The need for a new framework for the economic evaluation of health services in a national health scheme

doi:10.4236/health.2010.29165

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Vol.2, No.9, 1120-1133 (2010) Health

doi:10.4236/health.2010.29165

The need for a new framework for the economic

evaluation of health services in a national health

scheme

Jeff R. Richardson*, John McKie, Kompal Sinha

Centre for Health Economics, Monash University, Melbourne, Australia; *Corresponding Author: Jeff.richardson@buseco.monash.edu.au

Received 29 April 2010; revised 20 May 2010; accepted 25 May 2010.

ABSTRACT

The normative theory of economic evaluation

and its welfare theoretic basis are deeply prob-

lematical and result in recommendations which

are potentially unfair. The root cause of the

problem is the set of assumptions behind the

theory which posit behaviours and motivations

that are not universal, and which exclude other

behaviours and motivations that are potentially

important. As falsification of assumptions may

be evaded indefinitely this paper presents an

alternative critique. We commence with six an-

omalies with the theory which are attributable to

the assumptions. The first three—the net pre-

sent value criterion, the willingness to pay cri-

terion and moral hazard—arise from welfare

theory. The remaining three are associated with

the present definition of cost, the concept of

efficiency and the omission of sharing, which

are common to most economic evaluation. We

argue that these anomalies are indicative of a

defective core theory and that they are equiva-

lent to observations that conflict with a positive

theory. In the final section we outline and illus-

trate a more general framework for decision

making that is capable of overcoming the ano-

malies we discuss.

Keywords: Economic Evaluation; Economic Costs;

Welfare Theory; Empirical Ethics; Cost Benefit

Analysis

1. INTRODUCTION

Between 1990 and 2003 public expenditures on health

per capita in the OECD doubled. Unsurprisingly this has

resulted in closer scrutiny of the services provided.

Commencing with Australia in January, 1993, an in-

creasing number of countries have passed legislation to

ensure the economic evaluation of pharmaceuticals be-

fore receiving subsidy. Economic evaluation is also in-

creasingly adopted for other public health services, a

trend which is likely to be of increasing importance in

rationing health services, even in the USA where current

legislation prevents its full use in Medicare.

Given this scenario, the relatively low level of self-

criticism of fundamental elements of the theory of eco-

nomic evaluation is of concern. In the financial sector

the recent world-wide crash signalled the existence of

defects in both practice and theory. The doubtful activi-

ties of many financial managers are now well known.

Less publicised is that in the 1960s Mandelbrot demon-

strated that a fundamental tenet of financial theory was

wrong [1]: movements in the stock exchange follow a

power function and deviations are not normally distrib-

uted. Sometime earlier, Keynes had argued that the re-

turn on assets was often subject to uncertainty, not risk

(i.e., there is not enough information to justify assuming

a particular distribution of expected returns) [2]. Both

observations strike at the basis of the theory which un-

derpinned the financial structures of recent times, but

both have been largely ignored. The recent crash will,

hopefully, provoke introspection and error learning.

In contrast, there are no external events that could en-

courage examination of the theory and practice of eco-

nomic evaluation. However, there are anomalies in its

use in the health sector and elsewhere which are at least

as important as and much more obvious than those iden-

tified by Mandelbrot and Keynes. Some of these are out-

lined in Section 2 below. Those relating to the health

sector are largely associated with the neglect of fairness

and the drive to find technical answers to questions re-

lating to social values.

The proximate reasons for this outcome are discussed

in Section 3. To increase analytical rigour, assumptions

have been made in economic theory that oversimplify or

seriously distort reality (cf. risk versus uncertainty).

J. R. Richardson et al. / HEALTH 2 (2010) 1120-1133

1121

Equally damaging is the application of the standard “ce-

teris paribus”—all else equal—caveat. Especially in the

health sector, conclusions are often context-specific and

neglect of some elements may be as damaging as the

misrepresentation of others. Finally, in Section 4 we out-

line and illustrate some principles for the construction of

a better framework for economic evaluation.

The existing framework is broadly concerned with the

comparison of benefits and opportunity costs where the

latter are the benefits foregone by using resources in one

way rather than another. A key criterion in evaluation

theory is that the present value of benefits exceeds cost

(B > C), or that net present value is positive (B – C > 0).

A necessary condition for this is that the benefit-to-cost

ratio exceeds unity (B/C > 1), or the cost per unit of

benefit is less than unity (C/B < 1). This criterion defines

efficiency. If there is a constraint, such as a fixed budget,

then ‘unity’ is replaced by a threshold reflecting the op-

portunity cost of capital or use of the constrained re-

source.

In the health sector, however, there is tension about

the application of this broad principle. In more orthodox

‘welfare theory’ (WT) benefits are equated with indi-

vidual ‘utility’ where this, in turn, is equated with the

strength of a person’s preferences. While it is argued

(following Robbins [3]) that these subjective preferences

cannot be directly compared, they can be revealed by a

person’s willingness to pay [4], and social welfare—the

welfare of society—is a function only of individual utili-

ties: the doctrine of “welfarism”. The more orthodox arm

of health economics attempts to implement these princi-

ples. For example, the gold standard for benefit meas-

urement is revealed preferences, but in its absence the

second best approach is to use stated preferences and/or

stated willingness to pay. This includes the willingness to

pay for life itself, or at least a ‘statistical life’, which is

often inferred from an individual’s willingness to pay for

a reduction in the risk of death or the willingness to ac-

cept compensation for assuming a risk of death [5,6].

