maximize billable Inequitable access to care
insurance coverage services; focus on the because price to the
of only part of the insured from whom insured is much less
population reimbursement is than to the uninsured
guaranteed
Insurance coverage Keep total health care Guided through the
financed through costs for covered network of providers;
capitation payments population below sum typically faced with high
and administered as a of capitation payments; money prices if they
managed care system; this may lead to cost- violate the structure of
also direct insurance effective allocation of the managed care system
resources or
underprovision
(especially if there is
no competition among
providers)

Hospital Financing Alternatives 167
Appendix 4A. Optimal Prices for Hospital Services
The crux of a cost-recovery policy lies in setting prices and insurance
parameters that promote the equity, efficiency, and revenue goals that
are the objectives of financing. Fortunately, the general problem of
setting prices in the public sector has received growing attention by
welfare theorists during the last twenty years, and a flexible theory of
public sector enterprise pricing has arisen. The literature is capable of
illuminating important pricing and insurance issues and, in particular,
holds promise for application to hospitals.
Fees
A well-known result of welfare economics states that to achieve optimal
(Paretian) efficiency, prices for all firms should be set equal to marginal
cost:
(4-1) P =MC.
Were it not for market failure, and equity, the setting of fees for public
hospitals could follow this simple rule to achieve economic efficiency.
However, market failure and a concern for equity limit the application
of marginal cost pricing for hospitals (Baumol and Bradford 1970).
Optimal pricing principles for public enterprises provide an adjustment
to marginal cost pricing that can be used to address questions of market
failure and equity.
Public enterprise pricing (Ramsey pricing). To achieve social and political
objectives, hospital services are provided at less than cost and supported
by government subsidies. Additionally, some hospitals may have declin-
ing costs throughout the relevant range of production, and marginal cost
will be below average cost. Thus, a price equal to marginal cost will
perforce entail a loss, and a subsidy will be required. A pricing rule
developed by Ramsey (1927) and later modified by Boiteux (1971) max-
in-izes welfare constrained by a budget equal to cost-recovery revenue
plus a fixed subsidy. This rule, which forms the basis for pricing in
modern public enterprises, can be stated in terms of the price-cost
margin (that is, the ratio between the price-cost difference and price) as
(4-2) Pi [ i =1. ..n
where Ei is the elasticity of demand for service i and x is the added benefit
or shadow value of an additional unit of budget (subsidy).

168 Public Hospitals in Developing Countries
Although X is not directly observed, the Ramsey rule nevertheless
provides important implications for pricing (elaborated in Bos 1985). The
rule states that the price-cost margin is inversely proportional to the own
price elasticity of the good in question. The Ramsey rule does not provide
for explicit cross-subsidization, because the deficit is spread over all
services whether luxuries or not, but the rule does affect distributional
objectives through the role that price elasticities play in setting prices. In
effect, the inverse elasticity of each good is multiplied by the same value,
(X -1)/X, to obtain multipliers that can be used to mark down (or mark
up) costs so that the budget deficit (or surplus) is distributed over all
goods. Lower (absolute value) elasticities will have higher absolute
price-cost margins. If the goods to be priced are produced at a loss (that
is, the price-cost margin is negative, as is generally the case for public
hospitals), then the rule leads to relatively lower prices of price inelastic
goods and higher prices of elastic goods. If the goods purchased by
lower-income households are price inelastic, the equity effects of the
pricing rule will be favorable compared with, say, those of marginal cost
pricing.
6
The Ramsey rule is capable of practical application. Given a predeter-
mined level of subsidy, costs and estimates of the price elasticities for n
goods, the values of the prices, and the critical proportion can be imputed
from the n sets of Ramsey relationships and the budget constraint. In
practice all the elasticities required may not be available from economet-
ric estimates, but subjective estimates together with the restrictions of
demand theory may be sufficient to identify the required prices.
Public enterprise pricing with distributional weights (Feldstein pricing). The
equity benefits of applying the Ramsey rule to deficit budgets are not the
result of directly including distributional considerations in the planning
process but are an artifact, or side aspect, of the Ramsey result. The equity
effects of Ramsey pricing, although a move in the right direction, fall
short of the optimal effects that can result from directly including distri-
bution. Recent literature that incorporates distributional goals as well as
efficiency as a policy objective has grown as a result of seminal work by
Feldstein (1972a, 1972b, 1972c). The Feldstein method derives a rule for
pricing that maximizes social welfare defined as a weighted function of
the consumption of individual households with varying incomes and
consumption patterns affected by the level of their incomes. The weights
explicitly recognize that the value of additional consumption decreases
with rising household income. The Feldstein rule can be expressed as
Pi -mci rX-Ril 1
(4-3) P K2E Z=1 ... n

Hospital Financing Alternatives 169
where Ri is the "distributional characteristic" of the good and is, in fact,
the weighted function of household consumption. In general the speci-
fication of R can be complex. Feldstein suggests an approximation that
allows the calculation of the Ri in terms of the mean and variance of
income, an estimate of the income elasticity of demand and a normative
value for the elasticity of social marginal utility with respect to income.
7
The implications of the Feldstein rule for pricing can be elaborated.
Lower values of R yield higher prices.
8
The value of Ri is inversely related
to the income elasticity of demand (see Sherman 1989). Thus, goods with
higher income elasticity of demand have relatively lower values of R and
higher optimal prices.
Ramsey prices can be used for reference. When the income elasticity
of demand is 1, Ri will equal 1. Equation 4-3 then reverts to the Ramsey
rule. If the income elasticity of demand exceeds 1, the value of R will be
less than 1 and the Feldstein price will exceed the Ramsey price. Con-
versely, if the income elasticity is less than 1, the Feldstein price will be
less than the Ramsey price. Thus, the Feldstein rule increases the prices
paid for services consumed by the rich and reduces the prices of services
paid by the poor. Cross-subsidization will occur if the price elasticities
of the goods consumed by the rich are sufficiently high (in absolute
value) that P > MC.
The Feldstein prices will also vary with the distribution of income and
the rate at which marginal social valuation of income diminishes. The
greater the inequality of income distribution or rate at which the mar-
ginal valuation of income falls off as income rises, the lower will be the
value of R for any given income elasticity. Using the Feldstein approxi-
mation for Ri (given in note 7) and an estimated variance of household
expenditure for C6te d'lvoire (Glewwe 1988), and choosing an elasticity
of social marginal utility of -0.5, we find that the value of Ri is 1.3 for
goods with an income elasticity of 0, 1.1 for goods with an income
elasticity of 0.5, and 0.8 for goods with an income elasticity of 1.5.
Two-part pricing. Optimal public enterprise rules have also been de-
rived for two-part pricing, in which the first part is a flat fee for all
consumers to have access to services and the second part is a price for
services used. Optimal two-part pricing rules are relevant, for example,
if an admission fee is charged for hospital inpatient services or an
outpatient ward in addition to fees for specific services received. In
general two-part pricing rules with distributional weights are similar to
the Feldstein rule set out above. The principal difference is that fixed-fee
receipts are added to the subsidy in the budget constraint with the result
that the value of X changes. We do not pursue two-part pricing further
here because it would carry the discussion too far afield, but we do note
that the problem is tractable (Feldstein 1972b; Shernan 1989).

170 Public Hospitals in Developing Countries
A suggested pricing procedure. In application, a hospital has too many
services to allow the practical identification of all the information that
would be required to implement Ramsey or Feldstein pricing fully.
Instead, a procedure is suggested that would approach, but not fully
achieve, the optimal pricing solution and promote increased efficiency
and equity in comparison with either zero prices or arbitrary pricing not
directly relating costs and demand.
The procedure is as follows:
* Classify hospital services into large groups of bundled services and
differentiate the groups by subjective estimates of the income elasticity
of demand into, say, three broad categories: low-income elasticity goods
(including inferior goods), normal goods, and luxury goods.
* Carry out a unit cost analysis using, say, step down disaggregation
of cost as discussed in the previous chapter. Calculate the unit cost (ci)
of the services to be priced and the estimated total recurrent cost of the
principal service groups. A second subscript can be added to unit cost
to indicate the low-, normal-, and high-income elasticity categories as ciL,
ciN, and c
1H, respectively. The total recurrent costs of the groups can be
designated CL, CN, and CH, where, for instance CL = TXcL QiL. Total recur-
rent costs are then
C =CL + CN + CH
* Identify the magnitude of the hospital revenue objective as the ex-
pected total recurrent costs (C) less the government subsidy (S),
D=C-S.
Then, the problem to be addressed in the next steps (d and e) is the
selection of markdown coefficients (
6
,) for unit costs, so that the prices
determined,
Pi = °i ci,
will completely distribute the deficit among the categories, that is,
Y-
6
iL CiL QiL + Y SiN CiN QiN + X OjH CiH QuH = D
or, if 5A are the same within each group,
8L X CiL QiL +
6
N Y CiN QiN + 8 CiH QiH D,
which can be written

Hospital Financing Alternatives 171
(4-4) &LCL+ NCN+6HCH=D.
* Determine the distribution parameters, Ri. If information on income
distribution and income elasticities is available, Ri can be calculated for
a chosen elasticity of marginal social utility of income. If information is
lacking, a practical approximation is to set the value of RH at 0.75 for the
high-income elastic group, RN at 1 for the normal group, and RL at 1.25
for the low-income elastic group of services.
* Finally, choose markdown coefficients that are consistent with Feldst-
ein prices for each group. This is done through application of equation
4-3. In the absence of better information, use average unit costs (ci) as a
substitute for marginal costs (MCi) in equation 4-3. Assuming that price
elasticities are comparable within the groups, equation 4-3 yields expres-
sions for the markdown coefficients,
9
(4-5) 5, = -Ei i = L, N, H
The three equations represented by 4-5, together with equation 4-4,
can then be solved simultaneously for X, 8L, 8N, and 8H, which can in turn
be used to set prices within the groups.
As an example we take a hospital with total costs of C = 250, which
can be broken down into three primary service categories with group
total costs of CL = 100, CN = 100, and CH = 50. (To provide a frame of
reference, the three service categories can be thought of as a bundle of
services associated with inpatient care in wards, semiprivate care with
moderate amenities, and private room care with substantial amenities.)
The subsidy is 100, giving a deficit of D = 150 to be financed from
revenues on the sale of services. Using RL = 1.25, RN = 1.00, and RH = 0.75
and assuming the price elasticities are -0.05, -0.3, and -1.00 for the
income-elastic categories of low, normal, and high, respectively, one can
solve the budget constraint (equation 4-4) and the markdown coefficient
(equation 4-5) to obtain a markdown coefficient of
8
L = 0.12 for low-in-
come elastic services, 8N = 0.79 for the middle category of services, and
8H = 1.21 for high-income elastic services. The burden of the deficit then
falls on the high-income elastic category, which generates net profits,
whereas the lower-income elastic category receives a large share of the
cross-subsidy profits and the government subsidy.
Sensitivity of the pricing coefficients to the subsidy. The government sub-
sidy together with profits is the primary determinant of the markdown
coefficients. When the subsidy is very low the proportion of cost recov-
ered must be high even for the low-income elasticity good. In contrast,
when the subsidy is very high none of the goods is sold at a profit, and
the markdown on the low elasticity good becomes nearly complete. The

172 Public Hospitals in Developing Countries
data in table 4A-1 illustrate how the markdown coefficients vary with
the level of subsidy. The situation described is similar to the preceding
example with the exception that the Ri are calculated from the parame-
ters specified in the table. When the subsidy is 100 the high-elasticity
category is sold at a considerable markup above costs (
8
H = 1.42) and the
lower two categories are cross-subsidized. If the subsidy should rise to
200 (80 percent of total costs), &L would fall to a negligible value (0.02)
and even luxury services would be subsidized (FH = 0.59). In contrast, if
the subsidy should fall to 0,
5
L would rise to 0.4, 5N would go above unity
to 1.2, and
6
H would rise to 1.8 to provide additional profits to cover the
services provided at a loss in the low-income elastic category.
Sensitivity of pricing coefficients to the distributional parameters. The pric-
ing coefficients are also sensitive to the distributional characteristics of
the services, that is, the parameters determining Ri. Data in tables 4A-2
through 4A-4 illustrate the change of the markdown coefficients with
alternative values for the relative variance of the income distribution, the
income elasticity of marginal social welfare (n), and the income elastici-
ties of the services to be priced.
The markdown coefficients are not highly sensitive to the income
distribution through a range of values based on recent household sur-
veys in Ghana (Glewwe and Twum-Baah 1991) and C6te d'Ivoire
(Glewwe 1988). Ghana represents a moderately equitable distribution of
income with a normalized standard deviation of 0.70 (a variance ratio of
0.49), whereas C6te d'Ivoire represents a considerably less equitable
distribution with a normalized standard deviation of 0.91 (a variance
ratio of 0.84; in comparison, the variance ratio for the United States in
1970 was 0.55). The suggested distributional parameters to be used in the
absence of specific information (see step [d] above) used a normalized
standard deviation of 0.64 (a variance ratio of 0.80).
The income elasticity of marginal social welfare (rj) is a subjective
parameter. The more egalitarian the social objectives determining gov-
ernment policy the higher the value of rl that should be chosen. A value
of T = -1 implies that a 10 percent increase in income is associated with
Table 4A-1. Sensitivity of Pricing Coefficients to the Subsidy
Pricing Income Own price Subsidy (percent of total cost)
coefficient elasticity elasticity 0 40 80
oL 0.0 -0.05 0.41 0.12 0.02
°N 0.3 -0.40 1.18 0.68 0.18
°11 1.5 -1.00 1.80 1.42 0.59
Note; Eta = -1.0; total cost = 250 (cost of L = 100, cost of N = 100, cost of H = 50).

Hospital Financing Alternatives 173
Table 4A-2. Sensitivity of Pricing Coefficients to the Relative Variance
of the Income Distribution
Relative variance of income
0.84
Pricing Income Own price 0.49 (Cote
coefficient elasticity elasticity (Ghana) 0.65 d'Ivoire)
xL 0.0 -0.05 0.13 0.21 0.09
°N 0.3 -0.40 0.68 0.64 0.59
°H4 1.5 -1.00 1.42 1.48 1.63
Note: Eta = -1.0; total cost = 250 (cost of L = 1 00, cost of N = 100, cost of H = 50); sub-
sidy = 100; net deficit = 150.
Table 4A-3. Sensitivity of Pricing Coefficients to the Income Elasticity
of Marginal Social Welfare
OWtn
Pricing Income price Elasticity of marginal social welfare (-Eta)
coefficient elasticity elasticity -0.1 -0.5 -1.0 -1.5 -2.0
oZ, 0.0 -0.05 0.26 0.18 0.12 0.08 0.05
°N 0.3 -0.40 0.76 0.73 0.68 0.57 0.47
OH 1.5 -1.00 0.94 1.14 1.42 1.69 1.97
Note: Total cost = 250 (cost of L = 100, cost of N = 100, cost of H = 50).
Table 4A4. Sensitivity of Pricing Coefficients to the Income Elasticity
of Good 3
Pricing Income Own price Income elasticity of good 3
coefficient elasticity elasticity 0.5 1.0 1.5
OL 0.0 -0.05 0.17 0.15 0.12
5N 0.3 -0.40 0.82 0.75 0.68
°H (see at right) -1.00 1.00 1.20 1.42
Note: Eta = -1.0; total cost = 250 (cost of L = 100, cost of N = 100, cost of H = 50); sub-
sidy = 100.

174 Public Hospitals in Developing Countries
a 10 percent decrease in marginal social utility. The values in the table
range from extremes of 71 = -0.1 to -2.0. Through this broad range the
markdown coefficients vary considerably from no cross-subsidization
from profits (on the high-elasticity services) at the lower value of r1 to
considerable cross-subsidization from profits at the higher value of 11.
The suggested distributional parameters to be used in default of other
information employ a unit elastic value for 1.
Because the services are gathered broadly into only three groups the
income elasticities are highly approximate. Also, knowledge of income
elasticities depends on household survey and econometric information
that may not be available or affordable. The most critical category of
goods to classify are those with the higher-income elasticities that pro-
vide the profits for cross-subsidization. The sensitivity analysis suggests
that the markdown coefficients on the categories that are less income
elastic are not sensitive to a plausible range of elasticities for the luxury
category of goods. The markdown coefficient for the high-income elastic
good is only moderately sensitive, varying by less than 20 percent (from
8 = 1.2 to 1.4) as the elasticity goes from 1.0 to 1.5. The default values for
Ri assume income elasticities of 0.0, 0.3, and 1.0.
Marginal compared with average costs. The above procedure assumes
constant costs, that is, that marginal costs equal average costs or, as will
be made clear below, that the ratios of marginal and average costs are
the same for all service groups. Commonly, this is taken to be a reason-
able approximation of reality. The evidence reviewed in the previous
chapter was inconclusive for developing countries, but the consensus,
after many econometric studies in industrialized countries, appears to
reject hospitals as a declining cost industry. If additional information on
marginal costs is available, however, and the marginal cost and average
cost ratios are not the same, the costing procedure can be modified to set
prices with greater accuracy (in the sense of achieving the welfare and
efficiency objectives). If marginal and average costs are not equal the
markdown equations become
(46) i-= +XE
1_ c
1i = L, N, H.
Because the 6i are determined simultaneously they will be affected in
comparison with the prices set by using equation 4-5 only if the ratios
MCi/ci differ across the groups.
The number of groups. The procedure outlined above is generalizable to
more than three groups, say n. Additional categories only require the
addition of further equations parallel to 4-5 and an appropriate modifi-
cation to the budget constraint. Determination of the values of the
markdown coefficients, Si, will then require the solution of n + 1 simul-

Hospital Finiancing Alternatives 175
taneous equations, and this, as a practical matter, is easily executed using
nonlinear iterative techniques. The purpose of the sparse choice of only
three groups is to keep the problem tractable for small hospitals that do
not have a well-established costing system. It is also probable that the
additional welfare and efficiency diminishes rapidly with an expansion
of the number of groups much beyond four or five, as long as the
elasticity characteristics (both price and income) within the groups do
not vary too greatly.
Health Insurance and Optimal Pricing (Harris pricing)
The introduction of insurance alters the pricing rules set out earlier for
an environment without insurance. Harris (1979) has extended the
Ramsey analysis to derive optimal prices for a hospital operating in an
environment in which all members of the community are covered by
insurance. The addition of insurance means that the optimal price will
vary with the copayment rate, the price elasticity of demand, and the
marginal utility of income. The Harris analysis is explicitly designed for
retrospective reimbursement insurance that has a fixed premium equal
to the policy's actuarial value and fixed coinsurance rates. The full
derivation of Harris's results would take the discussion too far afield,
but the results can be summarized in the following pricing rule:
10
(4-7) P [ xj ] 5
where
wiher = -cov [ x
5, x] + (1 -ri)
Xi
and, in addition to the notation introduced in the previous section, ri is
the coinsurance rate (determined exogenously) for service i, xi is the
demand of the average consumer for service i, and cov [g
5,xJ is the
covariance of the marginal utility of income (i'J and the consumption of
service i across states of health, s.
This rule differs from the Ramsey optimal price (equation 4-3) with
the addition of 1i/X,, which adjusts for risk effects across health states. The
rule states that the optimal price will be increased by a decrease in the
copayment, ri, or the covariance term, cov f[,s, xis]. The covariance term
describes the extent to which the demand for specific health services is
associated with costly health states and large sacrifices in consumer
welfare. If the health service is covered by insurance, the covariance
between the marginal utility of income and the quantity of service
consumed will be reduced and, because the sign on the covariance term
in equation 4-6 is negative, the optimal price is increased. The effect of
the copayment rate can be regarded as a correction for the efficiency

176 Public Hospitals in Developing Countries
distortion of subsidized services provided under insurance. The covari-
ance term represents the equity benefits derived from spreading the risk
of expensive health states across the pool of insured persons.
Harris used this method to reexamine the prices for services in a
United States hospital. Sufficient data were available to allow the pricing
of a diverse set of surgical, diagnostic, intensive care, and ward services.
To be applied in most hospitals in developing countries, the analysis
would require fewer and more aggregated pricing categories. The infor-
mation required for the analysis would be estimates of the unit cost of
services, the price elasticities of demand, and a survey of the economic
and health status of consuming households.
Harris pricing is applicable when most or all of the population is
covered by insurance; any of the population not covered would be
served either by subsidized prices or at full prices as determined by
income screening. Thus, Harris pricing may be appropriate for a com-
prehensive system of national insurance or for smaller, circumscribed
communities served by a given health plan. If insurance covers only a
small proportion of the population, however, the Harris prices need to
be modified.
Adding distributional weights. There are several possible extensions of
Harris prices that have not yet been discussed in the literature on optimal
pricing but that could be useful for setting policy and should be ad-
dressed by future research. First, distributional objectives could be intro-
duced directly into the optimization objectives. The distributional effects
of Harris pricing are attributable to the welfare gain from spreading the
risk of exceptionally costly illness across the pool of insured households.
As with Ramsey prices, the inequity of the distribution of income is not
explicitly recognized, but the protection insurance provides against
market prices at least partly mitigates this failure. Distributional objec-
tives parallel to those specified by Feldstein could be combined with
Harris's specification to obtain a more complex rule, introducing the
distribution term, to set prices.
Optimnal coinsurance rates (Arrow prices). As a second modification to
Harris prices, it would be possible to reverse the optimization procedure
and derive the optimal coinsurance rates, given specified prices. Harris
prices are optimal, given a prespecified set of coinsurance rates. From
the point of view of a single consumer, Arrow (1976) discussed the
welfare implications of changes in coinsurance rates in the situation
where prices for health services are determined by the market but did
not actually derive optimal rates or consider the distributional im-
plications. His findings could, however, be modified to encompass
nonmarket prices and to yield optimal coinsurance rates. Optimal coin-

Hospital Financing Alternatives 177
surance rates, given prices, are potentially useful when a large part of
the population is not served by insurance.
A two-step procedure to set prices could provide substantial welfare
gain in situations in which the insured comprised only a minority of the
population. Feldstein pricing, which does incorporate the distribution of
income, could be used to set prices in the first step. The Arrow technique
would then be used to determine the optimal coinsurance rates given the
prices set in the first step.
Notes
1. For nontechnical reviews of the issues, see Griffin 1987; Hoare and Mills
1986; de Ferranti 1985; and Akin, Birdsall, and deFerranti 1987. A more technical,
yet accessible, discussion of pricing in the social sectors in general is in Jimenez
1987. Finally, excellent technical reviews of public sector pricing alternatives are
Atkinson and Stiglitz 1980; Bos 1986; and Sherman 1989. This chapter draws
substantially on all these studies.
2. A general discussion of incomplete markets in given in Laffont 1989.
3. This phenomenon can be made more explicit if we set out the algebraic
relation between the net government subsidy and fee retention and examine the
change in the net subsidy with the percentage of fees retained in order to identify
an optimal retention policy. Given the actual level of autonomous revenues
received (HA) and a proportion (p) of these revenues returned to the central
treasury, the net government subsidy (S) can be defined as
(1) S=S'-p HA O<p<l,
where S is the original budgeted subsidy. The relation between the actual au-
tonomous revenues (HA) and potential autonomous revenues (Hp) can be writ-
ten as
(2) HA=r- HP O<r<1,
where r, the proportion of potential revenues collected, is a measure of the effi-
ciency of cost recovery. Finally, the behavior of collecting agents is summa-
rized by
(3) R =f(p) af/ap < 0,
which states that the efficiency of cost recovery is inversely related to the pro-
portion of fees returned to the central treasury. Substituting (2) and (3) into
equation (1) and setting the derivative of S with respect to p equal to zero al-
lows a solution for the value of p that minimizes the net subsidy:
(4) p=-f/Q)f/ap).
If, to take a simple example, r = 1 -p, then the optimal fee retention policy
would be to set p = 0.5. In practice, the relation between p and r described by

178 Public Hospitals in Developing Countries
equation (3) has not been empirically determined and will have to be found by
incremental policy experiments.
4. With some liberal modifications, these are based on Ellis 1987.
5. The implementation of the pricing guidelines varies considerably across
provinces and districts in Indonesia. As implemented in Mataram hospital, the
1984 basic inpatient charge for beds was Rp. 600 for class III, Rp. 2,500 for class
II, and Rp. 6,000 for class I amenity levels. Drugs and diagnostics are included
in the class III price but excluded in classes II and I. The addition of an estimated
charge for drugs and diagnostics of Rp. 2,500 per bed-day (about 15 percent of
average costs) brings the total estimated price per bed-day for the three amenity
classes to Rps. 600,5,000, and 8,500. The estimated average cost per bed-day (1984
prices) is Rp. 16,500. Dividing the bed-day charges by the cost gives implied
pricing coefficients of 0.04, 0.30, and 0.51.
6. If, however, the goods are produced at a profit (which is seldom the case for
hospitals), then the converse result holds-the prices of price inelastic goods will
be relatively higher and the distributional effects will be adverse.
7. Using a log-normal distribution of income and a constant elasticity of
marginal social utility of income and normalizing by the mean of income, we can
estimate Ri by
R
2-=i {(+ V)(1O-)n +n1)} [1 + VI-,i
where in is the elasticity of marginal social utility of income, ai is the income
elasticity of good i, and V is the relative variance of income, c The elasticity
of marginal social utility of income provides an intuitively natural characteriza-
tion of equity (Feldstein 1972a, p. 36).
8. When R = 0, equation 4-3 becomes
Pi -MCi I
Pi -E'
which is the expression for the price that would be charged by a profit-maximiz-
ing monopolist.
9. If we substitute Pi=8ici for price, equation 4-3 can be written,
6ici -ci _- R 1
-"Ci X -Ei
or, canceling out the unit costs,
8i-1 X-Ri I
-i x -Es
which can be solved for Si as above.
10. The equation given incorporates several assumptions made by Harris to
simplify the application of the pricing rule. The most important of these assump-
tions is to define the marginal utility of income (X5) so that there is constant
absolute risk aversion at all levels of income.

5. Hospital Financing
Experience
During the 1980s, many countries implemented user fees in public
hospitals, increased existing fees, changed policies with regard to the
dispensation of fee revenues, or implemented or modified social insur-
ance schemes to pay for hospital services. The principal forces behind
these changes were a reduction in the availability of recurrent resources
from central or local governments (for example, in Indonesia; Prescott
1991) and rapid escalation of hospital costs (for example in Brazil;
McGreevey 1988). Many governments perceived a need either to in-
crease the availability of resources to health facilities or to reduce the
extent to which they subsidized these facilities.
As discussed in chapter 4, the salient features of alternative financing
programs can be broadly categorized as user fees and insurance, al-
though there are differences in how policies are implernented in specific
countries. The great variety of policy choices-such as exemptions, price
discrimination, differing subsidies for fees and premiums, deductibles,
coinsurance rates, excluded services, and reimbursement mechanisms
for risk-sharing schemes-give planners considerable freedom to tailor
a health financing system to planning objectives. The actual experience
of countries can illuminate the possible implications of policy alterna-
tives.
In this chapter we review user fee and insurance programs that have
been implemented in various countries during recent years. The focus
of the review is on the three objectives of alternative hospital financing
policies: revenue generation, efficiency, and equity. A review of experi-
ence provides some important practical lessons for the relation of financ-
ing mechanisms to the achievement of these policy goals. We consider
the institutional features of user fee and insurance programs and elabo-
rate on how alternative financing policies have interacted with problems
of service distortion, adverse technology choices, and inappropriate
referral. First, we present data on the revenue performance of fee and
179

180 Public Hospitals in Dezvelopinig Countries
insurance programs in several countries. We then assess key character-
istics of fee policies related to hospitals in selected countries for their
contribution to equity and revenue. Next, we discuss important charac-
teristics of risk-sharing programs in selected countries. After setting out
some examples of the effect of alternative financing policies on hospital
and sectoral efficiency and equity, we provide a policy summary of the
suggested financing alternatives.
Revenue Performance
Several aspects of the effectiveness of alternative financing policies in
generating revenues are considered. First, we assess the effect on reve-
nue of such policies in different countries by examining available data
on autonomous revenues (revenues raised through alternativefinancing
mechanisms) as a share of total hospital revenue or expenditure. Second,
we present available evidence on the potential of fees to recover costs by
comparing charges with average costs. We also compare fee levels with
per capita national income as an indication of the burden of hospital
charges. Finally, we compare actual autonomous revenues with "poten-
tial" autonomous revenues, that is, the revenue that would have been
collected if all those liable for reimbursing the hospital actually paid.
Analysis of these revenue aspects of alternative financing programs
helps to illuminate the relation between specific policies (such as fee
retention, periodic adjustment of fees, and exemptions) and the extent
to which a program generates revenue.
Cost-Recovery Ratios
The revenue effect of alternative financing programs in different hospi-
tals may be compared by examining the cost-recovery ratio, defined as
the ratio of total autonomous revenues (HA) to total recurrent expendi-
tures (C), HA/C. A number of studies either calculate these ratios directly
or provide data from which they can be calculated. The findings from
these studies are summarized in table 5-1. The denominator of the ratios
may be defined variously as actual or budgeted expenditures, depend-
ing on the available data. For our purpose, which is to get a rough sense
of the impact of cost-recovery efforts on hospital financing, comparabil-
ity of the ratios is not greatly affected by these alternative definitions.
Additionally, there are other variations in the definition of the denomi-
nator of cost-recovery ratios that are more substantial. For example, the
denominator in some cases is given as the total government subsidy
rather than total hospital expenditures. In these cases, the figures pre-
sented in table 5-1 are based on a recalculation of the cost-recovery ratio,
(if data are available to do so) to provide a consistent measure.

Hospital Financing Experience 181
Several studies present partial cost-recovery ratios, which compare
autonomous revenues to nonpersonnel recurrent costs. There are several
reasons for this. One is that the explicit policy goal of some countries is
to have hospitals recover these nonstaff recurrent costs through fees or
other measures. In these countries it is often the case that personnel
expenditures are made centrally and do not even appear in hospital
budgets. Another reason is that, in some countries, hospitals cannot
spend autonomous revenues on personnel. A third explanation is that,
in any year, a hospital's staff may be a relatively "fixed" recurrent cost,
whereas other recurrent cost items tend to be "variable" (that is, as use
of services increases, the total cost of these items tends to increase as
well). For those countries for which the appropriate data are available,
table 5-1 also includes the cost-recovery ratio with nonstaff costs used as
a base.
Inmost developing countries, public hospital cost recovery is very low
and often zero. As can be seen in the table, hospitals in many countries
that have user charges recover less than 15 percent of recurrent expen-
ditures. However, there are examples of hospitals-such as most Chi-
nese hospitals, two of Zaire's reference (district) hospitals, and Jordan's
University Hospital-that derive most of their recurrent resources from
these sources. In addition, cost-recovery ratios for hospitals within the
same country may also vary widely, as in Mali, Bolivia, Jordan, and
Turkey. Surprisingly, cost-recovery performance appears to be some-
what independent of a country's level of per capita income. For example,
hospitals in some low-income countries (China and Zaire) and middle-
income countries (Brazil and Korea; although not indicated in the table,
these countries finance their hospitals entirely through charges and
insurance programs) have very high ratios, whereas in other low- and
middle-income countries, cost-recovery percentages are low (Lesotho,
Honduras, Jamaica, Papua New Guinea) or moderate (Ethiopia, Indone-
sia, Mali, Jordan, Turkey). Distinguishing characteristics of each of the
countries that have very high cost-recovery percentages are high charges
in relation to costs and the presence of a fairly widespread insurance
system designed to reimburse hospitals the costs of providing services
to the insured.
Fees and Unit Costs
Another important indicator of the revenue performance of user charges
for hospital services is the level of service fees in relation to the cost of
service provision. In most developing countries, casual observation
suggests that charges are well below average and even marginal costs.
This has been difficult to document conclusively, however, because so
few hospital cost studies have been performed.

Table 5-1. Cost Recovery Ratios in Selected Developing Countries
(percent)
(HAIC) Number of
Country andyear of data Level of hospital (HAIC)a (nonstaff) hospitals in study Source
Low-income countries
China, 1986 I 90.1 118.9 8 Barnum 1989
II 87.9 123.2 11
III 97.3 131.9 7
Ethiopia, 1984-85 Urban 32.1 74.0 8 Donaldson and Dunlop 1987
Rural 22.9 55.9 10
Indonesia, 1985-86 All public 19.9 - Prescott 1991
Mali, 1986 I 7.5 19.0 1 MPHSA 1987a, 1987b
I 42.4 1
III 117.7 1
~ Niger, 1986-87 I 14.8 1 Wong 1989
Zaire, 1988 III 78.9 168.7 1 Shepard, Vian, and Kleinau 1990
III 66.3 100.5 1
Middle-income countries
Bolivia, 1988c La Paz 47.5 6
Cochabamba 51.5 4
Santa Cruz 38.4 5
Dominican Republic, 1986 I 2.7 7.9 1 Lewis 1987
II 2.6 7.3 5
III 1.5 1.9 3
Honduras, 1985 1 3.5 7.3 1 Overholt 1987
11 4.5 10.6 6
III 5.3 14.4 8

Jamaica, 1986-87 All publicd 2.8 5.7 22 Kutzin 1989
University 7.5 1
Jordan, 1987 All MOH 13.3 38.5
All RMS e 22.3 68.7
University 51.3 1
All publicf 22.6 52.5 -
Papua New Guinea, 1985 All public 2.5 - Thomason and others 1987
Senegal,
1985g II 14.5 1 H6pital de Saint-Louis 1986
St. Lucia, 1986-87 If 2.4 7.7 1 Russell, Gwynne, and Trisolini 1988
Swaziland, 1988-89 MOH 4.7 4 Collins 1990
Mission 12.6 2
Turkey, 1987 All MOH 12.6
All university 45.4
Zimbabwe, 1989 I 7.3 4 Hecht, Overholt, and Holmberg 1992
II 3.1 8
III 1.9 30
Total Health Servicesh
Botswana, 1983' All MOH 1.3
China, 1987 All public 85.6 Bumgarner 1992
health
Ghana, 19871 All MOH 11.8 Waddington and Enyimayew 1989
Lesotho, 1986-87 All MOH 5.8 United Medical Enterprises 1988
Yemen Arab Republic, 1983 All MOH 3.3
-Not available.
a. Total autonomous revenues (HA) divided by total recurrent expenditures or revenues (C).
b. Total autonomous revenues divided by nonstaff recurrent expenditures or revenues.
c. Unweighted averages of the cost-recovery ratios of the hospitals in each region.
(Table conitnues otn thefollowing page.)

Table 5-1 (continued)
d. Fee collections as a percentage of total hospital expenditures, including drugs and medical supplies allocated to hospitals from central stores.
e. Royal Medical Society (these are also public sector hospitals).
,_.., f. The nonstaff ratio excludes University Hospital.
co g. Official fees only; multiplied 6-month collection figure by 2 to match expenditure data.
h. Ratios reflect total hospital and nonhospital fee collections as a percentage of total public health expenditure. In most cases, the bulk of fee revenues come
from hospitals, so these ratios understate hospital cost-recovery performance.
i. Uncertain if total expenditure includes retained fee revenues (if any).
j. Uncertain if the total MOH expenditure data include expenditures out of autonomous revenues.
Source: World Bank sector reviews and appraisal reports, except as noted.

Hospital Financing Experience 185
There are several technical difficulties in making a comparison of fees
and unit costs. First, in an examnination of the appropriateness of the fee
in relation to resources used, the figures being compared should be the
fee and the marginal cost. With the exception of the few econometric
studies summarized in chapter 3, however, marginal costs are unknown,
and average costs must be used as an approximation. A second difficulty
is that the definition of the service to which the fee applies may not
coincide exactly with the definition used for cost estimates. For example,
if the fee schedule includes prices for inpatient and outpatient care and
separate fees for specific services such as drugs, X rays, or laboratory
tests, the inpatient and outpatient prices should not be compared with
the fully allocated average costs such as those given in table 3-1, which
include all support services. Instead, fees should be compared with
partially allocated average costs that exclude the costs of the intermedi-
ate services for which separate fees are charged. In table 5-2, which
contains a summary of comparisons of fees and costs for a number of
countries, average costs are adjusted to reflect the definitions of the
services priced.
Conclusions drawn from table 5-2 are tempered by the small number
of hospitals and countries for which data are available. For these few
countries, it can be seen that fees for most services are well below average
costs. In effect, governments have limited the financial liability of indi-
viduals for hospital costs and have, thus, implicitly provided protection
(insurance) against the costs of illness through the budget subsidy. In
none of these countries were fee levels explicitly related to the actual
costs of providing a specific service as a matter of policy. Apparently,
prices have been set based on political criteria, such as policymakers'
perception of the population's willngness to pay. As a result, the fee-cost
percentage for relatively low-cost services, such as laboratory tests, tends
to be much greater than that for expensive services, such as inpatient
ward care. It is also important to note that, with the exception of Niamey
Hospital in Niger, although the fee for private inpatients is often much
higher than for public patients in these hospitals, private patients also
receive subsidized services.
Fees and Ability to Pay
The first pricing principle delineated in chapter 4 was that fees should
be consistent with ability to pay and should not prevent essential access
to health care. A rough indication of the burden of fees can be obtained
by comparing fees and per capita GNP. A selection of public hospital user
charges as a percentage of GNP per capita for various countries is given
in table 5-3. Conclusions drawn from the table are only suggestive
because the definition of services covered by the fees varies across

Table 5-2. Hospital User Charges or Reimbursement Rates as a Percentage of Average Recurrent Costs, Selected Countries
Inpatient Operating
Level Public, per Public, Private, Casualty/out- Pharmacy theater Laboratory X-ray
Country and year of data of hospital admission per day per day patient visit prescription operation test exam
Ethiopia, 1985a 78 19
Grenada,
1985b II 0 0 6 0 8 48 49 32
Honduras, 1985c II 9 4
11 9 8
II 12
III 5 9
Indonesia,
1987d II 18
III 23
III- 16
x Jamaica, I985-86e 1 2 46 16 23 13 24
1 3 40 16 20 20 153 16
11 5 60 27 28 33 165 31
11 8 86 24 34 26 43
III 4 53 20 45 17 142
Niger, 1
986-
87f 1 8 110 51 136 146
Papua New Guinea,
1988g I 2 62 12 22 11
11 2 24 26 23 9
III 2 32 13 17 5
St. Lucia,
1986-
87h 11 18 69 66 51 108 58
Zimbabwe, 1987' 1 44 48
11/lll 36
a. Figures reflect comparison of the median charge in fifteen Ethiopian hospitals to the estimated marginal cost of producing the indicated services. The
authors also found that the median fee as a percentage of the marginal cost of a delivery was 9 percent.

b. There are no charges for public inpatients. The calculation of private inpatient costs includes intermediate services but not administrative overhead
and surgical costs. However, since private inpatients are not charged for intermediate services (except surgery), the private inpatient fee/cost percentage is
understated only by the lack of administrative costs in the average cost estimate.
c. Reported figures are simple averages of the percentage of average cost across four inpatient services in each hospital, with the greatest percentage oc-
curring in obstetrics-gynecology and the lowest in medicine and pediatrics. According to Overholt, the average costs reported by Honduran hospitals are
probably understated because they do not include ancillary services. The order of magnitude of the reported percentages is probably accurate, however.
d. Calculations are based on reimbursement levels from the public health insurance program (ASKES) for current and former civil servants and their de-
pendents (spouse and up to three children). The ASKES reimbursement packet per diem is inclusive of nearly all inpatient services (only select special ser-
vices, such as intensive care, heart operations, and hemodialysis are billed separately). The calculations use the median of inpatient packet reimbursement
amounts for level II and m hospitals. In the table, level 111- refers to Indonesia's class D hospitals.
e. Partially allocated inpatient and outpatient and fully allocated intermediate service average costs are used to be comparable with service fees. Average
costs do not differentiate public from private patients.
f. Charge for public inpatients is inclusive of all services and is thus compared with average costs including diagnostic and therapeutic services. There
are separate charges for specific services provided to private patients, so the bed fee is compared with the direct cost of these beds excluding specific ser-
vices (weighted average of fees and costs for three different levels of amenity beds). Laboratory figure reflects public fee and the average cost for hematol-
0 ogy test.
Nj g. Fully allocated inpatient and outpatient costs are compared with inpatient and outpatient fees.
h. Partially allocated inpatient and outpatient and fully allocated intermediate service average costs are used to be comparable with service fees.
i. Fees for specific services (operations, injections, and so on) exist, whereas average costs include all components of inpatient stay. Thus, inpatient
fee/average cost ratio is understated (percentage calculated using average fee of Z$5-35 range). Fees for children are lower than indicated. Private inpa-
tient fee/cost ratio for central hospitals uses estimated average cost per day for private patients at Parirenyatwa Central Hospital of Z$125.
Source: Bitran-Dicowsky and Dunlop 1989 (Ethiopia); Mohr 1986 (Grenada); Overholt 1987 (Honduras); Prescott 1991 (Indonesia); Kutzin 1989 (Jamaica);
Wong 1989 (Niger); JSI 1990 (Papua New Guinea); Russell, Gwynne, and Trisolini 1988 (St. Lucia); Hecht 1992 (Zimbabwe).