In contrast, in Cost-Effectiveness Analysis (CEA)

benefits are “external” and measured in physical terms,

either as lives saved, life years or “quality-adjusted life

years” (QALYs). The term “extra welfarism” has been

used to describe the theory that the only—or only rele-

vant—benefit which needs inclusion in CEA in the

health sector is health outcome [7]. While this ‘external

benefit’ or ‘material welfare’ tradition is the earlier his-

torically, welfare theory and welfarism are widely re-

garded as a gold standard with various attempts being

made to either reconcile CEA with them or to show the

special circumstances when CEA provides a consistent

‘theoretically correct’ solution to economic problems [8].

Some of the anomalies with the theory of economic

evaluation are unique to welfare theory. However, there

are anomalies which it shares with extra-welfarism

based CEA.

2. SOME ANOMALIES

2.1. Net Present Value: The Wrong Criterion

Welfare theory evolved from the context of the private

sector in which individuals chose whether or not to pur-

chase a commodity for their own benefit. Unsurprisingly,

it is assumed in WT that well-informed and rational in-

dividuals will apply the criterion that (personal) benefits

should equal or exceed (personal) costs—the positive net

present value criterion. If costs equal benefits plus $1

there will be, or should be, no transaction. This theoreti-

cal point has been transferred to the health sector: if total

costs as described by WT exceed total benefits as de-

scribed by WT no service should be provided even if the

patient dies. Welfare theory allows for compassionate

externalities—others may obtain utility if the patient

lives, but if not, then the patient should die as greater

utility can be gained if the resources are used elsewhere.

However, changing the context from a private market

to a national health service (NHS) may have profound

consequences for almost all aspects of evaluation in-

cluding the comparison of costs and benefits. At present,

the bulk of health costs are borne by ‘society’ (in the

form of tax or premium payments) and benefits are ob-

tained by an individual who will not bear (at least the

full) cost. Different principles almost certainly apply to

the willingness to provide benefits, or else the NHS

would have been unnecessary and if the scheme is suc-

cessful then the demands upon the national health sys-

tem will differ from the demands upon the private sys-

tem. With full knowledge of the magnitude of the utili-

ties involved those making decisions for society may

elect to save life, or improve life, when it is ‘uneco-

nomic’ according to WT. There are well known ethical

and rational reasons for this, including those appealing

to ‘sympathy’, ‘reciprocal altruism’, and ‘process utility’

(fairness). More significantly, there may be ‘counter-

preferential’ reasons, based on ‘duty’ or ‘commitment’.

A well-known argument against duty and commitment,

to which we return below, is that they may simply be

another source of utility: they are only superficially

‘counter-preferential’. More fully, since utility is re-

vealed by decisions, the decision to carry out one’s duty

indicates that the decision maker must have received

utility. However, while the revealed preference criterion

is potentially useful in a context where an individual is

well-informed and known to be only self interested, this

interpretation of the revealed preference definition of

J. R. Richardson et al. / HEALTH 2 (2010) 1120-1133

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utility converts the argument into a tautology: all action,

by definition, reflects utility. Some people may, indeed,

gain utility from fulfilling their duties, but as Sen has

pointed out [9], other motivations are clearly possible.

2.2. Willingness to Pay: An Unwanted

Element

Private willingness to pay (WTP) is still widely used and

vigorously promoted in the literature as a method for

evaluating improvements in quality of life (QoL), and

the value of life itself [6,10]. However, the wedge be-

tween recipients and funders of health services invali-

dates the logical connection between social goals and

private WTP and makes the interpretation of WTP data

problematical. As noted, if there was no difference be-

tween an individual’s WTP for a service for themself and

the WTP of the society, then it is unlikely that there

would be significant support for an NHS. Private, risk-

based insurance would probably satisfy the need for en-

suring health. But the great appeal of an NHS is that it

promotes fair access to health services. That is, the ap-

peal relates to the use, or potential use, of services spe-

cifically by those who would not otherwise have access

through lack of financial resources. Restated, the pur-

pose of an NHS is to ensure that services are available to

people when their private WTP is less than the cost. That

is, the purpose of an NHS is to ensure that the ‘optimal

outcome’ described by welfare theory does not occur.

Adopting the WTP criterion of benefit results in a fur-

ther paradox for the orthodox economist attempting to

achieve economic efficiency. For every additional dollar

that an individual is willing to spend on themself, the

NHS should also be willing to spend an additional dollar

on this person. With WTP benefits determined by in-

come, taxpayers would have to subsidise the wealthy,

who are willing to pay more for their own health care,

and spend less on the poor, who are the usual target

group.

A final defence of the WTP criterion is more ad hoc.

Since economists have not devised a better method for

determining the dollar value of health services, the WTP

may indicate the order of magnitude of appropriate

spending in the health sector. Some have adjusted the

WTP to take account of an individual’s wealth, but this

remains an ad hoc approach as it does not overcome the

theoretical problems outlined above [11,12]. The ad hoc

solution may, indeed, be the best available, but it has the

theoretical status of an opinion poll and should not claim

greater authority.