Table 5-3. Hospital User Charges or Reimbursement Rates as a Percentage of per Capita GNP, Selected Countries and Public Hospitals
Inpatient Casualtyl Operating
Level of Public, per Public, Private, outpatatient Phannacy theater Laboratory X-ray Maternity
Country and year of data hospital admission per day per day visit prescription operation test exam delivery
Ethiopia, 1985-86a Urban 1.2 5.9 2.0 106.2 2.0 6.7 20.3
Rural 0.8 2.1 1.0 21.2 1.1 10.4 5.4
Ghana,
1985b II, III 0.4 0.9 0.2 at cost 2.0 0.1 0.6 0.4
Haiti, 1988c University 0.8 29.2 0.2 13.9 0.3 0.8 1.4
II111 0.6 2.5 0.1 11.1 0.3 1.1 1.1
Honduras, 1986 Id 2.2 0.1 3.3 4.9 0.6
lIe 1.4 0.1 0.4 1.0 1.3
Ille 1.6 0.2 0.3 1.2 1.6
India, 1987 Public 0.03 1.7 free 0.3
Jamaica, 1990f Public 0.3 0.5 0.05 0.05 0.6 0.1 0.1 0.5
Mali,
1987g I 0.5 2.8 0.7 13.9
Nepal,
1986h Public free 3.8 0.1 1.1
Niger, 1986-87' I 2.3 2.2 1.3 1.3 4.8
Papua New Guinea,
1988i Public 0.6 1.7 0.1 free 0.1 0.1 free
Senegal, 1987 Officialk 0.3 1.4 0.3
APH 1 0.1 0.1 0.2 0.5 1.1
St. Lucia, 1986-87 II 0.4 2.0 0.4 0.2 7.4 0.3 0.6 6.1
Swaziland, 1988m MOH 0.1 1.0 0.1 0.1 0.5 0.1 0.1 0.1
Turkey, 1988" MOH 0.1 2.8 0.1 12.0 0.1 0.2
Zaire, 19880 III 6.2 4.5
Zimbabwe, 1990P I 1.0 4.1 0.7 3.7 0.8 1.7
II 0.7 2.4 0.2 3.7 0.5 1.2 1.0
III 0.7 2.4 0.1 0.3 3.7 0.5 1.2 0.3

a. Urban figures are based on the range of fees at several Addis Ababa hospitals; rural figures are based on the range of fees at several rural Ethiopian
hospitals.
b. Inpatient and outpatient refer to adult fees; the inpatient fee used is the charge for an open ward with catering. Used the mean of a range of laboratory
fees; the operation fee used is the mean of three fee levels.
c. Private bed per diem calculated as the mean of the endpoints of a range of fee levels. The operation fee is calculated as the mean of minor and major
fees.
d. Outpatient department charge is the mean of walk-in and emergency fees. Laboratory fees are I lempira (L) for basic tests, and L5-150 for complex
exams. X-ray charges are L5-150.
e. Based on the range of fees at several hospitals.
f. General ward fee is per admission; private patient fee is per day. Operation fee is the average of a range of five fee levels.
g. Fees are lower for civil servants. Private fee is the average of a range of amenity levels.
h. X-ray fee applies only to patients in paying beds.
i. Private bed fee is based on the weighted average of three categories of amenity beds. Laboratory figure reflects the public fee for a hematology test.
j. Higher specific service fees apply to private patients.
k. Adult fees only. Fees are lower for civil servants. Private fee is the average of a range of amenity levels.
1. Fees applicable to some of those exempt from official fees. Inpatient fee is CFA100/day for the first ten days, maximum of 500 for the days thereafter
t (the maximum total payment is 1,500).
m. Inpatient per diem fee based on the charge that applies to the first ten days in the hospital. Private inpatient fee is for a one or two bed room. Surgical
theater fee is the mean of fees for short and long operations.
n. Laboratory test fee is for a blood cell count. Operation fee is the average of four fee levels; private per diem is the average of three amenity levels.
o. Inpatient fee covers all services; it is calculated as the mean of the high and low ends of a range of fees. Delivery fee percentage is calculated using the
fee for matemity without prenatal care.
p. For level I hospitals, the public ward per diem and outpatient consultation fees reflect the midpoint of the income range of adult fees. For level II and
III hospitals, the public ward fee is the per diem charge for the first fourteen days of an adult stay. For level I and II hospitals, the maternity fee is the aver-
age of per diem fees, and for level IlI, it is the average of the flat fee for booked and unbooked cases in the maternity ward. Operating theater fee is the aver-
age of major and minor operations, plus the fee for thirty minutes of general anesthesia for the middle-income range and excludes surgeon's fees.
Laboratory fee is the charge to middle-income patients for a full blood count; X-ray fee is the charge to middle-income patients for a chest X-ray. Pharmacy
charge is the inpatient daily charge for drugs in level III hospitals.
Sourcer Donaldson and Dunlop 1987 (Ethiopia); Government of Ghana 1985 (Ghana); World Bank data (Haiti); Overholt 1987 (Honduras); Seth and
Gupta 1987 (India); Kutzin 1989 (amaica); Vogel 1988 (Mali; Senegal, official); Pande 1987 (Nepal); Wong 1989 (Niger); JSI 1990 (Papua New Guinea); APH
1987 (Senegal, APH); Russell, Gwynne, and Trisolini 1988 and Mohr 1986 (St. Lucia); Collins 1990 (Swaziland); World Bank data (Turkey); Shepard, Vian,
and Kleinau 1990 (Zaire); GOZMOH 1991 (Zimbabwe).

190 Public Hospitals in Developing Countries
countries. For example, in some hospitals inpatient fees cover all associ-
ated costs, such as pharmaceuticals and laboratory tests, whereas in
others supporting services are priced separately. Also, fee policy is not
necessarily uniform within countries, and in most cases the data given
represent information from only a few hospitals. Nevertheless, the over-
all evidence indicates that fees are modest in scale in relation to per capita
GNP in most countries. The median of fees is less than 1 percent GNPN per
inpatient day and 0.2 percent GNPN per outpatient visit.
The scale of the median fee level can be placed in perspective by using
an example of a family of five whose household income is 350 percent
GNPN and who uses health services to a moderately high degree. If the
family experiences one hospitalization of twelve days and five outpa-
tient visits, total hospital expenditure will be 13 percent GNPN, or 13/350
= 4 percent of household income. Given that hospitalization is a rela-
tively rare occurrence for a family, this is a modest burden on the average
household.
This discussion only gives a suggestion that, in many countries in
which there is some effort to recover cost in public hospitals, the scale of
fees does not constitute a heavy burden in relation to income for the
average household. This is not to suggest that the burden imposed on
poor households by a sickness requiring hospitalization of a family
member is negligible. Other costs, such as those associated with travel
to the hospital, medical expenditures on behalf of the sick person prior
to hospitalization, and the loss of the sick person's earnings or household
labor may be quite significant. Hospital fees are thus one component of
the overall financial burden of hospitalization. A full consideration of
the burden of fees must consider the distribution of income and the effect
of fee policy in public hospitals on the poorest groups in the population.
The relation of fees to equity is considered further below in the section
reviewing fee exemption policy.
Actual in Contrast to Potential Revenues
The revenues actually collected from hospital user charges are generally
less than those that would have been collected if all those who used
hospital services paid the designated amount. The principal reason for
this is that some of those using the hospital are exempted from payment.
Additionally, enforcement of payment is often lax, and nonexempt
patients are able to receive hospital services without paying for them.
Multiplying the total number of units of each service for a given year by
their respective prices gives one measure of the potential revenue that
could be obtained in the absence of any exemptions or evasion. Estimates
of potential revenue obtained in this manner may be overstated, because
having to pay the indicated fee might have dissuaded some persons from
using the hospitals. This error would probably be small, however, given

Hospital Financing Experience 191
the evidence of low-demand elasticities that exist at the low levels of
prices found in many countries (see table 4-2). An alternative measure
that gives some insight into the importance of lax payment enforcement
is to calculate potential revenues only on the basis of the number of
nonexempt units provided. Comparing actual with potential revenues
allows an assessment of the performance of alternative financing mech-
anisms with given prices (table 5-4). That is, the effects of nonprice
elements of alternative financing programs can be analyzed. The ratio of
actual to potential revenues under the first definition can help illustrate
the effect of formal exemption policy on total revenues, whereas that
under the second definition can illuminate the effects of nonprice aspects
other than exemption policy on the revenue performance of alternative
financing polices.
Information on actual and potential revenues is available for only a
small number of countries. Hospitals usually do not have records match-
ing fee collection to the use of services, and far less frequently do they
track the percentage of total patients who are officially exempt. The lack
of such basic management information creates difficulties in assessing
how well systems of user fees are operating. Of the countries cited in
table 5-4, only hospitals in Honduras, Mali, and St. Lucia keep such
records. Studies from these countries reveal that more than 20 percent of
inpatients were exempted from charges at the Hospital Escuela in Hon-
duras in 1985, nearly 70 percent of patient-days had to be provided free
at the H6pital du Point G in Mali in 1986 (Vogel 1988), and in St. Lucia,
it was estimated that 93 percent of the population was statutorily exempt
(Russell, Gwynne, and Trisolini 1988). Waddington and Enyimayew
(1990) report that in Ghana in 1986, the revenue foregone because of
exemptions (primarily for Ministry of Health staff and their dependents)
was estimated to be equal to about 21 percent of total fee revenue for that
year.
The limited data suggest that the wide application of official exemp-
tions can considerably reduce total autonomous revenues, as indicated
by the differences in the two ratios for the hospitals in Mali, Niger, and
St. Lucia and the revenue lost to exemptions in Ghana. In each case, total
revenues were substantially limited by rules granting a large number of
persons exemptions from payment, including free services to those
exempt for reasons other than their level of income. Hospitals in Hon-
duras and Papua New Guinea demonstrate another finding, which may
be relevant for many countries: many persons who are not officially
exempt receive services without paying. The percentage of nonexempt
nonpaying patients varies across countries and hospitals and is affected
by many factors, which are described later in this chapter.
Available evidence on the revenue performance of alternative financ-
ing measures in hospitals in developing countries is limited but suggests
considerable cross-country and within-country cross-hospital variation

Table 5-4. Actual as a Percentage of Potential Autonomous Hospital Revenues in Selected Countries
Number of Fee retention Percentage based Percentage based
Count ry Level of hospital hospitals Year of data rate on total revenues on nonexempt revenues
Ethiopiaa Urban inpatient 3 1984-85 0 68
Urban outpatient 4 1984-85 0 90
Rural inpatient 6 1984-85 0 85
Rural outpatient 5 1984-85 0 73
Hondurasb I (inpatient) 1 1985 100 22 28
Jamaicac All MOH 22 1985 0 42
All MOH 22 1987 50 47
Malaysiad All public 1981 61
All public 1982 62
All public 1983 68
All public 1984 74
All public 1985 65
Malie I (inpatient) 1 1986 100 22 52
Nigerf I (inpatient) 1 1987 0 59 86
I (outpatient) 1 50 40 68
St. Luciag II I 1986-87 0 5 73
Papua New Guineah I 1 1988 0 48
II 1 1988 0 35

III 3 1988 0 16
Zimbabwe' I 4 1989 0 62
II 8 1989 0 57
III 30 1989 0 79
a. Figures for Ethiopia reflect the percentage of patients who did not receive a "free care" card and thus paid for their care, which should give a good
proxy for the percentage of potential revenue actually collected. Rural hospitals exhibited a wide range of total patients treated for free, from 3 to 60 per-
cent of outpatients and from 9 to 41 percent of inpatients.
b. The fee per discharge at this hospital was either 35 lempiras or 10 plus 1 pint of blood. Potential revenues were calculated by multiplying the mean
lempira fee (22.5) by the number of total discharges and the estimated (based on a three-month survey) number of nonexempt discharges.
c. An upper-bound estimate is that 30 percent of patients at Jamaica's public hospitals are exempt by statute. Estimates of actual/potential percentages
for all MOH hospitals are overstated because statistics for the use of laboratory tests and drugs were not available to include in the estimate of potential rev-
enue.
d. Malaysia's fee retention policy is unknown.
e. Figures reflect percentages for bed-day fees only.
tD f. Figures derived from a survey of hospital patients (594 outpatients, 379 inpatients). Figures in the nonexempt column reflect percentage of persons in
u the category, 'Patients without Exemption from Payment," who paid for their care. Other categories of patients who were supposed to be fully or partially
exempted from fees were found to have actually paid for their care.
g. St. Lucia's MOH has estimated that 92.7 percent of the population is legally exempt.
h. Potential revenue estimates adjusted for exempt services and services rendered to private patients.
i. Figures are a weighted mean of each hospital's fee collections as a percentage of its billings.
Source: Donaldson and Dunlop 1987 (Ethiopia); Overholt 1987 (Honduras); Kutzin 1989 Uamaica); Ghazali and others 1987 (Malaysia); MPHSA 1987a
(Mali); Weaver, Handou, and Mohamed 1990b (Niger); Russell, Gwynne, and Trisolini 1988 (St. Lucia); JS11990 (Papua New Guinea); Hecht, Overholt, and
Holmberg 1992 (Zimbabwe).

194 Public Hospitals in Developing Countries
in both cost recovery and the percentage of potential revenues actually
collected. Hospitals in countries that recover more than half of their
recurrent expenditures are typically associated with policies to limit
govermnent budget subsidies and implement large-scale insurance cov-
erage. In most countries, cost-recovery ratios are much lower, largely as
a result of low fees and nonpayment of fees.
Fee Policy in Selected Countries
The policy objectives concerning fees and the pricing principles de-
scribed in chapter 4 provide an analytical context in which to examine
the institutional characteristics of policies on user fees in a number of
countries. The effect of alternative financing policies on revenue, equity,
and efficiency depends on the level and structure of prices charged for
specific hospital services. The available evidence suggests that revenues
from fees should increase as hospital prices rise. This conclusion is based
on studies (see table 4-2) that have demonstrated that, beginning from
low levels of prices, the price elasticity of demand for public sector health
services is low. Even in communities that have competing substitute
services, the price elasticity, although somewhat higher, remains sub-
stantially less than one (Akin and others 1986; Heller 1982; Akin and
others 1991). Achievement of the potential revenue, however, is strongly
related to institutional arrangements for setting, collecting, and using
fees. With regard to equity, most countries that have user charges for
hospital care have either risk-sharing mechanisms or fee exemptions that
attempt to shield most consumers from these prices. Several authors
have raised concerns about the effect on equity of user fees, particularly
if the fees are not graded to the income of the patient (Gertler, Locay, and
Sanderson 1987; Gilson 1988; Waddington and Enyimayew, 1989 and
1990). Differences in pricing or formal or informal exemptions designed
to protect the poor can be used to reduce the adverse equity conse-
quences of financing programs with high user fees, but they must be
carefully defined and enforced to be effective. Thus, demand elasticities
and the income and other social characteristics of users set the environ-
ment that determines the effect of fees on revenue and equity. The
success of meeting revenue objectives and safeguarding equity also
depends strongly on the institutional arrangements for setting fees,
adjusting fees through time, and the specific structure of fees. With
regard to efficiency, most countries without large-scale insurance pro-
grams have relatively low fees. The incentives that very low fees provide
to consumers and producers run counter to the achievement of sectoral
efficiency, except for services characterized by significant market fail-
ures. The effect of alternative financing programs on the efficiency of
resource use in the health sector is considered after the discussion of
insurance later in this chapter.

Hospital Financing Experience 195
Setting Fees and the Basis for Pricing
Fees may be set by central government, local governments, or individual
hospitals. There is usually little information available on the marginal or
even average costs of hospital services that could theoretically serve as
a basis for pricing. For countries that use fees to supplement hospital
operating budgets, fee levels are typically based on judgments (made
either centrally or locally) of the population's ability to pay and an
implicit assessment of the relative costs of hospital services. Countries
that expect their hospitals to recover a significant percentage of recurrent
costs (Brazil and Korea, for example) generally have insurance mecha-
nisms to shield a large proportion of consumers from the full cost of
hospital care, so the perceived ability to pay is less of an issue in
determining hospital reimbursement rates. The ways in which these
countries determine hospital fee levels vary.
There seems to be no discernible relation between a country's specific
revenue objectives, such as modestly supplementing hospital budgets or
substituting for a large portion of the government budget allocation, and
the extent to which pricing decisions are decentralized. An exception to
this may be that countries with comprehensive national health insurance
programs tend to determine hospital reimbursement rates centrally.
Table 5-5 relates the location of the pricing-reimbursement decision to
the cost-recovery performance of a number of countries.
The role of either local or central government in the establishment of
hospital prices ranges from determination of fee levels, to oversight of
fees established by hospitals, to nearly complete laissez-faire. In situa-
tions in which pricing decisions are decentralized, the fees for similar
services provided in different hospitals are likely to differ, even if the
hospitals are of similar type. Centralized fee setting may or may not
imply that one set of prices applies to all public hospitals in a country.
Central policy may set fees that reflect regional differences in price levels;
there may also be tolerance for autonomous deviations from central
policy by individual institutions or local governments. Decentralized
pricing is likely to generate fee levels that are more sensitive to the
income levels and ability to pay in a specific hospital's catchment area.
In addition, as is shown below, available evidence suggests that decen-
tralized systems yield more timely adjustment of prices to keep pace
with inflation. On the other hand, it can be politically difficult to justify
differences in charges for the same services provided in similar public
hospitals, particularly in a physically small country.
Differences in fees for similar services provided in hospitals of differ-
ent types (for example, secondary or tertiary) may also prove difficult to
justify, particularly if the referral system is weak. Although tertiary
hospitals are intended to receive patients referred for advanced treat-
ment, they often provide basic care to the population living nearby.

196 Public Hospitals in Developing Countries
Table 5-5. Government Level That Sets Hospital Fees and Reimbursement
Rates in Selected Countries
Decentralized
Hospital cost-recovery Local
performance category Centralized government Hospital
Low (less than Botswana Dominican
10 percent) Ghana Republic
Grenada Honduras
Jamaica Senegala
Kenya
Lesotho
Papua New Guinea
Senegala
St. Lucia
Swaziland
Zimbabwe
Medium (10 to 30 Jordan Indonesia Boliviab
percent) Mali Ethiopia
Turkey
High (above 30 Brazil Chinac Chinac
percent) Korea Zaire
a. At the H6pital Saint-Louis in Senegal, fee schedules set nationally and at the hospi-
tal are in use.
b. An official national hospital fee schedule exists in Bolivia, but in practice, hospitals
set their own fees.
c. Chinese hospitals set their own fees, but these must be approved by local govern-
ment price bureaus, which have established pricing guidelines.
Higher fees in tertiary hospitals for self-referred patients (bypass fees)
may be justified only if there are viable lower-cost treatment settings
available (see chapter 6 for a discussion of alternative treatment settings).
Bypass fees could then be implemented to encourage use of these alter-
natives.
The information in table 5-5 indicates that revenue objectives may be
addressed through use of either a centralized or decentralized method
of price setting. For example, hospitals in Ghana, Jamaica, the Dominican
Republic, and Honduras use some or all of the autonomous revenues to
supplement their operating budgets, yet Ghana and Jamaica have a
national fee schedule (Vogel 1988; Kutzin 1989), whereas hospitals in the
latter two countries set their own fees (Lewis 1987; Overholt 1987).
Similarly, in countries with somewhat higher hospital cost-recovery
ratios, there are differences in how prices are set. Indonesia has national
guidelines for hospital fees, but they are not binding on the levels of
government that actually set prices (Prescott 1991). On the other hand,
Mali's three national hospitals use a centrally determined fee schedule
in an attempt to recover nonstaff operating costs (Vogel 1988). Turkey

Hospital Financing Experience 197
also has an official, centrally determined fee schedule applicable to
Ministry of Health hospitals, but the goal of these fees is to supplement
hospital operating budgets. In addition, Turkey provides health services
through a large social insurance program (covering about 42 percent of
the population in 1987), which operates its own network of health
facilities separate from those of the MOH. The MOH fee schedule does not
apply in the hospitals of the social insurance program (World Bank 1990).
Countries with the highest hospital cost-recovery performance also
show diversity in their methods of price setting. Pricing of hospital
services in China and Zaire, as in the Dominican Republic and Hondu-
ras, is decentralized to the hospital level (Bumgarner 1992; Shepard,
Vian, and Kleinau 1990), although prices set by Chinese hospitals are
subject to the approval of local and provincial price bureaus. In Korea
and Brazil, the bulk of hospital services is provided in private hospitals
but financed by national health insurance programs. In these countries,
the insurance program, as main purchaser of hospital services, deter-
mines the rates at which private hospitals will be reimbursed for treat-
ment of insured persons. In Korea, hospital reimbursement rates for the
insured population are determined in consultation with health service
providers, and reimbursement and copayment rates are higher in terti-
ary care facilities than in community hospitals (World Bank 1989a). The
central Brazilian National Institute for Medical Care and Social Security
(INAMPS) sets payment rates for its case-based reimbursement system.
According to iNAMPS, the average values of bills for cases and procedures
from all over the country are used as a basis for determining the appro-
priate payment rates (Rodrigues 1989b).
The decision to determine hospital fees centrally or in a decentralized
manner depends on local conditions. For physically large countries or
those with wide regional disparities in income levels, decentralized
pricing may be more appropriate by being more responsive to local
needs. In smaller countries or perhaps in countries with poorly devel-
oped referral facilities, it may be more appropriate for prices to be
determined centrally. The relatively large number of countries in which
fees are set centrally that recover less than 10 percent of expenditures
through user fees suggests that decentralized pricing facilitates cost-re-
covery performance and is most appropriate when the revenue objective
is to supplement hospital operating budgets. Centralized pricing often
means that a political decision is needed to increase prices, and, as is
shown in the next subsection, many countries have delayed fee adjust-
ment for several years at a time.
Process for Adjusting Fees through Time
The regulations establishing a hospital fee schedule in many countries
do not make formal provision for periodic adjustment of the fees as

198 Public Hospitals in Developing Countries
needed to account for inflation. In countries in which periodic adjust-
ment is not institutionalized, the decision to change fee levels must go
through what is often a protracted political process. The experience of
countries indicates that the regular adjustment of fee levels is probably
the most important policy element contributing to the sustained ability
of user fees to generate revenues through time.
The processes by which hospital fees are adjusted through time in
several countries are summarized in table 5-6. In some countries, peri-
odic adjustment of hospital fees is inherent in the fee structure, because
fee levels are either directly related to cost (for example, Ghana's drug
fee) or are tied to price or cost indexes (for example, the recommended
fees in Indonesia). If fee setting is decentralized to the hospital level, as
in China, the Dominican Republic, and Honduras, fees can be adjusted
as needed by hospital managers to maintain or increase their real value.
Thus, in countries in which fees are indexed or pricing is decentralized,
fee adjustment is relatively easy and can be effected quickly to maintain
real price levels. In countries in which there is a centrally set schedule of
fees, adjustments occur through a political process and have proved
difficult to implement. Examples of such countries are Jamaica, Lesotho,
Mali, Papua New Guinea, Turkey, and Zimbabwe, each of which has
experienced periods of several years during which nominal hospital fees
were not changed. On the other hand, hospital reimbursement rates in
Korea are defined through a political process, but this process occurs
annually. Therefore, it is possible to institutionalize periodic fee adjust-
ments through a centralized political process. Removing adjustments
from such a process by tying fee levels explicitly to cost indexes, how-
ever, eases fee adjustment and probably improves the ability to maintain
real fee levels.
Cost-recovery ratios are functions of real prices and real incomes.
Therefore, policy with respect to periodic adjustment of fee levels is
critical for maintaining autonomous revenues as a percentage of total
hospital revenues or expenditures. One way to analyze the impact of this
and other policies is to examine cost-recovery ratios for a given hospital
or country for several years. Such longitudinal data on public health
facilities in twelve countries are provided in table 5-7.
One caveat on the interpretation of these data is that because the
cost-recovery ratios are indeed ratios, they are not solely a function of
the level of autonomous revenues. The denominator of the ratios always
involves, at least in part, the annual government subsidy to the hospital.
This subsidy is determined through a political process, and its magni-
tude is constrained by budgetary limitations. Variation in the magnitude
of the subsidy through time must be kept in mind when one interprets
cost-recovery ratios. An increasing cost-recovery ratio may mean that
public subsidies are being cut back. It does not necessarily imply that a
hospital is doing a better job of raising revenues than it had been doing

Hospital Financing Experience 199
Table 5-6. Means of Adjusting Hospital Fee Levels or Reimbursement Rates
in Selected Developing Countries
Country Process by which fee levels or reimbursement rates are adjusted
Low income
China Fees are set by hospitals, which can adjust them as needed
over time, though local governments conduct some review
and restrict the rate at which certain prices can increase.
Ghana Fees are set by law and require a new act to change them.
However, inherent in the current fee schedule is the means
for drug fees to increase as the costs of these items
increases; implementation of this feature has reportedly
lagged.
Indonesia Fees are set by the level of government that owns the hospital.
However, the nonbinding fee guidelines established by
central government tie fee levels to drug and food cost
indexes, implying that fees adjust as costs change.
Lesotho A fee schedule is set centrally for MOH facilities; it was not
adjusted between 1980 and mid-1988. At that time, a new
fee structure with higher charges became effective. It is un-
known if the new fee schedule institutionalizes periodic
adjustments.
Mali No institutional fee adjustment mechanism exists. Current
fees were set by a 1983 decree that defines the exact price
for each kind of treatment. Another government act would
be required to adjust these fee levels.
Zaire Each health zone sets the level of prices for its reference
hospital. Under the health insurance plan centered on the
Bwamanda reference hospital, premiums and copayments
have increased every year since 1986 to keep pace with
inflation, as have prices charged to the uninsured.
Middle incomne
Botswana Government sets fee levels for MOH and mission facilities.
Except for a modest increase in the private patient fee,
prices were not adjusted in the period from 1972 to 1984.
No data on fees since this time are available.
Dominican Hospitals set their own fees and are essentially free to
Republic adjust their prices over time; however, no fee may be
charged for inpatient care.
Honduras Hospitals set their own fees and are essentially free to
adjust their prices over time; however, no fee is charged for
pharmaceuticals.
Jamaica Fees are set by an act of central govermment and require
another such act to change them. Fees were increased in
1984 for the first time since 1968 and have not been raised
since. There is no inherent means for prices to increase as
costs increase.
(Table continues on thefollowing page.)

200 Public Hospitals itn Developing Countries
Table 5-6 (continued)
Country Process by which fee levels or reimbursement rates are adjusted
Jordan Fees for MOH hospitals are set by central government, and
government must act before prices can be adjusted. It is
unknown how frequently government adjusts prices.
Republic There is an institutionalized process for central
of Korea government, in consultation with private providers, to
periodically review and set reimbursement rates and
copayment amounts.
Papua New Public hospital fees are set by the central government, with
Guinea no provision for increases to keep pace with inflation. Fee
levels have not been increased since 1978.
Senegal There is a two-tiered price system with official fees set by
central government and retainable fees set locally by a
private organization supporting the hospital (APH). Local
fees can adjust as determined by the APH; it is unknown if
national fees are subject to periodic review and adjustment.
Turkey A central government act sets prices for MOH hospitals, and
another such act is required to adjust them. Prices have
been adjusted twice since mid-1981.
Uruguay Central government sets the level of premiums paid to
Mutual Aid Associations, which cover 40 percent of the
population, including social security beneficiaries. The level
of contributions is indexed.
Zimbabwe Central government establishes a national fee schedule, and
government action is required to adjust fee levels for most
services. The fee schedule has not been adjusted since 1985.
For diagnostic and treatment services, fees are based on a
relative value scale (Rvs) negotiated between the umbrella
organization for private insurers and private providers. The
RVS is regularly updated, and the public hospital fees for
these services increase with each update.
Source: World Bank sources except as noted. Bumgarner 1992 (China); Vogel 1988
(Ghana, Mali, Senegal); Prescott 1991 (Indonesia); Shepard, Vian, and Kleinau 1990
(Zaire); Lewis 1987 (Dominican Republic); Overholt 1987 (Honduras); Kutzin 1989 (Ja-
maica); JSI 1990 (Papua New Guinea); Marquez 1989 (Uruguay); Hecht 1992 (Zimbabwe).
previously. For example, the budget allocation for Bolivia's Ministry of
Social Welfare and Public Health fell by nearly 70 percent in real terms
from 1980 to 1986 (World Bank data). This drastic decline was probably
more responsible for the increase in the percentage of total hospital
resources generated through cost-recovery mechanisms during this pe-
riod than any changes in hospital service prices or improvement in fee
collection practices.
This caveat notwithstanding, the table provides evidence of how
important periodic adjustment of fees is to the amount of revenue

Hospital Financing Experience 201
Table 5-7. Longitudinal Data on Cost-Recovery Ratios in Selected Countries
(percent)
Expenditure Year Percentage
Country item of data cost recovery Source
Bolivia Santa Cruz hospitals 1984 12.6
1986 64.0
1988 38.4
Botswana Recurrent MOH 1974 7.0
expenditures 1978 2.9
1983 1.3
China All health 1985 77.8 Bumgarner 1992
expenditures 1986 81.9
1987 85.6
Ghana Recurrent MOII 1985 7.3 Waddington and
expenditures 1986 7.8 Enyimayew
1987 11.8 1989
Honduras 15 hospitals 1983 3.3 Overholt 1987
1984 4.1
1985 4.2
Indonesia All government 1983-84 20.2 Prescott 1991
hospitals 1984-85 22.0
1985-86 19.9
Jamaica All hospital regions 1985-86 3.0 Kutzin 1989
1986-87 2.8
Lesothoa Recurrent MOH 1974-75 16.0
expenditures 1980-81 6.3
1986-87 5.8
1989-90 8.8
Swaziland All public hospitals 1983-84 2.0 Collins 1990
1985-86 4.9
1988-89 4.7
Turkey All MOH hospitals 1984 9.1
1985 14.6
1986 14.4
1987 12.6
Zaire Bwamanda hospital 1985 48.7 Shepard, Vian,
1986 65.4 and Kleinau
1988 78.9 1990
Zimbabwe Recurrent MOH 1981-82 3.6 Hecht 1992
expenditures 1983-84 3.2
1984-85 4.3
1985-86 2.5
1987-88 3.0
a. The 1989-90 percentage is an estimate based on actual revenues and budgeted ex-
penditures for that year.
Source: World Bank sector reviews and appraisal reports, except as noted.

202 Public Hospitals in Developing Countries
collected by alternative financing programs. Hospital fees in Botswana,
Jamaica, Lesotho, and Turkey are not adjusted through an institutional-
ized process. In each case, fee levels have remained constant in nominal
terms for years, whereas nominal hospital budget subsidies and expen-
ditures have risen. In other words, prices for hospital services have fallen
in real terms, causing a decline in the proportion of total revenues
accounted for by fees. In Botswana and Lesotho, where fee levels went
unchanged for ten years, this decine was dramatic. Lesotho's cost-re-
covery performance rebounded somewhat after an increase in fees dur-
ing 1988. Jamaica is an interesting case because, in the latter year
(1986-87), hospitals were entitled to retain 50 percent of the fees, a policy
that was in place only during the last two months of the previous fiscal
year. The change in retention policy provided an incentive to collect fees,
but the drop in real prices (that is, the constant nominal fee levels)
outweighed this effect and resulted in a slight decline in the percentage
of the budget subsidy to hospitals collected as fees (Kutzin 1989).
Turkey provides another example of the importance of adjusting fees
over time. Fee levels that had been in place since 1981 were increased at
the beginning of 1985. The fee increase probably accounts for the increase
in the cost-recovery ratio between 1984 and 1985. Fees were not adjusted
during the next two years, however, and the cost-recovery ratio showed
a decline (World Bank 1990). Similarly, in Swaziland, public hospital fees
were increased in late 1984 for the first time since 1968, and the cost-re-
covery ratio for 1985-86 reflects the increase. Although fees were in-
creased again in 1987, the magnitude of the increase was small, and the
cost-recovery ratio has not risen above its 1985-86 level since this latest
fee increase (Collins 1990).
Tying fee levels to price or cost indexes should be effective in main-
taining real prices for hospital services, as nominal fees would tend to
rise with inflation. Indonesia's nonbinding fee guidelines tie fees to
indexes for drug costs and food costs, and cost-recovery data indicate
that such a structure has been in place in most public hospitals. During
a three-year period, the cost-recovery ratio remained about 20 percent,
which suggests that real fee revenue stayed roughly constant (Prescott
1991).
Ghana implemented increased fees in mid-1985, which contributed to
higher cost recovery in 1986 and 1987 (Vogel 1988). Revenues for the first
six months of 1985 were based on lower fee levels. Fee collections during
the latter months of 1985 were much greater than during the first half of
the year, which suggests that the money-price elasticity of demand for
services was quite low. The substantial improvement in 1987 may reflect
improvement in the process of fee collection and an increase in patient
volume. It is expected that the share of total revenues from drug fees
would increase through time because these fees are tied to the costs of

Hospital Financing Experience 203
drugs, whereas other fees are fixed in nominal terms (although increases
in drug fees reportedly have been implemented only after a considerable
lag). But on the whole, the percentage of cost recovery is expected to
decline if fee levels for all services are not maintained at constant real
levels, unless there is a substantial improvement in the percentage of
potential revenue actually coflected.
The available evidence suggests that hospital user charges generate
revenue much more consistently in countries in which the level of
charges can respond flexibly to economy-wide price changes. Such
flexibility is most easily gained when prices are determined by individ-
ual hospitals, but it can also be built into a centrally determined national
fee schedule by indexing fees or requiring that periodic adjustments be
made. Evidence from several countries makes clear that it is often
difficult to maintain constant real fee levels if an act of government is
needed to change hospital charges. Introducing hospital user charges
where none had existed before requires overcoming what are often
considerable political obstacles. Designing a hospital fee system so that
future price adjustments are removed from political processes is a key
to maintaining the viability of a hospital fee system.
Strticture of Hospital Fees
In addition to the level of charges in relation to costs, the extent of
decentralization, and exemption and fee retention policies (discussed
below), the structure of hospital fees, which involves the types of hospi-
tal fees and the units of service to which they apply, also affects the
performance of a country's system of user charges. There are often
incentives inherent in the structure of hospital fees or other reimburse-
ment mechanisms that can have important effects on hospital efficiency
(see the section on the effect of hospital financing programs on efficiency
and equity, below, for a more detailed assessment of these incentives).
Examination of the structure of fees within and across health facilities
allows for insight into the extent to which a country's system of user
charges provides proper signals for the use of health services and health
sector resources (the second pricing principle described in chapter 4).
Fee structure varies across countries. Examples of structural variations
in hospital fees include whether charges for inpatient services are per
admission or per day; whether outpatient charges for first visits differ
from charges for later visits; whether charges differ according to the type
or level of hospital; whether diagnostic services are priced in detail;
whether some defined services are excluded from fees; whether fee levels
are related to the age or income of the patient; whether amenity services
are present; and whether patients who refer themselves to a hospital for
ambulatory care are charged more ("bypass" charges) than those who

204 Public Hospitals in Developing Countries
are referred by a lower-level hospital or health center. Table 5-8 summa-
rizes the structure of hospital fees in a number of developing countries.
Fees and facility type. Some countries (for example, Ghana, Korea, and
Zimbabwe) set different fees according to the complexity of the facility.
A penalty bypass fee for patients who refer themselves to hospital
outpatient departments is also often recommended as a means to im-
prove the economic efficiency of a country's public sector health facilities
by encouraging patients to enter the health system at the least-cost
provider. Pricing services in this manner does not prohibit self-referral,
but a reduced government subsidy for this type of behavior would
clearly signal the preferred referral pattern. Although there was no
information on any of the countries studied that suggested the presence
of such penalty fees for self-referred patients, the insurance plan for
Zaire's Bwamanda health zone requires that all hospital cases must be
referred from a health center (Shepard, Vian, and Kleinau 1990). A
self-referred patient at the hospital is not entitled to the reduced rates
charged to insured patients. This element of the program is clearly
consistent with the pricing principle referred to above.
Price discrimination. The presence or absence of income-related price
discrimination in the structure of fees is relevant to the principle that fees
should be consistent with ability to pay. In most developing countries,
equity concerns are addressed by fee exemptions for the poor rather than
price discrimination built into the structure of fees (see discussion of
exemptions and table 5-11). In countries with health insurance programs,
the level of individual contributions is often based on a percentage of
earnings. This implicitly provides for different levels of payment for
health services according to income. Some countries, however, grade
fees according to the income level of the patient. A formal sliding scale
charge structure is most clearly demonstrated in Zimbabwe's four cen-
tral hospitals, in which different inpatient per diem charges were, until
recently, assigned to each of seven categories of patient income. Accord-
ing to a World Bank report (Hecht 1992), this attempt to build equity
considerations into hospital pricing has not been very effective because
the administrative skills required to apply such a detailed and rigid fee
schedule successfully are often absent. As a result, the MOH has recently
reduced the number of categories of patient income to three. An alterna-
tive approach is used in public hospitals in the Dominican Republic.
Lewis (1987) reports that although hospitals set one level of fees, patients
unable to pay the full amount often pay less, the ability to pay being
ascertained by a social worker at the hospital. In effect, therefore, an
informal sliding scale system is in place. On the basis of the information
gathered from a small number of hospitals, Lewis concluded that, at

Table 5-8. The Structure of Hospital Fees in Selected Developing Countries
Fees adjusted by
Patient Patient Amenity Hospital
Country Major aspects of hospital fee structure age income services type
Low income
China Three factors affect the structure of fees: decentralized fee setting by hospitals; No No No No
rigidities in the pricing system; and the stipulation that hospitals cover their
nonstaff operating costs through fees. The result is that some prices approximate
costs, some fall short of costs, and some exceed costs. In most hospitals, inpatient
charges are per diem, and outpatient charges are higher for first than later visits.
Most hospitals also have a detailed schedule of prices for specific diagnostic and
therapeutic procedures.
Ghana The fee schedule indicates that the fee charged for drugs should be the cost of Yes No Yes Yes
the item. General consultation charges are lower in district hospitals than in
regional and teaching hospitals. Charges for first visit specialist consultation in
teaching hospitals are higher than for follow-up visits. Consultation charges
in nonteaching hospitals are the same for each visit but are higher for adults than
for children. There are somewhat detailed fees for specific diagnostic tests. There
is a detailed list of surgical procedures grouped into three payment categories.
Inpatient charges are per diem, with higher charges for adults than for children,
two levels of amenity wards, and a low noncatering per diem option. About
twenty-five (largely communicable) conditions are defined for which all fees
except for drugs are waived.
Haiti Charges for most services are higher at the University Hospital than at regional No Yes Yes
and district hospitals. Inpatient charges are on a per diem basis, with a range of
private room fees much higher than fees for public wards.
(Table continues on the following page.)

Table 5-8 (continued)
Fees adjusted by
Patient Patient Amenity Hospital
Country Major aspects of hospital fee structure age income services type
Indonesia The nonbinding guidelines for hospital tariffs define fees for outpatient visits Yes Yes
and inpatient days that differ by level of hospital (for outpatient visits) and the
amenity level selected (for inpatient days). Patients accommodated in wards
with the least charges are also exempt from medical consultation and drug fees.
Additional fees exist for surgery and diagnostic services. The insurance program
for civil servants reimburses hospitals on a per diem basis a fixed price covering
a bundle of services (room and board, supplies, diagnostic and therapeutic proce-
dures). A few other items are billed separately. The insurance program for
private employees also reimburses on a fixed per diem basis for a bundle of
services, but at a much higher rate.
Kenya Inpatient charges are per admission in MOH hospitals (for adults only); there are No Yes Yes
no outpatient charges. There are also charges for deliveries and some other ser-
vices. A per diem charge exists for amenity beds. Charges are higher in the
national hospital than in other MOH hospitals.
Mali Inpatient charges are per diem and differentiated by amenity level. Patients with Yes Yes
certain conditions (for example, cancer, psychiatric) are exempt from payment.
There are also fees for outpatient consultations and diagnostic procedures.
Niger In all national hospitals and hospital centers, there are per diem fees for four Yes Yes Yes No
levels of amenity beds and a per admission charge for public ward beds. Patients
in amenity beds are subject to charges for diagnostic and treatment services,
but this rule is not enforced. Ward bed patients pay a flat admission fee only.
Amenity bed charges are lower for "public sector patients," a category that
includes the military, civil servants, indigents, students, and employees of

public enterprises. The general ward flat fee applies to inpatients who qualify on
the basis of their household income. Children age five or under pay 25 percent of
the adult fee; children age six to twelve pay 50 percent. The outpatient
consultation fee has two levels: a lower fee for general practitioners, and a higher
fee for specialists in specific services. Charges for medical acts and diagnostic
examinations are highly differentiated and are based on a unit price for a
category of services multiplied by a number assigned to the specific service. Unit
prices are higher for private patients.
Middle income
Brazil Hospitals (public and private) are reimbursed by INAMPS according to per No
procedure prospective prices, inclusive of all hospital services.
Dominican Inpatient fees are prohibited, with a few minor exceptions. However, most hospitals Informal In one
Republic either charge for blood when needed or require the patient to bring a donor. In sliding hospital
CZo addition, one hospital has a private wing that charges for all patient services and scale
supplies. Outpatient fees vary widely across hospitals, with some charging for
consultations and others not. All have some charges for outpatient laboratory
and X-ray services, though the level of detail of these fees varies across hospitals.
Honduras There is some variation in fee levels across hospitals, but this is unrelated to
complexity. Inpatient fees are generally per admnission and include all services
related to hospitalization except blood transfusions (though most hospitals
accept blood as partial payment of the inpatient fee). Some hospitals, however,
do charge on a per diem basis. There are fees for outpatient consultations as well
as a range of charges for laboratory and X-ray procedures with varying degrees
of differentiation according to resource intensity. There are no fees for drugs.
(Table continues on thefollowing page.)

Table 5-8 (continued)
Fees adjusted by
Patient Patient Amenity Hospital
Country Major aspects of hospital fee structure age income services type
Jamaica For MOH hospitals, inpatient fees are per admission, with separate fees for No Only in Private No
services received during the inpatient stay. Private inpatient fees are per diem. University wards
There is a flat fee for deliveries and a five-tiered schedule of surgery fees related Hospital in a few
to complexity. Charges for laboratory and X-ray tests do not differentiate by the hospitals
type of test. The University Hospital has a four-tiered structure of fees, with
payment amounts defined by the income category of the patient. A very detailed
price list for specific laboratory and X-ray procedures is also defined at this
hospital.
,\, Korea Hospitals are reimbursed on a fee-for-service basis according to the nationally No For the No No
°0CZ) derived reimbursement rates, which vary somewhat according to the type of indigent
hospital. Hospitals are paid for each itemized service. Copayment rates also vary
according to the level of hospital, and, in addition, according to the level of
patient indigence.
Papua New Public inpatients are charged per admission. Many hospitals have No No Yes No
Guinea "intermediate" (that is, amenity) wards, which charge per day. There are also
higher charges for intermediate patients for outpatient, diagnostic, and
treatment services.
Senegal The national fee schedule defines inpatient per diem fees for adults and two age- Yes Yes Yes
differentiated groups of children across three amenity levels. There is also a
charge defined for indigents. Inpatient fees also differ by civil service or military
status of the patient. Outpatient visit fees differ by civil service status.
Apparently, inpatient and outpatient fees are inclusive of all services provided
by the hospital. The local (APH) fee schedule at the Hopital Saint-Louis also has

a per diem inpatient charge, and the rate charged decreases by half after the first
ten days. There is a consultation fee, a general laboratory fee, and four X-ray fees
based on the type of test.
Turkey Inpatient fees in MOH hospitals are on a per diem basis, with four amenity levels. No Yes
There are also four surgery fees, and there are a number of specific fees
associated with outpatient consultations. There are also detailed lists of fees for
X-ray, laboratory, and pharmaceutical services.
Zimbabwe For inpatient care at central hospitals, there is a per diem fee progressively Yes Yes Yes Yes
related to three patient income (and insurance) categories (with fees for children
about 60 percent of adult fees at each defined income level) for general wards.
Inpatient charges are higher at provincial than at district hospitals and are not in-
come-related in either, and the per diem rate is halved after fourteen days (child-
ren's ward fees are one-third of adult fees). There is a higher per diem rate for
private ward care at all hospitals. At small rural hospitals, there is an inpatient
flat fee that results in considerably lower charges than at higher levels.
Consultation fees are differentiated by income and insurance status at central
hospitals, but not elsewhere, and charges are graduated by level of hospital.
There are fees for specific hospital treatments (for example, operations,
anesthesia, plaster casts, occupational therapy) that are income-related but are
not graduated by hospital level. Drug charges are income-related at the central
and provincial levels and are based on private sector fees; at district hospitals,
there is a flat fee. Laboratory charges are 1.4 times higher in central hospitals
than at lower levels, and charges for these services are income-related in all
hospitals. Radiology charges are income-related at all levels and are the same in
provincial and district hospitals.
Source: World Bank sources, except as noted. Bumgarner 1992 (China); Government of Ghana 1985 (Ghana); Prescott 1991 (Indonesia); Vogel 1988 (Mali,
Senegal); Weaver, Handou, and Mohamed 1990a (Niger); McGreevey 1988 (Brazil); Lewis 1987 (Dominican Republic); Overholt 1987 (Honduras); Kutzin
1989 Jamaica); JSI 1990 (Papua New Guinea); GOZMOH 1991 (Zimbabwe).

210 Public Hospitals in Developing Countries
most, hospitals fully exempt up to 60 percent of their patients and charge
less than the full amount for up to about 50 percent. The application of
an informal sliding scale at the facility level appears to be easier to
manage than a formal system using specific charges for relatively narrow
income categories.
Most of the countries studied offer hospital patients the option of
paying a higher fee in exchange for inpatient services with nontreatment
amenities, such as a semiprivate or private room. Ghanaian hospitals
have four levels of charges for inpatients: two levels of amenity beds, a
general ward charge, and a lower general ward charge for those not
wishing catering services (Government of Ghana 1985). Other countries
(for example, Haiti, Indonesia, Turkey) also define several amenity levels
in their fee schedules. Providing amenity services is a way that hospitals
can generate higher revenues from those willing to pay for them, and
such revenues can possibly be used to cross-subsidize care provided to
poorer patients. In many countries (for example, Grenada, Jamaica,
Papua New Guinea, St. Lucia, and Zimbabwe), however, the net revenue
arising from provision of these services is negative (see table 5-2). Thus,
amenity services are often subsidized, and it is not always true that the
margin (that is, revenues minus costs) for these services is much greater
(less negative) than for general ward services. The limited evidence
suggests that amenity services are not providing a source of profit to
public hospitals and thus do not yield cross-subsidization possibilities.
It is possible that they could do so, but the price charged to (and the
amount collected from) private patients in public hospitals, especially
for those covered by formal insurance programs, must first be raised.
Several other characteristics are commonly found in hospital fee
schedules. For example, although hospitals in most countries do not
build equity concerns into their fee structure by scaling charges to patient
income, many charge lower fees for children than for adults. Another
interesting characteristic of most of the fee systems studied is that they
are very detailed, even in countries in which the level of fees is quite low.
For example, Jamaica's fee schedule defines five different payment rates
for surgical operations, Ghana has three surgery rates and specific
charges for different laboratory and radiological examinations, and Tur-
key has four surgical rates and different charges for specific diagnostic
investigations. If a country intends to keep fees at a very low level, the
fee structure should be simplified to the degree possible in order to
minimize administrative costs. Griffin (1987), using examples from Sen-
egal and Sudan, argues that enforcement of only a single fee at admission
is a feasible method for increasing revenues substantially in most hospi-
tals in which cost-recovery objectives are modest.
Revenue performance of specific service fees. The contribution of fees for
specific hospital services to total autonomous revenues depends princi-

Hospital Financing Experience 211
pally on the level and structure of fees. Revenues are also dependent on
the (nonpolicy) demand characteristics of each service (that is, underly-
ing epidemiology and the income and price elasticities). Table 5-9 pro-
vides data from hospitals in five countries on the contribution of specific
service fees to total autonomous revenues. Although the evidence is
limited, some condusions can be drawn.
China, which has achieved the greatest degree of cost recovery of the
countries in the table, demonstrates the importance of fee structure and
the level of fees. Although fee setting is decentralized to the hospital,
rigidities in the pricing of certain services remain. The effect of these
rigidities is that prices for services that were in use during the 1950s, such
as bed fees and outpatient registration charges, are set below cost,
whereas charges for newer, technologically advanced services, includ-
ing many diagnostic and therapeutic procedures, can be set much higher
in relation to cost (there are no price guidelines for these newer services).
The fee for drugs is typically set about 10 to 20 percent above the cost to
the hospital (Bumgarner 1992). The result of this fee structure is clearly
shown in table 5-9. Fees for drugs account for more than 50 percent of
total autonomous revenues, and registration and bed fees together ac-
count for less than 10 percent.
Drug fees also play a leading role in Ghanaian hospitals. The fee
schedule indicates that the price for drugs should be equal to their cost.
Even if this policy has not been fully implemented, it is likely that drugs
are priced closer to their cost of provision than are other hospital services.
Data reported by Vogel (1988) indicate that drug fees accounted for
between 35 and 73 percent of total fee revenues in seven hospitals. Given
the characteristics of the drug fee and the apparently greater willingness
to pay for drugs than for other services, it is likely that drugs will account
for an increasing share of total hospital fee revenues.
Prescription drugs may be characterized as a low-cost, high-volume
hospital service. The evidence from China and Ghana suggests that
charging at or above cost for this type of service can generate a substan-
tial share of hospital revenues. The low cost of drugs means that they are
affordable to many people, and the fact that people receive a tangible
item seems to be associated with willingness to pay. A negative aspect
of this situation that has manifested itself in China is that hospitals are
overproviding drugs to patients. Bumgarner (1992) reports an average
of 2.3 drugs prescribed per patient-visit in China. This overprovision of
drugs not only leads to cost escalation but also appears to run counter
to sound medical practice. In this example, the price signals to providers,
contrary to the second pricing principle in chapter 4, are not generating
incentives for proper use of resources.
Jamaican hospitals, which have a low level of cost recovery compared
with that in hospitals in many other developing countries, show more
balance in the contribution of different services to overall fee revenues.

Table 5-9. Share of Specific Services in Hospital Autonomous Revenues in Selected Developing Countries
(percent)
Level of Nuinber of Year Registration,
Country hospital hospitals of data Bed fees consultationt Drugs Laboratory X ray Deliveries Other
Chinaa 1 8 1986 6.3 1.0 51.2 41.5
11 10 1986 6.3 1.7 57.6 34.5
III 8 1986 4.8 1.3 64.8 29.1
M Ghana I lb 1986 23.9 15.6 43.9 3.3 2.9 10.5
I 1' 1986 19.2 27.8 35.1 4.0 1.4 0.6 11.8
Accra 3d 1986 22.4 13.4 50.0 1.4 2.7 1.3 8.9
Region
Ashanti 2e 1986 55.9
Region
Hondurasf I 9 1984-85 22.0 27.0 2.0 10.0 39.0
11 3h 1982-85 50.0 20.7 12.0 14.3 2.7
III 2' 1983-85 44.0 25.0 9.0 11.5 10.5
Jamaicai I 1 1985-86 23.2 19.1 14.9 8.1 12.2 14.9 7.6
11 4 1985-86 28.2 10.2 17.2 7.3 8.8 11.7 16.9
III 14 1985-86 24.0 10.2 26.1 4.9 7.3 18.6 8.9
Mali I Ik 1986 48.2 10.8 3.2 19.3 1.8 16.7
I 11 1986 23.6 43.7 0.5 6.1 26.0
III lm 1986 25.1 47.9 1.7 24.1 1.1
National 3 1986 33.8 31.4 1.8 15.0 17.3

Niger' I 1 1988 10.0 22.9 22.2 17.8 27.8
II 4 1988 35.5 21.3 16.2 5.8 21.1
III 3 1988 40.2 8.1 7.2 1.3 43.2
a. Specific fee data are available only for bed-days, outpatient registration, and drugs. All other specific service fees are grouped under "Other."
b. Based on two months of data. "Other" includes fees for operating theater, mortuary, dental, and physiotherapy services.
c. Based on one month of data. "Other" includes fees for ambulance, mortuary, and dental services.
d. Based on one month of data. "Other" includes fees for operating theater, dental, mortuary, and other services.
e. Based on one month of data. Data are available for drug and total fee revenues only.
f. "Other" also includes fees for the blood bank, electroencephalogram (EEG), electrocardiogram (EKG), special drugs, dental clinic, and health cards. Be-
cause blood donations can be made in lieu of part of the inpatient fee, Overholt lists the fees for the blood bank as an inpatient service.
g. The blood bank accounted for 30 percent of total revenues at this hospital.
h. Unweighted average of percentages of three hospitals. Inpatient percentage includes the blood bank, which could not be separated out in the data.
i. Unweighted average of percentages of two hospitals.
j. "Other" includes fees for morgue, dental, physiotherapy, and operating theater services.
9 k. "Other" includes fees for special examinations, nuclear medicine, drivers' licenses, EKG, and other services.
Cn I. "Other" includes arrears and fees for private rooms and EKG.
m. "Other" includes fees for dental consultations.
n. "Other" includes revenues from employer contracts and outpatient fees for medical certificates, annual checkups, and other ancillary services. Bed fee
reflects all revenues from inpatients; no disaggregation is available.
Source: Barnum 1989 (China); Vogel 1988 (Ghana); Overholt 1987 (Honduras); Lewis 1988 (Jamaica); MPHSA 1987a (Mali); Weaver, Handou, and
Mohamed 1990a (Niger).

214 Public Hospitals in Developing Countries
The relatively high percentages of revenues attributed to admission and
delivery fees may be a function of the process for collecting these fees
and, as a result, the extent to which fees for these services are collected
in relation to other services. The fee collection process for inpatients
generally requires a deposit, so it is harder for those who are not officially
exempted to avoid payment than it is for nonexempt outpatients. Re-
flecting this are data from one tertiary hospital in 1986 (reported in
Kutzin 1989), which indicate that the percentage of potential revenue
(assuming no exemptions) actually collected was greater for maternity
(59 percent) and admission (52 percent) fees than for other services.
The ability to derive substantial revenues from more costly and less
frequent events (such as inpatient admissions, CAT scans, or surgical
operations) is constrained by the extent of health insurance coverage. In
China, insurance coverage of 20 to 35 percent of the population makes
high charges feasible for some expensive procedures. None of the other
countries in table 5-9 charges as near to cost as does China, nor do any
of them have insurance programs that are as widespread. The limited
evidence available suggests that countries that seek to supplement hos-
pital revenues through fees but that are not interested in comprehensive
explicit national health insurance programs could increase revenues by
charging at or near average cost for services that are highly used but low
in cost and that provide patients with a tangible output, such as drugs,
laboratory tests, and routine X rays. Patients tend to perceive receipt of
such services as an indicator of good quality, and their willingness to pay
is consistent with the third pricing principle, which links fees and
quality. However, prices set in this manner can generate signals to
providers and consumers leading to improper service use. Therefore,
monitoring of use is needed to check the incentive to overproduce
profitable services. Although it is still appropriate to charge for expen-
sive procedures and inpatient stays, these services should be subsidized
for the uninsured. The suggested policy is, in effect, an implicit form of
catastrophic health insurance, in which government covers some or most
of the services defined as having catastrophic costs. More complicated
systems would involve limiting, but not eliminating, individual or fam-
ily financial liability for chronic conditions, the costs for which could
become substantial in time.
Fee Retention Policy and the Efficiency of Revenue Collection
In chapter 4 it was hypothesized that the efficiency of revenue collection
is linked to whether or not the hospital can retain a portion of the user
fees it collects. Providing hospital managers a financial incentive to
enforce fee collection is likely to be more effective and less costly than a
bureaucratic solution that requires periodic oversight to certify that all

Hospital Financing Experience 215
potential revenues are being collected. Furthermore, in countries in
which most resources allocated to the hospital from government budgets
are tied to narrowly defined expenditure categories, the use of fee
revenues by hospital administrators gives local managers greater auton-
omy and responsibility for resource allocation decisions. In table 5-10 we
describe hospital fee retention policy in a number of countries and, for
those countries that allow for at least partial retention, the ways in which
these autonomous revenues have been used.
For hospitals in countries that do not allow fee retention, fee revenues
essentially substitute for government financing by replenishing the trea-
sury with a portion of the revenue that had previously been allocated to
the hospital. Such a system provides little incentive for hospital manag-
ers to make strong efforts to collect fees because the hospital receives no
direct benefit from the revenues and essentially serves the role of tax
collector. Local managers do not gain greater responsibility and auton-
omy under these conditions. In addition, allowing a degree of fee reten-
tion makes it possible to reduce the net government subsidy to hospitals
if this policy induces an increase in actual revenues collected. The
effectiveness of hospital fees as a cost-containment mechanism to ration
demand, however, does not depend on whether revenues are retained,
unless the lack of retention results in such little effort to collect that
potential patients do not consider the official fees relevant.
Indirect evidence of the importance of fee retention is provided by
joint consideration of the policies in table 5-10 and the cost-recovery
ratios in table 5-1. Cost recovery is more sensitive to the level of prices
than to retention policy, but an examination of this evidence is sugges-
tive. In general, countries that disallow hospital fee retention tend to
have low cost-recovery ratios, and countries with high cost-recovery
ratios tend to allow full or partial fee retention. There are exceptions,
however. The most striking are Ethiopian hospitals, which are not
entitled to retain any fee revenues yet show moderately high cost-recov-
ery ratios. It is also important to note that several countries that allow
fee retention, such as the Dominican Republic, Honduras, and Jamaica,
have low cost-recovery ratios. The expectation that achieving significant
cost recovery requires that hospitals be allowed to retain some portion
of fee revenues is given only weak support by the indirect evidence of
cost-recovery ratios.
The best way to examine the effect of fee retention policy on the level
of autonomous revenues is to compare the ratio of actual to potential
revenues across countries with different retention rules or for one coun-
try for the years before and after a change in these rules. Unfortunately,
the data are so limited that any conclusions drawn are merely suggestive.
Indeed, for cross-country comparisons, table 54 shows that hospitals in
Ethiopia, which must turn over all fee revenues to the treasury, collected

216 Public Hospitals in Developing Countries
Table 5-10. Fee Retention and Use in Selected Developing Countries
Country Fee retention policy Use of fee revenues
Low income
Burundi All revenues are sent to the
central treasury.
China Hospitals retain all fee Intended to cover nonstaff
revenues. operating costs. Surplus
revenues are also used for
medical equipment purchases
and staff bonuses.
Ethiopia All revenues are sent to the
central treasury.
Ghana Hospitals retain 25%; the Unknown.
MOli is sent 25%, and the
Ministry of Finance is sent
50%.
Indonesia Revenue accrues to the level Revenues returned to the
of government that owns the hospital are in the form of
hospital and is sometimes budget allocations. No data
returned to the hospital. are available on how retained
Hospitals retain all revenues revenues from insurance are
collected from the insurance spent.
scheme for civil servants.
Kenya Beginning in late 1989, Hospitals used their share for
hospitals were entitled to operating expenses; the
retain 75% of collections; the district share was for
remaining 25% is deposited reallocation to PHC and
with District Health improvement of care in
Management Boards. The poorer areas. However,
cost-recovery program was district boards lacked
abandoned in late 1990. authority to perform this
intended role.
Mali Hospitals retain all fee Uses vary among the three
revenues. national hospitals, but
principal among them are
drugs, maintenance and
repairs, and a category
defined as "operating costs."

Hospital Financing Experience 217
Country Fee retention policy Use of fee revenues
Niger 50% of revenue from office Retained revenues are dis-
visits, medical acts, and tributed among hospital staff
diagnostic tests is retained by (the ristoume).
the hospital; the remainder is
sent to the central treasury.
Middle income
Brazil Hospitals (which are mostly Hospitals use fees to cover all
private) retain all of the costs.
reimbursement paid by
INAMPS.
Dominican Hospitals retain all fee Drugs are the most frequently
Republic revenues, with virtually no purchased item, followed by
restrictions on their use. maintenance and medical
supplies; several hospitals
also allocate funds to hire un-
skilled staff or top off
professional salaries.
Honduras Hospitals remit fee revenues There is considerable cross-
to the treasury but have the hospital variation. Major
exclusive right to use the categories of expenditure are
funds. Unexpended revenues general materials and
revert to the treasury at the supplies, casual labor and
end of the fiscal year. The overtime, and surgical sup-
MOH must approve all plies.
expenditures.
Jamaica All revenues are sent to the Most expenditure is on main-
MOH, and 50% are returned to tenance, followed by
collecting hospital. equipment and supplies.
Jordan All revenues are retained Unknown.
by the National Medical
Institution; it is uncertain if
they are reallocated across
hospitals.
Korea Hospitals are private and Hospitals use fees to cover all
retain all reimbursements and costs.
copayments.
Papua New All revenues collected by
Guinea hospitals go to general
revenues.
(Table continues on the following page.)

218 Public Hospitals in Developing Countries
Table 5-10 (continued)
Country Fee retention policy Use of fee revenues
Senegal Revenues from official fees Autonomous revenues from
are sent to the central the first month under the local
treasury; revenues from fees were spent pre-
local fees supplement the dominantly on medications,
hospital budget. maintenance, and day-to-day
functions.
Swaziland All revenues from MOH hos- Mission hospitals use revenue
pitals are sent to the central for their operating expenses.
treasury; mission hospitals
retain all revenue.
Turkey MOH hospitals retain 85% of MOH hospitals can use their
fee revenues, 5% is sent to the funds only to purchase equip-
central treasury, and 10% is ment or cover operation and
transferred to the MOH. maintenance expenses. Data
on two such hospitals showed
the majority being devoted to
drugs and medical supplies.
Zimbabwe All fee revenues are sent to
the central treasury.
Source: World bank sources, except as noted. Bumgarner 1992 (China); Donaldson and
Dunlop 1987 (Ethiopia); Vogel 1988 (Ghana, Mali, Senegal); Prescott 1991 (Indonesia);
Epstein and Coultas 1991 (Kenya); Weaver, Handou, and Mohamed 1990b (Niger);
McGreevey 1988 (Brazil); Lewis 1987 (Dominican Republic); Overholt 1987 (Honduras);
Lewis and Parker 1991 (Jamaica); JSI 1990 (Papua New Guinea); Collins 1990 (Swazi-
land); Hecht 1992 (Zimbabwe).
the highest percentage of fees from their patients, much higher than
hospitals in Honduras or Mali, which retain 100 percent of revenues. This
outcome is contrary to expectations, and it may be due to the very long
length of time that hospital fees have been in place in Ethiopia.
It is interesting to compare Jamaican hospitals in 1985, when they
retained no fees, with the same hospitals in later years, when they
retained 50 percent of the fees. Assuming that the proportion of patients
exempt by statute was the same in each year, we find from table 54 that,
for all MOH hospitals, the revenue collected per patient, at the same level
of prices, was slightly greater in 1987 (with 50 percent retention) than in
1985 (with no retention). The data suggest that the allowance of fee
retention increased collections but only to a small degree. Some support
for the significance of fee retention is provided by Lewis (forthcoming),
who suggests that the large increases in cost-recovery ratios between
1983-84 and 1985-86 and in revenues per patient between 1984-85 and

Hospital Financing Experience 219
1987-88 in Jamaican hospitals demonstrate the effect of the incentive to
retain 50 percent of the fees. This result, however, is obscured by the fact
that some proportion of the increase in revenues was also due to the
substantial increase in the level of fees in late 1984 for the first time since
1968.
Niger's Niamey National Hospital provides an interesting counterex-
ample to the Jamaican case, showing a large effect on total revenues of
specific fee retention provisions. Beginning in 1987, the "ristourne"-a
system in which 50 percent of revenues from office visits and diagnostic
examinations was distributed among hospital staff-was introduced.
The hospital's 1988 activity report noted that revenues from these ser-
vices increased by nearly 70 percent between 1986 and 1988 and that the
share of total hospital fee revenues accounted for by these services
increased from 45 to 74 percent (Weaver personal correspondence 1990).
Prices remained constant during this period.
Evidence from public and mission hospitals in Swaziland (Collins
1990) supports the argument that fee retention policy yields increased
efforts to collect fees. Since late 1984, public and mission hospitals have
charged the same fees for public patients under a uniform hospital fee
structure set by the government. Although they both charge the same
fees, mission hospitals retain 100 percent of collected revenues, whereas
public hospitals must return such revenues to the central treasury.
Indirect evidence of the effect of the different fee retention policies is
provided in table 5-1, in which cost-recovery ratios in two mission
hospitals are shown to be substantially higher than in four public hospi-
tals. More direct evidence is provided by comparing the unit revenues
(that is, revenue per patient, in this case measured as the total revenue
divided by the sum of inpatient days and first outpatient visits) in public
and mission facilities. In 1988-89, revenue per patient was more than
three times as great in a large mission hospital as in a large public
hospital. Given that prices for services provided to public patients in
both hospitals were the same, Collins (1990) suggests that higher unit
revenues in mission hospitals could be explained by some combination
of the following: higher fees for private patients, a greater number of
ancillary services charged to outside private physicians, and better col-
lection practices. Another possible reason for the difference would be
that patients who used mission facilities had higher incomes than those
who used public facilities. Collins concluded that retention policy has
been an important factor contributing to better collection practices in
mission hospitals.
Although the theoretical argument that individuals and institutions
make a greater effort to collect fees if they benefit from the collection is
strong, there is insufficient current empirical evidence to support this
conclusion and to measure the effect of fee retention policy on total

220 Public Hospitals in Developing Countries
autonomous revenue collections. If an estimate is to be made of the
optimal fee retention rate, data on the ratio of actual to potential revenues
with alternative retention policies must be gathered (see chapter 4, note
3). In addition, more evidence is needed on other factors that may also
affect the efficiency of hospital fee collection activities, such as billing
and banking practices. Despite this lack of strong direct empirical sup-
port, most countries with medium to high rates of cost recovery allow
substantial if not complete retention of revenues by hospitals. The logic
of the argument for allowing fee retention coupled with this indirect
evidence suggests that collection incentives should be part of a system
of hospital user charges.
Use of Fee Revenues
The third pricing principle delineated in chapter 4 was that fees and the
quality of services should be linked. More specifically, given that estab-
lishing or raising the price of a service will reduce the quantity de-
manded, a portion of revenue should be retained by the collecting facility
and used to improve the quality of services. This issue is particularly
important when the revenue objective is to supplement the operating
budget of public hospitals because such an objective implies an intention
to improve the quality of hospital output by increasing the quantity of
inputs. Policy simulations (described in chapter 6) from Kenya and
Nigeria illustrate that improved quality (suggested by supply-side indi-
cators, such as increased availability of drugs) purchased by these sup-
plemental revenues can boost demand to a point that will more than
offset the effect of the price increase. Unfortunately, little actual data are
available on how fee revenues are used, and almost no data are available
on the response of demand to changes in both price and quality.
The right-hand column of table 5-10 is a description of how fee
revenues are dispensed in certain countries. Fees are intended to be used
to supplement government budget allocations in the Dominican Repub-
lic, Honduras, Jamaica, Kenya, and, partially, in Senegal. Although the
amount collected in relation to hospital expenditures in these countries
is small, fee revenues can be important in maintaining services when
other funds are insufficient. In Jamaica, for example, these revenues
allowed hospital managers to make emergency maintenance expendi-
tures that in previous years (prior to fee retention) would not have been
made. In the past, insufficient funds to repair buildings and equip-
ment have sometimes resulted in entire wards or other hospital units
being shut down (Lewis and Parker 1991). Therefore, even though
Jamaican hospitals recover an average of less than 6 percent of nonstaff
operating costs through fees, these revenues have proved important at
the margin.

Hospital Financing Experience 221
Kenya's experience highlights the danger of not maintaining govern-
ment budget allocations after hospitals have been entitled to retain fee
revenues. Reforms introduced in December 1989 allowed hospitals to
retain fee revenues (75 percent) for the first time; the remainder was
given to district health management boards for reallocation to primary
and preventive care in poor areas. The goal, perhaps based on the
conclusions of the aforementioned policy simulations (Mwabu and
Mwangi 1986), was to use fee revenues to supplement government
budget allocations and thus improve the quality of hospital services. In
fact, however, given diminishing availability of resources from the cen-
tral government, the fee revenues served as a substitute for, rather than
a supplement to, the budget allocation and reportedly added nothing to
the quality and availability of services. Kenya's user fee program also
suffered from poorly defined administrative procedures for patient
exemptions and expenditure of revenues by the district health manage-
ment boards. The combination of increased fees and no visible improve-
ment in service quality, a poorly administered system, and growing
political and economic difficulties led the government to abandon cost
recovery in the health sector in September 1990 (Epstein and Coultas
1991). Thus, contrary to the third pricing principle in chapter 4, fees were
raised but quality was not improved. This contributed to the disintegra-
tion of Kenya's user fee system.
Exemption Policy
An argument often made against the establishment of user fees for public
hospital services is that fees will reduce access to needed services for
low-income groups. Exemption from payment on the basis of income is
a form of price discrimination and is consistent with the principle that
fees should not prevent essential access to health care. Most countries
that charge for the use of public hospitals explicitly define categories of
persons who are exempt from payment, usually on the basis of income,
but other reasons are used as well (see table 5-11). For instance, some
countries exempt hospital staff or pensioners from payment, regardless
of their income level. In addition, patients with certain conditions may
be fully or partially exempted from payment, which may be justified on
the basis of the principle that services subject to market failures be
subsidized (treatment of communicable diseases, for example). The
general rule is that no one shall be denied treatment because of an
inability to pay. However, the effectiveness of fee exemptions in target-
ing those most in need and the extent to which the poor are cognizant of
the availability of free care have not been studied. Therefore, it is uncer-
tain whether fees limit access for the poor even in the presence of
exemptions.

Table 5-1 1. Policies for Exemption of Persons from Payment of Hospital Fees in Selected Developing Countries
Exemptions
Based Based Based For civil
Country Description of policy and extent of exemptions on income on age on condition servants
Low income
Ethiopia Persons from households with income of less than 50 birr per month X Tuber-
may apply to their local authorities for a "free care certificate" entitling culosis
them to exemption from hospital fees. The burden of proof is on the and
user, not the hospital. It is estimated that 30-35% of inpatients and less leprosy
than 10% of outpatients in Addis Ababa hospitals and between 7 and
t'i 40% of inpatients and 20 to 60% of outpatients in rural hospitals receive
free care.
Ghana "Paupers" are entitled to free care, with such status determined by the X X Health ser-
person in charge of a health facility. This provision has been little used. vices staff
Other full and partial exemptions are granted for specific conditions
and procedures and for MOH staff, their spouses, and up to four
children.
Indonesia Indigent persons can request local authorities to certify their status and X
thus qualify for exemption.
Mali Exemptions exist for the poor, soldiers, primary and secondary school X X Partial
students, and for tuberculosis, leprosy, and psychiatric patients. Civil
servants are liable for only 20% of fees; their ministries are supposed to
reimburse the remaining amount (but rarely do). Nearly 70% of inpa-
tients at one of Mali's national hospitals were statutorily exempt in 1986.

Niger There are exemptions for indigents, students, infectious disease pa- X Students Infectious Partial
tients, and psychiatric patients. Civil servants and mnilitary personnel diseases; for civil
are exempt from 80% of fees; their ministries are supposed to reimburse psychiatric servants
the remaining amount but rarely do. A survey at Niamey National and
Hospital found that 60% of outpatients and 40% of inpatients did not military
pay for care.
Middle income
Brazil Government pays social insurance premium on behalf of the indigent. X
Dominican There are no national criteria for exemption. Ability to pay is ascer-
Republic tained at the hospital level by a social worker; this may involve a
reduced fee rather than complete exemption. At a maximum, hospitals
fully exempt 60% and reduce fees for about 50%.
Honduras There are no national criteria for exemption. Ability to pay is ascer-
tained at the hospital level by a social worker. A survey at the national
hospital showed that 20% of inpatients were exempted.
Jamaica Those qualifying for food stamps (based on a prospective means test) X Partial
are statutorily exempt (between 17 and 30% of the population, for
assuming use of the stamps by household members), as are high-risk chronic
pregnancies. Persons with chronic conditions are partially exempted. care
Often, hospitals make (non-statutory) exemptions of pensioners and
hospital staff.
Jordan Persons with annual income below a defined threshold are included in X
a social insurance program that covers all inpatient and most outpatient
costs. It is unknown how they are identified for such inclusion.
(Table continues on thefollowing page.)

Table 5-11 (continued)
Exemptions
Based Based Based For civil
Country Description of policy and extent of exemptions on income on age on condition servants
Korea Prospective means testing for coverage of the poorest 10% by the X X
"Medical Aid System" is implemented by local governments. Income,
age, pregnancy, and immigration status are used to guide eligibility
decisions. Three levels of indigence define qualifications for either free
care or reduced copayments.
Papua New Children attending high school, adults over fifty-nine years old, and X X X
Guinea persons judged to be indigent are exempt. Children under fourteen are
exempt from outpatient charges. Free services include vaccinations and
t', injections as part of a disease control program; treatment for leprosy, TB,
C-i or sexually transmitted diseases; and blood tests for malaria or filariasis.
Senegal Broad exemptions to official fees are based on income, other patient X X
characteristics, and medical condition. Exemption from new fees is
based on certification of indigence by local govemment authorities.
St. Lucia National exemption criteria are defined based on income, student sta- X X X
tus, and participation in the social insurance program. Determination of
payment status is made at the hospital level. About 93% of the popula-
tion is estimated to qualify for exemption.
Turkey Fees are waived for the indigent, or are paid on their behalf by charita- X
ble institutions.
Uruguay Public hospital users are required to obtain a beneficiary card; the card X
is free to users below a defined poverty threshold.

Former Students and military personnel are exempt. In addition, hospital direc- X Students Military
Republic tors can exempt patients considered to be in financial hardship. An
of Yemen unofficial estimate is that about 25% of patients are exempted.
Zimbabwe Persons from families with monthly incomes less than Z$150 are X TB, lep- X
exempt; this criterion has not been adjusted since 1980. At provincial, rosy, com-
district, and rural hospitals, patients can qualify on the basis of an mitted
uncontestable verbal statement (no documentation needed). In the four mental
central hospitals, the burden of proof is on patients who must patients
document their indigent status.
Source: World Bank sources, except as noted. Donaldson and Dunlop 1987 (Ethiopia); Waddington and Enyimayew 1990 (Ghana); Prescott 1991 (Indone-
sia); Vogel 1988 (Mali, Senegal); Weaver, Handou, and Mohamed 1990b (Niger); McGreevey 1988 (Brazil); Lewis 1987 (Dominican Republic); Overholt 1987
(Honduras); Kutzin 1989 (Jamaica); JSI 1990 (Papua New Guinea); Russell, Gwynne, and Trisolini 1988 (St. Lucia); Marquez 1989 (Uruguay); Hecht 1992
(Zimbabwe).