2.3. Moral Hazard: Replacing Normative

with Technical Objectives

Disagreement exists about the benefits of health insur-

ance and at least part of this has arisen because of the

different lenses through which the protagonists have

viewed the issue. Following Pauly [13], economists have

almost universally accepted that health insurance is sub-

ject to ‘moral hazard’. That is, it causes an ‘excess bur-

den’—an inefficient use of resources, where the benefit

(determined by willingness to pay, or the area under the

demand curve) is less than cost. This arises because the

price to the patient has been reduced (by the insurance

rebate) to be less than the cost (possibly zero in a ‘free’

scheme). Patients are therefore willing to pay the re-

duced (or zero) cost of additional care for which society

pays the full cost. It is usually concluded that insurance

therefore induces the use of resources where costs ex-

ceed benefits and that this inefficiency should be limited

by the use of patient co-payments to reduce the “excess

burden”.

The argument appears, prima facie, a good example of

value free social science. However, social welfare

groups and supporters of universal health insurance tend

to have a different focus. The demand curve used in the

economist’s argument is a simplification. There are, in

fact, many demand curves determined primarily by lev-

els of illness and ability to pay. The demand of the

wealthiest will be relatively unresponsive to prices, with

responsiveness, or ‘elasticity’, increasing as family in-

come falls and price becomes a larger real burden. As the

patient co-payment rises (to reduce the excess burden)

the reduction in health care will be determined very

largely by income. The savings to a tax-financed NHS

will primarily benefit wealthy taxpayers. In the extreme,

the ‘excess burden’ may be interpreted not as a measure

of pure inefficiency, but as a measure of the extent of the

redistribution of income from the wealthy and healthy to

the poor and unhealthy, and it is to the former group that

there is an “excess burden”. In Australia, at least, co-

payments have been supported for reasons of sectional

interest by doctors (to give some control over incomes),

by government (to shift costs to patients) and by social

welfare groups (to protect the poor). Economists alone

have perceived co-payments to be primarily related to

efficiency.

The literature on moral hazard is an example of the

consequences of the previous error of treating the net

present value (NPV) as a gold standard criterion. Be-

cause behaviour changes as a result of an NHS the de-

viation from the (NPV) criterion is considered to be a

source of inefficiency, and to be avoided, even if from a

social perspective this deviation was the purpose of the

scheme.

Of less relevance here, the moral hazard anomaly also

applies in a private market with an additional error caused

by an omission from the theory, namely utility obtained in

J. R. Richardson et al. / HEALTH 2 (2010) 1120-1133

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the “pre outcome” period before a person knows whether

or not they will be sick [14]. The disutility of risk induces

the purchase of insurance in the knowledge and with the

purpose of altering realised spending in the case of illness.

The moral hazard argument defines this deviation as inef-

ficiency reflecting the analytical weakness of orthodox

economics’ treatment of time.

2.4. Economic Costs: The Wrong

Comparator

The problems outlined above arise in cost-benefit analy-

sis (CBA) where both benefits and costs are reduced to

dollars. In practice, the predominant form of economic

evaluation in the health sector is cost-effectiveness

analysis, or cost minimisation analysis, which seeks to

rank services according to their cost-per-unit of benefit

(lives, life years, or quality adjusted life years in the case

of cost-utility analysis). Cost-effectiveness analysis can

be justified independently of welfare theory as it indi-

cates how benefits, somehow measured, may be maxi-

mised given resources or from a given budget. Benefits

need not be measured by individual utility. Nevertheless

it encounters problems which also apply to CBA.

A simple extension of the earlier arguments indicates

that the ‘costs’ that are relevant in evaluation studies

may not be the resource costs of economic theory, i.e.

the value of the resources expended (labour, time, capital,

stock depleted, etc). The ‘social willingness to pay’ - the

amount an individual is willing to contribute to an NHS

(or the willingness of the individual’s “agents” on their

behalf)—depends upon their “social generosity”. This

may or may not be closely related to an individual’s

perception of their personal benefits from the NHS. Of

greater relevance here, it will not depend upon net use of

resources but upon the amount of money lost personally

through the taxes and premiums that finance the NHS.

These are not the same. The net resource cost of a medi-

cal service is equal to the direct cost minus indirect

benefits, where the latter is the value of employment

gained (or not lost) by a patient’s return to the workforce.

But the chief beneficiary of this is the employer or pa-

tient not the taxpayer. Consequently, an increase in taxes

or premiums which resulted in increased employment

and in ‘negative real costs’ would still impose a personal

cost on the taxpayer. If willingness to pay and cost are to

be equated to achieve the usual notion of efficiency, it is

this personal cost to the taxpayer, not the net resource

cost, which should be compared with the social willing-

ness to pay.

The argument is even clearer if the scope of govern-

ment services is broadened to include pensions. In prin-

ciple every person with a chronic illness could be of-

fered a compensatory pension in exchange for their ac-

cess to the NHS. As normally understood, pensions are a

“transfer” (from the taxpayer to the recipient) and omit-

ted from the calculation of “costs” as no real resources

are consumed. Consequently, the compensatory pension

would generate similar satisfaction but no real cost. It

would always be the better strategy. But the strategy

would impose a (possibly much higher) personal cost on

taxpayers and the optimal strategy could not avoid tak-

ing this into account.

2.5. Equity and Efficiency: A Misleading

Distinction

To a greater or lesser extent every country endorses eq-

uity of access to needed services (somehow defined).

But the cost of providing needed services varies. Patients

in inaccessible locations are more costly to treat than

those close to major hospitals and medical facilities.