226 Public Hospitals in Developing Countries
Exemption policies have many distinguishing characteristics. Most
are concerned with providing access to hospital care for disadvantaged
groups, defined by income, age, or disease-condition. In addition, certain
exemptions may have little to do with equity, often resulting in free
hospital care being provided as a nonsalary benefit to civil servants.
Criteria for exemption are often explicitly defined (usually in association
with an official fee schedule), but in some countries there are no formal
criteria. In many cases, the assessment of a patient's payment status is
determined at the point of service. A few countries have prospective
means tests that identify exempt persons prior to their arrival at any
health facility. Countries also differ as to whether it is the responsibility
of patients to prove their indigence or that of the hospital to determine
their payment status.
Adhering to the principle that fee levels be consistent with ability to
pay has proved to be administratively difficult to implement in practice
because two of the objectives of a hospital user fee system with exemp-
tions for the poor are in conflict: maximizing revenue collection and
ensuring access for those unable to pay. The effectiveness of exemption
policies in guaranteeing access has not been studied extensively, but the
evidence of low fee collection rates and high percentages of persons who
are exempted from fees in many countries indicates that ensuring access
is generally given priority over maximizing revenue.- In St. Lucia, for
example, the government estimates that more than 92 percent of the
population is exempt under current legislation (Russell, Gwynne, and
Trisolini 1988). At Hopital du Point G in Mali in 1986, about 70 percent
of inpatient days qualified for free care (Vogel 1988). In Ghana, the bulk
of fee exemptions were for MOH staff and their dependents. Waddington
and Enyimayew (1990) report that total revenue lost from exemptions in
1986 was estimated to be equal to about 21 percent of total collections.
These examples suggest that official exemptions can reduce the level of
fee collection considerably. The extent of exemptions further suggests
inequitable situations in which many nonpoor persons are provided free
care.
Niger's fee system includes different fees (see table 5-8) for public
sector and private patients, as well as exemptions from payment based
on several patient characteristics, only one of which is income. A survey
of patients at Niamey National Hospital revealed that the median in-
come of patients who had no exemptions from payment was less than
the median for the entire sample of patients. The probability of paying
for care for this group was higher than for several other groups with
higher median incomes. There was some evidence that the poor were
protected because patients in the "indigent" category were less likely to
pay for care than patients in other categories. In general, however, the
survey results suggest that the exemptions incorporated into Niger's

Hospital Financing Experience 227
hospital fee schedule do not promote greater equity (Weaver, Handou,
and Mohamed 1990b).
Some countries, particularly those with national health insurance
programs, haveimplemented means tests to identify prospectively those
who will be fully or partially exempt from hospital charges or for whom
the government will subsidize an insurance premium. When they arrive
at a hospital for treatment, prospectively exempt patients must generally
present proof of their payment status. Prospective identification is usu-
ally performed through local government institutions and requires pe-
riodic updating of the list of those who qualify for exemption. The
updating can be a costly proposition and is perhaps too much of an
administrative burden for countries that are using fees to achieve only
modest supplements to hospital operating budgets.
Two countries that have prospective identification of the fully or
partially exempt are Korea and Jamaica. In Korea, where most hospital
care is delivered by private facilities financed by a publicly mandated
universal health insurance system, the poorest 10 percent in each county
are judged eligible for inclusion in the Medical Aid Program, under
which insurance coverage is provided free, with beneficiaries required
to meet different cost-sharing obligations, depending on the indigent
category to which the person is assigned (one category provides full
exemption from all cost sharing, two others provide for partial exemp-
tions). Local governments are responsible for the means testing (World
Bank 1989a). Jamaica's hospital financing system is considerably differ-
ent from Korea's, because its hospitals are financed almost entirely from
government budget allocations, with operating budgets only modestly
supplemented by revenues from user fees. Yet Jamaica also has a pro-
spective means test that identifies individuals who will be exempted
from hospital user charges. If the Ministry of Health administered this
means test solely for the purpose of identifying those who would be
exempt from fees, its costs would possibly be higher than the revenues
raised by the fees. However, the MOH uses a preexisting means test that
is administered by local government authorities to determine eligibility
for a national food assistance program. Those who receive food aid also
qualify for free hospital treatment. Thus, prospective identification of
those exempt from hospital user fees does not impose any additional
administrative costs (Kutzin 1989).
In many countries, determination of whether a patient is liable for fees
is made after the patient arrives at the hospital. This may involve actually
means testing the person prior to admission or treatment. Means testing
at the point of service is likely to be less accurate than a formal, prospec-
tive means test, and it does place a greater burden on hospital staff and
on patients seeking admission, but it is less costly than maintaining an
updated exemption list. Also, in a few cases, means testing at the point

228 Public Hospitals in Developing Countries
of service may be quite accurate, especially in rural facilities. This is more
likely to be true in small health centers than in large urban hospitals
because it is less likely that the person conducting the hospital means
test is personally acquainted with the patient.
Zimbabwe does not prospectively determine patient liability for hos-
pital fees through a national means test, but there is a national criterion
for exemption. Shortly after the country gained independence in 1980, it
was determined that persons from families with monthly incomes of
Z$150 or less were to be exempt from user charges in government health
facilities. This exemption criterion has not been adjusted despite the
inflation that has occurred since that time. Presumably, therefore, as
nominal incomes have increased, fewer persons qualify for exemption.
The burden is on patients to demonstrate their eligibility for free care
with either a pay slip or a letter from social services authorities. This
requirement has not been effectively implemented, however, because
few patients who claim exemptions bring the necessary documents. The
result has been that, in practice, medical records or accounts clerks
decide either to exempt the patient from charges or to bill the patient for
services rendered. Overholt and others (1990) report that only about 20
to 30 percent of these bills are ever paid.
Examples of countries that conduct informal means tests and that do
not have explicit national exemption criteria are Honduras and the
Dominican Republic. In Honduras, large hospitals have social workers
who develop exemption criteria that are unique to each institution. The
director of each hospital has the final decision as to who will be exempt
from fees (Overholt 1987). The process is similar in the Dominican
Republic, where persons who indicate they cannot pay fees are inter-
viewed by a hospital social worker. Very often when it is determined
that the person cannot pay the full fee, he or she will be required to pay
a lesser amount (Lewis 1987).
This review of the experience of selected countries suggests some
important lessons in setting policies for hospital fee exemption. First, the
purpose of exemptions should be limited to promoting equitable access
to needed services and, in some cases, to increase the use of services with
important externalities or which exhibit other market failures. Provision
of free or nearly free care to civil servants, if this is desired by the country,
should be in the form of a direct intragovernmental transfer to the
Ministry of Health or the hospital. Although this policy exists in several
countries, enforcement of the actual transfer has been lax. Second, na-
tional or regional criteria for exemptions should be defined and pro-
moted so that those qualifying on the basis of age, income, or
disease-condition are aware of their entitlement to care. Third, income
criteria must be updated periodically or indexed to prevent inflation
from limiting access for the poor. Fourth, determination of patient

Hospital Financing Experience 229
payment status at the point of service appears to work adequately for
countries with relatively low levels of fees, although it may be somewhat
burdensome for the hospital. Patients should have to apply for exemp-
tion on the basis of the explicit criteria so that the hospital will not be
burdened with the responsibility of assessing the payment status of
every patient. Placing the burden for demonstrating indigent status on
the patient rather than the hospital, however, may not be feasible or fair
in countries with high rates of illiteracy and innumeracy.
If a country has or is planning to implement a health insurance
program for its entire population, it will be necessary to establish a
prospective means test to ascertain whose premium the government
(central or local) must subsidize and the extent (full or partial) of the
subsidy. In addition, periodic updating of the means test (including the
exemption criteria) must be institutionalized to keep the system func-
tioning accurately over time. The costs of such testing must be included
in a country's analysis of the overall costs of moving toward a com-
prehensive national insurance program. For countries that use fees to
provide a modest supplement to hospital operating budgets, the use of
a prospective means test to identify those exempt from hospital fees is
not likely to be cost-effective, because the cost of the means test may be
a high percentage of total revenue collections. However, if there are
preexisting means tests used for other purposes (to qualify for food
assistance, for example), these might be a reasonable proxy for targeting
the medically indigent at little marginal cost to the country.
Insurance Financing of Hospitals
As noted in chapter 4, health insurance provides financial protection
against the high cost of medical treatment and unpredictable health
events, and it also provides a form of earmarked savings to care for more
predictable needs. The institutional arrangements for the provision of
insurance differ across countries and schemes. Table 5-12 illustrates this
diversity.
The extent of total population coverage is related to the overall level
of employment of the urban formal sector because it is easier to enforce
premium collection on this group, through deductions from wages, than
on the self-employed or on others working in agriculture or the informal
sector. This is reflected in countries-such as Argentina, Brazil, Jordan,
Korea, Turkey, and Uruguay-that have a relatively large proportion of
the labor force working in the formal sector and have significant public
or quasi-public insurance programs. In many other, less-industrialized
countries (for example in Ghana, Mali, and Senegal), social health insur-
ance programs are much smaller, covering less than 5 percent of the total
population. Civil servants are the group most commonly covered by

Table 5-12. Characteristics of Insurance Programs in Selected Developing Countries
Hospital reimbursement
Country Description of program Population covered Financing mechanisms mechanisms
Low income
China All programs are public GIS: civil servants (2.4% of GIS: out of MOH budget; LIS: With the exception of some
insurance: (1) Government population); LIS: employees for state enterprise workers, experiments with copay-
Insurance System (GIs); (2) of state-owned enterprises either entirely by employers ments and caps, the GIS and
Labor Insurance System (LIS); plus half of medical care (tax deductible) or mixed LIS for state enterprise work-
(3) Communal Rural Insur- costs for dependents, employer/employee; for ers have no cost-sharing pro-
ance collective enterprise workers, collective/township/ village visions for beneficiaries. LIS
and township and village employees, by the for collective/township/vil-
enterprise workers (15.3%); employees; Communal lage employees and com-
Communal Rural: rural Rural: by the participants. munal rural programs
,x, persons (10-20%). About typically require copayments
ui 20% of the population is and have ceilings on total
covered under major pro- benefits.
grams; another 10-15% has
limited coverage.
Ghana There is no formal insurance Civil servants (employees of Civil servants are reimbursed Does not involve the hospital.
program, but civil servants government ministries). by their ministries for their
have a type of coverage. hospital charges.
Indonesia All social insurance (some ASKES: mandatory for active ASKES: 2% of salary from ASKES: prospective per diem
private firms self-insure): (1) and retired civil servants active civil servants and of rate encompassing nearly all
ASKES (English translation: plus spouse and up to three pension payments from services rendered during
health insurance for civil dependents (about 9% of retirees, and from interest on hospitalization (still far
servants); (2) Pemeliharaan population); PKTK: voluntary the program's savings below costs) plus diagnosis-
Kesehatan Tenaga Kerga pilot scheme for private deposits; PKTK: (Jakarta) 7% related length-of-stay guide-
(health care for workers) sector employees. of wages. lines, no cost sharing unless
(PKTK). patient opts for greater
amenities;

PKTK: similar coverage as
ASKES, but rates paid to
hospitals are much higher
(but still below cost).
Kenya Private: employment-based Private: 60,000 employees in Private: presumably from Private: indemnity coverage
group coverage; public: formal sector (0.3% of popu- employer and employee with no catastrophic stop-
National Hospital Insurance lation); NHIF: persons with contributions; NHIF: until loss, some with cost sharing;
Fund (NHIF). taxable income above a mid-1990, flat monthly NHIF: inpatient services only,
defined monthly threshold amount deducted at the fixed per diem payment with
and spouse and all depen- source of income. Now, defined annual maximum
dent children (estimated at contributions are graduated (no catastrophic coverage).
nearly 30% of the popula- to income. Historically, very little has
tion). gone to public hospitals.
Mali (1) Civil servants: reduced Civil servants; INPS: formal Civil servants: ministries pay Civil servants: individuals
out-of-pocket liability for sector employees, same 80% of fee out of their budget pay 20% of fee, ministries
fees; (2) social security (rNPS). contribution also covers allocation; INr--employer liable for 80% (often goes
spouse and all dependent and employee contributions. uncollected); INPS: hospital
children. Program covers less financing uncertain, INPS
than 1% of the population. provides "free" primary care
through its own facilities.
Zaire Direct insurance plan man- About 60% of the health The plan has been com- Case-based reimbursement,
aged by the Bwamanda zone's population was pletely financed by premium with different rates defined
health zone covers hospi- enrolled in 1989. payments since it was for each of 16 broad
talization and chronic care established in 1986. Premium diagnostic categories. Each
treatment at health centers. levels have increased month, the hospital bills the
annually to keep pace with insurance fund for services
inflation. Premiums are provided to beneficiaries.
collected once a year, at There is a 20% copayment,
harvest time, and deposited in except for delivering mothers
(Table continues on thefollowing page.)

Table 5-12 (continued)
Hospital reimbursement
Country Description of program Population covered Financinig mechanisms mechanisms
a special interest-earning who have been given
fund for the insurance plan. prenatal care. The plan
The premium collections are specifies that to be
intended to cover hospital reimbursable, all
operating costs (excluding hospitalized cases must be re-
depreciation) for benefi- ferred from a health center.
ciaries.
Middle income
Argentina Social security: more than More than 70% of the The obras sociales are financed There are two types of obras
320 autonomous health population belong to an by payroll deductions. sociales: (1) direct providers
insurance institutions (obras obra social. of services, including hospi-
sociales). tal services, that are paid on
a capitation basis; and (2)
financial intermediaries,
which purchase services for
their affiliates from both
public and private providers.
Reimbursement rates are set
according to a fee schedule
negotiated by the obras sociales,
professional associations,
and private providers.
Brazil Public: (I) social security IPMSSSI: civil servants (state IPMSSSI: employee and IPMSSSI: own facilities from
institute (INAMPS); (2) civil and local) and dependents; employer contributions; premiums and cost sharing;
servants of state and local INAMPS: active and INAMPS: payroll deductions of INAMPS: procedure-based
governments (IPMsssI); unemployed workers and beneficiaries and from general prospective price paid per

Private: (3) fee-for-service dependents, active and retired revenues on behalf of the case to hospitals, which are
insurance; (4) emp- civil servants of the federal indigent; fee-for-service predomninantly private, with
loyer/union facilities; government and dependents, insurance and HMO/PPO: no cost sharing; fee-for-
(5) HMO/PPO (preferred and some indigent (90% of employer and employee service: retrospective; PPO:
provider organization). population); HMO/PPO: about contributions. retrospective but with a
20 million people (who are restricted list of providers;
also INAMPS beneficiaries) are HMO: capitated prepayment.
enrolled in these plans (14% of
population).
Jamaica Private only, mostly fee-for- Mostly employment-based Tax-deductible employer Retrospective (except HMO):
service, with one small iMo, group coverage (also for and employee contributions, public hospitals are entitled
and several self-insuring spouses and dependents), including government in its to the maximum reimbursable
firms. plus a small number of role as an employer. under an insurance plan, but
individual plans (about 14% they rarely receive this
of population is covered). amount.
Jordan All public: (1) Civil Health CHI: active and retired civil cE-n: employee contributes 2% CHI: beneficiaries receive free
Insurance (CHI); (2) Military servants, students, poor of salaries, wages, and inpatient and near-free
Health Insurance (MHI). It is people (income below pensions; MHI: similar to CHI. outpatient care, CHI does not
intended to merge these into defined threshold), and reimburse MOH hospitals;
one program. dependents of each of these MHI: similar to CHI, except
(about 28% of the popula- that contributions are
tion); MHI: active and retired channeled into military
military, police, and airlines health facilities.
personnel and dependents
(magnitude unknown).
Korea Compulsory national health All. Percentage contributions by Fee-for-service basis, with
insurance. employers, employees, and provider paid for each
pensioners vary depending itemized service. Also
(Table continues on thefollowing page.)

Table 5-12 (continued)
Hospital reimbursement
Country Description of program Population covered Financing mechanisms mechanisms
on region, employment involves significant cost-
category, and insurance sharing requirements.
society. Flat sums are paid by
rural residents and self-
employed, subsidized by
government. Government
also covers premiums of the
indigent.
Senegal (1) Social Security (IPM). Employees (and all depen- Employers and employees Not much involvement with
dents) of firms with at least each contribute 6% of the public hospitals; there is
100 employees must create employee's monthly salary, full indemnity reimburse-
their own IPM, though some with amounts capped at a ment with no cost sharing.
smaller firms may also group defined level.
themselves into IPMs (the
extent of total coverage is
unknown).
Turkey Public: (1) civil servants; (2) Civil servants and Civil servants: budget of Civil servants: no cost
Government Employees dependents (11 % of each ministry; GERF: em- sharing, ministries reimburse
Retirement Fund (GERF); (3) population); GERF: retired ployees contribute 11% of MOH facility; GERF: no cost
Social Insurance Organi- civil servants and their base salaries, and govern- sharing, hospital bills GERF
zation (sio); (4) Social dependents (1 %); Slo: formal ment (as employer) contrib- for charges; SIO: own net-
Insurance Agency of sector and permanent utes 18%; Sio: health work of facilities, no cost
Merchants, Artisans, and Self- agricultural employees, component is 5% by em- sharing except for drugs for
Employed (BAG-KUR). Also (5) retirees, military personnel, ployees, 6% by employers; dependents; BAG-KUR:
private funds. domestic servants, and all BAG-KUR individual comparable to Sio; private:
dependents (25%); contributes percentage of employer reimburses facility.
BAG-KUR: members and income up to a

dependents (18%); private: defined maximum; private:
employees of financial provided by employers.
institutions, insurance
companies, and chambers of
commerce and industry
(limited dependent coverage)
(1%). About 53% of total
population is covered in
some form.
Uruguay Social security: Sickness DISSE: private sector DISSE: 7% payroll tax (4% DISSE uses capitation payment
Insurance Fund (DISSE) employees and dependents employer, 3% employee), arrangements to purchase
contracts with health care (12% of population); IAMCS: with payments made out of health services from iAmcs for
institutions selected by each individual enrollees (30%) this to contracted IAMC. its beneficiaries. IAMCs own
private sector worker and DISSE beneficiaries. Total Premium levels of the IAMC ambulatory facilities and small
contributing to social IAMC enrollees distributed as are paid on a monthly basis, clinics with fewer than thirty
security. Private: prepaid follows: (1) mutual aid are fixed by government, and beds. They also contract with
01 organizations (IAMCs), associations-32%; (2) are indexed. Other sources of public and private hospitals.
including (1) mutual aid professional cooperatives- financing are sale of services Reimbursement modalities for
associations, (2) professional 9%; (3) limited insurance to DISSE and user charges at physicians include salaries, fee-
cooperatives, and (3) limited plans-I%. IAMc-operated health for-service, lump sum
insurance assistance plans. facilities. In addition, more payments, and capitation.
than half receive state There are copayments for
subsidies because of financial ambulatory services. IAMC
difficulties. members also contribute a
fixed monthly amount to the
National Catastrophic Health
Insurance Fund to cover the
costs of defined expensive
inpatient procedures.
(Table continues on the following page.)

Table 5-12 (continued)
Hospital reimbursement
Counltry Description of program Population covered Financing mechanisms mechanisms
Zimbabwe Private: about thirty About 524,000 (5.5% of the Monthly premiums are set NAMAS negotiates fees with
nonprofit organizations population) public and by individual societies, with private physicians for
under the umbrella of the private sector employees and employee/employerbreak- specific procedures, which
National Association of their dependents. There are downs determined by the are published in a relative
Medical Aid Societies also some individual firms involved. Premium value schedule. NAMAS also
(NAMAS). The societies are enrollees. levels are scaled to employee negotiates fee levels with
unregulated by government. income and number of public hospitals for medical
dependents; 20% of medical aid beneficiaries. Although
expenses, including these private ward fees are
contributions by individual higher than fees for other
employees to medical aid, patients, reimbursement
are tax deductible, and levels probably remain
employer contributions can below the cost of provision;
be deducted from taxable thus, government is
company profits. subsidizing private care in
public facilities. Copayments
exist for drugs but for no
other medical-hospital
service.
Soiurce: World Bank sources, except as noted. Bumgarner 1992 (China); Vogel 1988 (Ghana, Mali, Senegal); Prescott 1991 (Indonesia); Shepard, Vian, and
Kleinau 1990 (Zaire); Marquez 1990 (Argentina); McGreevey 1988, Briscoe 1990, and GHAA 1985 (Brazil); Kutzin 1989 (Jamaica); Marquez 1989 (Uruguay);
Hecht 1992 and Overholt and others 1990 (Zimbabwe).

Hospital Financing Experience 237
publicly provided health insurance. There are exceptions to the largely
urban, formal sector employee domination of the health insurance mar-
ket, however. China has a large number of rural persons covered by
health insurance programs, leading to moderately extensive coverage in
that country. The insurance program for Zaire's Bwamanda health zone
shows that it is possible to get a high proportion of participation (60
percent enrollment) in a largely rural area.
Social health insurance programs are generally financed through pre-
mium payments by employers and employees (for example, in Argen-
tina, Brazil, China, Korea, Senegal, Turkey, and Uruguay). There are,
however, no premium payments for civil servants in some countries (for
example, Ghana and Mali) in which the employee's ministry is supposed
to reimburse hospital charges. Reducing government health expenditure
is a reason often cited for instituting health insurance, yet in many
countries that have implemented health insurance programs, govern-
ment remains a principal source of financing by its role as employer or
through a tax code that allows for contributions to private health insur-
ance to be tax deductible, as in Jamaica and Zimbabwe, for example.
Large-scale social insurance programs either finance hospital care
directly through ownership of facilities or indirectly as third-party pay-
ers for services provided in private or public (that is, Ministry of Health)
hospitals. In Turkey, the Social Insurance Organization (SIO) has its own
network of hospitals, which are financed from payroll contributions
without service-specific cost sharing for beneficiaries. Similar financing
schemes for separate facilities are also used in many Latin American
countries; for example, in Ecuador, Mexico, and Paraguay.
Two broad types of hospital payment through insurance were de-
scribed in chapter 4: retrospective reimbursement and prepaid capita-
tion. Fee-for-service retrospective reimbursement is the most common
form of hospital payment found in the programs listed in table 5-12.
Some programs, such as the Government Insurance System (GIs) and the
Labor Insurance System (LIs)-for state enterprise workers-in China
and the Government Employees Retirement Fund (GERF) in Turkey, pay
100 percent of billed charges, whereas others, such as the Korean pro-
gram, require beneficiary cost sharing, typically through copayments.
Case-based reimbursement, another form of retrospective hospital
payment, is used in a few countries. Recent developments in Brazil's
hospital financing system through INAMPS are an example. A patient's
point of entry into the health care system is through an INAMPS primary
care physician. This physician determines whether hospital admission
is indicated and, if so, also assigns the patient to a particular service
group prior to admission. The grouping is based on the procedures to be
performed on the patient, and each group has a case payment rate
associated with it. This is the amount that the hospital treating this
patient will be reimbursed (McGreevey 1988). Similarly, Indonesia's

238 Public Hospitals in Developing Countries
insurance program for civil servants (AsKEs) defines reimbursement
rates according to hospital type and the amenity level for which the
beneficiary qualifies. Unlike the Brazilian program, however, the rate
covering a bundle of inpatient services is per diem rather than per case,
and the amount reimbursed is far less than the cost of providing services
(Prescott 1991).
A mix of case-based retrospective reimbursement and prepaid capita-
tion is used for hospital payment in the insurance program run by the
Bwamanda health zone in Zaire. In 1989 there were sixteen rates based
on broad diagnostic classifications. Noninsured residents of the health
zone are charged case-based fees for inpatient care. Insured persons,
unlike the case-based reimbursement systems discussed above, are re-
sponsible for a 20 percent copayment. Another distinguishing character-
istic of the program in Bwamanda is that it is direct rather than
third-party insurance. The health zone manages both the hospital (and
other health facilities) and the insurance plan (Shepard, Vian, and
Kleinau 1990). Therefore, as in a health maintenance organization, pre-
payments and copayments finance the care of insured persons, rather
than reimbursement of the hospital for each person treated.
Hospital financing through organized prepaid capitation plans is not
widespread in developing countries, but such plans do exist in several
countries, primarily in South America. In Uruguay they are perhaps
furthest developed, with about 43 percent of the population enrolled in
health maintenance organizations. The Sickness Insurance Fund (DISSE)
contracts with private health care organizations (lAMcs) to provide
ambulatory and inpatient care to beneficiaries and their dependents,
making a capitation payment for each enrollee. There are generally
cost-sharing requirements for ambulatory care but not hospitalization
(Marquez 1989). A substantial number of prepaid capitation plans are
also found in Argentina and are growing more popular in Brazil's
private sector.
As expected (see the discussion in chapter 4), the use of private health
insurance to finance public hospital services in developing countries is
not extensive because government is implicitly providing this coverage
by subsidizing public services. An illustration is provided by the pattern
of private health insurance claims payments in Jamaica and Zimbabwe.
Only about 2.5 percent of such payments by Jamaican insurance compa-
nies was for public hospitals (including the University Hospital) in 1986
(Kutzin 1989). In Zimbabwe in 1986-87,3.5 percent of claims paid were
for MOH services, which are predominantly those of hospitals (Hecht
1992). About 80 percent of claims payments went to private physicians
and pharmacies in Jamaica, with a comparable figure of 67 percent in
Zimbabwe (including dental claims). Private hospitals absorbed only 11
percent of Jamaican claims, whereas the figure for private hospitals and

Hospital Financing Experience 239
nursing homes in Zimbabwe was 15 percent. This evidence suggests that
in these countries in which public hospital services are heavily subsi-
dized, the demand for private health insurance arises primarily from a
desire to have financial access to private physicians and pharmaceuticals
for routine random, as opposed to catastrophic, needs.
Explicit forms of health insurance that pay for hospital services exist
in many developing countries but tend to cover only civil servants and
the relatively small number of employees in the industrial sector of the
economy. Few developing countries have national health insurance
programs that have achieved, or nearly achieved, universal coverage.
Movement toward national programs is most advanced in Latin Amer-
ica, though there appears to be growth in other parts of the world as well.
Hospital financing through health insurance is least developed in sub-
Saharan Africa, although the Bwamanda plan in Zaire indicates that
such development is possible. Whatever the magnitude of a particular
program, insurance as a means of hospital financing implies a set of
incentives facing consumers and producers of hospital services. These
incentives differ according to the specific reimbursement mechanisms
and other institutional features in place and have implications for the
efficiency and equity of the health system. They are discussed in greater
detail in the next section of this chapter.
The Effect of Alternative Hospital Financing Programs
on Efficiency and Equity
Alternative financing programs provide policy levers for a country to
address the issues of resource mobilization and resource allocation.
Changes in prices and reimbursement mechanisms, however, send new
signals to producers and consumers of hospital services, which affect the
allocation of health resources. In practice, there has often been conflict
between the goals of resource mobilization and optimal resource alloca-
tion. Countries that have implemented relatively modest hospital user
fees have not witnessed important distortions in incentives inducing
changes from previous patterns of resource allocation. However, the
revenues raised, though helpful, have typically been of insufficient
magnitude to meet supplemental revenue objectives. Conversely, fee
and insurance systems that have generated enough revenues to substi-
tute for a significant share of what had hitherto been government budget
allocations to health facilities have changed the allocation of resources,
with implications for the efficiency and equity of the sector as a whole.
Distortions in patterns of service use have occurred with regard to
specific hospital services, between hospitals and other levels of care, and
across groups of individuals (for example, insured in contrast to unin-
sured populations).

240 Public Hospitals in Developing Countries
In table 4-3 we summarized the incentives to producers and consum-
ers of health services generated by different types of hospital payment
systems. These incentives can beneficially or perversely affect the effi-
ciency and equity of both hospitals and the health sector more generally.
In the rest of this section we present case studies of alternative financing
programs from four countries-Brazil, China, Korea, and Zaire-to help
illustrate the effect of various financing policies on the escalation of
hospital costs, resource allocation and referral between secondary or
tertiary and primary care, the use of specific medical technologies, and
equity of access to health services. In addition to the system for reim-
bursing hospitals, the case studies describe other important institu-
tional features of insurance programs, including the specific types of
services covered by insurance, the role of the insurer in enforcing cost
control, the extent of consumer cost sharing, and the extent of population
coverage.
We selected the case study countries because their hospitals are fi-
nanced largely, and in some cases entirely, by sources other than gov-
ernment budget allocations and because excellent descriptions of their
health financing systems exist. Understanding how alternative financing
programs have distorted the allocation of health resources and
how these distortions might be mitigated is important for these countries
and others considering changes to their present system of health care
financing.
Brazil
Most hospital (and other personal health) care in Brazil is financed by
INAMPS, the health insurance component of Brazil's payroll-financed
social security system.
2
Preventive care and basic curative services for
the poor are provided by the Ministry of Health and are financed
through government budget allocations and administered separately
from INAMPS. Social security has grown rapidly, from coverage of 23
percent of the population in 1963 to coverage of more than 90 percent in
1982. In 1983, INAMPS instituted major reforms to its system for reimburs-
ing hospitals.
INAMPS prior to 1983. Until 1983, INAMPS reimbursed hospitals on a
fee-for-service basis for each service provided to patients according to
an official price list, which included 2,600 items. All costs were paid by
INAMPS; covered persons were not responsible for any cost sharing.
Under this system, INAMPS served as a third-party payment mechanism
for services delivered by private providers. In 1981, for example, 85
percent of hospitalizations paid for by INAMPS were in private contract
hospitals, whereas only about 9 percent (including 2 percent in INAMPS's
own facilities) were in public sector facilities. Under the fee-for-service

Hospital Financing Experience 241
reimbursement system, INAMPS served as a passive financial conduit; it
did not try to impose cost consciousness on providers; indeed, they
would earn more by ordering additional tests or pharmaceuticals. This
reimbursement system fostered the widespread fraud (for example,
billing for nonexistent patients and procedures by the private health
provider network) discovered in the early 1980s. With no cost-sharing
requirements, consumers similarly had no reason to be cost conscious.
The private provider network "responded to a set of incentives that paid
[providers] whatever they billed to provide virtually unlimited services
to patients who bore none of the costs directly" (Briscoe 1990, p. 92).
Largely as a result of the incentives of the curative care reimbursement
system, health expenditures increased by more than 20 percent annually
during the 1970s, and public sector health expenditure as a share of the
gross domestic product (GDP) rose from 1 percent in 1949 to 3.7 percent
in 1975 and 5.6 percent in 1982.
The fee-for-service reimbursement system encouraged hospitals to
increase both the number of patients and the amount of services pro-
vided per patient as a means of generating profits. From the late 1960s
until the early 1980s, the number of private hospital beds increased by
over 40 percent, and the hospital industry grew faster than the rest of the
economy. The curative health subsystem, financed through payroll
taxes, developed independently from the Ministry of Health's public
health programs and grew with increased employment and economic
expansion. The MOH budget, which largely financed preventive services,
did not keep pace. The result of these forces was that the share of public
health expenditure devoted to curative (medical and hospital) as op-
posed to preventive services rose from 36 percent in 1965 to 70 percent
in 1975 and 85 percent in 1982. Hospitals alone accounted for nearly 70
percent of public health expenditures in this latter year, up from less than
40 percent in the 1960s.
Because hospitals were reimbursed a specific amount for each indi-
vidual service provided to a patient, they had a clear incentive to
encourage the use of the most profitable treatment technologies. One
such service was cesarean sections, which in 1981 accounted for 31
percent of all births, the highest rate of any country in the world. Another
example is diagnostic services, particularly X rays, use of which grew at
a very rapid annual rate from 1970 to 1981. Reportedly, many of these
tests could have been avoided without detracting from treatment. In
1979, for example, the Rio de Janeiro State University Hospital reduced
the number of X rays by 40 percent and found no loss in diagnostic
efficiency. McGreevey (1988) cites this and examples of other types of
complementary examinations that could have been eliminated with no
effect on the treatment ultimately administered to patients. Indeed, there
have likely been deleterious health consequences from such heavy use
of radiological services. Overprescription of drugs, especially antibiot-

242 Public Hospitals in Developing Countries
ics, was also a problem. Again, this had negative health effects, in
addition to the effects of such heavy consumption on total costs.
The fee-for-service reimbursement system also skewed the allocation
of public sector health resources toward costly, technologically ad-
vanced services that benefited a relatively small number of people.
Among these services were renal dialysis, heart bypass operations, and
CAT scans. The magnitude of this effect was such that, in 1981, total
expenditure on 12,000 high-cost patients was greater than the amount
spent to provide basic health services and disease control for 41 million
people.
The experience of Brazil prior to 1983 highlights many issues. First,
fee-for-service reimbursement of private hospitals with no beneficiary
cost sharing by a public agency that exercised no control over utilization
led to provider-induced increases in the volume of medical services.
Second, specific services (more explicitly, technologies) with the greatest
profit margin grew at the fastest rates. The combination of these factors
resulted in rapid growth of expenditure on curative services and distor-
tions away from a cost-effective mix of preventive and curative care. This
distortion was especially pronounced because these services were fi-
nanced and administered separately; therefore, the revenues generated
for curative care through an expanding insurance system could not be
used to subsidize the preventive services provided by the Ministry of
Health.
INAMPS reforms. The Brazilian government introduced many reforms in
its hospital reimbursement system during the 1980s in an attempt to
control the growth in hospital costs and use that had arisen from the
fee-for-service insurance system. A pilot program of financing and ad-
ministering health services was implemented in one relatively prosper-
ous state. This program, called the Curitiba Plan, had features aimed at
many of the problems inherent in the existing system. Prior to im-
plementation of the Curitiba Plan, for example, private hospitals treated
many walk-in patients as emergency cases and thereby received substan-
tially higher fee-for-service reimbursements from INAMIPS. The Curitiba
Plan created a structured referral system that gave public primary care
providers ("physician-auditors") authority to set the course of treatment
for all patients and diminished the financial incentive to recommend that
patients be hospitalized in private facilities. Under the initial Curitiba
project, hospitalizations were reduced to 5 percent of initial consulta-
tions, as compared with a Brazilian average of 6.5 percent. By mid-1982,
INAMPS declared that the plan had reduced hospital admissions by 30
percent.
Another feature of the Curitiba Plan was a case-based retrospective
hospital reimbursement system. This financing mechanism gave clear
incentives to providers to economize on the treatment provided to an

Hospital Financing Experience 243
individual patient (see discussion of case-based reimbursement in chap-
ter 4). For example, a private hospital would not be reimbursed for
ordering tests in addition to those prescribed by the physician-auditor,
and such a hospital would also have a clear incentive to limnit each
patient's length of stay. Despite these changes, however, there are still
no cost-sharing provisions for iNAMPS beneficiaries, so patients have no
financial incentive to limit their demand for medical services.
These features of the Curitiba Plan were implemented more broadly
throughout INAMPS in 1983. By requiring entrance to services to be
through public primary care providers (that is, its own employees) who
had the responsibility for defining a patient's course of treatment for
which prices were already set, INAMPS took a more active role in enforc-
ing cost discipline on private providers. The reforms did not alter all the
problematic features of the health insurance system, however. With a
fixed reimbursement rate per case type, hospitals could maximize profits
per case by minimizing the level of inputs per admnission, which raises
concerns about the quality of care. Although a case-based reimburse-
ment system encourages providers to economize on the level of re-
sources allocated to the care of an individual patient, such a system also
provides incentives for hospitals to maximize the volume of profitable
admissions. Because there are a limited number of payment categories,
there will be patients of varying severity within each category. There is
some evidence that this case-based reimbursement system led to a
change in hospital case mix. Rodrigues (1989b) concluded that private
hospitals shifted more costly patients to public and university hospitals,
leaving themselves with a mix of less severely ill patients for which profit
margins per patient were greater. Such shifting could lead to intense
pressure on public facilities.
A reform of the Brazilian health care financing system, announced in
1987, is the Unified and Decentralized Health System (SUDS), which may
address the problems of escalating costs of curative care and distortions
in the allocation of resources across preventive and curative interven-
tions. By integrating management of all levels of care and of contracts
with suppliers of private medical services at the state level, SUDS estab-
lishes an administrative framework that is consistent with an effective
referral system. In addition, SUDS unifies the functions and resources of
iNAmpS and the MOH at the state and local level. This strategy allows for
cross-subsidization of preventive (MOH) services from the revenues gen-
erated through the insurance system (iNAMPS), although there are as yet
no data from which an evaluation can be made. Such a reallocation of
health resources could lead to a more cost-effective mix of preventive
and curative care services.
Brazil's attempts to address the problems of its health care financing
system appear to generate better incentives for a more efficient health
care delivery system, although the available data are insufficient to

244 Public Hospitals in Developing Countries
evaluate their effect. The reforms that began under the Curitiba Plan
created an institutional framework to guide consumers through the
health care system. Another aim was to limit provider-induced demand
by requiring that the gatekeepers to the system be employees of the
insurer and that these persons determine the total course of treatment to
be provided. Fixed reimbursement on a case rather than fee-for-service
basis should reduce the number of unnecessary procedures that are
performed. Finally, unifying the resources and administration of the
institutions responsible for delivering both curative and preventive
services allows for cross-subsidization and the possibility of a more
cost-effective health care delivery system.
China
China's system of health financing has two characteristics that are crucial
to the incentives it creates.
3
First, financing of hospitals and other health
institutions was decentralized in 1981, and these facilities were in-
structed to cover their nonstaff recurrent costs through user charges. The
second characteristic is health insurance programs, most of which reim-
burse hospitals (and other providers) 100 percent of charges. Overall,
about 20 percent of the population is covered under such programs, and
another 10 to 15 percent of the population has more limited insurance
coverage (that is, with cost-sharing provisions). Reimbursement under
these programs is on a fee-for-service basis, and insurers are third-party
payers who are separate from the providers of care and who play no role
other than financing services. Provision of more services, meeting the
demand for services, and the decentralized financing incentives are
linked to the expansion of capacity rather than to increased efficiency in
the provision of services.
The decentralization reforms, which were intended to reduce the
health sector's drain on public budgets by requiring most health institu-
tions to earn revenues sufficient to cover operational costs and some
capital costs, have resulted in supplier-induced consumption of those
health services on which a profit (that is, a positive margin of revenues
over costs) can be earned. The pricing of hospital services, coupled with
the knowledge that most insurance will reimburse 100 percent of charges
billed to their beneficiaries, has encouraged health care providers to offer
more and higher priced services. Rapid escalation of health costs has
been one result of these policies. Total health costs have grown steadily
from 2.6 percent of GDP in 1980 to 3.2 percent in 1988, and total health
expenditures grew at an annual average rate of 17 percent in real terms
between 1980 and 1988. Most of this growth has resulted from increases
in fee payments by patients and in insurance reimbursements.
The pricing of hospital services has created distortions in the mix of
services provided. Fees for technologies and services that were in use in

Hospital Financing Experience 245
the 1950s (for example, outpatient consultation, inpatient care, surgical
operations) were set well below cost at that time, and even with price
reform in 1985, fees for most of these "older" medical technologies,
procedures, and services are considerably below cost. Older price guide-
lines do not exist for new technologies, and case studies of the service
costs and prices for many of these (for example, electroencephalography,
coronary care, CAT scans, ultrasound, and renal dialysis) reveal strong
financial incentives for their provision. There is an incentive for hospitals
to use equipment frequently, especially for those insured patients who
bear none of the cost of these procedures. To the extent that prices
charged for the use of these technologies are greater than their marginal
cost to the hospital, the hospital makes "profits" that can be used for yet
more sophisticated equipment purchases and expansion of services,
paid into workers' welfare funds, or given as incentives and bonuses.
Another category of hospital prices is drugs. Hospitals are explicitly
allowed to mark up the price of drugs by 10-18 percent above the
wholesale price for which they acquire them. While the markup is
intended to cover storage and distribution costs, there are clear incen-
tives to overprescribe. Overprescription is probably occurring, as evi-
denced by an average of 2.3 drugs prescribed per patient contact and the
nearly 50 percent of total health expenditures going for drugs. As in
Brazil, this is not just a financial problem; overprescription is clearly
contrary to sound medical practice and can have deleterious health
effects. Pricing policy has led to a de facto subsidy for the domestic
pharmaceutical industry by the health system, and particularly the
insurance systems.
Another consequence of the incentives of the financial decentraliza-
tion reforms in China is that government health expenditure, and to a
much greater extent total health expenditure, has been increasingly
devoted to higher-level hospitals at the expense of lower-level hospitals.
Data on government health expenditure show that the share of higher-
level hospitals rose from 38 percent in 1980 to 44 percent in 1987, whereas
that of basic hospitals fell from 23 to 17 percent during the same period.
Antiepidemic and maternal-child health activities remained about 17
percent of public expenditure. The growth in the percentage of total
health expenditure financed by fees and insurance (from 72 percent in
1980 to 81 percent in 1987), however, and the preponderance of fee and
insurance payments devoted to hospital services, meant that the share
of total health expenditure devoted to basic and preventive services
undoubtedly fell during the period.
Changes in the share of total health expenditure between the insured
and uninsured during the 1980s reflect a skewing of health service
provision away from the uninsured majority of the population. By 1988,
insurance reimbursements accounted for 44 percent of total health fi-
nancing, yet only about 20 percent of the population was covered under

246 Public Hospitals in Developing Countries
official insurance programs in that year. On a per capita basis, consump-
tion of health care by insured persons is much greater (and is rising
dramatically) than by uninsured persons, suggesting some moral hazard
on the part of the insured and possibly limited access for low-income
uninsured persons.
As in Brazil, the experience in China suggests that third-party fee-for-
service reimbursement of 100 percent of hospital charges leads to rapid
cost escalation. In a system in which only part of the population has
insurance coverage, there is clear evidence of differential use of services,
although the relative extent of moral hazard on the part of the insured
and lack of access for the uninsured is uncertain. China's experience also
highlights the importance of price incentives for the use of particular
medical technologies. The signals sent to providers have resulted in the
expansion of profitable high-technology services and drugs, which is
probably not a cost-effective use of hospitals. In addition, because invest-
ment decisions are based on existing signals, the long-run consequences
of today's distorted price signals are likely to be an even more inefficient
mix of facilities and equipment. In short, although China's decentralized
pricing system and insurance programs have been effective in generat-
ing revenues for hospitals, they have done so at the cost of equity in the
use of services and inefficiency in their organization and production.
Republic of Korea
Korea introduced a compulsory social security health insurance scheme
in 1977 that initially covered less than 15 percent of the population.
4
Since
that time, legislation has rapidly increased the beneficiary population,
and universal coverage was achieved during 1989. Insurance is provided
through a large number of nonprofit, noncompeting societies orgarized
at the firm, firm group, or county level. There are programs for the
unemployed and self-employed, plus public assistance programs that
subsidize the insurance premium for indigent persons (about 10 percent
of the population). A national fee schedule is negotiated annually, and
hospital payment rates are set on a cost-plus basis. Providers are retro-
spectively reimbursed on a fee-for-service basis according to this sched-
ule. Unlike the program in Brazil and most health insurance in China,
there are significant cost-sharing requirements in the Korean program,
except for certain categories of the medically indigent. A combination of
deductibles and copayments yields effective coinsurance rates of 62,65,
and 41 percent for outpatient services in upper-level hospitals, other
hospitals, and clinics, respectively. The inpatient coinsurance rate is 20
percent at all facilities. Extra payments to senior physicians and other
undocumented expenses, however, mean that the extent of actual cost
sharing is even greater.