Even a partial concession to equity therefore implies the

provision of services with higher costs per unit of benefit

than might be provided to patients in large cities. Mini-

mising cost or cost-per-unit of benefit will not, therefore,

achieve social goals efficiently. Stated simply, when

there are two objectives—cost and equity—social goals

cannot be achieved by focusing only upon one of these.

In principle this is acknowledged and formalised in

textbooks by recognising the existence of an equity-

efficiency trade-off. In practice the evidence reveals lit-

tle concern with equity, with most studies providing no

evidence relevant for its assessment.

By contrast, attention has been given to what is easily

measured, while the various elements of fairness and its

inclusion in empirical studies have been neglected [15].

The somewhat emasculated concept of fairness—“equity”

—has been largely consigned to the realm of theory. But

even the concept of an equity-efficiency trade-off is un-

satisfactory. This may be seen by considering a well-

defined category of patients, viz, those with a ‘difficult

disease’, where costs are high and the effectiveness of

treatment is low because of the type of disease and cur-

rent state of medical technology. There is no obvious

logical or ethical reason why the principle of equal ac-

cess for equal need should allow an increased cost

threshold because of, say, a person’s geographical loca-

tion, but no similar increase because of a person’s medi-

cal problems. To the contrary, those who live in remote

locations do so voluntarily. Those contracting difficult

diseases generally do so through bad luck. From behind

a veil of ignorance we would therefore expect to give

higher priority to the latter, not former group. Of course,

not all treatments can be provided irrespective of cost.

But just as those who have been historically singled out

J. R. Richardson et al. / HEALTH 2 (2010) 1120-1133

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as beneficiaries in the equity-efficiency trade-off (e.g.

rural patients) receive some (incomplete) compensation,

so it might be expected that those with difficult diseases

would similarly receive some consideration possibly at

the expense of those with “lucky” illnesses. In practice

this commonly occurs. Few are left to suffer in a severe

condition because all of the options are cost-ineffective:

those with only days to live are accommodated in a

high-cost hospital minimally receiving palliative care

which is highly “cost-ineffective” as judged by the crite-

rion of cost-per-life year gained or cost-per-quality ad-

justed life year gained. However economic theory has

not caught up with practice.

The efficiency goal of minimising the cost of achiev-

ing objectives becomes problematical, as one of the ob-

jectives is—all else equal—the (part) provision of ser-

vices to those with inefficient-to-treat diseases. The

concept of a trade-off between cost/QALY (efficiency)

and cost/QALY (fairness) therefore becomes, at best,

ambiguous.

2.6. Sharing: Ignored Social Objectives

Perhaps the greatest anomaly with economic evaluation

theory is the theoretical framework itself. The frame-

work is based upon an analysis of the individual and the

way each individual maximises their utility or wellbeing.

Prima facie, however, this is almost the opposite of the

perspective embodied in the rhetoric of an NHS. The

latter social perspective relies heavily upon the concepts

of “community”, “solidarity”, “sharing” and emphasises

the need to off-set the barriers to uneven access caused

by price and income inequalities—which are precisely

the variables that drive the allocation of resources and

define benefits in the orthodox economic model. Indeed,

while in theory the vocabulary of the entire English lan-

guage is available to economists, in practice orthodox

welfare economists rarely speak about “community”,

“sharing”, “duty” etc. This can have damaging conse-

quences, as described by George Orwell [16] in an ap-

pendix to his classic novel on tyranny, “Nineteen Eighty-

Four”. He observes that in the absence of appropriate

vocabulary the conceptualisation of ideas becomes very

difficult1. It is arguable that this has happened in ortho-

dox welfare economics in which these important con-

cepts play no role. (For exceptions see the advocacy of

communitarianism, in particular, by Mooney [17,18],

sympathy and justice by Sen (2009), also discussions of

“sharing”, “fairness”, “altruism” and “trust” in the ex-

perimental economics literature [19-22].

This truncation of the available language is, in fact,

facilitated by the core definitions of welfare theory. Us-

ing Samuelson’s revealed preference criterion, it might

be argued that if any action, including voting, was ob-

served because of any possible motive, then this would

indicate that individuals were obtaining utility from that

motive, otherwise they would not have done it. There-

fore, the reason for self-sacrifice is that it maximises

utility. In the extreme case of one person giving their life

for another, this must be construed as utility maximising.

However, the logic is vacuous. As illustrated in Figure 1,

the answer to the question “why does an individual take

a particular action”, is that “this action maximises util-

ity”. But the answer to the question “how do we know

that this action maximises utility”, is that ‘they have

taken the action’.

The more defensible argument offered by orthodox

economics is that its framework includes “externalities”

—the utility which people obtain from something exter-

nal to the market. There is a long and detailed literature

demonstrating how, in theory, “fairness”, “reciprocity”,

“participation”, and so on, understood as externalities,

can be employed to “shoehorn” the elements of a com-

munitarian framework into an orthodox framework (see

particularly the works of Culyer [7,23]. In practice this

theory is never operationalised. Rarely are measure-

ments of the benefit of this type of externality included

in economic evaluations. Rather, it has been used to jus-

tify the retention of the narrow focus of current practice.

Behaviour

Obser ved

Motivation

Utility

Maximisation

Evidence

Figure 1. Revealed preferences and the resur-

rected primacy of utility.

1In ‘1984’ the control of thought was achieved by the truncation o

language ‘It was intended that when Newspeak had been adopted once

and for all ... heretical thought ... should

e literally unthinkable, at least

so far as it is dependent upon words. This was done ... chiefly by elimi-

nating undesirable words ... countless other words such as honour,

ustice, morality, internationalism, democracy, science and religion had

simply ceased to exist. A few blanket words covered them, and in cov-

ering them, abolished them. What was required in a party member was

an outlook similar to that of the ancient Hebrew who knew, without

knowing much else, that all nations other than his own worshiped “false

gods” ... he knew Jehovah and the commandments of Jehovah; he knew,

therefore, that all gods, with other names or other attributes were “false

gods”.’ [16] pp. 317-319.

J. R. Richardson et al. / HEALTH 2 (2010) 1120-1133

1125

The defensive logic of the argument is effectively that

other motivations may (possibly) be attributable to (self-

ish) externalities and other, non-selfish motives may

(possibly) not exist. Alternatively, if they exist, that they

are of no interest to economics. Therefore we may treat

them as if they do not exist or are irrelevant. External-

ities are a satisfactory explanation for altruism and

commitment; orthodox theory and therefore current

practices are justified.

However, there is strong evidence that people have

additional motivations to selfish utility maximisation

and that these can be behaviourally significant. Bein-

hocker [24] for example, summarises a large body of

evidence obtained from experiments and anthropology

which indicates that human beings are conditional co-

operators and altruistic punishers, behaviour some-

times described as “strong reciprocity”. This results in

a predisposition to cooperate with others and punish

(even at personal cost if necessary) those who violate

the norms of cooperation, even when it is implausible

to expect these costs to be recovered at a later date [25].

One of the most widely replicated experiments de-

monstrating strong reciprocity is the so-called ultima-

tum game. Using real money, one individual divides the

money between themselves and a second person who

has the ability to either accept the money or reject the

offer. In the latter case neither person receives any

money. The utility maximising strategy for the second

person is to accept what they are offered, however

small it is. However, the universal observation is that

the second person will reject the offer if it is too small,

in order to punish the first person. In countries as var-

ied as the USA, Mongolia and Zimbabwe it has been

found that most individuals divide the money more or

less equally and that the second person will reject the

offer when it is less than about 30 per cent of the total

[24]. One group of respondents has been found to be-

have in the way predicted by economic theory, namely

those who have a disorder related to autism in which

they have little capacity to empathise with others [26].

Alternatively, people could derive from such behaviour

benefits that go beyond the monetary payoff - e.g. the

‘warm glow’ that derives from sharing, defending jus-

tice, etc. [27,28].

The prevalence and importance of motivations apart

from utility maximisation are apparent in the results

from two research projects undertaken at the Centre for

Health Economics at Monash University. In the first,

501 Australians were asked to indicate their agreement

or disagreement with a series of statements relating,

inter alia, to their motivation. Results reported in Table

1 indicate that the majority of respondents care about

relative and not just absolute income levels (Question 1)

and an even larger number rejected the view that the

maximisation of happiness is the most important ethical

principle (Question 2). An overwhelming majority re-

jected the view that they, personally, fulfilled their duty

to achieve happiness (Question 3,4) and less than 1 in 5

believe that other people help one another only if they

gain something personally (Question 5). This is not

conclusive however. For example, 84.2 per cent of re-

spondents also agreed with the statement: “I fulfil my

duties to individuals and organisations (to family,

country etc) because doing so will make me happier in

the long run”. This suggests that motivations may not

be clearly separated in people’s minds. People may

fulfil their duties out of genuine self-sacrifice (which

conflicts with utility maximisation as a psychological

hypothesis) or it may be because it will enhance their

own well-being, or both.

The second study was web based. Individuals were

asked to allocate a block of money to one of four pa-

tients, each of whom would die without treatment. Pa-

tients were identical except for the cost of treating their

disease, which led to a different outcome. One block of

money could produce 12, 8, 6 or 4 additional years of

life. After allocating the first block of money respon-

dents were asked to allocate a second, third and fourth

block, etc, to any of the patients. This left respondents

with a choice of allocating resources where they pro-

Table 1. Results from the monash ethics survey.

Questions/Statements % (Strongly) agree% Neutral % (Strongly) disagree

1. Australia is better off if the wealthy receive even higher incomes so long as

the income of the poor does not fall. 22.8 22.8 57.4

2. Maximising happiness is more important than any other ethical principle. 14.3 19.8 65.9

3. I have some duties that I must fulfil even if doing so makes me a little less

happy. 91.5 4.7 3.9

3. I fulfil my duties to individuals and organisations (to family, country etc) not

primarily because it will make me or others happy, but because it is my role

(e.g. as a mother, father, employee etc).

77.8 5.6 16.7

4. People help others only because they gain something personally. 18.2 21.2 60.7

Source: [44]

J. R. Richardson et al. / HEALTH 2 (2010) 1120-1133

1126

duce most life (minimum cost per life year), sharing

resources or some combination of the two strategies.

Figure 2 is similar to the visual representation given

to respondents. Initially only the blocks in bold type

were shown. When the respondent clicked on ‘patient

1’ the second block of 12 years (in broken bold type)

appeared which could be selected in the second choice.

The exercise ended when there was no longer a choice.

The order in which resources were allocated was re-

corded and analysed.