Hospital Financing Experience 247
The combination of third-party benefit payments and cost sharing
serves to finance hospital care, which is largely provided by private
facilities. The insurance societies and the government exert more control
over providers than do their counterparts in China (and in Brazil prior
to 1983). In mid-1989, for example, a law was passed requiring patients
to have a referral slip from clinics before being allowed to use hospital
care. The Ministry of Health also defines the services that are covered by
insurance and ultimately determines the prices for covered services. A
number of expensive, high-technology services, such as CAT scans and
extracorporeal shock wave lithotripsy (ESwL), are not covered, however,
and providers can charge unregulated prices for these.
Attempts to sort out the effects of the expansion of insurance coverage
on total Korean health expenditures are confounded by the effects of the
rapid growth in per capita income (about 8 percent annually during the
last two decades) on demand. Total health spending grew from 2.7
percent of GNP in 1976 to 5.1 percent in 1985. This growth resulted from
a combination of increases in cost per case (inpatient cost per case nearly
tripled and outpatient costs nearly doubled from 1980 to 1988, as com-
pared with an increase of only 60 percent in the consumer price index
over the same period) and in the volume of services used (physician
visits per capita nearly doubled and hospital admission rates rose by
about 40 percent between 1980 and 1988). The health insurance system
magnified the increased utilization and costs that would have been
expected as a result of income growth and an aging population because
the fee-for-service system using cost-plus pricing rewarded cost-increas-
ing rather than efficient behavior. Despite the presence of significant
copayments in the system, hospital utilization data indicate a growing
tendency to increase the volume of services provided; the frequency of
repeat visits is rising and lengths of hospital stay are increasing. These
increases suggest that incentives on the demand side (that is, substantial
cost sharing) have not been very effective at limiting service use in the
face of rapidly rising incomes.
The insured population shows a marked tendency to use large general
hospitals even for primary care; these hospitals tend to have higher
proportions of specialists and advanced medical equipment and are
accordingly more costly. Using general hospitals is also the most expen-
sive option for a consumer: such hospitals are allowed to charge fees that
are about 15 percent higher than they are at clinics, and the percentage
copayment for outpatient care is 50 percent greater. Despite these higher
charges, however, the use of general hospitals has risen at almost the
same rate as that of clinics in recent years. The pattern of overuse of the
more sophisticated general hospitals that is becoming established in
Korea may be incorrectly interpreted by planners as a need for more of
these facilities, which could generate still more undesirable cost escala-

248 Public Hospitals in Developing Countries
tion. The referral requirement introduced in mid-1989 appears to be an
appropriate device for initially steering patients toward lower-cost pro-
viders, but there are as yet no data to suggest how effective this has been
in practice.
Because prices are set by the government, Korean hospitals must
compete for patients on some other basis than price. This other basis
primarily has been the availability of senior medical staff and of sophis-
ticated medical equipment. Given the strong societal preference for
senior physicians and new technology, it is not surprising that hospitals
are acquiring more and more modem equipment. For example, CAT
scanners are now in nearly every hospital with more than two hundred
beds. The costs of these devices generally are greater than the revenues
collected from their use, but hospitals use them as loss leaders to attract
patients. Other technologies used in this manner are heart transplant
facilities and ESWLs. Korea has thirty-eight heart transplant centers and
twenty-six ESWLs. Canada, by way of comparison, has only thirty-two
and four, respectively.
Universal coverage under Korea's national health insurance program
theoretically should provide for universal access and better equity than
had previously existed. However, the very high coinsurance rates
charged to all patients irrespective of income (with the exception of some
categories of the medically indigent) raise equity concerns because they
are more of a burden for the poor. Data on per capita health service use
by income class for insured persons in 1987 show that use by the poorer
insured was considerably less than that by higher-income insured per-
sons. In addition, the capacity to make informal "under the table"
payments and to pay for noncovered high-technology services has re-
portedly led to a two-class system of health care.
Despite significant beneficiary cost-sharing requirements in Korea's
fee-for-service hospital reimbursement system, the introduction and
expansion of insurance has been associated with rapid growth in health
and hospital costs. In addition, demand-side strategies designed to
encourage appropriate use of referral facilities have not been very effec-
tive. This suggests that the key to encouraging a more efficient service
delivery system is to create strong incentives to providers to limit the
volume of services they provide and use more cost-effective treatment
settings. Clearly, such incentives do not arise from Korea's cost-plus
fee-for-service system, although the referral requirement added to the
system in 1989 should mitigate some problems if implemented force-
fully. Korea's insurance program uses its strength as the principal pur-
chaser of services to negotiate a national hospital fee schedule, but an
unintended consequence of this has been the means by which private
hospitals compete for patients on the basis of perceived quality and

Hospital Financing Experience 249
status. Because consumers' understanding of hospital and medical prac-
tice is usually limited, there may often be great differences between
perceived quality and actual quality. As a result, hospitals have com-
peted by accumulating technologically advanced equipment to attract
patients. As in China, this action creates a distorted pattern of investment
that will lead to an increasingly inefficient mix of services in the future.
Finally, equity problems remain despite the achievement of universal
coverage. The heavy official cost-sharing obligations and the unofficial
payments demanded by private providers weigh most heavily on lower-
income insured persons, who consequently use fewer health services
than the rest of the population.
Zaire
The focus of this case study is on only one small region of Zaire, not a
national system of hospital financing as was the case in the other exam-
ples.
5
In 1975 the government developed a plan to organize its health
services around a large number of "health zones," each serving approx-
imately 100,000 people with a reference hospital and satellite health
centers. The health zones were given a considerable degree of autonomy,
including responsibility to develop cost-recovery programs to meet their
operating and maintenance costs (Bitran and others 1987). In 1985 the
management of one of the zones, Bwamanda, created an insurance
program as a means of generating revenue for its reference hospital and
organizing the delivery of services in the zone. Unlike the insurance
programs discussed earlier, the Bwamanda insurance plan covers only
hospital services (plus chronic care treatment in health centers). In
addition, it is organized and managed by the health zone and is thus a
direct rather than a third-party program, and it is administered as a
prepaid capitation health care organization. Enrollment in the plan is
voluntary, but to limit the effects of adverse selection, all members of a
family are required to join if one member joins. For residents of the zone
who are not enrolled in the plan, case-based fees are charged, with
patients assigned to one of sixteen categories according to their cinical
characteristics. The insured population pays 20 percent of the case price
charged to uninsured residents of the zone. In addition, the hospital
charges nonresidents twice the resident rate and employed persons
(whose employers are required by Zairian law to pay the full cost of their
medical care) 250 percent of this rate.
Even though the insurance plan does not cover charges in health
centers (except for care of chronic conditions), it includes strong incen-
tives to discourage self-referral to the hospital. Specifically, the plan will
pay for hospital care only if a beneficiary has a referral slip from a health

250 Public Hospitals in Developing Countries
center. The incentive for first using less-complex facilities is thus built
directly into its reimbursement rules. Another aspect of the plan that
encourages appropriate use of primary care facilities is that insured
women who have received prenatal care are entitled to a free hospital
delivery.
The uninsured were found to have hospital admission rates that were
lower than for those insured through the plan, and much lower (nearly
twentyfold) than for those whose fees were paid by their employers.
This suggests a combination of limited access for the very poor, because
there are apparently no exemptions from payment, and moral hazard
arising from the financial protection provided by insurance and em-
ployer payment. The enrollment in the plan of individuals who believed
they were likely to use the hospital (adverse selection) was probably also
a factor in the overrepresentation of plan members in the use of hospital
services.
The purpose of establishing a hospital insurance program in
Bwamanda was to increase the level of resources available for health
services. Increases have been achieved, yet there have not been gross
distortions created in the process, as has occurred in other countries.
There is no evidence to suggest that the case-based reimbursement and
pricing system has resulted in distorted incentives for the use of any
particular technologies. The direct insurance model, wherein the insurer
and provider are the same entity, offers several advantages over third-
party payment in regard to the efficient organization of the health care
system. For example, no specific referral incentives to providers are
needed; therefore, referral rules are more easily enforced. The principal
drawback of the voluntary insurance plan used in Bwamanda is that
access to care is not the same for the uninsured and the insured (includ-
ing employer-paid). The greater use of services by the insured reflects
moral hazard arising from insurance coverage; it may also mean that
access for the uninsured is limited by their unwillingness or inability
to pay. The latter is of greater concem, but the magnitude of this problem
is unknown. One possible way to encourage greater equity would be
to subsidize insurance premiums, fully or partially, for those unable to
pay, although this would involve means testing that might be relatively
costly to apply. Another issue related to the Bwamanda plan is that it
has a monopoly on the provision of hospital services in the region. This
may limit the replicability of this model in other regions unless they have
the resources and the will to ensure maintenance of the quality of
services. Overall, however, the Bwamanda health plan has successfully
organized and sustained the services provided in the zone, demonstrat-
ing that insurance can be a viable option for financing health services in
a rural area with a population primarily composed of self-employed
farmers.

Hospital Financing Experience 251
Synthesis
These case studies suggest that the role played by the institution admin-
istering an insurance program is perhaps the principal determrinant of
the effects of the program on the efficiency and equity of health resource
use. In particular, insurers should not merely channel funds to providers;
rather, they should take a very active role in establishing mechanisms
(such as contractual obligations) that encourage providers of health
services to make efficient and equitable resource allocation decisions.
By controlling supply and strongly influencing demand for services,
providers can increase the use of curative care services in a manner that,
as the examples of Brazil, China, and Korea show, leads to rapid escala-
tion in health care costs, distortion of resource allocation, inappropriate
use of medical technologies, and inequitable access to the services
available.
Cost escalation. In each of these countries, alternative financing mecha-
nisms were introduced as a means of increasing the level of resources
available in the health sector and reducing government subsidies. Thus,
it is not surprising that each has been associated with rapid growth in
expenditures for health and hospital care. Cost escalation becomes prob-
lematic when the incentives of a specific financing mechanism cause
expenditures to spiral out of control. These studies indicate that third-
party fee-for-service reimbursement leads to large and rapid increases
in hospital costs because of provider incentives to increase the volume
and even the cost of services. The presence of significant cost-sharing
requirements in Korea apparently did little to mitigate this cost escala-
tion, although more analysis is needed to isolate the partially offsetting
effects of rapid income growth and cost sharing on service demand.
Certainly, however, providers have a very important effect on the quan-
tity of services ultimately demanded by health consumers, given the
ignorance of most consumers of their medical treatment needs and
options. Greater cost containment can be achieved by creating incentives
for providers to limit the volume of services rather than focusing efforts
solely on the demand side through price signals.
Case-based reimbursement should result in less cost escalation than a
fee-for-service system, but the evidence from Brazil is insufficient for an
evaluation. Case-based reimbursement does not eliminate the incentive
to increase costs; it does motivate health care providers to maximize
profitable admissions and minimize the quantity of services provided
per admission. This incentive is likely to limit cost increases somewhat.
It may, however, have a negative effect on the quality of care, and either
competition or regulation are necessary to maintain standards. Further-
more, where a mix of private and public providers are financed on this

252 Public Hospitals in Developing Countries
basis, as in Brazil, private hospitals have an incentive to alter their case
mix by taking less severe, more profitable patients and leaving sicker
patients for the public hospitals. This can result in an overly strained
public system.
Resource allocation and referral. Because third-party fee-for-service reim-
bursement by a passive insurer generates rapidly rising costs for hospi-
tals, and, moregenerally, for curative services, it tends to lead to a decline
in the relative share of health resources devoted to preventive services.
This does not necessarily imply a decline in resource availability for
prevention, but for most countries the marginal benefit of additional
resources in preventive services would be greater than in curative ser-
vices. This effect can be mitigated if the provision of preventive services
can be subsidized from the surplus generated by the expansion of
curative care. Such cross-subsidization is most feasible when a unitary
authority is responsible for all levels of health care, from primary pre-
vention to hospital services. Two models for this are the direct insurance
plan used in Bwamanda, in which the health zone is responsible for all
levels of care but generates revenues through the provision of curative
care, and the SUDS in Brazil, which unifies the resources and administra-
tion of curative and preventive services. Both strategies should be closely
monitored to determine how effectively they allocate resources.
Financing systems can generate incentives for the use of specific types
of facilities by price incentives to consumers or by fiat. Evidence from
Korea suggests that price incentives alone may not work very well if
perceived quality differences between levels of facilities are great. Mak-
ing reimbursement contingent upon a patient's use of specified points
of entry into the provider network appears to be more effective. In Zaire's
Bwamanda health zone, this functions as a price incentive, with a very
large (80 percent) penalty for insured persons who self-refer to the
hospital. Brazil's Curitiba Plan suggests a strategy for countries with a
diverse mix of providers: require entry into the network to occur through
a primary care facility run by the insurer (an aspect of the direct insur-
ance strategy). This requirement not only reduces self-referral to hospi-
tals, it also removes the decision on the course of treatment from the
provider who will ultimately be reimbursed.
Incentives for the use of medical technologies. The financial incentives that
influence the use of a medical technology arise from how these specific
services are priced, as is evident from the experience of Brazil and China.
Hospitals have an incentive to maximize use of those services for which
the margin of reimbursement above the cost of provision is greatest.
Consumers rely on the medical judgment of providers and often tend to
equate new, high-technology procedures and a greater quantity of phar-

Hospital Financing Experience 253
maceuticals with better health care. When the price or reimbursement
rate differs from the marginal cost of a service, the incentive may shift
the provision of services away from what is medically appropriate by
introducing financial considerations into the decision about the choice
of technology. The consequences of this distortion in regard to long-term
efficiency can be severe, because investment in future capacity is often
based on current levels of service use. The problems can be mitigated to
some extent by using case-based rather than retrospective reimburse-
ment, but overprovision incentives may remain, depending on the na-
ture of the case payment categories.
Equity of access. Insurance coverage is a means of ensuring access to
medical services that may otherwise be difficult for many persons if
prices for services are high enough to recover costs. When coverage is
universal, as is practically the case in Brazil and has become true in
Korea, differences in access arising from insurance status should not
occur. When only part of the population is covered by insurance, as in
China and Zaire's Bwamanda health zone, disparities are likely, because
the cost to the uninsured of using health services is radically different
from the cost to the insured population. Such disparity does not neces-
sarily mean that access for the uninsured is inadequate, however. Al-
though heavier utilization among the insured population (moral hazard)
can be expected, it is not a serious problem so long as sufficient access
for the uninsured can be guaranteed. Access problems may exist even in
the presence of universal coverage, however. Briscoe (1990) shows that
in Brazil, for example, poor rural areas may lack sufficient facilities or
trained personnel even when the population has insurance coverage. In
Korea, access is limited for poor persons who cannot make informal cash
payments to providers.
In poor countries in which lack of access is clearly a problem, the issue
of publicly subsidized insurance coverage for one segment of the popu-
lation raises serious questions of equity. Partial insurance for a relatively
well off section of the population exists in a number of countries, even
those whose health services are priced modestly and are thus heavily
subsidized by government. In Indonesia, for example, beneficiaries of
the compulsory health insurance program for active and retired civil
servants (ASKES) are entitled to free use of public hospitals. The hospital-
ization rate of the beneficiaries of ASKES is about five times the national
average, and most ASKES families are probably in the top quartile of the
Indonesian income distribution. Their heavy use of services, which
remain heavily subsidized, implies that this relatively well off segment
of the population captures a disproportionate share of public subsidies
for health as a result of the easier access they have because of their
insurance coverage (Prescott 1991). This issue may also be of concern in

254 Public Hospitals in Developing Countries
several African countries (see Vogel 1988 for brief descriptions of health
insurance in Cote d'Ivoire, Mali, and Senegal).
Summary and Recommendations
The use of fees and risk sharing offer the possibility of reducing the
financial dependence of the hospital system on public sector funds while
meeting equity objectives, but this possibility has not been exploited in
many countries. The general conclusion from the review of revenue
experience in this chapter is that in most countries revenues generated
from nongovernment alternative financing sources remain a small frac-
tion of total hospital expenditures. Surprisingly, the percentage of costs
recovered does not appear to be related to the level of per capita income
or the prevailing ideology of a country. The experience with cost recov-
ery in such diverse countries as Brazil, China, Turkey, and Zaire
demonstrates both its feasibility and usefulness as an alternative source
of revenue for hospitals.
Many countries have formal fee policies for hospitals but collect only
negligible revenues. In these countries, the low level of unit fees, loose
enforcement of payment of these fees, and broadly defined exemptions
contribute to the small size of collected revenues. Commonly, the failure
to adjust for inflation erodes initially modest fees to the point that they
become negligible. Inadequate enforcement adds to the problem and
results in the collection of substantially less money in fees than could be
collected, even when the existing fee structure is used as a basis for
calculating the potential.
The usefulness of fees to achieve the objectives of equity and efficiency
is impeded by the lack of a systematic relation between fees for specific
services and the related marginal or average costs. Ideally, to promote
efficiency, fees should act as a device to encourage the rational use of
resources, but fees kept at negligible levels cannot provide the correct
incentives to achieve efficient resource use. Also, to promote equity, fees
for services used by higher-income households can be set at levels that
return a profit to subsidize more broadly used services. More often,
however, fees are set well below costs even for private amenity hospital
services, with the inequitable result that such services are subsidized
from general government revenues.
Review of the experience with fees suggests some practical additions
to the guidelines for fee policy set out in chapter 4:
* The routine adjustment of fees over time should be an institution-
alized administrative action rather than a political decision. This can
be done by tying fee levels to price indexes.

Hospital Financing Experience 255
* The structure of fees should be simple. The price structure should
be the least detailed in situations in which the cost-recovery goals are
modest, but in any case a simple structure is easiest to administer. The
complexity of fee structure is also limited by the degree of institutional
and management development.
* Price setting should be decentralized in large countries and in
countries that have great geographic variation in per capita income.
* Some degree of fee retention should be allowed so that hospitals
are provided with a financial incentive to collect fees. These revenues
should be used by the hospital to increase the quality of services and
thus increase the willingness to pay for hospital care.
* Exemptions should be limited largely to those made on equity
grounds. Extra subsidization and often complete exemption are also
warranted for services that have substantial benefits well beyond
those to the patient, such as treatment of communicable diseases.
As long as fees remain low, allowing for the recovery of, say, less than
30 percent of total recurrent hospital costs, exemption policy and gov-
ernment subsidies can absorb the financial risk of high-cost illness. A
higher degree of cost recovery, however, requires some form of explicit
risk protection. Whether the form of hospital payment is retrospective
reimbursement or prospective capitation payments, the presence of high
user charges and insurance affects the efficiency and equity of the
system. In many countries, insurance and fees have led to cost escalation
in hospitals caused by incentives for providers and consumers to pro-
duce and use services and for providers to adopt cost-ineffective tech-
nology. Retrospective reimbursement can lead to a declining share of
health resources used for prevention because of the rapid expansion
induced in the provision of curative care. Government-subsidized insur-
ance plans that cover only a small percentage of the population create
the possibility of great inequities in the provision of and access to
services.
The analysis in chapter 4 and the experience of selected countries
reviewed in this chapter lead to some recommnendations for the design
of a risk-sharing system to avoid these problems.
* The institution administering the insurance program should take
a very active role in establishing mechanisms that encourage provid-
ers of health services to behave in a manner consistent with the goals
of efficiency and equity. This is most easily achieved with direct
insurance, but it is also possible for third-party payers.
* Cost sharing is needed in either reimbursement or prepaid capita-
tion schemes to provide consumer incentives for efficient use of ser-

256 Public Hospitals in Developing Countries
vices. More important, however, are mechanisms to change provider
incentives, because cost sharing by itself is unlikely to be sufficient for
effective cost containment.
* In countries with large social insurance programs, revenues gener-
ated by the expanding curative care sector should be used to cross-
subsidize preventive services. Such a program is facilitated when all
levels of care are managed by a unitary authority on a geographic
basis.
* Prepaid capitation and direct insurance schemes are recommended
over retrospective reimbursement as practical means of cost recovery
and provision of managed care in circumscribed communities.
* Case-based reimbursement is preferred to a fee-for-service system
to diminish provider incentives to overproduce.
* In most cases, publicly sponsored insurance for only a small part
of the population should be avoided. The insured provision of subsi-
dized services will add to the inequity of resource use across income
groups. If sufficient political will can be mobilized, however, profits
can be generated from the provision of insured services to a small
population group. Then insurance can allow cross-subsidization, but
the situation can quicldy erode because of the greater political power
of the high-income insured.
In considering changes to existing health financing policies, some
contrasts can be drawn between the elements of alternative policies that
might be suggested for low- and middle-income countries. The elements
of a recommended hospital cost-recovery strategy can be differentiated
by the levels of per capita income and institutional development for a
prototypical country. Individual countries, such as China, that have low
per capita income yet advanced institutional development provide ex-
ceptions to this model. The evolution of hospital fee policies from low-
to middle-income developing countries is tied to information and
recordkeeping capacity, a concern with equity, the potential for insur-
ance, and the quality of services.
In countries with low income and poorly developed institutions to
administer fee collection and provide complementary management in-
formation, equity requires that fees be kept low, and the difficulty of
administering fees requires a simple fee structure. With low fees and
poorly developed institutions, reimbursement insurance may not be
practical or required. The experience reviewed above for selected low-
income countries does suggest, however, that prepaid capitation
schemes can be practical in circumscribed regions in which community
support and institutional development provide the needed environ-
ment. The quality of services affects the success of cost-recovery mea-
sures, and, likewise, if a portion of cost-recovery revenue is retained for
the use of the hospital, these measures can improve quality.

Hospital Financing Experience 257
For middle- and high-income countries, fees collected can be more
substantial. A higher level of fees should be accompanied by develop-
ment of the institutional infrastructure to manage fee collection,
recordkeeping, and data collection. Some increase in the complexity of
the fee structure may become practical if the objective is to achieve
greater equity and efficiency through cross-subsidization and to make
fees reflect costs more closely. Higher fees will also make it more practi-
cal to cover the cost of collection and enforcement of exemptions. Some
means of risk sharing must be introduced if fees are increased, and the
use of reimbursement insurance will also put greater demands on data
collection and recordkeeping. Higher fees, too, will mean that even
greater attention must be paid to the quality of services.
For both high- and low-income countries, the level and structure of
hospital fees should reflect the role of the hospital in the referral system.
Fees can act as a market signal to direct client demand to the most
efficient service providers. This aspect of fees is considered further in the
next chapter.
Notes
1. Waddington and Enyimayew (1990) reportanecdotalevidence that suggests
that in Ghana, unlike in many other countries, there is a reluctance to use the
exemption based on income. As a result, some people are foregoing treatnent
because of the cost.
2. Information on Brazil is drawn from four sources: Briscoe 1990; World Bank
1988; McGreevey 1988a; and Rodrigues 1989b.
3. Information on health and hospital financing in China is based on Bumgar-
ner (1992).
4. Information on hospital and health financing in Korea is derived largely
from Yang 1991, and World Bank 1989a.
5. Information on the financing of hospital services in Zaire is derived from
Shepard, Vian, and Kleinau 1990.

6. Reallocating Hospital
Resources to Improve
Health Services
This chapter covers the role of hospitals in the health service system and
suggests changes that can improve the use of health sector resources.
Hospitals are an essential part of the health system, but the reallocation
of resources to nonhospital alternatives can reduce the cost of providing
health services. Such reduction does not necessarily imply budgetary
savings; rather, it may imply increasing the number of people who are
served or improving the quality of services for a given level of expendi-
ture.
The term "hospital" connotes an image of a physical building in which
services are delivered by a skilled staff. Traditionally, hospitals have
provided a focus for the delivery of interventions requiring special
personnel skills and equipment, monitoring of patients, or containment
of patients for therapeutic reasons. Most health care, however, actually
takes place outside of hospitals, in clinics, medical offices, pharmacies,
schools, and homes. Hospitals, by providing a technical focal point for
the referred delivery of skilled care, can magnify the effectiveness of
nonhospital health care.
One common description of the health sector uses a pyramid, such as
that in figure 6-1, to emphasize that hospitals are the end point in a
referral hierarchy that provides most care at the bottom of the pyramid
through primary health care. Although the pyramid is a stylized depic-
tion of a health system and does not illustrate the relations between and
the functions of the different levels of the system, it does clearly describe
the principle of providing most care at the lower levels. Movement
between levels of the pyramid occurs, theoretically, by referral and
according to need. Within this general view of the health system, how-
ever, there is considerable flexibility to redefine specific functions carried
out at different levels in the system and to change referral patterns.
259

260 Public Hospitals in Developing Countries
Figure 6-1. Health Referral System
Central
hospital
Prov. hospital
District hospital
Health center or post
/ ~~~~Community\
/ ~~~~~~Fariily and home\
The pyramid is not merely descriptive. It is prescriptive, suggesting
how the health care system should be organized. There is an economic
logic inherent in the structure of the pyramid, which reflects the relative
cost-effectiveness of alternative technologies for providing care. The
width of the pyramid at any point represents the relative number of
persons who should be served by a particular provider category. The
criteria for determining which provider should provide care at a given
level are (a) epidemiology (the frequency of various diseases and condi-
tions in the population) and (b) the unit costs of providing services at
each level. At the bottom of the pyramid should be the most frequently
occurring conditions that are the least expensive to treat, whereas at the
top should be the rarest conditions that are the most expensive to treat.
This depiction is consistent with the goal of patients to minimize the costs
(induding travel and time) of having their illnesses treated.
Each provider category represents, in broad terms, a technological
alternative for treating diseases and conditions arising in the population.
Health planners can use epidemiological analysis, a knowledge of tech-
nological alternatives, and the unit costs of these alternatives to derive a
cost-effective network of providers for their country. Mwabu (1989)

Reallocating Hospital Resources to Improve Health Services 261
notes that cost-effective delivery of basic health services occurs within
the context of a particular organizational structure of facilities. Because
different structures, or delivery systems, have different costs of deliver-
ing the same package of basic health services, the structure with the
lowest cost (that is, the one that would maximidze population coverage,
given resource constraints), is the most cost-effective one.
For each provider category, health care elements such as use of phar-
maceuticals, treatment, disease control, maternal and child health and
family planning (MCH/FP), water and sanitation, nutrition, and health
education are relevant. Providing these elements of health care involves
functions such as information, management, personnel development,
logistics, facilities, and research. There are linkages between health care
elements and functions at all levels of the health care system. This
conception of the health care system recognizes, for instance, that the
household and community can provide labor, facilities, logistics, and
other functions for treatment and disease control. Or, to provide a
contrasting example, all levels of hospitals can be involved in nutrition,
health education, and basic MCH/FP. Simply the recognition that specific
services can be provided at different levels of the system does not imply
that these services should be provided at many levels (or at least subsi-
dized to the same extent across all provider categories). Nevertheless,
this concept recognizes that there is considerable interaction between the
levels with regard to all the functions and health care elements (WHO
1987a).
The growing use of alternatives to the traditional structure of hospitals
represents an effort to increase the delivery and improve the effective-
ness of health care services in low-cost settings. This notion is consistent
with efforts to encourage patients to use lower levels of the referral
pyramid. A more cost-effective network of providers can use hospital
resources to support primary health care and create new institutional
settings for care at the community and family levels. Because we are
concentrating on hospitals in this book, we make no attempt to provide
a complete model of the interactions between all providers in a referral
network (see King 1966 for a detailed discussion). The focus in this
chapter is on the role of the hospital, including the potential for hospitals
to support primary health care, the reallocation of patients and services
across basic and tertiary hospitals, and the use of innovative alternatives
for providing care ordinarily delivered on an inpatient basis in hospitals.
Accordingly, in the first section of this chapter we discuss possibilities
for improving the overall cost-effectiveness of hospitals by changing
referral patterns and thus the mix of services delivered in lower-level
hospitals and the mix of patients seen in higher-level hospitals. In the
next section we discuss the use of hospital resources to support primary
health care. Finally, in the last section we discuss alternative institutional
designs or treatment settings to reduce the cost and increase the effec-

262 Public Hospitals in Developing Countries
tiveness of health services usually provided on an inpatient basis in
hospitals.
Changing Hospital Referral Patterns
Hospitals provide a wide variety of services, from basic care to highly
specialized diagnosis and treatment, depending on the technological
capacity of the specific hospital. There is considerable duplication of
services provided in different levels of facilities, and in many countries
tertiary hospitals with advanced technical capacity devote considerable
effort to delivering basic secondary and even primary curative care.
These hospitals, however, are designed to treat complicated cases, and
because of their composition of skilled staff and medical equipment the
cost of treating a patient is often higher than the cost would be for the
same type of patient in lower-level or specialized alternative facilities.
This misuse of the capacity of tertiary hospitals affects outpatient as well
as inpatient services. The outpatient departments of large tertiary care
hospitals often suffer from overcrowding; this situation is exacerbated
by the presence of a large number of patients who require only basic
curative care that could be provided in a lower-cost setting such as a
district hospital or health center. If patients requiring basic care could be
shifted to medically appropriate lower-level or alternative treatment
facilities, health system costs would be reduced and economic efficiency
improved.
Analysis of discharge information by cause and severity of the illness
or condition is needed to assess the potential for reallocation of the case
load within the hospital system. In large tertiary facilities in urban
centers, perhaps 75 percent of outpatient care and 30 to 50 percent of
inpatient care could be effectively delivered in district hospitals or at
lower levels. The average cost data presented in table 3-1 suggest the cost
savings that could be obtained from improved referral. A comparison of
the cost per outpatient visit or inpatient day between varying levels of
hospital suggests that the savings could be on the order of 50 percent of
current costs per patient shifted in a typical hospital system. Secondary
(provincial-level) and tertiary hospitals absorb about 30 percent of gov-
ernment health expenditures (see chapter 2). If just 33 percent of patients
could be shifted from upper- to lower-level hospitals, the total savings
would be 5 percent of the current government health expenditures and
10 percent of government hospital expenditures. This example is only
an approximation, because the average costs may differ from the appli-
cable marginal costs required to shift users from upper- to lower-level
hospitals. But the estimates, even if taken as rough, indicate that the
order of magnitude of the savings could be considerable.

Reallocating Hospital Resources to Improve Health Services 263
The potential for these savings is clearly recognized in many govern-
ment and donor surveys of health sector needs (see, for example, Jolly
and King 1966 and World Bank projects in Botswana (1984 Family Health
Project) and Brazil (Sao Paulo Basic Health Care Project). Recognition of
the need to improve the referral system is much easier, however, than
implementation of the change has proved to be. A WHo Expert Commit-
tee on the Role of Hospitals at the First Referral Level cited many
problems impeding the development of better referral systems (WHo
1987a; Paine and Tjam 1988), which can be summarized as follows:
* Overloading of hospitals with self-referrals or poorly judged referrals
* Barriers of distance or patient financial status that prevent the
patient from carrying through with referral
* Lack of confidence in lower-level facilities because of perceived low
quality of care
* Inadequate flow of information between the hospital and health
center or health post levels
* Lack of organizational and management links between levels of
care.
These problems are interrelated. For example, the overuse of second-
ary and tertiary facilities with inappropriate referrals is affected by the
poor quality of lower-level services and the lack of organizational links
and poor information. As a second example, the inadequate flow of
information between service levels is related to a poorly integrated
organizational framework, as well as the reverse. Overcoming these
problems requires a set of interrelated policies. We briefly discuss three
key policy areas-structure of the referral system, management coordi-
nation, and quality improvement-that address the problems identified
above.
Structure of the Referral System
To function effectively in encouraging patients to use the level and type
of service that fits their needs most efficiently, the referral system needs
a carefully developed structure. This structure should be integrated with
primary health care at all levels, and in the next section of the chapter
we explicitly examine the role that hospitals can have in supporting
primary health care. At each level of the system, the mix of patients to
be seen and available services should be consistent and well defined.
Referral criteria should be set out for major diagnostic characteristics and
disease categories. Manuals, information, training, facility capacity, and
management should support the referral policy.

264 Public Hospitals in Developing Countries
Although these recommendations appear clear and reasonable, care-
ful, detailed planning and analysis are needed to implement them. A
working system requires a specific design that details referral policy and
conforms to local circumstances, such as the pattern of diseases, popu-
lation density, transportation and communication infrastructure, educa-
tion and income of clients, facility capacity, and training of providers.
The system should be designed in consultation with providers and
consumers at all levels, from the community through professionals at
the tertiary level.
Development of a formal referral policy. A useful starting point for the
development of a formal referral policy is the supply and demand
paradigm. This paradigm clearly recognizes that client demand is
formed by medical needs, a perception of facility abilities to fill the needs,
and perceived costs of services, and that supplied services and referral
rules interact with this demand to determine the use of services at each
level. Development of the policy should begin with an epidemiological
analysis of the population to determine the relative prevalence and
incidence of various diseases and conditions. Next, alternative methods
of addressing these diseases and conditions should be defined and
costed. At this stage of health sector planning, highly detailed cost
studies are probably not required, but cost analysis should account for
the scarcity of inputs such as physicians, pharmaceuticals, or highly
trained medical technicians. The appropriate mixes of providers and of
services to be available at different levels of the provider pyramid are
those that generate the greatest population coverage at least cost. Popu-
lation density is a key determinant of the appropriate composition of the
provider network. A survey of existing referral patterns and facility use
should be an integral part of the analysis and should include an account-
ing of the disease classification of patients treated; type of service re-
ceived; distance of treatment center from household location; and
referral history with regard to prevention, diagnostics, treatment, and
outcome. This information, together with a review of existing proce-
dures, staff training, manuals, and facility quality, can be used to inform
the development of an improved system.
So far, the discussion has focused largely on health planning decisions.
It should be recognized, however, that patients exercise considerable
sovereignty in deciding where they will seek treatment. Mwabu (1989)
notes that under certain conditions, a hierarchical referral system (such
as that depicted by the pyramid) minimizes consumer costs of treating
or preventing illnesses, and so cost-minimizing behavior on the part of
consumers and health planners would lead them both to this common
organization of health services. But the accuracy of the referral system
as a model of consumer behavior is affected by the extent to which six

Reallocating Hospital Resources to Improve Health Services 265
stringent assumptions, in addition to cost mininiization, hold. The first
assumption is that the same conditions can be treated at more than one
level of the provider network. The second is that treatment costs for
everyone are greater in higher-level facilities. The third, that the quality
of services at all levels would be acceptable to patients. The fourth, that
patients are well informed about the types of services available at each
level of the network. The fifth, that patients could not bypass one level
of the system without the consent of personnel at that (or lower) levels.
The final assumption is that public providers would be the only source
of medical care available.
The first assumption clearly holds for some conditions but not for
others. Under conditions in which it does not, patients will not necessar-
ily visit the cheapest treatment source. If the second, third, fourth, or fifth
assumptions do not hold, patients will bypass the nearest facilities.
Evidence on costs in different levels of hospitals suggests that the second
assumption is generally an accurate depiction of the world. Inadequate
consumer information and the perception of poor quality at lower-level
facilities, however, often cause referral systems to function poorly. The
enforcement of referral rules (the fifth assumption) varies across coun-
tries. The last assumption would ensure that follow-up care is provided
in the public referral system. Mwabu's evidence from Kenya suggests
that if nongovernmental alternatives are available, patients often leave
the public provider network.
Expert assistance is needed to design a referral system. The skills
needed are those of health planners, epidemiologists, medical doctors
and nurses, economists, and sociologists. A nation's health authorities
should convene a panel of clinicians and others to define the services to
be provided at each level of the system. After the services are defined, it
is useful to form a task force that includes representatives of consumers
and producers at all levels to review the design. The referral system is
more likely to be effective and followed by consumers and producers if
it reflects their insight. In any case, whether through a formal process or
not, draft designs for referral should be thoroughly discussed at all
levels. Referral systems should also be tested in prototype, and mecha-
nisms should be provided for review and adjustment before the system
is extended to a large area.
At the hospital level, improving the referral system implies defining,
on the basis of epidemiological and cost analyses, the specific services to
be provided and, perhaps more important, not provided at the different
levels of hospitals-for example, district; provincial, or secondary; and
central, or tertiary. An example of this definition of services is given in
table 6-1, in which the types of activities to be performed (and some not
to be performed) are defined for three categories of services (diagnostic
X ray, obstetrics, and surgery) at each type of hospital in a hypothetical

266 Public Hospitals in Developing Countries
Table 6-1. Examples of Selected Services for Hospitals at Different Levels
of a National Referral Network in a Low-Income Country
Level of
hospital Diagnostic X ray Obstetrics/matemity Surgery
I High-cost procedures Moderate- to high- Specialized and major
requiring specially risk pregnancies operations with
trained personnel intensive care unit
available
II 500-ma equipment Moderate- to high- Intermediate-level
and tests using risk pregnancies operations involving
contrast media, not some degree of
CAT scans or MRI specialization
III Routine exams using Ordinary deliveries Basic surgery not
BRS technology, not (which may also use requiring surgical
contrast exams lower-level facilities), specialists
outpatient pre- or
postnatal care
(coordinated with
health centers);
capacity to handle
some birth difficulties,
possibly cesarean
sections
Source- Authors.
country. The actual definition of the services to be supplied at different
levels of hospitals in the referral network must, of course, be a country-
specific decision. The theme of the table is that the more technically
complex interventions and those that require staff with scarce, special-
ized skills and training should be performed at higher-level hospitals.
These interventions are typically for conditions that appear relatively
infrequently in the population. Although it is suggested that higher-level
hospitals limit themselves (to the extent possible) to performing tertiary
interventions, it is often not possible for them to do so because alternative
lower-level facilities may not exist in large urban areas. In addition, it
may be cost-effective for a tertiary hospital to have certain lower-level
technologies at its disposal, such as BRS X-ray equipment.
Tools that can support the operation of the referral system have been
identified by wHo (1987a). The referral system needs to be supported
with manuals and training that specify the functions of different ele-
ments of the system and the relationships between them. For example,
a referral manual (or a training course for administrators) should em-
phasize that a hospital should endeavor to limit its services to the skilled
and technical care designated in order to fulfill its role in the system. The

Reallocating Hospital Resources to Improve Health Services 267
hospital should discourage potential clients from consuming services
that can be delivered more cost-effectively by community health centers
or other nonhospital facilities. One way to do this is to reduce the extent
to which such services are subsidized in hospitals. Communication
between different levels of providers should ensure that patients who
are properly referred to hospitals from lower levels are not subject to
additional delays or duplicate investigations. Patients should be referred
back to lower levels with full information when upper-level hospital
services are no longer needed. Finally, the organization and manage-
ment of the health system should reinforce the functioning of the referral
system.
These tools and principles can be applied to alter referral patterns and
improve the mix of services provided in hospitals. Lower-level hospitals
should concentrate on providing a reliable supply of inpatient, ambula-
tory, and diagnostic services. The emphasis should be on basic services;
specialty care should be left to tertiary centers. Particular attention
should be focused on the specific diagnostic and treatment services that
support primary health care. In addition to supporting primary care,
basic hospitals have important relationships with tertiary hospitals.
Basic hospitals should have the capacity to identify patients who require
specialized care and the means to transfer these patients to appropriate
facilities. They should also be able to care for patients who have received
tertiary care and require recovery and rehabilitative services, either as
inpatients or in follow-up ambulatory visits. The referral role of basic
hospitals should thus be bidirectional.
Changing the mix of patients served in tertiary hospitals. As indicated
above, a problem often faced by hospitals designed to provide highly
specialized services is that relatively few of their patients require such
services. There are three principal causes of this situation. First, the
hospital serves the role of district (that is, first-level referral) hospital for
a relatively large urban population. Second, oftentimes, there is no basic
facility nearby that can lessen the load on this hospital. Third, the
population is dissatisfied with lower-level facilities and believes that
effective, quality care is available only at the tertiary hospital.
The first two causes are related and reflect a reality that comes from
the urban location of the tertiary hospital. Adding a basic hospital nearby
may not be feasible because of the additional recurrent costs it would
entail, but the establishment of ambulatory care centers may be a possi-
ble option. Still, it is to be expected that a large proportion of patients in
tertiary care hospitals are urban people in need of basic care, and perhaps
little can be done to change the case mix of this group. The third cause
is more amenable to policy. By improving the quality of lower-level
hospitals and other treatment settings, the population will be given