If respondents behaved as economic theory predicts

they do (or should) the life years gained with each new

block of money would be maximised - that is, in the

order: 12, 12, 12, 12, 8, 8, 8, 8, 8, 8, 6...6, 4...4. In con-

trast, the 532 respondents allocated resources so that an

average of only 62.5 per cent of the maximum life years

were obtained. 37.5 per cent were sacrificed in order to

share resources between the four patients. The statistical

analysis of choice indicated that this was dominated by

the life expectancy of different patients which accumu-

lated as more resources were given to them. The cost per

life year was statistically significant but relatively un-

important despite the fact that the ‘opportunity cost’ of

allocating resources to a ‘high cost’ patient was (visually)

obvious in the form of a greater number of years of life

which might have been obtained by allocating resources

to another patient.

3. THEORY

Economic theory consists of a set of assumptions and

logical deductions. As the latter are generally correct,

criticism necessarily focuses upon the assumptions and

there have been numerous critiques. In the context of

health economics perhaps the most comprehensive is

Rice [29] but the present authors have also made a con-

tribution [15,30]. In the present context, we focus upon

the subset of assumptions of orthodox economics which

Pat i e n t 1

Pat i e n t 2

Pat i e n t 3

Pat i e n t 4

25374961 73

12yrs

8yrs

6yrs

Patients

starthere,

allaged25

andabout

todie

4yrs

(a)

Pat i e nt 1

Pat i e nt 2

Pat i e nt 3

Pat i e nt 4

2537496173

12yrs

8yrs

6yrs

Patients

starthere,

allaged25

andabout

todie

4yrs

(b)

Figure 2. Web-based allocation exercise. (a) The diagram represents 4 patients, all aged 25 facing immediate

death. Whichever block is selected will extend that patient’s life for the number of years indicated in that block;

(b) When a block is clicked, it fills with colour and the next block becomes available. The patient will now live

until the end of the filled block.

J. R. Richardson et al. / HEALTH 2 (2010) 1120-1133

1127

facilitate the normative conclusions of economic evalua-

tion theory, namely that in an NHS services should be

offered ideally when their net present value is positive

and, when budgets are constrained, according to the ratio

of costs to benefits as these terms are defined.

Using Sen’s terminology, the most fundamental as-

sumptions behind welfarism economics are these:

A.1 Individuals are motivated only by utility which

they seek to maximise;

A.2 Utility is only derived from the consequences of

actions (consequentialism); and;

A.3 Social welfare—the wellbeing of society—is a

function of (only) individual utility;

However, these assumptions are insufficient to allow

applied evaluation studies and, in practice, some ancil-

lary assumptions are also made. These are that;

A.4 If one person’s utility is increased without a re-

duction in the utility of anyone else—a ‘Pareto im-

provement’ - then society may be presumed to be better

off;

A.5 People are ‘rational’ and well-informed implying

that their choices reveal their utility maximising strate-

gies;

A.6 A net increase in utility increases social welfare,

even if there are winners and losers, provided it is theo-

retically possible for the former to fully compensate the

latter;

The final assumption—the potential compensation or

Kaldor-Hicks criterion—permits each dollar to be treated

as of equal value since it may be redistributed and dol-

lars may therefore be added to obtain potential benefits

and costs;

To a greater or lesser extent each of these assumptions

is necessary to justify the practice of cost benefit analy-

sis (CBA) as shown in Box 1. If a willingness to pay

(WTP) methodology is used to reduce benefits to dollars

(the defining characteristic of CBA) a positive net pre-

sent value (NPV) assures a surplus, as measured in dol-

lars, which might, in principle, be redistributed (step 2

Box 1). In principle no one need have fewer dollars

while leaving the beneficiary better off. In the case of

health economics, the WTP is for a final health state

(consequentialism) and from the revealed (stated) pref-

erence criterion the surplus indicates an increase in the

person’s utility. Consequently the positive NPV is

‘Pareto efficient’ (step 3) and social welfare will be in-

creased (step 4). Note that only rarely are relative costs

and benefits taken into account, although they can sig-

nificantly affect social welfare via envy.

With CEA the role of utility in this argument is

largely replaced by an explicit target, commonly the

life year (LY) or quality adjusted life year (QALY).

Consequentialism is more explicit and social welfare is

implicitly a linear function of the number and quality of

life years deflated by a rate of time preference. The

causal sequence is represented in Box 2. As benefits

cannot be reduced to dollars, the cost/LY of different

Service Benefit>Cost

(WTP)>(OC.)

Re d istribution

noneworseoff

Socialwelfare

increase d

Pareto 

efficiency

Indiv idual

utilitie s;

consequences

Thisdo e s

not/cannot

occur

Definition(only) Onlyifallnon‐

utilityobjectives

ignored

Box 1. The logic of cost benefits analysis.

Step2

(Individual )

LY

Step4

Socialwelfare

increased

Step3

Netgain

Otherunitsof

benefitposs ible

eg QALYs

Onlyif

costs=budg etary,

noteconomiccosts

Onlyifvalue

LY>costs

OnlyifallnonLY

obj ectivesig nored

Step1

(Cost/LY)

<(co s t/ LY

)

Box 2. The logic of cost effectiveness analysis.

J. R. Richardson et al. / HEALTH 2 (2010) 1120-1133

1128

services are compared (step 1). Selecting the service

with the minimum cost/LY allows more life years to be

produced (step 2) which is considered to be a net gain

(step 3) which increases social welfare (step 4).

As with CBA, social welfare is only affected by total

life years or QALYs (consequentialism), not by relative

gains and losses. The explicit view in CBA that a dollar

should be treated as a dollar due to potential compen-

sation is replaced by the view that all QALYs should be

treated equally [31]. As this cannot be judged by the

potential to compensate those who do not receive

QALYs (and are therefore dead) the judgement is an

ethical assumption.

Box 1 and Box 2 highlight the reliance of the two

forms of economic evaluation upon the various as-

sumptions. In Box 1 benefits are reduced to dollars

(normally) by assuming that revealed preferences are

the result of rational well-informed choice (step 1). But

only the utility of the final health states, and util-

ity-based indirect benefits and externalities, are in-

cluded in the evaluation. Non-utility consequences and

processes are excluded. The redistribution of benefits

to ensure that no one is worse off in step 2 never occurs

in practice in the health sector and often cannot occur -

e.g. when people die [30,32]. Pareto efficiency need not

result in an increase in social welfare if any of the ob-

jectives assumed irrelevant by welfarism (e.g. those

relating to equity which are independent of utility ef-

fects) are in fact quantitatively important.

The logic of CEA side-steps the initial problems of

CBA typically by assuming that some spending will

occur or that there is a fixed budget and that the prob-

lem is how best to spend the resources. But this justifi-

cation alters the logical sequence. Life years (or QA-

LYs) (step 2) are only maximised if the ‘cost’ in step 1

is the constrained (budgetary) cost not resource cost. To

illustrate this consider a project with small benefits but

with no resource cost because the exceedingly high

cost-to-budget is off-set by indirect benefits—cost sav-

ings through an early return to work by patients. With

costs/LY = 0 the project would be prioritised, exhaust-

ing the budget and crowding out projects with a lower

budget cost-to-benefit ratio which would achieve greater

net benefits.

In the UK the National Institute for Clinical Excel-

lence (NICE) has recognised this problem and its

guidelines specify that the relevant costs are those that

relate to the NHS; that is, economic evaluation for the

NHS longer employs economic costs. Similarly, NICE

has sanctioned a (particular type of) QALY (based upon

the EQ-5D QoL instrument) for cost utility analysis

[33]; that is, it no longer employs the usual concept of

economic benefits. The latter change has commonly

been justified by an appeal to extra-welfarism. Coast et al.

[34] note that ‘the apparent success of the extra-welfa-

rist approach ... in the UK ... might lead to the view that

there is general satisfaction with the theoretical ap-

proach in health economics’ (p 1994). (The authors

then express concern with this view.)

However, the chief characteristic of extra-welfarism,

on one interpretation [7], is its minimalism. (Other in-

terpretations of extra-welfarism, which allow a place

for health, utility, capabilities, and other factors, are

also possible (Hurley 2000). It amounts to the assump-

tion that the only purpose of the health sector, or at

least an NHS, is the maximisation of health. The NICE

directive to employ NHS costs may be considered a

consequence of this theory/assumption.

The unique feature of extra-welfarism - on its mini-

malist interpretation - is its assertion that only health is

of concern for economic evaluation, and the number of

issues excluded by this form of extra-welfarism makes

it highly contentious and, indeed, far more restrictive

than welfare theory in which, in principle, no objec-

tives are excluded as long as they are consequences

which affect utility. The importance of health may in-

deed be implied by Sen’s capabilities approach (and by

other social philosophies [35]) but this does not estab-

lish it as being the exclusive objective for an NHS.

The assumptions that are necessary for the validity

of the theory of CBA and CEA and the causal pathways

shown in Boxes 1 and 2 are responsible for the anoma-

lies that started this paper. The relationships between

the anomalies, the (chief) assumptions from which they

arise, and the (chief) problems with the assumptions are

summarised in Table 2. A problem which emerges in

the context of each anomaly is that the assumptions do

not permit a satisfactory treatment of the distribution of

costs and benefits. In effect, they extinguish the need

for considerations of fairness and, more generally, any

normative judgement with the sole exception of the

assumption that social welfare as a function of utilities

(in CBA) and that health is the only benefit of interest

(in CEA). With the doctrine of revealed/stated prefer-

ences or the assumption of a single objective, economic

evaluation becomes a purely technical matter of ob-

serving preferences or the assumed maximand and fol-

lowing through the implications for costs and benefits.

Other social judgements are unnecessary.

Two assumptions are of particular importance in this

process of excluding matters of fairness. First is the key

assumption of welfarism stated above that only utility

matters for social welfare. Apart from the circular ar-

gument summarised in Figure 1 there is no satisfactory

argument for believing that welfarism is true. The ex-

istence of other ethical theories - including the deon-

J. R. Richardson et al. / HEALTH 2 (2010) 1120-1133

1129

Table 2. Anomalies and justifying assumptions.