268 Public Hospitals in Developing Countries
credible alternatives to tertiary hospitals. Given these alternatives, terti-
ary hospitals can actively discourage self-referrals from outlying areas
by enforcing policies on nonreferred admission or charging a penalty
fee. Furthermore, patients who receive specialty care but require only
basic rehabilitation and follow-up can be transferred back to a lower-
level hospital nearer the patient's home.
If the tertiary hospital successfully alters its case mix by reducing the
proportion of cases it treats that are not tertiary in nature, the likely result
will be an increase in the cost per case at the hospital, because the
resulting clinical composition of cases will increase in severity. The effect
on unit costs at the lower-level hospitals to which these cases are trans-
ferred is uncertain. Average cost per case may increase or decrease,
depending on the complexity of the additional cases and the extent of
excess capacity previously existing in these hospitals. In this situation,
the increase in "unit costs" at the tertiary hospital would reflect im-
proved economic efficiency because a greater proportion of patients
would be treated at less expensive, lower-level facilities. Facilities and
their associated inputs would be more appropriately matched to patient
needs. The overall economic efficiency of the health services would be
improved, not just that of the tertiary hospital. Therefore, when a country
evaluates the outcome of improving referral, efficiency should be as-
sessed by consideration of the whole regional network rather than just
one hospital budget.
Hospital financing and the referral system. Adequate levels of capital and
recurrent resources are required for district hospitals and health centers
to fulfill their designated roles in the referral system. The defined role
will not be effective in practice if recurrent resource needs are continually
underfunded. This is particularly true if the underfunding is greatest in
basic facilities and results in shortages of supplies, insufficient staffing,
and equipment breakdowns. When these conditions occur, consumers
are more likely to refer themselves directly to tertiary centers in the belief
that they will have a greater probability of receiving their desired treat-
ment.
The financing system should support the referral design by creating
appropriate provider and patient incentives. If the quality of services
available in lower-level facilities is adequate, the fee structure can im-
pose penalties on patients who refer themselves to a hospital when their
condition actually warrants entry at a lower level in the system. Poor
patients who use the referral system can be identified at lower levels
(where such identification is easier), and if referral to more complex
facilities is warranted, they can be exempted from hospital charges
(Mwabu 1989). An estimate of the elasticity of demand for entry at
different levels can provide information to determine a price that will

Reallocating Hospital Resources to Improve Health Services 269
allow optimal cross-subsidization of patients using lower levels of ser-
vices (see the appendix to chapter 4). A health insurer can also require
referral compliance by withholding reimbursement or providing only
partial reimbursement for patients who are not properly referred. For
example, beneficiaries of the insurance program in Zaire's Bwamanda
health zone (discussed in chapter 5) are responsible for 100 percent of
hospital charges if they do not have a referral slip from a satellite health
center. Finally, in prepaid capitation or fixed global budget systems, the
provider will have an incentive to reinforce referral policy by using the
most cost-effective level of services in managing patient care.
Some examples. The district hospital in Patan, Nepal, provides a good
example of a facility that has committed itself to provision of basic
services. It has 140 beds and serves a population of 210,000 in a region
that does not have easy access to specialist hospitals. Nevertheless,
planners resisted the urge to design and equip the hospital to provide
specialist services and instead kept true to their prime objectives-pro-
vision of primary curative care, provision of secondary care through four
departments (medicine, surgery, pediatrics, and obstetrics-gynecology),
support for community health services, and training for health workers
(Paine and Tjam 1988). The absence of specialists in lower-level hospitals
may reflect a health system survival strategy for low-income countries
that must cast a broad net of basic services and concentrate specialist
services in a limited number of areas.
A second example of a hospital referral system that has acted to alter
the role of lower-level hospitals to improve the efficiency of the mix of
patients across several hospital levels is found in Sao Paulo, Brazil. In a
World Bank project (Sao Paulo Basic Health Care) developed during the
mnid-1980s, several small hospitals in outlying barrios were created to
provide credible basic inpatient services with close referral links to
primary health care. None of the hospitals has an outpatient department.
Instead, the hospital staff serves on rotation in satellite neighborhood
health centers, designated the basic health unit, and screens for patients
whose conditions warrant hospital care. The development of the new
system was carried out in cooperation with INAMPs, the state social
insurance system, to provide a higher quality of basic care and divert
unwarranted use of expensive, higher-level services to be reimbursed by
INAMPS.
Management Coordination and Organization
The organization of the health sector determines the relation between
levels of hospitals and between hospitals and other parts of the health
system. The organizational framework varies greatly across countries,

270 Public Hospitals in Developing Countries
from those in which tertiary and large secondary hospitals are separately
organized from lower-level facilities and most aspects of preventive and
primary health care programs, to those in which regional organization
and responsibilities emphasize the integration of different levels of
facilities and services. Between these two extremes are regional or dis-
trict administrative arrangements that emphasize coordination but fall
short of complete management integration.
The arguments for and against integration or separation of hospitals
parallel those raised in the larger debate on vertical as opposed to
horizontal programs in health. There are strong arguments for both
types of organization. Separation helps to maintain the financial auton-
omy of lower-level facilities and prevent larger facilities from absorbing
recurrent revenues and staff ostensibly allocated to primary health care.
Separation also provides some advantage in allowing management
concentration on the reliable delivery of a more narrowly circumscribed
set of activities. In many countries, however, these advantages may not
offset the large benefits that integration provides in improving the
functioning of referral and the effectiveness of primary health care
delivery. An absence of organizational integration among hospitals at
different levels impedes the functional coordination that is necessary to
implement a referral policy that emphasizes the use of lower-level
facilities to provide care.
One of the primary advantages of integration is that it internalizes
incentives to contain cost and maintain the quality and flow of services
at lower levels in the hospital and health services systems. Prevention
programs should become important to managers responsible for the
overall system because, if successful, they can reduce the use of expen-
sive secondary and tertiary facilities. These managers also have an
incentive to treat services at lower cost in district-level hospitals or in
nonhospital facilities. An integrated system also adds incentives to
improve logistics and maintain the flow of drugs and supplies to all
levels of hospitals and other health facilities. Finally, the flow and use of
information is improved by integration of planning and management
across levels of hospitals.
Achievement of effective integration can be difficult, however, partic-
ularly if management skills are in scarce supply. The goal is to bring
together the planning and budgeting process as well as broad aspects of
management so that decisions affecting resource allocation at all levels
can reflect the overall goal of providing the most effective services within
the constraint of available resources. The diversity and complexity of
hospitals presents an inherently exacting management problem, and the
linking of hospital management across levels can add to the manage-
ment burden. The difficulty is to provide sufficient links to create desir-
able incentives among different agencies in the supply of cost-effective

Reallocating Hospital Resources to Improve Health Services 271
services and yet retain enough autonomy within the individual health
unit to capture the efficiency of flexible decentralized management.
Coordination rather than integration may be a better management
policy for the overall hospital and health system. The difference is more
than semantic, because integration implies the formal merger of man-
agement functions under one administration. Coordination, in contrast,
can be achieved without the imposition of a single, rigid, management
structure. Innovative solutions to the management problem that empha-
size coordination have been distilled by WHO (1987a) from the global
experience. Among these solutions are the creation of area health boards
to take responsibility for a range of hospital and nonhospital services,
including, for example, secondary and district hospitals as well as lower-
level services; the establishment of district health management teams
that bring together health care professionals and managers from differ-
ent levels and different functions within the system; the establishment
of a community health department within hospitals; the location of the
district health office within district hospitals; and the encouragement of
community involvement in hospital managerial decisions.
Prior to the establishment of SuDS in Brazil (discussed in chapter 5),
curative care services were financed and managed by INAMPS, the na-
tional insurance program, and preventive services were provided by the
Ministry of Health. Under SUDS, the financing and management of
curative and preventive services were unified and placed under the
control of state and municipal authorities. By integrating management
of all levels of personal health services, SUDS establishes an administra-
tive framework that is consistent with an effective referral system. By
unifying the functions and resources of INAMPS and the MOH at the state
and local level, SUDS allows for a reallocation of health resources to a
more cost-effective mix of preventive and curative care services and
provides an administrative framework consistent with a well-coordi-
nated referral network (World Bank 1988).
Quality
The quality and reliability of services provided in lower-level hospitals
is critical to the overall functioning of the referral network. If patients
have serious doubts that they will obtain the services they desire at a
basic hospital, or if they do not trust that this level of hospital provides
an adequate backup to their local primary care provider, they may
bypass their local lower-cost providers and refer themselves directly to
a tertiary hospital. Such activity adds to the economic inefficiency in the
delivery system-tertiary facilities become overcrowded with basic
cases, the fixed inputs of basic secondary hospitals are underused, and
patients incur travel and waiting costs that would have been avoided if

272 Public Hospitals in Developing Countries
local facilities provided a reliable supply of adequate quality services.
An improvement in quality that shifts demand for basic services to basic
facilities will result in a more economically efficient use of health sector
resources and allow for greater coverage than was previously possible.
Quality and the market for health services. The perceived quality of health
services acts together with price to determine an equilibrium quantity of
those services demanded in the market. The critical question is whether
the magnitude of the additional benefit resulting from improvements in
quality that shift demand to lower-level facilities more than offsets the
cost of the improvements. This is an empirical question that has recently
begun to receive tentative answers. Policy simulations for Kenya
(Mwabu and Mwangi 1986) and Nigeria (Akin and others 1991) that use
empirically based parameters demonstrate that increases in fees that are
used to improve the quality of services in lower-level facilities could
actually lead to increased use. Mwabu and Mwangi estimate that the
probability of government facility use will increase with the introduction
of fees and an upgrade of quality to the level of nearby mission facilities.
With an increase of fees from free to one Kenyan shilling per outpatient
visit, the probability of use goes down by about 5 percent if there is no
change in quality, but an upgrade in quality made possible by the fee
increase would increase the probability of use by 25 percent. The basis
for Mwabu and Mwangi's cost estimates is not made explicit. A similar
finding, however, has been obtained for Ogun State in Nigeria using a
facility demand function estimated by Akin and others (1991) and a cost
function estimated by Wouters (forthcoming; discussed in chapter 3). A
doubling of fees would mean less than a 4 percent decline in the proba-
bility of use, but if the fee increase were used to ensure the availability
of essential drugs, the probability of use would increase by 35 percent.
This evidence of the willingness of users to pay for improved quality
is expected to hold its general validity in many countries in which the
price of services is currently low and poor quality is an impediment to
appropriate use. The appendix at the end of this chapter provides an
analytical framework that unites the demand and supply responses with
quality and relates them to price changes. Most decisionmakers are
aware of the role of prices in equilibrating service demand with available
supply. It is important for managers and planners to be aware that
reaction to quality can be as important as reaction to price in determining
demand and equilibrating the market for health services.
The appendix identifies the role of quality as an equilibrating force in
the market for health services and identifies the critical parameters to
estimate the net effect of price and quality changes. The overall quantity
response to a price increase, where the revenues derived are used to
bolster quality, depends on the relative magnitudes of the price and

Reallocating Hospital Resources to Improve Health Services 273
quality elasticities of demand and the cost elasticity of quality. If plausi-
ble values are used for these elasticities in a setting in which fees and
quality are initially low and in which any increase in revenues is used to
improve quality, it is estimated that a 10 percent increase in prices will
have the net effect of increasing demand by 6 percent. Further research
on the effect of quality on demand and cost is needed to establish the
quantitative importance of these findings in a variety of settings. The
findings in the appendix demonstrate, however, that the willingness to
pay for quality is a robust conclusion over a wide range of plausible
values for the underlying demand and supply elasticities.
The dimensions of quality improvements. There are several dimensions to
the quality of hospital services, including availability of supplies, staff
training, and type and condition of equipment, all of which affect the
cost of services. The population's perception of an adequate quantity and
reliable supply of pharmaceuticals and supplies is related to the demand
for services as established in econometric studies of health services
demand in Nigeria (Akin and others 1991) and elsewhere. An extensive
and costly list of drugs is not required to bring about an increase in the
use of lower-level facilities. The United Nations Children's Fund (UNI-
CEF) program of essential drugs has demonstrated that basic health
requirements can be met by a relatively limited list of pharmaceuticals,
and WHO has developed suggested lists of essential pharmaceuticals for
district hospitals and health centers. Patterns of demand for health
facilities also illustrate that patients are sensitive to the training and
availability of health facility staff. The occupancy rates of Indonesia's
district hospitals are related to the available specialties. During the 1980s,
the Indonesian government upgraded selected district hospitals to in-
clude staff with some added training in basic radiology, surgery, and
obstetrics, and the demand in these hospitals grew significantly. Finally,
equipment in lower-level hospitals need not be extensive to fill their
basic referral role, but appropriate maintenance and the staff training to
make proper use of it is required. The kind of equipment and pharma-
ceuticals that are selected for district hospitals will vary with the resource
constraints and epidemiological needs in a given country. For countries
of middle income or below, WHO has suggested norms for laboratory
equipment, diagnostic imaging, and pharmaceuticals in a district hospi-
tal (wHo 1979; wHo 1987c; wHo 1986; and WHO 1985). These norms do
not have an official WHO status but do suggest that it is possible to
provide high-quality service, with regard to supplies and equipment,
using relatively low-cost technologies.
Maintenance is a perennial problem at all levels in the hospital system
in many countries but is especially critical at the lower levels, at which
access to parts and routine maintenance are hampered by location and

274 Public Hospitals in Developing Countries
communications. It was noted in a WHO meeting on maintenance of
health equipment (WHO 1987b) that maintenance is a pervasive problem
across geographic regions. In Brazil in the early 1980s, for example, an
estimated 2 billion to 3 billion dollars of existing equipment was not
working because of inadequate service, lack of parts, or simply a failure
to install the equipment. In their study of medical equipment in Africa,
Bloom and Temple-Bird (1988) note that preventive maintenance is the
exception rather than the rule in many sub-Saharan countries. Both the
WHO and the Bloom and Temple-Bird reports note that the neglect of
maintenance is the result of insufficiently trained personnel, lack of
funds for tools and parts, and poor organization of existing maintenance
capacity with maintenance responsibilities spread over several agencies.
Mwabu (1989) suggests six reforms to improve the efficiency and
equity of referral systems. Four of them relate specifically to improving
the quality of services at the most basic units of the provider network.
These four include increasing budget allocations to health centers and
dispensaries; providing incentives for doctors based at hospitals to visit
health centers regularly; strengthening the diagnostic capabilities of
health centers; and ensuring that essential drugs are available in health
centers and dispensaries. His other recommendations are to increase
patient charges for self-referred use of hospitals and to abolish the
general outpatient services provided in hospitals. This latter recommen-
dation would be appropriate only if the reforms aimed at improving the
quality and scope of nonhospital services were implemented, so that
hospitals would need to provide only specialized services. Although
eliminating the general outpatient function of hospitals would not be
immediately feasible in most countries, the transfer of patients who do
not require specialized services to less complex facilities located closer
to their homes would result in greater efficiency in service use and is an
appropriate long-term goal.
Using Hospital Resources to Support Primary Health Care
Improvements in the referral system are closely related to the use of
hospitals to support primary health care. Although the bulk of primary
health care activities are carried on outside the hospital through outreach
programs, community service, education, and outpatient care, hospitals,
nevertheless, are important contributors to the success of PHC programs.
In particular, the role of district-level (first-level referral) hospitals in
supporting PHC has become critical.
The full range of primary health care activities that can benefit from
hospital involvement is long. A survey conducted in a sample of sixty-
five hospitals in Delhi, India, and the surrounding region (Ghei 1985)
suggests the extent of potential involvement. The survey, which is

Reallocating Hospital Resources to Improve Health Services 275
summarized in table 6-2, revealed that hospitals were involved in ad-
ministrative support, training of nurses, outpatient rehabilitation, and
health education, as well as in the more obvious primary health care
activities of health promotion, family welfare, and ambulatory care. The
list of activities from the Delhi survey only suggests the number of
different functions that hospitals might support but does not detail the
form of support. The form of hospital support for primary health care
can involve integrated (or coordinated) management, logistics, training,
and, finally, credible referral.
Coordinated Regional Management
In the previous section on referral we discussed the importance of
management coordination across referral levels. Here, we emphasize
that the links should also be carefully made with PHC. The WHO Expert
Committee on the Role of Hospitals at the First Referral Level (WHO
1987a) found that hospitals and PHC were administered separately in
many countries, making coordination difficult. Even in some countries
that make no formal distinction between hospitals and PHC, it has long
been the practice to keep hospital management and information systems
separate from those of community health services.
To bring about management coordination of primary health care, the
WHO Expert Committee recommended that all local services, including
hospitals at the first referral level, should relate themselves to a defined
population.Within this population, communities should be involved in
operating the "district primary health care complex," which includes
district hospitals. It was further recommended that district hospitals, in
consultation with their community and relevant agencies in the area,
should have clearly defined referral, management, and support roles to
play in their specific locality. Finally, these roles should be arranged to
relate closely to other sectors of the economy, to higher health facility
referral levels, and to various levels of government.
A serious impediment to carrying out the WHO recommendations is
the separate administration and management of primary and secondary
care found in many countries, which makes coordination of these levels
of care a difficult process. Unified administration of all district health
services, although not in itself sufficient to improve the referral system,
would facilitate implementation of the strategy suggested by the WHO
Expert Commnittee. Given a budget and a mission to provide health
services to a district population, the administrators could face incentives
somewhat similar to those of a prepaid capitated health plan, such as a
health maintenance organization. The administrators of an HMO use the
resources generated from premium payments to meet the health care
demands of each participant in the plan. If these demands are met using

276 Public Hospitals in Developing Countries
Table 6-2. Substantive Support for Selected Primary Health Care Functions
in Sixty-five Delhi Hospitals
(percentage of hospitals involved with function)
Function Percentage of hospitals
Health promotion
Well-baby clinic 69
Education 62
Early detection programs 34
Marriage and motherhood 32
Curative health care
Emergency services 46
Ambulatory care 100
Home care 17
Administrative support
Planning and management 31
Office accommodation 37
General supplies (including pharmacy cold 37
chain and the like)
Transport 32
Rehlabilitationi
Inpatient 29
Outpatient 37
Home 8
Family welfare
Education 60
Services 77
Supplies 75
Sterilization 69
Integrated hospital/community care
Hospital responsibility for total health care 15
in a designated geographical area
Hospital-based mobile clinics 17
Training
Community health volunteers 2
Nurses 31
Paramedical staff 15
Management 5
Reorientation of professional staff 10
Preventive health care
Drinking water and waste disposal 17
Communicable disease control 12
Imnmunization 69
Supplementary feeding 15
Source: Ghei 1985.

Reallocating Hospital Resources to Improve Healthi Services 277
less than the HMO's premium income (less administrative expenses), the
HMO makes a profit. If health service expenses exceed premium income,
it operates at a loss. The analogy to an HMO is most appropriate if the
district health service managers are held accountable for their resource
allocation decisions, a condition that is not typical in publicly adminis-
tered health systems. Management accountability is important because
the effects of incentives are likely to be more powerful when managers
have something to lose as well as something to gain as a result of the
decisions they make.
Similarly, coordination of regional budgets and administration to
include primary curative and preventive care as well as secondary and
possibly even tertiary curative care would provide incentives to the
administrators to organize the delivery of health services in a cost-effec-
tive manner. If the district is the unit of health management and operates
under a fixed budget, management has an incentive to minimize expen-
sive hospitalization through early detection and treatment of illnesses.
The district would then be the level of administration at which attempts
could be made to improve the allocation of resources across as well as
within health facilities. To improve the referral system through support
for PHC, it is not sufficient merely to establish the proper administrative
structure, but it would seem to be necessary. As the principal health
facility in a district, the hospital may be the logical place for the unified
administration to be based. However, there may be some tendency for
the hospital to be favored in the allocation of resources simply because
of the presence of the administrators, who see the hospital's problems
on a daily basis. Administrators should be conscious of this and guard
against a hospital bias.
An example of a unified approach to the management of all health
services for the population of a specific region is the Kasongo Public
Health Project (de B6thune, Mercenier, and Van Balen 1985), which has
been operating in eastern Zaire since 1971. The Kasongo area has one
referral hospital plus a network of health centers. The health manage-
ment team is based at the referral hospital and strives to cover its
catchment population (about 250,000 people) with integrated and con-
tinuous care from an annual operating budget of about US$3 per person.
Unified management of the area's health facilities has enabled the devel-
opment of a coherent system that directs people toward the most appro-
priate setting and organizes service delivery using appropriate
technologies.
The integration of the management of health services at Kasongo has
resulted in many policies that have improved the functional relationship
between the hospital and primary health care activities. The roles of the
health centers and the hospital are clearly defined and relate to the
severity of patients' conditions. Some complex diagnostic tasks and a

278 Public Hospitals in Developing Countries
few appropriate surgical procedures have thus been entrusted entirely
to nurses. Downward referrals to health centers from the hospital are
routine, and home visits (when needed) are included in the package of
services provided to the referred patient. The main pharmacy, which
serves all the health facilities in the area, is located at the hospital, but
priority in ordering and distribution is systematically given to the health
centers. The financing system reinforces the primary health care struc-
ture. Referral and hospitalization charges are induded in the initial fee
paid by the patients on their first visit to a health center, whereas
self-referred patients in the hospital's outpatient department face higher
fees, long lines, and systematic encouragement to use a health center.
Hospital length of stay has been reduced as more patients whose recov-
ery can be managed at health centers are treated at that level of care.
Logistics
Regardless of the administrative structure of the district health services,
a hospital can support primary health care activities in its region by
assisting with the planning, budgeting, procurement, and distribution
of needed materials to the PHC network. According to Milner (1985), the
purpose of these logistical activities is to provide the necessary equip-
ment and supplies, in correct amounts, to the correct health facility,
health provider, or health program, and to do so in a way that minimizes
costs. In many countries, hospitals are intermediate facilities in the
procurement and distribution of items to PHC facilities and programs.
Items are initially purchased and stored centrally, in bulk, and distrib-
uted to intermediate facilities (that is, hospitals) for their use and for
redistribution to local facilities and programs. With limited stocks of
supplies, however, the lion's share of these items typically goes to the
intermediate facility.
The type of transport system best suited for support of primary health
care depends on the means available to a country, the geographical
accessibility of a region or district, and climatic factors. Because the
viability of a transport system is somewhat dependent on policies out-
side the purview of the Ministry of Health, such as those determining
road conditions or vehicle maintenance, intersectoral cooperation in the
planning of public works projects is necessary to ensure that the needs
of the health transport network are considered. Milner described how
an effective transportation service can support the health system in a
number of ways:
* provision of needed supplies and equipment-including move-
ment of supplies from manufacturers or port of entry to the central
stores, and distribution of supplies throughout all levels of the health
service

Reallocating Hospital Resources to Improve Health Services 279
* training-transport of supervisors and trainers from hospitals to
satellite facilities, or bringing community health workers to hospitals
for training sessions
* patient referral-bidirectional transport of patients across levels of
providers in the referral network, including back to the community.
It is important for relatively isolated health posts to be able to commu-
nicate regularly and, on occasion, rapidly with their referral hospital. In
rural areas without reliable telephone services, radio communications
may be needed to support the education of community health workers
by regular consultation with hospital staff and to inform the hospital of
sudden changes in situations affecting health or the need for replenish-
ment of specific supplies.
Training
The attitudes of those working in hospitals, influenced by their educa-
tion and training, are often quite distant from what is needed for a
community-based approach. Improvement of PHC systems involves re-
training of hospital personnel to increase their awareness of the import-
ance of PHC activities and to provide them with the supplemental skills
necessary to carry out PHC tasks (Dean 1981). In addition, once trained,
hospital staff can provide an appropriate base for regional training of
outreach workers. The literature on the connection between hospitals
and primary health care (Walker 1986) repeatedly emphasizes that rela-
tively highly trained hospital staff members, such as physicians and
registered nurses, can support primary health care activities in their
region by providing continuing or in-service training to lesser-trained
community health workers. This training can be done either in a hospital
setting or as part of the outreach services provided by a hospital to its
catchment community. Several studies (Kleczkowski, Elling, and Smith
1984; Carreon 1982; and Pust 1985) also make strong cases for the
desirability of outreach supervisory and training visits.
The relationship between the Community Primary Health Care Pro-
gram and the Patan Hospital in Lalitpur, Nepal, provides many oppor-
tunities for hospital staff to engage in educational activities. When
patients are referred from the hospital back to health centers closer to
their home, the hospital doctor sends written comments concerning the
previous and future treatment for the patient, in addition to his or her
diagnosis. Health assistants come to the hospital each month for lectures,
and physicians from the hospital also travel to health posts. In this way,
the hospital's doctors not only provide some on-site education to the
lesser-trained health assistants, they also gain a better understanding of
the conditions faced at the health posts (Gsellman 1985).

280 Public Hospitals in Developing Countries
The Bethesda Tomohon Hospital in North Sulawesi, Indonesia, is
involved in the training of volunteer health workers (VHWs), who pro-
vide basic primary health care to the villages from which they are drawn.
The hospital staff members who provide the training to VHWs are them-
selves given prior training or retraining to impart knowledge that, until
recently, has not been a part of medical training. Important components
of the training program for primary health care integration in the
Bethesda Tomohon Hospital include education concerning prevailing
health problems and methods of prevention and control; nutrition edu-
cation, available foodstuffs, and food preparation; basic sanitation and
safe water supply; maternal and child health, including family planning;
immunization against major infectious diseases; prevention and control
of locally endemic diseases, particularly tuberculosis; appropriate treat-
ment of common diseases and accidents, such as the use of oral rehydra-
tion therapy and basic first aid; and the use of essential drugs (Supit
1985).
The hospital can, thus, be both a base and a source of skilled personnel
for continuing education and training of community health workers. The
district will benefit by the training, advice, and supervision that highly
qualified health professionals from the hospital can provide to PHC
workers. In addition, the district health system can be the setting for
university or other professional education programs to bring the impor-
tance of PHC directly into the training of future health professionals (wHo
1987a).
Diagnostic Support and the Credibility of the Referral System
The effectiveness of a referral system depends on the population's
willingness to use lower-level facilities as a point of entry into the health
system. As was emphasized in the first section, this willingness depends
on individual perceptions of the quality of services likely to be received.
Laboratory tests are an especially important service linked to quality that
can be provided at the primary care level. Typically, the test is taken at
the primary level, and the specimen is sent to a hospital laboratory for
analysis. The results are then sent back to the primary care facility. If
specimens are often lost or the results do not come back in a timely
manner, people may bypass the health center and go directly to the
hospital. This may be perceived by health planners as resulting in an
inefficient pattern of health sector resource use, but it is perfectly rational
behavior on the part of a consumer who has lost faith in the referral
system. Providing accurate and timely diagnostic support to primary
health care is an important means by which the credibility of the entire
network of providers can be increased in the eyes of the public. This
credibility is necessary for a referral system to function effectively.

Reallocating Hospital Resources to Improve Health Services 281
The Ministry of Health in Jamaica is seeking to upgrade the laboratory
and X-ray diagnostic support services throughout its network of hospi-
tals, from district to tertiary facilities. One of the reasons for doing so is
to improve the capacity of hospitals to support primary health care
(GOJMOH 1987). Such improvements in the hospitals are expected to
facilitate early diagnosis of certain conditions, support clinical strategies
to improve quality and continuity of care, and strengthen linkages
between the primary and secondary levels. The provision of reliable
diagnostic services at the first referral level is an important means by
which hospitals can increase the credibility of primary care in the eyes
of the public and encourage a more economically efficient pattern of
service and facility use.
Some Examples of Primary Health Care Activities Supported
by Hospitals
Hospitals can play an important role in promoting all primary health
care activities through the forms of involvement outlined above. For
some activities, hospital services are involved directly through clinical
referral support. In these activities, the health services provided by
the hospital are directly integrated with the structure of the PHC pro-
gram. Some important examples are provided by programs for breast-
feeding, acute respiratory infection, safe motherhood, and cervical
cancer screening.
Breast-feeding. Promotion of breast-feeding, which is a core component
of the UNICEF and wHo child survival strategy, is often neglected in
hospitals. An innovative program in the Philippines is demonstrat-
ing the importance of breast-feeding as a means of reducing hospital
costs as well as improving child survival. In 1979, in response to a decine
in breast-feeding in the Philippines, the Department of Health instituted
a policy requiring roomning-in within maternity facilities and govern-
ment hospitals (Wellstart 1990). In 1986 the Philippine milk code was
adopted, restricting the sale of substitutes for breast rmilk directly to the
public and through hospitals. As implemented in the hospital with the
largest maternity service in the Philippines, the program involves inpa-
tient breast-feeding with the child in the mother's room twenty-four
hours a day, immediate nursing after delivery, and follow-up with
special clinics that support outpatient lactation management. A detailed
study of the program revealed that, in addition to the benefits of in-
creased breast-feeding, it is saving a net amount equal to 8 percent of the
hospital budget per year. The savings derived from reduced costs of
formula, bottle-feeding sets and associated supplies, and savings in
nursing staff time.

282 Public Hospitals in Developing Countries
Acute respiratory infection. Acute lower respiratory infections (ARm) are
a major cause of child mortality. Development of new, low-cost diagnos-
tic and treatment alternatives for bacterial-based infections has created
the potential for special programs targeted at acute respiratory infec-
tions. Succinctly stated, the programs include three elements: identifica-
tion of infection, treatment at home or through outpatient care where
possible, and referral of severe cases to higher-level facilities. District-
level hospitals can play an important role in developing and sustaining
an ARm program. The hospital plays an obvious role in referral but is also
involved in the other elements. The need for timely and careful diagnosis
of infection and adherence to the treatment regime places an emphasis
on training and information for the mother and outreach workers. A
regular and sufficient supply of antibiotics is also essential to the pro-
gram. Potentially critical to its success is hospital involvement in train-
ing, logistics, and supervision. Finally, referral of severe cases to
higher-level facilities requires adequate drugs, oxygen, and laboratory
and radiological capacity in the district hospital.
The cost-effectiveness of ARI programns has not yet been carefully
established, especially across urban and rural settings with varied infra-
structure. Problems of identification of false positives, failure to comply
with treatment instructions, diversion of program antibiotics to other
uses, and a lack of adequate backup facilities may limit their impact in
some communities. In other communities, with sufficiently motivated
and trained staff, adequate supplies, and adequate supervision and
management, the programs may prove highly cost-effective. Ultimately,
the cost-effectiveness of ARI programs in specific environments may
depend on the level of development of infrastructure, including hospi-
tals.
Safe motherhood. Worldwide, an estimated half million women die in
pregnancy and childbirth annually. Almost all these deaths occur in
developing countries (Starrs 1987). A comparison of the less than 15
maternal deaths for every 100,000 live births occurring in industrial
countries with the 450 per 100,000 occurring in developing countries
makes it apparent that many of these maternal deaths could be pre-
vented. An important initiative by international development agencies
collaborating with individual ministries of health has been mounted to
promote safe motherhood. The major elements of the initiative are
promotion of a full range of family planning services; prenatal care,
including assessment of maternal risk; safe, routine delivery for low-risk
mothers; and hospital delivery for mothers with complications.
Hospitals, especially at the district level, play an indirect part in risk
assessment (especially through training) and a direct part in the other
three elements. To support family planning, hospitals need adequate

Reallocating Hospital Resources to Improve Healtlz Services 283
facilities for abortion and sterilization. In low-resource settings, hospital
delivery of low-risk mothers is not cost-effective, but delivery by trained
birth attendants in the home, in bedded health centers, or in birth centers
outside of hospitals can substantially reduce maternal and child death
caused by septic or traumatic delivery. A functioning transportation
system is required to provide timely access to hospital services for
pregnant women with complications. Deliveries requiring referral ser-
vices vary from 5 to 15 percent of births. During pregnancy or delivery,
women with disease or complications may require hospitals with a
reliable blood bank and the capacity to perform safe cesarean sections.
A small proportion of high-risk deliveries will need further referral to
higher-level hospitals.
The cost-effectiveness of safe motherhood programs has not been
assessed in an operational setting and with all the elements of the full
program. Cost-effectiveness of prenatal screening and risk assessment
followed by appropriate delivery is strongly suggested by the prototypi-
cal model set out by Herz and Measham (1987) and used for the cost-ef-
fectiveness comparisons in table 2-9. Given the potentially critical
importance of hospitals in all elements of the program, however, the
cost-effectiveness of safe motherhood programs in alternative settings
needs to be further examined. In particular, the sensitivity of the cost-ef-
fectiveness to the availability of hospital services at the district level
needs to be established.
Cervical cancer screening. Globally, approximately 500,000 new cases of
cervical cancer occur per year, and 80 percent of these occur in develop-
ing countries.' In the cervix, progression from normal cells to cancer
usually occurs slowly (during a period of fifteen to thirty years) and in
phases of dysplasia, carcinoma in situ, and finally invasive cancer. The
long period during which the condition can be detected at a preinvasive
stage makes screening a practical and effective possibility. In the United
States, Canada, and Western Europe, widespread use of the Pap test for
screening has contributed to a fall in mortality from cervical cancer.
In developing countries the success of a cervical cancer screening
program depends on the level of development of supporting infrastruc-
ture to provide accurate testing and timely and effective follow-up of
confirmed cancer. A Pap smear can be taken at a health post, but access
to laboratory facilities and communication back to the health post and
then to the patient are potential problems in environments that have a
poorly developed infrastructure. District hospitals can play an import-
ant role in providing adequate laboratory analysis of the smear and,
especially if they are well integrated into the larger primary health care
system, can also facilitate communication and supervision required for
follow-up. When carried out efficiently, screening for cervical cancer by

284 Public Hospitals in Devieloping Countries
use of the Pap smear allows early diagnosis of the disease and therefore
the use, in a health center or first-level referral hospital, of a low-cost and
low-risk procedure (cone biopsy) to remove cells and prevent occurrence
or spread of invasive cancer. Cervical cancer diagnosed at later stages
requires more costly surgical intervention in higher-level facilities.
As summarized in chapter 2 (see table 2-9), cervical cancer screening
is a cost-effective intervention in middle-income countries. It is also
potentially cost-effective in low-income countries provided that ade-
quate supporting hospital infrastructure exists. As with the other PHC
activities noted in this section, clarification of the cost-effectiveness of
cervical cancer screening in alternative environments, especially with
regard to hospitals, is necessary. Unlike the other activities cited, how-
ever, the existing literature on cost-effectiveness of cervical cancer
screening provides a good basis for further studies (see especially, Parkin
and Moss [1986] and Eddy [19861).
Alternatives to Inpatient Hospital Care
The need for low-cost alternatives to the existing use of hospital care is
motivated, in part, by the economic implications of demographic and
epidemiological projections that demonstrate that the potential demand
for hospital services will continue to outstrip available resources for the
foreseeable future. (See, for example, projections for China [Bumgarner
1992] and Brazil [Briscoe 1990].) The development of innovative, lower-
cost alternatives to inpatient hospital care is consistent with the logic
underlying the referral pyramid. If a specific technology or treatment
setting is relatively low cost and the disease to which the alternative
applies occurs with sufficient frequency in the population, it will be a
cost-effective alternative, by the same rationale that health centers are
more cost-effective than hospitals for treatment of certain very basic
conditions. The motivation is not only economic, however; alternative
modes of delivery may also be more effective, accessible, or humane. We
consider several examples below of alternatives that potentially cost less
and are more effective than hospital care. The alternatives fall into two
basic categories. First are alternatives that involve changing treatment
protocols or use treatments that substitute new and appropriate technol-
ogy for inpatient care; and second are alternatives that replace care in
tertiary facilities with lower-level treatment and palliation.
Treatment Alternatives
Considerable cost savings are possible from revising treatment to exploit
new technologies or procedures, and many newer and cheaper proce-
dures result from improved pharmaceuticals or equipment. But reexam-

Reallocating Hospital Resources to Improve Health Services 285
ination of older treatment protocols has also brought about a revision in
accepted medical views on the use of home care and ambulatory services
in place of extended inpatient care, and many new treatment procedures
do not require expensive new equipment. Medical personnel trained
many years ago and not in close communication with medical change
may not have incorporated recent cost-effective techniques in their
everyday practice. Also, many of the improved treatment alternatives
are not easily changed by an individual hospital or practitioner but
require functional changes across health care institutions and, thus, must
be introduced as part of the health planning process.
Planning and implementing new treatment procedures is detailed and
technical, and no general rules for change can be given here. Extensive
experience does exist worldwide with new protocols that hold out the
promise of more efficient resource use in developing countries from the
adoption and adaptation of existing technology. New technology is a
two-edged sword that can either increase cost and reduce the equity and
efficiency of the overall system or reduce cost and increase the accessi-
bility of health care. Analysis of the cost-effectiveness of potential new
technology is required to establish the desirability of change. In countries
isolated from the mainstream of new medicine, it is recommended that
expert assistance be used to survey existing practice and suggest new
modes for improving the cost-effectiveness of treatment practices. Ac-
tual change in practice should be carried out cautiously with experimen-
tal implementation and evaluated before systemwide adoption.
As means to reduce the use of secondary and tertiary inpatient care,
new treatment procedures are particularly promising in the following
areas:
-Low-risk deliveries. As noted above, improved screening of pregnan-
cies may allow low-risk deliveries to be shifted to urban matermity
centers. The effectiveness of this strategy is related to the existence of
a reliable emergency transport system so that cases with unforeseen
complications can be brought to a nearby hospital.
* Tropical and communicable disease treatment. New pharmaceuticals
make it possible to treat some stages of selected communicable dis-
eases through outpatient care. Examples can be found in treatment for
malaria, tuberculosis, and leprosy.
* Reduction of unnecessary surgical procedures. Cesarean sections, ton-
sillectomies, and hysterectomies are common examples of procedures
that have been overused in the past. Overuse of these procedures is
dosely associated with the design of health care financing.
* Ambulatory surgeryfor selected procedures. Ambulatory surgery has
become common in industrial countries. The practicality of ambula-
tory surgery in developing countries depends on the geographic

286 Public Hospitals in Dezvelopinig Countries
accessibility of health services and the quality of the home recovery
environment. Among the many procedures that have become more
common in ambulatory care are inguinal and umbilical hernia; der-
matological surgery; breast biopsy; surgery for cervical neoplasia;
many ear, nose, and throat procedures; vasectomies and tubal ligation;
and orthopedics.
* Outpatient treatment of chronic disease. Heart disease, diabetes, and
cancer provide examples of diseases for which outpatient protocols
and home care have increasingly replaced hospital inpatient care.
These possibilities suggest that innovative treatments that can reduce
the cost and use of hospital services cover a wide range of activities.
Outpatient hospitals, tuberculosis treatment, and oral rehydration ther-
apy provide especially clear and contrasting examples of cost-effective
alternative treatment methodologies.
Outpatient hospitals. Greater use of outpatient services to treat and
diagnose disease that has been more traditionally addressed through
inpatient services can provide cost savings through reduction of over-
head and staffing. New approaches to surgery provide an example of
the cost savings that are possible through substitution of outpatient for
inpatient care. In Europe and the United States, many basic surgical
procedures, which formerly required short stays in the hospital for the
patients, are provided in specialized facilities called ambulatory surgery
centers. In these centers, the surgical procedure is performed, and if there
are no complications, the patient is released the same day. Surgery is
mentioned because it provides a striking instance of how the mode of
service delivery can be restructured to achieve greater efficiency. A range
of other services, however, are also being made available in outpatient
facilities in OECD countries. Similar facilities have been made available
in some parts of the developing world.
Outpatient hospitals in Call, Colombia, are examples (Velez-Gil and
Pardo de Velez 1985). These hospitals provide a wide range of services:
normal maternity and delivery care, first-contact emergency services,
diagnostic services with full X-ray and laboratory facilities, ambulatory
surgery, and outpatient treatment and follow-up for a broad spectrum
of conditions. The importance of these centers lies in their capacity to
provide a wide range of services in a more cost-effective location than
the inpatient hospital yet retain credibility and quality from the point of
view of the patient.
As an indicator of the relative cost-effectiveness of the outpatient
hospitals in Cali, Shepard and others (1991) evaluated the cost-effective-
ness of the ambulatory surgery centers that are an integral part of the
outpatient hospital design. These ambulatory surgery centers were cre-

Reallocating Hospital Resources to lmprove Health Services 287
ated in response to findings that nearly 70 percent of surgeries performed
at the tertiary hospital in the area did not require highly specialized
services. Analysis demonstrated that ambulatory surgery centers located
in nearby urban or peri-urban areas could provide simple elective pro-
cedures at far lower cost. For low-risk patients, inpatient procedures and
follow-up were replaced by ambulatory surgery with postoperative
home care. Shepard and his colleagues found that the average cost per
inguinal herniorrhaphy patient in the ambulatory surgery centers was
about one-quarter that of those treated as hospital inpatients. Further-
more, the quality of care (based on an assessment of postoperative results
and complication rates) provided in hospitals was not found to be better
than that provided in the centers. There may have been differences in
case mix between the sets of patients sampled at each facility, however,
because the mean age of the hospital patients was twelve years greater
than that of the patients in the surgery centers. Nevertheless, the magni-
tude of the cost difference clearly points to the conclusion that the cost
(adjusted for quality and case mix) per inguinal herniorrhaphy patient
in the ambulatory surgery center is considerably less than in the hospital.
Several factors contribute to the success of the center in Cali, Colombia,
that may cause difficulties in replicating its benefits elsewhere. Colom-
bian health facilities have an excellent referral system, which works
especially well in Cali because of its urban location and its relatively high
standard of living. Furthermore, Colombia is reported to have an "over-
supply" of physicians. It would probably be difficult to sustain ambula-
tory surgery centers in a rural area of a poor country suffering from a
scarcity of physicians. Additionally, adverse home conditions that could
impede recovery can be an important limitation to the wide use of
ambulatory surgery in the least industrialized countries. In these circum-
stances, having separate ambulatory surgery centers in addition to hos-
pitals would be less likely to be as cost-effective for a health ministry.
It is uncertain how the savings resulting from the use of ambulatory
surgery centers in Colombia are being used. However, one benefit that
seems apparent is that the operating theater of the nearby tertiary
hospital can now handle a greater number of more complicated cases
than was previously possible (though this was not explicitly assessed as
part of the study). Studies similar to this one, performed on a prospective
basis or as evaluations of pilot schemes, should be conducted by coun-
tries as part of their health sector investment planning activities to
determine the usefulness of outpatient hospitals, and the range of ser-
vices to be made available, in specific contexts.
Tuberculosis treatmient. Until recently, the conventional treatment for
tuberculosis was long-term therapy that involved approximately three
months of inpatient care followed by about fifteen months of outpatient

288 Public Hospitals in Developing Countries
care. Treatment was based on the antimycobacterial drugs thiacetazone
and isoniazid. In the 1970s the introduction of new antimycobacterial
drugs, ethambutol and rifampicin, made shorter-term treatments of six
to eight months possible. The cost-effectiveness of rifampicin and eth-
ambutol is not self-evident, given that isoniazid is only a fraction of the
cost of the short-treatment drugs, and the older therapy requiring long-
term treatment remains in use in regions of many industrial countries.
The high cost of rifampicin and ethambutol is more than offset in most
countries, however, by the higher compliance of the patient in the
short-term treatments and the substitution of ambulatory for inpatient
care.
The unit cost of tuberculosis treatment is high, especially if the long-
term inpatient protocol is used, and in countries in which it is endemic
the cost of treatment of this one disease can amount to more than 10
percent of the total public expenditure on hospitals. Analysis of the
cost-effectiveness of tuberculosis treatment in Botswana (Barnum 1986)
revealed that after improved compliance and a shift to ambulatory care
were taken into account, the cost of the short-term treatment is less than
one-third to one-half the cost of isoniazid-based regime per person
effectively treated. Any given program is necessarily a mix of treatment
strategies, depending on the accessibility of services, health care prac-
tices and customs affecting compliance, and the prevalence of resistant
strains. Data for Botswana for 1982 suggest that the adoption of the
short-term ambulatory treatment for 80 percent of patients would reduce
the total health expenditure for tuberculosis by two-thirds, and the
number of people that complied with the treatment and were cured
would double.
Oral rehydration therapy. Diarrhea is a major cause of early childhood
death throughout the developing world. Death occurs primarily as the
result of dehydration. Until the early seventies, the standard treatment
was to use intravenous (IV) rehydration therapy in an institutional
setting. The high cost of iv therapy and a lack of timely access to a
hospital or health center limited its usefulness in combating diarrheal
mortality. More recently the introduction of oral rehydration therapy
(ORT), which consists of a simple solution of sodium and potassium salts
in water administered in the home or other outpatient setting, has
dramatically increased the effectiveness of treatment and reduced the
need for the higher-cost intravenous therapy.
Many studies have confirmed the very high cost-effectiveness of ORT.
Horton and Claquin (1982) used 1980 data for the diarrheal program in
Matlab, Bangladesh, to compare the cost of diarrheal treatment in a large
health center with that in a health post. In both cases the therapy
involved a combination of IV and ORT as required in each case, but with

Reallocating Hospital Resources to Improve Health Services 289
the primary difference that the larger facility relied more heavily on Iv
therapy. They found that the cost per death prevented in the health post
was less than one-fifth that of the large health center. Still greater savings
are possible through the use of home-based ORT supported by outreach
workers or outpatient clinics. A study of ORT therapy delivered through
alternative modes in Egypt (Shepard, Brenzel, and Nemeth 1986, based
on a reinterpretation of data analyzed by Mobarak and others 1981)
provides a comparison of ORT used in the home with hospital clinic-
based therapy. The cost per death averted by using premixed salts in
home therapy was less than one-tenth of the cost of care in a control
group in which the primary therapy was hospital-based IV treatment.
Thus, considerable benefits in saved resources and increased effective-
ness can be obtained from shifting treatment from a large to a small
facility, and still greater gains can be realized from the substitution of
home-based ORT therapy for clinic-based iv treatment.
The example of the treatment for diarrhea illustrates two important
points. First, it provides another illustration of the close link between
hospital services and the design of primary health care programs. Oral
rehydration therapy is a core intervention in primary health care efforts
to improve child health. Second, it demonstrates that technological
change supporting more efficient use of hospital resources can be simple
and relatively inexpensive.
Lower-Level Treatment and Palliation for Chronic Diseases
Alternatives to the use of hospitals designed to provide acute care
services are needed to provide more cost-effective and more humane
palliative and rehabilitative services to those suffering from chronic
conditions. Although most of these conditions, such as cancer, are non-
communicable, the rise of the AIDS epidemic is also placing tremendous
burdens on the existing health facility infrastructure. Lower-cost settings
and the conversion of hospitals from acute to chronic care facilities are
alternatives that have been used in some developing countries.
Use of district hospitals as extended care facilities. In some areas, district
hospitals whose capacity is underused have the potential of being used
for extended care. Basic secondary facilities that serve as extended care
institutions and provide recovery and rehabilitative care to patients
suffering from chronic conditions could be an important complement to
a coordinated referral network among different levels of hospitals. Also,
underused secondary care facilities could be adapted to provide hospice
in addition to chronic care. Such institutions could remove from tertiary
care those patients for whom the higher-cost technical capacity is not
required or effective. As the demographic and epidemiological transi-

290 Public Hospitals in Developing Countries
tion that has started in many countries continues, a greater proportion
of patients are likely to suffer from chronic diseases, and extended care
and rehabilitation will therefore become increasingly important. Cur-
rently, in many countries, acute care hospitals are being inappropriately
used to provide both acute and chronic care because of the lack of
facilities that can provide rehabilitation services (Young 1989). A referral
system that provides early identification of those who need long-term
care and directs them to an appropriate lower-level facility may reduce
the burden on larger, short-term hospitals. Reducing the rehabilitation
function of tertiary hospitals should allow for some reallocation of staff
and equipment across facilities, which may result in improved sectoral
productivity.
One strategy that has been implemented in China is for groups of
hospitals to coordinate their services used in the treatment of chronic
care in an attempt to reduce duplication and waste of resources. Chron-
ically ill patients are transferred from tertiary-level to district hospitals
for recovery and rehabilitative services (Young 1989). Such arrange-
ments hold out the possibility of a more economically efficient allocation
of resources within a health system, but detailed quantitative evalua-
tions need to be conducted to establish cost-effectiveness.
Alternative institutional settings. The technology exists to provide much
of the treatment and care needed by persons with chronic diseases
outside of a hospital. Also, for the terminally ill, hospice care provided
in either a home or institution may be a humane alternative to hospital-
ization. Home care and the use of neighborhLood or community centers
provide the advantages of retaining the proximity of the patient to family
and community and potentially lowering the cost of care. However,
although experimental programs exist in various countries, no clear
analysis of the cost-effectiveness of these alternatives has been con-
ducted. For example, in a few areas China has experimented with the
use of home beds as well as community centers for those suffering from
chronic diseases, but no cost-effectiveness studies have been done to
establish the cost advantages of these arrangements over the use of
hospitals. Nevertheless, it is likely, particularly for countries that have
overcrowded hospitals, that the use of alternative settings would relieve
some of the burden from hospitals designed to deliver acute care and
would result in a more economically efficient use of a country's health
sector resources.
Care provided at home by family members may be a practical alterna-
tive for delivering some rehabilitative services such as chest percussion
and drainage for emphysema patients. Analysis of the cost-effectiveness
of this alternative in a particular setting is needed to establish the
usefulness of a home care policy. Family members giving care may not

Reallocating Hospital Resources to Improve Health Services 291
be available cheaply if they must forgo productive labor to tend to their
sick relative. Another home care alternative is to have a trained health
worker (for example, a nurse) visit the homes of persons requiring
rehabilitative care or monitoring. Again, this may be practical in some
countries, but the viability of such a program depends on the availability
of trained personnel and the population density of each region that is
considering such a visiting service.
Another alternative to hospital-based management of patients with
chronic conditions is care provided to a group of disabled persons in a
neighborhood or community center. It would seem to be economical to
have a single care provider, such as a physical or respiratory therapist,
deliver services to several patients with similar symptoms or disabilities.
A community facility could potentially serve as an adult day care center,
providing health assessment, monitoring, nutrition counseling, personal
care, and various forms of rehabilitative therapies. Possible problems
with such centers involve the financing of their recurrent costs (over and
above the costs of health personnel) and transport of disabled persons
to the centers on a regular basis. In addition, community-based rehabil-
itation programs may not have large or powerful enough constituencies
to provide the support needed for the development of such programs
(Young 1989).
Drummond (1980) has suggested that the cost of caring for the depen-
dent elderly as a function of disability will differ markedly by institu-
tional setting (figure 6-2). Although Drummond's intended context is
care for the elderly in an industrial country, the conception of cost as a
function of disability is applicable more generally to care for the chron-
ically disabled in developing countries. As depicted in the diagram, the
cost of home care is initially low but increases more rapidly with disabil-
ity than does the cost of care in an institution in which the equipment
and training are designed to cope with disability. The critical points to
be discovered through cost-effectiveness research are the point at which
home care becomes less cost-effective than community residential care
(point A), and the point at which disability is so severe that hospital (or
possibly, hospice) care becomes most cost-effective (point B). The dia-
gram illustrates the complexity of answering the question of relative
cost-effectiveness of care in alternative settings and suggests that the best
solution will be a mix of care possibilities. Development of appropriate
disability scales and collection of cost data in alternative settings is
needed to identify the likely points of intersection.
Acquired immunodeficiency syndrome. Consideration of alternative set-
tings of care has been made more urgent by the burden on health
facilities that, in some areas, has already resulted from the epidemic of
acquired immunodeficiency syndrome (AIDS). A Panos Institute dossier

292 Public Hospitals in Developing Countries
Figure 6-2. Variation in Cost with Level of Disability and Form
of Care for Chronic Disease
Cost
Long-term care
Home care facility
//SSL/ '~~~Hspta
Level of disability or dependence
Source: Drunmmond 1980.
(Sabatier and Tinker 1989) reported that one-quarter to one-third of beds
in some central African hospitals were occupied by AIDS patients. The
burden will certainly increase, as persons infected with the human
imununodeficiency virus (HIv) develop AIDS. According to WHO esti-
mates, the annual number of new AIDS cases in sub-Saharan Africa is
projected to grow from less than 300,000 in 1991 to nearly 450,000 in 1994.
The total number of cases in Asia is projected to increase more than
tenfold during the same period (WHO/GPA 1992).
Episodes of illness in AIDS patients often result in repeated hospital-
izations. Yet the wide range of estimated treatment costs per AIDS case
exhibited in both Tanzania and Zaire suggests that low-cost (presumably
community and home care) and high-cost (hospital care) settings exist
for the care of such patients (Over and others 1988). There is not much
available information on alternative treatment settings for AIDS patients
in developing countries, however. A report summarizing the medical,

Reallocating Hospital Resources to Improve Health Services 293
public health, social science, and popular literature on AIDS in Africa
(Johnson and Pond 1988, p. 5) noted the need for such information:
With so many preventable and 100% curable health problems in Africa
it might be argued that it is a mistake to divert scarce resources to
management of a 100% fatal disease.... It is inevitable that medical
treatment of AIDS will consume a growing part of African health care
budgets. Much more needs to be written about humane yet cost-sav-
ing approaches to managing these patients both in hospitals and in the
community.
Sewankambo (1989) advocates a strategy to deal with Inv-induced
disease similar to those strategies used for chronic diseases such as
diabetes mellitus and hypertension, wherein the patients take an active
role in their own treatment. Three levels of coordinated care are sug-
gested. First and foremost, home and community-based care can give
patients cost-effective treatment while enabling them to lead as normal
a life as is possible. Most care should be provided by members of the
family of the infected person, and family caregivers must be educated
about HIv transmission and prevention. Second, specialized HIV clinics
should be established in areas in which infection rates justify their
existence. Finally, inpatient care should be a last resort and used only if
outpatient treatment is not feasible and if the patient would benefit from
hospitalization. Although Sewankambo stresses the need to prevent
nosocomial HI-v transmission through infection control procedures, he
rejects the idea of establishing separate AIDS wards because they would
be likely to stigmatize patients and increase their sense of isolation.
Palliation. An important part of chronic disease care, especially for the
elderly, is concerned with palliation. The pain of cancer or discomfort of
chronic obstructive pulmonary disease leads patients to seek hospital
care even though such care may not offer any prospect of cure. An
alternative that may be at once less costly and more humane is to provide
palliative outpatient support. Cancer provides an example. The World
Health Organization recommends a three-stage analgesic therapy that
moves progressively from nonopioids for mild pain, through weak
opioids to strong opioids for moderate to intense pain (Swerdlow and
Stjernswird 1982). The cost of palliation, including drugs and staff time,
for an average duration of therapy of ninety days represents 3 to 7
percent of the cost of alternative tertiary hospital treatment of advanced-
stage cancer (Barnum and Greenberg 1991).
The failure to use palliative alternatives for chronic disease results
from a lack of recognition by health care professionals that effective and
humane alternatives exist to hospital care. A lack of availability of the
required drugs, unreasonable fears concerning addiction, and poor ed-

294 Public Hospitals in Developing Countries
ucation of health professionals on pain management have also been
important factors. Legislative reform, improved pharmaceutical man-
agement, and training can reduce these blocks to outpatient palliative
care.
Summary
In this chapter we have described options for improving the economic
efficiency and accessibility of health services through alternatives to the
existing organization of hospitals in many countries. At a time when
nearly every country in the world is experiencing severe problems in the
provision of an adequate level of services to its population, the im-
plications of the demographic and epidemiological transitions lend
added urgency to the need for changes in the manner in which health
services are delivered. The rise of the AIDS epidemic has placed a further
stress on health systems that may be bankrupted if no changes are made
in the technologies and settings used to deliver services. There is much
scope for improving the cost-effectiveness of overall service delivery
through a reorganization of the functions of specific types of facilities
and a reallocation of resources across these facilities. The alternatives
seek to match the need for specific services to the least-cost provider of
these services. As a result, the case mix of various levels of facilities
should become more consistent with their technical capacity, with fewer
relatively simple cases being treated in higher-level hospitals. A more
precise definition of the roles of each type of facility in the referral system
is a necessary first step toward a service delivery network that is more
cost-effective.
On the demand side, further steps should be made to encourage users
of health services to follow the desired referral pattern. Such steps
include improving the reliability and quality of services in lower-level
facilities in a way that will be perceived by consumers and structuring
prices to provide an incentive to enter the network at the most appropri-
ate facility. Investing in improved quality and reliability at less techno-
logically complex facilities will be costly, and it is an empirical question
as to whether the benefits will outweigh the costs. In the absence of
empirical data, however, it is presumed that the reductions in over-
crowding in hospital outpatient departments and the reduced travel and
time costs of consumers who could now rely on the nearest facility for
most of their service needs would improve economic efficiency and
access.
On the supply side, administrative and financial functions of the
management of primary and secondary care facilities that are integrated
at the district level (the district primary health care complex) yield better
linkages in logistics, training, and patient care than do separate manage-

Reallocating Hospital Resources to Improve Health Services 295
ment functions at each level of care. Effective integration requires con-
siderable management skills, however, and some separation may be
necessary in countries in which lack of a sufficient cadre of trained health
system managers might lead to inadequate support for primary health
care. Nevertheless, coordination, whether through formal administra-
tive integration or other means, such as the establishment of district
health management teams or regional health boards, is necessary to
achieve efficient service delivery across levels of care.
In addition to generating a more efficient pattern of use for existing
hospitals, alternative treatment strategies and specialized facilities that
provide a limited number of specific services can also yield im-
provements in efficiency and access. Some examples of changes in
treatment protocols based on new technological approaches that have
been proven to be cost-effective in some developing countries include
greater reliance on ambulatory services (for example, ambulatory sur-
gery), new pharmaceuticals for tropical and communicable diseases, and
the use of urban maternity centers for low-risk deliveries. Changing the
function of underused hospitals to extended care facilities or creating
other alternatives for persons who do not require the same level of skilled
nursing care that is available in hospitals can also lead to systemwide
improvements by freeing hospital beds for those with acute conditions.
Finally, the use of alternatives to inpatient care for palliation of chronic
diseases such as cancer can be effective, humane, and less expensive than
hospitalization.
Appendix 6A. Quality and the Market for Health Services
This appendix outlines the role of quality in the market for health
services. The issue of quality enters into both demand- and supply-side
decisions. In a competitive market, quality plays an equilibrating role
that parallels and interacts with that of price. The important differences
are that the signs of the demand and supply responses are reversed
compared with those of price and that, unlike price, quality enters
directly into the cost function. On the demand side, an increase in quality
increases the quantity of services demanded. On the supply side, an
increase in quality is accompanied by an increase in cost that reduces the
quantity of services supplied at any given price. The market equilibrium
will occur at the point at which the price and quality elicit a demand that
is equal to supply.
For services produced by public hospitals, the price (fee) and quality
are both policy choices made by the government producers. The quantity
of services is determined by the reaction of consumers to the price and

296 Public Hospitals in Developing Countries
quality of services offered if, as is commonly the case in lower-level
hospitals, demand is below maximum capacity. A simple analytical
framework is derived below to describe the market for services produced
by public hospitals. The framework is used to examine the change in
quantity demanded when fees are increased and the new revenues are
used to improve quality.2 The quantity of services demanded (Q) is
specified as a function (D) of price (P) and quality (Z),
Q = D (P,Z).
The cost (C) of supplying this quantity of services is specified as a
function of quantity and quality,
C = C (Q,Z)
or, substituting the demand function for Q,
C = C [D (P,Z), Z] .
Fiscal solvency requires a revenue balance equation specifying that total
revenues, including fee revenue (P- Q) and subsidies (S), must equal
costs,
C [D (P,Z), ZI = P D(P,Z) + S.
Totally differentiating the revenue balance equation allows an examina-
tion of the effects of changes in prices and quality,
fCz + CQ Dz -P Dz] dZ = [P Dp + Q -CQ Dp] dP,
which is written using the convention that subscripts indicate partial
derivatives (for instance, Cz = C/Z) and noting that the subsidy is
fixed. This result can be recast in terms of elasticities as:
(6-1) EZP = dZ P =(1 + 1lQP -TlcQnqp)
dP Z (ricz+TlcQTIQz-TIQz)
where Ezp is the expression for the total elasticity of quality with respect
to a change in prices that retains the equality of total revenue and total
cost and where TlcQ and flcz are the partial elasticities of cost with respect
to quantity and quality and TIQP and T)QZ are the partial elasticities of
quantity with respect to price and quality.
3
The total elasticity of quantity with respect to price can be found by
totally differentiating the demand function and rewriting the result in
terms of elasticities:

Reallocating Hospital Resources to Improve Health Services 297
(6-2) EQP = TlQp + TlQZ Ezp.
The total response of quantity to price is thus decomposed into two
components, giving the response to the price change itself and the
response to the quality change made possible by the increased revenues.
The total response will be positive if the quality term is sufficiently great
to offset the negative price term.
Some idea of the total response of quantity to price can be obtained by
substituting plausible estimates of the separate elasticities comprising
Ezp and then EQP. Empirical application of the formulas requires the use
of the same definition and scale for quality in both the demand and
supply functions. In the available empirical studies of quality and de-
mand carried out thus far, quality has been associated with a productive
input such as supplies or pharmaceuticals. Using this definition, we can
roughly estimate that the partial elasticity of demand response to a
change in drugs, which we will substitute for lQz, is in the neighborhood
(Mwabu and Mwangi 1986) of 0.3. An estimate of the partial elasticity of
demand with respect to price is approximately -0.05 (Akin and others
1991). To turn to cost elasticities, if we assume the underlying production
function is linear homogenous, the elasticity of cost with respect to
output is 1. Finally, if drugs and supplies are 40 percent of cost, an
estimate of the elasticity of cost with respect to supplies, which we will
substitute for Tlcz, is 0.4.
Substituting these rough estimates of the underlying elasticities into
equation 6-1 gives an estimate of about 2.5 for Ezp. Making further
substitutions in equation 6-2 yields an estimate of about 0.6 for the
elasticity, EQP, giving the total response in the quantity demanded to an
increase in fees. Thus, if plausible estimates of the elasticities are used, it
is concluded that imposing user fees to improve quality is justified on
the basis of willingness to pay.
Given the lack of strong empirical estimates of the elasticities it is
appropriate to examine the sensitivity of EQP to alternative values. The
elasticity of demand and cost with respect to quality are especially
roughly estimated. For the specified values of -qQP and 7Icz, table A6-1
gives the critical value of the elasticity of demand with respect to quality,
Table A6-1. Critical Value' of TlQz
flQP TICZ = 0.1 rlCZ = 0.5
-0.05 0.01 0.03
-0.50 0.05 0.25
a. Below this value the total response of quantity to a price increase is negative.

298 Public Hospitals in Developing Countries
below which the total response to a price increase is negative. If the price
elasticity of demand is high, say, above -0.5, the positive sign for EQP is
sensitive to the size of the quality elasticities. However, at the low price
elasticities suggested thus far by the econometric research of Akin and
others (1991) and Gertler and van der Gaag (1988), the positive value for
EQP is robust, and the policy conclusion is that the imposition of fees is
warranted by the demand for increased service quality.
Notes
1. This section draws from Barnum and Greenberg (1991).
2. The framework uses, as a point of departure, the supply and demand system
specified by Jirnenez (1987, appendix C). The authors appreciate a discussion
with Jeffrey Hammer of the material in this appendix.
3. For example, TlCz = (aC/aZ)/(C/Z) is the partial elasticity of cost with respect
to quality.

7. Conclusions
Our goal in this book has been to contribute to the development of
policies that will improve the efficiency of the use by the health sector,
and especially by hospitals, of public sector resources. Hospitals have
held a pariah status in the health policy dialogue because of the amount
of recurrent resources they absorb and the recognition that other types
of interventions are much more cost-effective ways to provide the ser-
vices most needed in developing countries. Yet, because they account for
such a large share of public sector health expenditure, improvements in
the efficiency of resource use by hospitals can yield tremendous benefits
for the entire sector. To assess hospital resource use in the public sector,
we have focused on the broad issues of resource allocation, costs, and
financing. Improving the economic efficiency of the health sector entails
improving resource allocation between hospital and nonhospital activi-
ties and between hospitals at different levels of the health system.
Knowledge of hospital costs, particularly the average and marginal costs
of service provision, is needed to analyze the technical efficiency of
hospitals and highlight areas in which waste can be reduced. A keenly
debated policy area concerns hospital financing, particularly the issue of
recovering costs through user charges and health insurance. Policy in
this area is also important to the efficiency and equity of resource use in
that financial incentives will affect the behavior of health care providers
and consumers. This study of the costs, financing, and use of public
sector resources by hospitals will, it is hoped, assist developing countries
in their search for solutions to the problems of economic inefficiency and
financial crisis in the health sector. The principal conclusions are reca-
pitulated below, followed by suggestions for further research.
Hospital Resource Use
Most governments of developing countries spend more than half of their
recurrent health resources on hospitals. This does not necessarily imply
a misallocation of resources. Hospitals are complex, high-cost institu-
299

300 Public Hospitals in Developing Countries
tions in relation to primary health care facilities, and their very existence
means that they will absorb a considerable amount of the total health
budget, especially in small countries. Moreover, the public hospital share
does not, by itself, demonstrate the level of commitment or the effective-
ness of a country's PHC strategy. The health gains achieved by countries
such as China and Sri Lanka suggest that the way a country spends its
health resources on primary care is more important than simply the
percentage of the total budget allocated to nonhospital activities. Never-
theless, it is clear that in some countries, the consumption of recurrent
budgets by hospitals, especially tertiary hospitals, is starving other ac-
tivities. In chapter 2 we provided a considerable array of evidence to
support the frequent contention that, especially in poor countries, non-
hospital interventions are generally more cost-effective than those per-
formed in hospitals. Thus, it would be wise for policymakers to ensure
the recurrent resource requirements of priority (that is, preventive and
promotive) health programs. This recommendation holds at all times but
is especially relevant during periods of acute fiscal constraints, when
maintaining this commitment would likely entail a reallocation of re-
sources away from hospitals.
The need to reallocate resources from more complex to more basic
levels of the health care system is a recurring conclusion, discussed in
chapters 2,3, and 6. The necessity derives from the need to improve the
quality of services at basic facilities in order to encourage consumers to
use local, low-cost providers instead of hospital outpatient departmnents.
If the referral system worked as intended, a greater number of patients
could be served by national health systems at less cost to consumers.
Instead, the situation often found in developing countries is one of low
use of basic facilities because the public perceives the services at these
levels to be of poor quality or unavailable, coupled with overcrowded
tertiary care facilities, often with patients who do not require complex
treatments. A priority for improving the economic efficiency of the
health sector, therefore, is to improve quality and the perception of
quality at lower-level health facilities. The suggested means for doing so
is the reallocation of recurrent resources from tertiary hospitals to pri-
mary health care and first-level referral facilities.
Without substantial changes in the way services are currently organ-
ized and delivered in most developing countries, the financial crisis in
the health sector is likely to worsen. It was demonstrated in chapter 2
that older persons use hospitals disproportionately, and the average cost
of treating noncommunicable diseases is greater than for conditions that
are of greater consequence for younger age groups. Therefore, as popu-
lations age and noncommunicable diseases become relatively more
prevalent, the resource requirements of hospitals will grow if there is no
change in modes of service delivery. For countries on the brink of this

Conclusions 301
transition, there is a need to reallocate resources from treatment in
hospitals to prevention and control of chronic diseases in order to avert
or minimize future high hospital costs. Alternatives for treatment and
palliation in lower-cost settings should also be assessed and used in
situations in which they are determined to be cost-effective. Im-
provements in referral and the development of alternative treatment
settings should seek to match patient needs with the least-cost provider
of services.
Another reason for consideration of nonhospital treatment settings
and other forms of technological alternatives to the hospital model
adopted from industrialized countries is that the relative prices, or
scarcity, of such inputs as staff, equipment, supplies, and maintenance
in developing countries differ greatly from those in richer countries. In
general, the share of labor in hospital recurrent costs is lower in poorer
countries because imported inputs are expensive in relation to labor, and
there is apparently only limited substitution of labor for supplies. The
higher nonlabor share does not imply that drugs and supplies are
available in sufficient quantities. And in many poor countries, the share
of personnel is very high (more than 60 percent of hospital recurrent
costs), reflecting a low-productivity environment in which shortages of
supplies and inadequate maintenance are commonplace. These circum-
stances demand the assessment of alternative technologies to allow for
the provision of services in countries in which skills and imported inputs
are in short supply.
The limited available evidence suggests that public expenditure on
hospitals is biased in favor of urban populations, which tend to have
higher incomes than rural populations. An urban bias in hospital use is
expected, given the economic logic behind locating hospitals in urban
areas. Excessive concentration of resources in hospitals, however, limits
the availability of quality services in rural areas and thus hinders the
functioning of the referral system. Reallocation of resources in favor of
basic services would not only increase the efficiency of the health sector
but would improve equity by providing poorer persons who live in rural
areas greater access to health care.
Hospital Costs
Variation in cost estimates results not only from the relative efficiency of
input use but also from variation in case mix and quality, because studies
of the average or marginal cost of hospital services do not typically adjust
for the clinical characteristics of the hospital's patients (that is, the case
mix) or the quality of services provided. This limits but does not exclude
the use of cost studies in evaluating hospital performance. The growing
number of step down accounting studies demonstrates the feasibility of

302 Public Hospitals in Developing Countries
conducting this type of average cost analysis, and despite the inability
to adjust fully for quality and case mix, the studies have yielded conclu-
sions that are relevant to policy, especially when the estimates are
interpreted in the context of hospital service statistics. One important
finding is that the budgetary information available centrally or even at
the hospital level typically understates the actual resources that can be
spent by or on behalf of the hospital. This suggests that financial infor-
mation systems could be made more transparent to give managers a clear
idea of the resources with which they are working and, furthermore,
how these resources are being used in specific departments of the
hospital.
The magnitude of the difference in average costs found between
tertiary and lower-level hospitals suggests that there is considerable
scope for savings (or increased service provision) by shifting patients
who do not require sophisticated care from facilities that are more
complex to those that are less so. Moreover, basic hospitals often exhibit
lower bed turnover and occupancy rates than upper-level hospitals,
which reflects a lack of demand for these less expensive facilities. This
lends further weight to the policy conclusion that efforts should be made
to encourage patients to use their local facilities for basic care. Although
the suggested means to accomplish this-reallocating resources from
upper- to lower-level facilities to improve their quality-will increase
their total recurrent cost, demand response to the improvement in qual-
ity may be sufficient to lower average cost per patient. In any event, the
expected change in demand patterns should yield improved economic
efficiency throughout the network of providers with the result that a
greater number of patients can be served without an increase in the level
of resources.
Statistical studies of hospital costs in developing countries are in a
nascent stage, and thus generalization of the results can only be made
cautiously. The identification and analysis of hospital cost functions
represent an important development because of the answers these stud-
ies could provide to some important policy questions, such as the
relation between marginal and average costs and the optimal size and
scope of hospitals. For example, one finding from the survey of cost
functions in developing countries that is consistent with studies from
industrial countries is the absence of long-term economies of scale. The
discussion of statistical cost studies in chapter 3 focused on the import-
ance of understanding the nature of the underlying cost function. Al-
though accounting studies probably provide a good approximation of
costs in the short run, they may be a misleading foundation on which to
base longer-term investment decisions because the actual cost function
is likely to differ markedly from the "passive" accounting estimate if
substantial changes occur in current levels of output.

Conclusions 303
When used together, inpatient performance indicators-bed occu-
pancy rate, bed turnover rate, and average length of stay-provide a
useful tool for comparing the relative performance of similar types (that
is, similar function and case mix) of hospitals within a country. They
enable rapid identification (followed, it is hoped, by investigation) of
hospitals that exhibit signs of technical inefficiency, such as a basic
hospital whose patients have long average stays. Similar indicators are
needed to evaluate outpatient performance. Although rectifying techni-
cal inefficiency typically requires the skills of managers rather than
economists, widespread problems in the use of personnel and technical
inputs are often related to the presence of inappropriate incentives
generated by the health financing system. Such deficiencies in incentives
should be addressed by economic analysis.
Hospital Financing
Government intervention in the market for hospital (and other health)
services is necessary because substantial market failures are associated
with this sector. In other words, some of the assumptions underlying the
optimality of free market activities, such as the availability of sufficient
information about the nature of the services for providers and consumers
to make informed decisions, are violated. As a result, the activities of
unregulated private buyers and sellers do not yield an economically
efficient allocation of resources.
The desire to explore alternatives to central treasury financing of the
health services has typically been motivated by a desire to expand the
availability of resources, but any program of health financing has im-
plications for the efficiency and equity of the sector in addition to its
effects on revenues. The review of the experience of various countries
and analysis of market failures indicate that there is no single, optimal
solution to the question of how to finance hospitals, or more generally,
the health services. All the options-ranging from public financing and
provision, to modest user charges, to explicit forms of health insurance-
have potentially undesirable effects on resource allocation. Neverthe-
less, in all countries there is scope for making practical improvements to
existing financing systems by improving incentives to support alloca-
tional efficiency.
In chapter 4 principles were elaborated for setting fees in public sector
facilities that attempt to balance the objectives of efficiency, equity, and
revenue collection. Hospital prices should (a) not limit access of poor
persons to essential services, (b) provide proper signals for the use of
health resources across services and facilities, (c) be linked to the quality
of services, and (d) be subsidized for services that would otherwise not
be adequately consumed as a result of market failures. A guide for setting

304 Public Hospitals in Developing Countries
prices that is consistent with these principles is called optimal pricing.
Optimal prices reflect a combination of the demand characteristics (that
is, income and price elasticities) associated with a specific service, dis-
tributional goals, and the cost of providing the service. Prices are set
lower for services that are consumed disproportionately by the poor yet
contribute to efficiency goals by interfering minimally with private
preferences.
The review of country experience with user charges presented in
chapter 5 found that fees usually contribute only a small proportion of
total expenditures on public hospitals. Yet the countries that are excep-
tions to this finding demonstrate the feasibility of cost recovery to
provide substantial revenues in both low- and middle-income econo-
mies. Experience suggests some complementary recommendations to
the pricing principles summarized above. First and foremost, regular
adjustment of fee levels to keep pace with inflation should be institution-
alized as part of any fee system, perhaps by tying charges to price or cost
indexes. To the extent possible, price changes should be an administra-
tive or technical decision rather than a political one. Second, the setting
of prices should be decentralized in countries that are geographically
large or in which there is a considerable degree of regional variation in
income levels. Third, price schedules should be kept simple (for example,
a single charge for each broad category of services rather than multiple
prices for fine gradations of services within a category) if cost-recovery
goals are modest and institutional development is weak. A fourth rec-
ommendation that derives from analysis of the incentives that should be
in place but for which more empirical support is needed is that hospitals
should be allowed some degree of fee retention and that they should use
the revenues to purchase recurrent inputs needed to enhance the quality
of services. A fifth recommendation that is related to equity rather than
revenue is that no personal criteria for exemptions from payment other
than patient income should be used. However, patients who use services
with important externalities, such as treatment of certain communicable
diseases, should be exempted from payment so that the use of such
services will be encouraged.
In most countries, fees are set at minimal levels and thus do not alter
financial incentives very much from those prevailing under completely
free systems of service provision. Where fee levels are low, governments
are implicitly providing financial protection against the risk of a high-
cost hospitalization. Given the expensive nature of inpatient care in
relation to the incomes of both poor and many nonpoor persons, sub-
stantial cost recovery for inpatient services requires some type of explicit
risk-sharing mechanism.
Health insurance programs vary along a number of dimensions, in-
cluding the hospital payment mechanism, the services covered and

Conclusions 305
excluded, the role of the insuring institution, the extent of cost sharing
required of beneficiaries, and the proportion of the population covered
by the program. The specific institutional arrangements have different
implications for client and provider behavior. As with the principles for
user charges (but more important, given the stronger effects of the price
signals for substantial reimbursement of inpatient costs), health insur-
ance programs should be designed with an eye toward providing the
proper incentives to providers and their clients for efficient and equitable
behavior.
Experience suggests that institutions that administer insurance pro-
grams should not serve merely as financial conduits between benefici-
aries and providers. They should actively encourage (via incentives or
some type of contractual relationship) providers and consumers to
behave in a manner that limits cost escalation, excessive allocation of
resources to curative care, use of inappropriate medical technology, and
inadequate access for financially disadvantaged persons. Incentives to
providers, such as those inherent in prepaid capitation programs, seem
to be more effective in limiting cost escalation than do cost-sharing
obligations directed at consumers. The underlying reason for this is a
critical market failure: asymmetry in the availability of information on
the nature of health services between doctors and their patients. This
asymmetry typically results in patients' relying on their provider for
information on the services they need. One way to address this conflict
of interest for providers is to make the insuring institution the "agent"
for the patient, thus removing the decision on the course of treatment
from the provider to be reimbursed.
Health financing policy should be coordinated across levels of care on
a regional or national basis. Health facility user charges should reflect
incentives to use the least costly provider and should reward (penalize)
appropriate (inappropriate) use of the referral network. Likewise, deny-
ing reimbursement for patients who self-refer to hospitals is an import-
ant institutional measure that insurance programs should use to support
economically efficient use of a country's health facilities. In other words,
health financing policy should complement measures to reallocate re-
sources from tertiary care and improve the quality of basic health ser-
vices. Together, these policies can lead to improved efficiency and
availability of services throughout the health system.
Suggestions for Future Research
Because of data limitations and the need to restrict the scope of the
inquiry, the answers to many questions raised in this book remain
tentative. We have attempted to extract the salient implications of obser-
vations and experiences from a wide cross-section of countries, using

306 Public Hospitals in Developing Countries
economic analysis to sharpen the focus on specific issues. Such a general
survey can flag broad issues and outline potential solutions for consid-
eration by those whose task it is to develop a strategy for hospitals and
the health sector in a specific country. Defining specific policies, how-
ever, requires further research on many detailed questions of resource
allocation, costs, and finance in the countries concerned. Some of the
most important questions and possible directions for refinement are
noted below.
Resource Allocation
Identification of the optimal amount of resources to allocate to hospitals
under alternative resource constraints and at different levels of develop-
ment of the health sector remains a significant problem for health system
planning. This identification requires clear definitions of hospitals (at all
levels) and their role in a country's health system. Given these defini-
tions, an understanding of both the efficiency and equity implications of
hospital resource use can enable policymakers to determine the appro-
priate share of public sector resources to devote to hospitals.
With regard to economic efficiency of resource allocation in the health
sector, a fundamental need is to identify the health outcomes of hospital
services. To do this, better information on inpatient and outpatient case
mix is necessary, especially by level and ownership of hospital. Given
the case mix, information is needed on the effect of hospital services on
health status for individual case types and on the cost and effect of
alternative nonhospital interventions. Measurement of health status on
admission and discharge and attribution of the change in health status
to hospital intervention would be an ambitious research effort. Construc-
tion of scales from physiological measures and the application of these
scales to estimate the effect of hospital services would require careful
statistical design and training of evaluators. One possible direction for
such research is that taken by Watters and others (1989), who adapted
the strategy used by Knaus and his colleagues (1985; later updated; see
Zimmerman 1989) to classify critically ill patients at Zambia's University
Teaching Hospital into severity categories, allowing for a case mix-ad-
justed assessment of the effects of alternative types of treatments. Al-
though such studies would be expensive and not routinely practical, the
information gained would provide insights that not only could answer
economic questions related to the efficiency of resource allocation within
and across hospitals but would aid management and planning of the
health sector more generally. Better understanding of the outcomes
associated with health services would improve the interpretation of
process measures (for example, by enabling the comparison of observed
input use with normative models associated with desired outcomes),

Conclusions 307
which are more readily available to management than outcome mea-
sures. It would also help clarify the role of hospitals, especially hospitals
of different levels, in planning the health system.
The reallocation of resources from more complex to less complex
facilities as a way of expanding the availability of services (given a fixed
budget) at the national or regional level requires an assessment of the
strengths and weaknesses of the existing referral system. For this pur-
pose analytical tools need to be developed. An important focus of
applied research in this area would be analysis of the costs, case mixes,
and outcomes of services provided in different settings that could be
substituted for each other. A likely example would be a study of hospital
outpatient and health center services in the same district. The analytical
method used by Shepard and others (1991) to compare the costs and
outcomes of hernia surgery in the University Hospital and "outpatient
hospitals" in Cali, Colombia, provides a good model for such research.
With regard to equity, more research is required on the distribution of
benefits from hospital services by income, region, and age. Also, equity
of hospital use by sex should be studied. More detailed information
would be useful on distributional equity with regard to access to, use of,
and benefit from hospital services in relation to the need for services.
Studies should also distinguish between use of public and private ser-
vices (for specific types of services used) by different socioeconomic
groups, and the equity goal should be clearly defined. For example, the
goal could be defined as equal per capita use of hospitals for urban and
rural populations or as equal access to necessary care. The latter is a
broader goal that acknowledges greater use of hospital (especially out-
patient) services by the urban population. In the pursuit of such an
objective the focus would be on improving the referral system to increase
the likelihood that rural persons would gain access to hospital care when
needed. Assessing use in relation to "need" would be much more diffi-
cult, however, than simply measuring differences in per capita use across
income and geographic groups. Yet the available information even on
this latter issue is scanty, although hospital resources appear to be used
disproportionately by middle- and upper-income groups because of
their largely urban location. More likely is that there is considerable
variation across countries and regions in the equity of hospital resource
use depending on prevailing economic structure, population distribu-
tion, and social norms.
Hospital Cost and Production
We need a better understanding of the institutional structure of hospitals
and the maximizing behavior of hospital managers in order to predict
their response (in terms of hospital service mix and technology choice)

308 Public Hospitals in Developing Couintries
to alternative policies. What are the objectives of hospital managers?
How does the behavior of physicians serving both public and private
patients affect service delivery? How does physician education affect the
choice of technology (including the use of hospital as opposed to non-
hospital services)?
Improved understanding of the production process and cost functions
facing hospitals could result from a clearer knowledge of the optimizing
behavior (or lack thereof) of hospital managers. We are not aware of any
published studies of statistical production functions for developing
countries, and, as reviewed in chapter 3, only a handful of statistical cost
functions have been estimated. Better understanding is needed of the
hospital production process. Statistical production functions could add
insight into the degree of substitutability among hospital inputs and the
role of technological change. Knowledge of cost functions also helps in
assessments of marginal costs and the importance of economies of scale.
Hospital service statistics should be more fully integrated into this
analysis, and to this end there is a need to develop useful indicators for
outpatient performance similar to those available for inpatient services.
The problem of defining and identifying quality of hospital services
pervades all the research needs discussed in this section, whether con-
cerning resource allocation, cost and efficiency, or financing. Identifying
the dimensions of quality enhancement and then measuring the recur-
rent costs of improving quality need further study. Ideally, quality
should be defined in terms of health outcomes, but this is probably
unrealistic except for special studies that specifically measure health
status. Alternative indicators of quality can be developed, such as the
use of benchmark protocols for inputs (for example, the level and type
of training received by staff, the quantity and selection of drugs, and the
kind of diagnostic equipment available and its state of repair), and case
mix-adjusted rates of infection, complication, and survival. Calibration
of these alternative normative indicators of quality can be based on
research that uses special surveys to link process and outcome measures.
Such calibration would make it possible to use reasonable inferences to
monitor quality on an ongoing basis.
Very little is known about the crucial behavioral parameters needed
to understand the role of quality as an equilibrating force in health
markets. The relation of quality as perceived from the point of view of
hospital users to quality as actually measured by health outcome has not
been adequately examined. Research is needed into how consumers
perceive quality, the response of demand to changes in quality, the effect
of quality changes on the cost of services and, finally, the relation
between prices and quality. A potential framework for research on these
questions is provided in the appendix to chapter 6. Data to examine these
questions can be accumulated by linking specific information about

Conclusions 309
health service providers (including hospitals) to data from household
surveys.
Financing
In order to achieve equity, efficiency, and revenue goals, more needs to
be known about the effect of prices on household consumption choices.
The econometric studies cited in chapter 4 provide evidence on the price
elasticity of hospital services but do not identify the effect of price
changes on the pattern of consumer expenditures for other goods. Al-
though the price elasticity of hospital services is low, increased prices for
hospital services may bring about reductions in the consumption of
other basic items, such as education or food, and thus have a substantial
effect on welfare. Estimation of demand and income elasticities within
the framework of a full household model is needed to understand the
cross-elasticities associated with an appraisal of the effect of hospital fees
on welfare. In addition, the household model must be extended to deal
with changes in asset holdings if the mechanisms that households use to
cope financially with the sporadic high cost of hospital care are to be
understood. This applies to costs actually incurred by households and
to estimates of the costs that would be incurred if the subsidy to public
hospital care was reduced or eliminated.
We single out hospital services for special treatment, rather than
merely using an aggregate category of "health care" expenditures be-
cause hospital care, when it is required, is by far the largest health
expenditure item for households or the health system. Careful design of
future surveys to address the question of hospital pricing may provide
information on the best ways to bundle hospital services. Extension of
models of household utility maximization to encompass separate con-
sumption categories for hospital services and to include changes in asset
holding provides a substantial research challenge both in obtaining
health-specific household consumption data and in the design of appro-
priate econometric models. However, work by Gertler and van der Gaag
(1990), Pitt and Rosenzweig (1990), Rosenzweig and Schultz (1983), and
Behrman and Deolalikar (1990), which adds nutrition and health to the
household utility framework, is moving in the appropriate direction and
indicates that the challenge can potentially be met.
The equity implications of alternative insurance schemes could be
illuminated by research on the kind and level of services demanded by
different income groups according to insurance status. By linking infor-
mation from client surveys with studies of the resource content of
hospital services it would be possible to reconstruct the actual distribu-
tion of the benefits from hospital resources used. Critical questions
concern the resource benefits flowing to insured population subgroups,

310 Public Hospitals in Developing Countries
such as civil servants and high-income urban workers, compared with
those received by rural or low-income urban populations. This question
can be extended, by using information on tax incidence and resources
received from cost recovery, to compare the incidence of benefits with
the incidence of payments.
A better understanding of the incentive effects of alternative plans on
producers and clients is needed. There is an expectation that, given
similar case mix, there will be lower admission rates under prepaid plans
than under retrospective reimbursement, and producers will use fewer
resources per admission under case-based payment than they would
under fee-for-service payment. There is also an expectation that the
insured will use more services than the uninsured. Difficult but critical
research problems are posed by the need to test whether these expecta-
tions are valid, and if valid, to estimate the extent to which the changed
use of services conflicts with health needs. More research is also needed
on the institutional features complementary to reimbursement mecha-
nisms that can help contain costs and mitigate the potentially deleterious
effects of insurance programs on equity, resource allocation, and tech-
nology choice.
Finally, this book has been restricted primarily to a study of public
hospitals. One important financing alternative that was not examined
was the possibility of explicitly shifting part of the burden for delivering
hospital services from the public to the private (voluntary and for-profit)
sector. Consideration of this possibility requires answers to questions
about the relative efficiency of public and private hospitals as deter-
mined by comparative cost functions or accounting cost studies. Setting
up appropriate efficiency studies is difficult because differences in qual-
ity and case mix, which may be substantial, must be measured. The
incorporation of private hospitals in health care planning also raises
important questions related to the setting of fees in the public sector.
How should access for the poor be guaranteed? Should private physi-
cians be charged for the use of public facilities? Competition between
public and private hospitals might affect the availability of skilled per-
sonnel in public facilities. To what extent would this affect the quality of
services available to poor people? What are the cross-elasticities between
prices for public and private services? How is the use of public and
private services affected by income, distance between hospitals, and
differences in quality? These important questions are beyond the scope
of the present study of resource use, cost, and financing of hospitals in
the public sector. Nevertheless, they remain important policy issues that
governments and researchers must address.

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Index
Accounting-based cost studies, 6, 23, 82- vices and, 85,88-89,133-34; reasons
83; aggregate-data cost studies and, for measurement of, 83; tertiary hospi-
84-85; conclusions derived from, 88- tals and, 89; unit costs and, 82
90; day-equivalent method and, 84- Average length of stay (ALOS), 3, 7,99-
85, 90; methodology of, 82-85; 104, 278; case rnix and, 99; definition
statistical models and, 115 of, 91,140 n3; diagnostic services and,
Acquired Immune Deficiency Syn- 102-03; as performance indicator, 80-
drome (AIDs), 289, 291-93, 294 81, 303; extended care and, 103; hospi-
Acute respiratory infection (Am), 282 tal-acquired complications and, 104;
Administration, 255,256,305. See also hospital level and, 101-02; hospital re-
Management; Organization imbursement policies and, 100; sched-
Admissions, 38,41,44-45, 306; average uling problems and, 102; as service
cost of, 81, 96; by cause, 41,43-47 indicator, 90, 106; treatment protocols
Adverse selection, 162,249,250 and, 103-04
Africa, 23, 27, 239, 274, 282; AIDs in, 292- Bed occupancy rates. See Occupancy
93. See also names of specific African rates
countries Bed size, 23; hospital levels and, 25
AIDS. See Acquired Immune Deficiency Beds per capita, 15
Syndrome Bed turnover rates. See Turnover rates
ALOS. See Average length of stay Belize, 26,41
Ambulatory care. See Outpatient services Bolivia, 181
Argentina, 35,229,237 Botswana, 202
ARI. See Acute respiratory infection Brazil, 19, 36, 251, 253,269, 274; alterna-
Asia, 160; AIDS in, 292. See also names of tive financing programs in, 240-44;
specific Asian countries case-based reimbursement in, 237; Ce-
Autonomous revenue, 180,181, 191,196; sarean deliveries in, 57; Curitiba Plan
actual revenue and, 190-91,194; fee and, 242; epidemiological transition
retention and, 215,219-20; potential and, 46; health insurance in, 101, 229,
revenue and, 152,190-91, 194; specific 237; prevention programs in, 65; re-
service fees and, 210-11, 213; use of, current cost recovery and, 195; suDs,
220-21 243, 271
Average cost, 6, 119-20, 146, 174, 286- Brazilian National Institute for Medical
87,302; ALOS and, 80; case mix and, Care and Social Security (INAMPS),
85, 88, 89, 105, 134,268; caveats on in- 197, 237,240-41,269; system reforms
terpretation of, 85, 88; compared with and, 242-43
marginal cost, 174; fees and, 171, 181, Breast cancer, 286; secondary preven-
185,195, 214, 254; hospital levels and, tion programs and, 57
104-05, 133-34, 262; quality of ser- Breastfeeding, 56-57,59,281
327

328 Public Hospitals in Developing Countries
Cancer, 56, 286, 289,293; palliation of Cost-effectiveness: average cost-effec-
pain, 293; secondary prevention pro- tiveness and, 58; of basic services, 58,
grams for, 57-58. See also Breast can- 261; bias problems in, 58; of cervical
cer; Cervical cancer cancer screening, 58, 284; of child sur-
Capital expenditures, hospitals and, 1, vival resources, 59; of health sector,
101, 113-14, 141 n9. See also Invest- 19; hospital service and PHC, 56; of
ment; Maintenance; Recurrent capital hospital services, 47-49, 55-58; mar-
cost ratios ginal (MCE), 58-60; of outpatient ser-
Capitation plans, 162,238,249,255-56, vices, 286-87; of prenatal screening,
269,305 283; referral system and, 261; second-
Case mix, 2, 44, 85, 88, 89, 108, 134, 139, ary prevention programs and, 57-58;
301-03; across facility levels, 111, 294; technology and, 260-61, 285
ALOS and, 99, 101; case-based reimbur- Cost recovery, 1, 4, 6, 144, 165, 194; alter-
sement and, 243,252; demographic native financing vehicles and, 167; eq-
transition and, 65; epidemiological uity goals of, 150; fee levels and, 4,
transition and, 65; Korean data on, 46; 194, 202, 256; per capita income and,
tertiary hospitals and, 8,268 181; pricing schemes and, 27, 158; re-
Catastrophic coverage, 164 current costs and, 83. See also User fees
Central-level hospitals. See Tertiary hos- Cost-recovery ratio, 196; caveats on in-
pitals terpretation of, 198; fee retention and,
Cervical cancer, 57-58, 283-84; second- 215,218-19; revenue performance
ary prevention programs and, 57,58 and, 180-81
Cesarean deliveries, 56-57,241, 285 Cost sharing, 161, 227, 237, 240, 243, 249;
Childbirth. See Cesarean deliveries; coinsurance as, 176-77, 248,305;
Pregnancy and birth; Safe motherhood copayment as, 100,164,238,247; de-
Chile, 35 ductibles as, 159; risk-sharing systems
China, 5,16, 25, 27, 48, 88; ALOS in, 100, and, 162,166,176-77, 227,246-47,
102; adult hospital admissions in, 38; 255-56
alternative financing programs in, Cost studies: alternative behavioral
244-46,256; chronic care in, 290; cost models and, 117; cost functions and,
recovery in, 181; decentralized fee set- 114-33,302,308; performance stan-
ting in, 197,198; epidemiological tran- dards from, 133; policy guidance and,
sition in, 46-47, 49; health insurance 134; referral systems and, 83; service
programs in, 237,244,251; home care indicators and, 90-91; statistical mod-
in, 290; hospital-acquired complica- els and, 114-21; step down analysis
tions in, 104; hospital cost studies for, and, 83-84, 135-37,301-02; using ag-
90,128-30, 131; occupancy rates in, gregate data in, 84-85. See also Ac-
96,130; prevention programs in, 65; counting-based cost studies
recurrent resource allocations in, 300;
urbanization of hospital use in, 36 Demand for health services, 146,194,
Chronic diseases, 38,49, 286, 289-94, 247; and drug availability, 97-98; fee
300-01; lower-level treatment and pal- revenue and, 211; financing and, 7,
liation for, 289-94 143 148,304; market failures and, 147,
Colombia, 37,286; hospital cost studies 149,244,251; medical supply avail-
in, 126-28,131; outpatient hospitals ability and, 97-98; price elasticity of,
in,286-87 152-55, 157,167-69,175-76,194,202;
Communicable diseases, 41,44,46,285; quality and, 6,97-99,221, 272-73,295-
infant mortality rates and, 41; preven- 98,303; referral system and, 294
tion programs and, 41, 44 Demographic transition, 38,64,294; fu-
Costa Rica, 35,47 ture resources and, 64-65; hospital
Cost centers, 84; hospital cost analysis case mix and, 65
and,135-37 Diagnostic services, 100-01, 203,265-66;
Cost containment, 8, 161,215,251; insur- ALos and, 102-03; CAT scanners and,
ance programs and, 305 109, 147, 242, 245, 247, 248; economic

Index 329
inefficiencies in, 110-14; fluoroscopes 301; health financing and, 150-51,194,
and, 109; and integration of services, 203, 239-54, 304-05; factor substitu-
277-78; laboratory tests and, 185,190, tion and, 113; labor inputs and, 31;
280; scheduling of, 102; supporting management and, 271; matching
PHc and, 280-81; technical inefficiency needs with facilities and, 104-06,269,
in, 109-10; X ray equipment and, 109, 271, 294,295,302; outpatient services
185,281 and, 132-33,286; quality and, 274,
Discharge information analysis, 262 300; service indicators for measuring,
Diseases, 1, 65; communicable, 41, 44, 90-91, 106-09,303; treatment proto-
46, 285. See also Admissions, by cause; cols and, 285; of revenue collection,
Chronic diseases 151-52,177-78 n3, 214-15,218-20;
Distribution of resources: across age technical, 108-10
groups, 38-41; across geographical EPI. See Expanded program of immuniza-
lines, 36-38; across income groups, 33- tion
36; equity of hospital use and, 64-65; Epidemiological transition, 38,64, 294;
within health sector, 62-63; hospital child-infant mortality and, 57; future
definitions and, 16-17; hospital invest- resources and, 64; hospital case mix
ment and, 21-23; hospital level and, and, 65; innovative primary health
23, 25; within hospitals, 26-28, 31-33; care and, 46
optimal pricing and, 156-58,168,304; Epidemniology, population, 5, 8, 260;
of recurrent resources, 13, 15-21 health services and, 2; referral system
District hospitals, 4-5, 25-26, 61,63,97, development and, 264
163; case mix and, 108; cost and, 89, Equity, 249, 274, 285,304; of access, 253-
122, 134; district management and, 9, 54,310; alternative financing and, 148-
271,275,277; equipment and, 109; ex- 49,239-54; exemption policy and, 228;
tended care in, 289-90; occupancy free service and, 149; government in-
rates in, 91; outpatient care in, 262; surance and, 163; health care distribu-
quality and, 273; referral systems and tion and, 12,64-65; optimal pricing
97,106, 265-67,269, 282-83; role of, and, 157,168-69; price discrimination
133, 268,274,281; screening in, 283- and, 154, 204,210; selection bias and,
84; staffing, 110-11,113 162; user fees and, 194
Doctors, 18,274; hospital resource share Ethiopia: cost recovery ratios in, 215;
and, 19; perception of service quality, cost studies for, 124-25, 131
98-99; private practice and, 98-99, Europe, 99,103,286
102,109; scheduling problems and, Expanded program of immunization
102; staff substitutions and, 32,111, (EPI), 56
113; effect of supply-limitation policy Extended care, 101, 289-90; ALOS and,
on, 19,62-63; treatment protocol and, 103
103-04 Externalities, 144-47; fee subsidization
Dominican Republic, 35,196,197,198, and, 155, 228,304; hospital care and,
215; average cost-quality relationship 145
in, 88-89; exemption policy in, 228;
sliding fee scale in, 204, 210; use of fee Factors. See hnputs
revenues in, 220 Fee revenue. See Autonomous revenue,
Drugs. See Pharmaceuticals Revenue
Economies of scale, 6,79, 118-19, 134, Fees: ability to pay and, 185, 190; basis
144-45; hospital care and, 146; indus- for setting, 195-97; bypass, 196, 203,
trial countries and, 130-31, 146; long- 204; collection efficiency and, 152,156;
run costs and, 121 cost containment and, 8,161, 215; ef-
Economies of scope, 121, 131,134 fect on revenues of exemption from,
Ecuador, 237 191; equity and, 152; health care ac-
Efficiency, hospital, 4,6,299, 301; al- cess and, 97,154; level of, 256-57; pric-
locational, 144-48,152,268; caveats ing principles for, 153-54,167-77,194;
on interpretation of costs and, 85, 88, quality and, 154-55,272-73,296-98,

330 Public Hospitals in Developing Countries
308; referral network and, 154; subsi- Hospital-acquired comphcations, 104
dization of, 152,155; unit costs and, Hospital class. See Hospital level
181,185. See also Cost recovery; Pric- Hospital level, 49; average cost differ-
ing; User fees ences and, 302; definition of, 25;
Fees: policy for, 149, 152, 165, 190, 194; matching needs with facilities and,
adjustments to, 197-98, 200, 202-03, 104-06; occupancy rates and, 91, 96,
254; centrahzed versus decentralized, 98-99; referral patterns and, 105-06,
195,197,304; exemption policy and, 134,262-63,265-66,269; resource allo-
194, 204, 221-29, 255,268, 304; index- cation and, 23-26; service mix and,
ing and, 202, 228; means testing and, 261, 267; turnover rates and, 91, 96,
227-28; retention pohcy and, 152,177 101
n3, 214-15, 218-20, 255; setting fees Hospital service indicators, 113,303;
and, 195-97, 303-04; structure of fees ALOS and, 99-104, 100; assessing per-
and, 203-04, 210-11, 214,255,268. See formance with, 80-81,90,91, 106-08,
also Inflation 137; defined, 140 n2, n3, n4; occu-
First-level referral hospitals. See District pancy rates and, 3, 6, 96, 133, 146, 273;
hospitals simultaneous use of, 106-08; turnover
rates and, 96,101-02, 106, 133. See also
Gambia, The, 19, 21 Outpatient hospitals; Performance in-
Ghana, 48,172,198; autonomous reve- dicators; Service statistics
nues and, 196; exemption policy in, "Hotel" cost, 80-81
191, 226; fee collection in, 202-03; HYLGa. See Healthy years of life gained
health insurance in, 229,237 ICD. See International Classification of
Government health sector. See Public Diseases
health sector INAMsP See Brazihan National Institute
for Medical Care and Social Security
Health centers, 122, 125; as alternative to Incentives, 116,147,160,194,243,248,
hospital ambulatory service, 8,267; 274; adverse selection and, 162; capita-
bypassing, for primary care, 203-04; tion plans and, 162; case-based plans
conversion of small hospitals into, 99, and, 161, 250; case mix and, 252; cost
110-11; diagnostic support for, 280- containment and, 161; decentraliza-
81, 283-84; district health system and, tion and, 245; fee-for-service plans
277-78,282; essential drugs in, 273; fu- and, 161; fee retention and, 152, 177
hure research and, 307; means testing n3, 214-15,304; fee structures and,
in, 228; oral rehydration therapy in, 203; hospital input mix and, 26-27; in-
288-89; pricing in, 159,164; referral tegrated systems and, 270; limiting
and, 249,242-63,268-69,274; training volume of service and, 248,251; selec-
staff in, 279-80 tion bias and, 162; using medical tech-
Health maintenance organization (HMO), nology and, 252-53
162, 238, 275, 277. See also Capitation Income, 15,57,64, 203,226; cost recov-
plans ery and, 181; hospital use and, 33-36;
Healthy years of life gained (HYLG), 49; insurance and, 163, 164; in low-in-
prevention and, 55 come countries, 5, 6, 48-49, 59-60, 62,
Hepatitis, 57 181; means testing and, 227-28,229; in
HIv (Human imrnune deficiency virus). middle-income countries, 47-48,56,
See AIDs (Acquired Immune Defi- 181; prices and, 7, 158; subsidies and,
ciency Syndrome) 34-35
HMO. See Health maintenance organiza- Incomplete markets, 145,148-49
tion India, 274
Home care, 290-91 Indonesia, 13,15,25,34-35, 37,158,181;
Honduras, 181, 191; cost-recovery ratios insurance program for civil servants
in, 215; fee revenues in, 218, 220; user in, 163, 237-38, 253; cost studies in, 90;
fees in, 197, 198, 228 fee guidelines in, 196; hospital service

Index 331
use in, 34, 137-39; hospital staffs in, 238-39; means testing in, 227; use of
111; occupancy rates in, 96,98, 273; fee revenues in, 220
revenue stability in, 151; training PHC Jordan, 181,229
personnel in, 280; using service indica-
tors in, 137-39 Kenya, 22,26; fee revenue use in, 220-
Inflation: fees and, 228-29,304 21; hospital cost studies in, 122-24,
Information failure, 145,146-47,265, 131; policy simulations and, 272; user
303,305 fees in, 155
Inpatient services, 33,35,102,113, 269; Korea, Republic of, 38,181,197,198,
breastfeeding and, 281; case mix in, 251; ALOS in, 100; alternative hospital
262, 267; cost centers and, 136-37; cost- financing in, 246-49; case mix weight
effectiveness of, 59; costs of, 80-85, data in, 45; effect of high GNPN in, 41;
104,118-21,122-29,131; for Korean exemption policy in, 227; inpatient
age groups, 40-41; hospital service in- care by age group in, 40-41; insurance
dicators for, 90-91,98,106-08, 137-39, coverage in, 229, 237; recurrent cost re-
303; reimbursement for, 100,304-05; covery in, 195
treatment alternatives to, 9, 284-94;
use by age groups and, 38 Latin America, 21, 35, 237, 239. See also
Inputs, 31, 88, 113,117,264; efficient use names of specific Latin American coun-
of, 108-14; internal hospital efficiency tries
and, 31-32; production of hospital ser- Lesotho, 16,181, 198
vices and, 26-27; statistical cost stud- Logistics, 103,278-79
ies and, 116 Long-term care. See Extended care
Input substitution, 32-33,111,113-14, Low-income countries: epidemiologi-
116 cal environments in, 48-49; evaluat-
Insurance,36,101,159-65, 239-40,251- ing care interventions, 58; feasibility
54, 304-05; catastrophic coverage and, of cost studies in, 6; health sector
164; demand and, 159,161-62, 164, investments in, 59; hospital labor
239,248; direct insurance model and, productivity in, 64; less complex in-
162; efficiency and equity, in Brazil, terventions in, 58; nonhospital inter-
240-44, in China, 244-46, in Korea, ventions in, 62
246-49, in Zaire 249-50; efficiency of
various types of, 160-62; equity and, Maintenance, 80, 96, 102, 104, 111, 113-
163; future research into, 309-10; gov- 14, 135,301; cost of, 113-14, 141 n9;
ernment-provided forms of, 160, 163, management of, 89, 110; use of fee rev-
237, 239; hospital financing and, 143, enues for, 220
159, 179,229,237-39; national health Malawi, 25, 41, 108
insurance programs and, 197,214, Malaysia, 33, 36, 82
239,248; optimal pricing and, 175-77; Mali, 181,191,196, 198, 218,226; health
recommendations for program design insurance in, 229,237
and, 255-56; types of coverage and, Management, 2,3,7,261; accountability
164 for resource allocations and, 277; cost
Investment: in hospitals, 21-23; low-in- center method and, 6, 84; fee collec-
come countries and, 59-60; recurrent tion and, 156; fee-retention incentives
resources and, 22-23; sectoral effi- and, 214-15; geographical coordina-
ciency and, 12, 302. See also Capital ex- tion and, 9,263,269-71, 275, 277-78;
penditures hospital input mix and, 26-27; incen-
tive models for, 117; integrating
Jamaica, 22,38,41,181; centralized fee health services and, 277-78, 294-95; of
policy in, 1%, 198; cost recovery ra- patients, 291, 293; of pharmaceuticals,
tios in, 215; exemption policy in, 227; 294; of primary health services, 275,
fee retention in, 218-19; hospital staffs 282; referral and, 267. See also Admin-
in, 111; insurance-claim payments in, istration

332 Public Hospitals in Developing Countries
Marginal cost, 3,105, 115,134, 146, 229; Outpatient hospitals, 286-87
compared with average costs, 174; Outpatient service, 102,275, 281, 285,
fees and, 147,181,185,195, 245, 253; 295; AIDs care and, 293; chronic dis-
optimal pricing and, 156-57, 167-68, eases and, 286; cost centers and, 136-
171 37; costs of, 80, 82, 84-85, 104, 122-33;
Market failures: economies of scale and, drug availability and use of, 97; fu-
144-45; equity and, 148; externalities ture research and, 307; income spec-
and, 144; fee subsidization and, 155; trum and, 35; need for performance
incomplete markets and, 145,148-49; measures of, 303; palliation and, 293-
information failures and, 145,146-47; 94; quality and, 103; referral system
intervention and, 145-46,156; merit and, 269,272,278,294,300; service in-
goods and, 145, 149; public goods dicators and, 91; shifting hospital lev-
and, 144; subsidized services and, 221 els and, 132-33; as substitution for
Means testing, 227-28, 229 inpatient care, I 13, 282, 287-89; sur-
Medical supplies, 27-28,63,278; avail- gery as, 8, 285; in tertiary hospitals,
ability of, 97-98. See also Pharrnaceuti- 262
cals Overhead cost, 80-81
Merit goods, 145, 149,155
Mexico, 19,46, 237 Pacific rim countries, 130
Moral hazard, 162,163, 246,250,253 Palliative services, 12, 293-94
Morocco, 58 Papua New Guinea, 36,38,181,198
Paraguay, 237
Nepal, 13,269 Paramedics, 111
NGO. See Nongovernmental organiza- Patient-days, 80-82
tions Performance indicators. See Hospital ser-
Niger, 35,185, 219; fee system in, 226- vice indicator
27; hospital staffs in, l 11 Personnel, 17; doctors as, 18-19,98-99,
Nigeria, 41, 155,220; hospital cost stud- 102, 103-04, 274; nurses as, 278, 291;
ies for, 125-26; policy simulations for, paramedical staff as, 111; primary
272 health care and, 279-80; staff-to-bed
Nongovernmental organizations (NGO), ratios and, 25,111; substitution across
3,83, 148 categories of, 32-33,111; training inef-
Nurses, 111, 278,291; staff substitutions ficiencies and, 110
and, 32-33 Pharmaceuticals, 27-28, 63,88, 190,261,
284; effect of availability and, 97, 140
Obstetrics. See Cesarean deliveries; Preg- n5; fees and, 155; palliation and, 293;
nancy and birth; Safe motherhood shortages of, 31; substitution for labor
Occupancy rates, 6, 91, 96, 133, 273, 302- of, 113
03; average cost of services and, 91, PHC. See Primary health care
96,146; calculation of, 140 n2; explana- Philippines, 19, 21, 34, 281
tion of, 91; hospital level and, 91, 96; Pregnancy and birth, 41,162; prenatal
perception of service quality and, 98- care and, 56; cost-effectiveness of pre-
99, 273; as service indicator, 90, 106 natal screening, 283. See also Cesarean
Oman, 41 deliveries; Safe motherhood
Oral rehydration therapy (ORT), 47,56, Prepaid plans, 162,163-64, 310. See also
288-89; community-based programs Capitation plans
and, 49 Prevention, 1, 12,47,270; Communica-
Organisation for Economic Cooperation ble diseases and, 41, 44; cost-effective-
and Development (OECD), 56,99, 100, ness of, 58, 59; H-YLG and, 55;
103, 286 immunization programs and, 49,56;
Organization. See Management; Admin- PHC programs and, 47; primary pre-
istration vention programs and, 41,44,57; re-
ORT. See Oral rehydration therapy gional budget coordination and, 277;

Index 333
secondary prevention programs and, Public goods, 144; fee subsidization and,
55,57-58 155; hospital care and, 145
Price discrimination, 154,179,204,210 Public health sector, 1, 60-61, 146; alloca-
Prices, 7,147,301. See also Cost recovery; tion issues and, 3, 11; distribution of
Fees; Incentives resources within, 62-63; equity and,
Pricing: Arrow model for, 176-77; case- 12; hospital-expenditure bias and, 61;
based and, 101; centralized strategy hospital financing and, 143-44, 152;
for, 197; decentralization of, 255; elas- hospital resource share in, 4-5, 11,15-
ticity of, 272-73,295-98; Feldstein 19; nonhospital resource share in, 11;
pricing model for, 16849; Harris pyramidal concept of, 259-60
model for, 175-76; optimal, 167-77,
304; principles for, 7-8,153-54,303; Quality-adjusted life years (QALY), 49,
procedure for, 170-71; Ramsey model 55; hospital costs and, 82; treatment
for, 16749; referral system and, 268- and, 55
69, 294; relation to costs and, 134; Quality of service, 3-4,11-12,131-32,
sensitivity of pricing coefficients 286-87,302; ALOS and, 99, 103; case-
and, 171-74; service-mix distortions based reimbursement and, 161; con-
and, 244-45; simplicty of schedules centration of resources and, 26; costs
for, 304; two-part and, 169; type of fa- and, 85,88-89, 96,116-17, 133-34,
cility and, 204. See also Cost recovery; 301-02; cost recovery and, 256; devel-
Fees oping indicators for, 308; district man-
Primary health care (PHC), 5, 12, 261, agement and, 270; efficiency and, 108,
270, 289; activities supported by hospi- 110,134; future research on, 308-09;
tals and, 281-84; competition for pub- health service market and, 295-98;
lic expenditures and, 62; coordinating hospital use and, 35,97-99,123,139,
regional management and, 275,277- 269; perception of, 248-49,263, 265,
78; diagnostic support for, 280-81; dis- 267,280,309; physician availability
trict hospitals and, 37; efficiency of and, 98-99; proxies for, 111,126; refer-
interventions and, 48; health insur- ral system and, 105-06,264-65,268,
ance and, 159; logistics and, 278-79; 27]-74, 294,301; user fees and, 154-
marginal cost-effectiveness of, 59; na- 55, 303-05
tional health indicators and, 13; na- Recurrent-capital cost (Rcc) ratios, 23
ture of, 47; resource allocation and, Recurrent cost, 33,267; cost center analy-
11, 62; revenue declines and, 21; train- sis and, 135-36; cost of services and,
ing personnel and, 279-80; unit of ex- 79; cost- recovery policies and, 83,
penditure and, 19; using hospital 195; efficiency and, 4; inpatient costs
resources for, 274-84; village-based and, 80; maintenance and, 113-14,
strategy for, 19-20. See also District 273-74; marginal costs and, 83
hospitals Recurrent resources, 13, 15-21, 268; cost
Private sector health care, 23,35-36,109, recovery and, 181; hospital share of,
251-52,310; private patients in public 19, 22-23, 299-301; real public reve-
hospitals and, 185, 210, 219, 226, 227, nue decline and, 21
254; private health insurance and, 237- Referral system, 4,65, 248, 264-65,278,
38; private hospitals and, 197, 240-44, 300,307; cost studies and, 83; Curitiba
247-49; by public-sector physicians, Plan and, 242; formal policy for, 264-
98-99,102 67; hospital cost- effectiveness and,
Production, 116-17; economics of, 2; fu- 261; hospital financing and, 268469;
ture research and, 307-09; of hospital impediments to improving, 263; inte-
services, 26-27; subsidization of, 146 gration of hospitals and, 270-71; man-
Provincial hospitals, 25,97, 122, 124, agement coordination of, 269-71;
130, 262; cost of, 104-05,128, 131, 133; matching needs with faclities and,
equipment and, 109; service indica- 105-06; organizational framework for,
tors in, 91 269-71; PHC and, 37; pyramidal con-

334 Public Hospitals in Developing Countries
cept of, 25,264; perception quality of, Service statistics. See Hospital service in-
265; secondary prevention and, 58; dicators
self-referral and, 105, 1%, 204, 263, Somalia, 22
268; structure of, 263-64; support South America, 130. See also names of spe-
tools for, 266-67; tertiary hospitals cific South American countries
and, 267-68; user fees and, 154 Sri Lanka, 5, 36, 47, 300
Rehabilitative services, 12 Step down studies, 83-84,89; for hospi-
Reimbursement: capitation and, 162, tal costs, 135-37,301-02
238,255-56,305; case-based, 100-01, Subsidies, 37,146, 170-71,179,250,267;
161; effect on cost of case-based, 237, across income groups, 34, 35; cross-
242-43, 250,251, 256; fee-for-service subsidization, 150,163,257; equity of
(FFs) plans and, 237, 24041, 244, 246, access and, 35,253; fee subsidization
248, 251; effect on cost of fee-for-ser- and, 155, 221
vice 100-01,161. See also Insurance; Substitution: of drugs and equipment
Prepaid plans for labor, 113, 301; of factors, 113, 116;
Research, future, 261, 298; on case mix, hospital staffs and, 32,111; between
96, 306-07; on cost-effectiveness, 291; maintenance and other expenditures,
on costs and production, 307-09; on 113-14; of outpatient for inpatient
effect of quality and demand cost, 97, care, 9,286,288,289
273,308-09; on efficiency, 306,309, suDs. See Unified and Decentralized
310; on equity, 306,307,309; on financ- Health System
ing, 309-10; on private sector, 307, 308, Swaziland, 202,219
310; on resource allocation, 306-07
Resource allocation, 152; alternative fi- Tanzania, 22,292
nancing programs and, 239; and alter- tB See Tuberculosis
natives to hospital care, 284-94; Technology, 252,284-85; cost-effective
average or marginal effects and, 58; uses of, 26041
changing referral patterns and, 262- Tertiary care, 277,305; and reallocafion
74; future research on, 306-07; hospi- of recurrent resources, 300
tal level and, 25-26; within hospital Tertiary hospitals, 5, 21, 26, 88, 101, 271;
sector, 63; insurance programs and, allocation of resources to, 61; average
251; marginal versus average effects costs and, 89,134,302; case mix of,
and, 58; market failures and, 144; pri- 108,268; equipment and, 109; fee pol-
mary health care and, 11, 274-84 icy and, 195-96; outpatient depart-
Revenue, 150-52; efficiency of collection ments in, 262; referral system and, 25,
of, 151-52; fee retention and, 214-15, 97,265-68; specialized care and, 8;
218-20; levels of budgeting and, 150; support to lower levels and, 49
recurrent resources and, 21; stability Treatment protocols, 103
of, 151. See also Autonomous revenue; Tuberculosis (TB), 146, 287-88
Fee revenue Turkey: adjusting fees in, 198, 202; cost
Risk-sharing. See Insurance recovery in, 181; fee schedule in, 196-
Rwanda, 84,90 207; insurance in, 229,237
Turnover rates, 81,96,133, 302-03; calcu-
Safe motherhood, 41, 282-83, 285. See lation of, 140 n4; explanation of, 91;
also Cesarean deliveries; Pregnancy hospital level and, 91, 96; reducing
and birth ALOS and, 101-02; as service indica-
St. Lucia, 191 tors, 90,106
Secondary prevention, 55; cervical can-
cer and, 57, 58, 283-84; cost-effective- Unified and Decentralized Health Sys-
ness of, 57 tem in Brazil (suDs), 243, 271
Selection bias, 162 Unit costs, 34, 6-7,80, 82,181, 268. See
Senegal, 220, 229,237 also Average cost; Marginal cost

Index 335
United States, 48, 49, 99; extended care World Health Conference (0978),19
in, 103; outpatient hospitals and, 48 World Health Organization (WHO), 2,
United States Agency for International 266, 271,273, 274
Development (UsAl), 2
Uruguay, 35, 229, 237, 238 Years of life gained (YLc), 49, 55
User charges. See User fees
User fees, 151-52,153-55,179,181, 221, Zaire, 181, 197, 204, 238, 239; AIDS in,
304; demand and, 151-215; efficiency 292; alternative financing in, 249-50;
of collection and, 151-52; hospital fi- integrated management of health
nancing and, 143-44; recurrent re- services in, 277-78; referral system
sources and, 181; referral system and, in, 269
153; revenue generation and, 203. See Zambia, 19,21, 26,306; revenue stability
also Cost recovery; Fees in, 151
Zimbabwe, 26, 90,198,228; insurance-
wHo. See World Health Organization claim payments in, 238-39

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