Are of anomaly Justifying assumption Problem*

NPV  Potential Pareto efficiency; potential

compensation; validity of WTP

 Different persons receive benefits, costs; and no com-

pensation occurs

 Benefits are redistributed

 Procedural and deontological goals are excluded

WTP  Benefits = (selfish) utility (only)

 Individualism, rationality

 Benefits (objectives) not restricted to selfish utility

 Communitarianism

 Non-rational behaviour

 Unwanted distribution of benefits

Moral hazard

 Consequentialism

 Potential compensation

 Individualism

 Ex-ante (pre-outcome) benefits/costs

 Non transferable benefits

 Communitarianism

 Inequitable distribution of benefits

Economic costs  Sacrifice by a

person = resource loss

 Health budgets not resources are the constraints in an

NHS

 Tax burden to an individual = transfer, not a resource cost

Equity and efficiency  Separability of equity, efficiency

 Consequentialism

 Unfair to high CB patients

 Sharing, duty, procedural justice

 Distribution of benefits excludes high CB patients

Sharing  Individualism

 Communitarianism

 Non welfarist goals motivation

 Distribution of benefits unfair

*Some of these are practical problems rather than theoretical - e.g. no compensation occurs in practice, procedural goals (‘process utility’) are not included in

practice, etc.

tology and religiously-based views, which are nomi-

nally endorsed by the vast majority of the population -

at least suggests the need for more than a bold assertion

of welfarism. The compatibility of observations with

welfarism is of lesser significance for its universality

than the incompatibility of other observations (i. e.

anomalies).

The second key assumption is the Kaldor-Hicks po-

tential compensation principle. It permits abstraction

from the distribution of costs and benefits. Once NPV

is positive it is as if it were ‘disembodied’ - unattached

to any particular person - and can be shifted at will

from person to person. But the principle is misleading.

Firstly, ‘potential’ is not the same as ‘actual’. No

amount of persuasion is likely to convince a person

who has suffered a financial catastrophe that this out-

come is desirable because another person has obtained

a windfall from the same event that is more than suffi-

cient to compensate the first person for their loss even

though they will not do so. They may agree that the

new situation is “efficient” according to the Kaldor-

Hicks criterion. They could not disagree since the cri-

terion is treated as a definition. But they might cer-

tainly object that the outcome is unfair.

Secondly when patients are left in a state of extreme

disability or allowed to die, compensation is impossible

even in principle and the Kaldor-Hicks criterion is ir-

relevant. Finally, in the context of an NHS the argu-

ment for potential compensation conflicts with the

purpose of the NHS. This is to redistribute the cost of

illness from those who are sick to the taxpayer: the

taxpayer is the final loser (if only money and health are

taken into account). Compensation would involve a

reversal of this redistribution. The unhealthy who

benefit from the NHS would be taxed in order to com-

pensate the healthy. But this conflicts with the purpose

of the scheme implying the irrelevance of the Kaldor-

Hicks principle (again, unless “process utility”, “par-

ticipatory utility”, “duty utility”, etc, are taken into

account, which does not happen in practice).

In CEA the assumption of welfarism is replaced with

the adoption of a stated objective (LY, QALYs). There

is no explicit equivalent to the Kaldor-Hicks criterion

as the theory has been less developed than welfare the-

ory. As noted, theoretical concerns have focused upon

its consistency with the assumptions of orthodox eco-

nomics rather than the development of an independent

rationale for its methods. However, like CBA it has no

satisfactory method for resolving issues associated with

the distribution of benefits, and generally there is an

implicit assumption that social welfare rises directly

with the number of life years or QALYs gained. The

assumption plays the same role as the Kaldor-Hicks

principle in abstracting evaluation from issues of dis-

tributive justice.

3.1. Empirical Ethics and a General

Framework

In both its practice and underlying theory economic

evaluation based upon welfarism or extra welfarism

J. R. Richardson et al. / HEALTH 2 (2010) 1120-1133

1130

may be described as “efficiency focused”. As discussed

above, assumptions largely purge the theory of the need

for ethical decisions and, in practice, measurement fo-

cuses upon efficiency. However, the evidence over-

whelmingly suggests that the raison d’être for an NHS

is not the maximisation of individual utility as defined

in orthodox welfare economics—i.e. the maximisation

of self-interested preferences. Nor does it suggest that

maximising health is the only goal. Rather, the empiri-

cal evidence, based on community surveys, suggest that

the purpose of an NHS is to ensure fair treatment in

health related matters, and this should be an important

focus of the framework.

The difficulty encountered in progressing beyond

this point and developing the framework is that there is

no objective basis for demonstrating the truth or supe-

riority of a normative rule. There is a sufficient con-

sensus about the importance of health, social justice

and costs to conclude that the framework must include

these, especially when they remain as abstract notions.

But it is not possible to determine what other goals

should be included or excluded and, when included,

how they should be measured and weighted. With re-

spect to this problem the literature is unhelpful. Welfa-

rism might be considered an exception only because of

its longevity and the elegance of the model woven from

its troubled assumptions.





12 3

/1/ ii

CostLYbabBudgetb LEbX 

We cannot offer a final solution to these problems.

As argued elsewhere, there can be no objectively cor-

rect metric - that is, no metric that everyone will agree

upon [36]. Further, drawing normative conclusions di-

rectly from objective evidence is a well-known error

(the ‘naturalistic fallacy’).

Nevertheless, for the solution of social problems it is

important to know what the public thinks. This has

been described elsewhere as empirical ethics [37,38]. It

is little more than the suggestion that population values

should be taken into account in the final decision algo-

rithm or at least understood through empirical inquiry.

Prima facie the proposition is trivial. Nevertheless, the

suggestion has not been adopted and the volume of

literature investigating population values and the prob-

lems with basing normative conclusions on them re-

mains negligible.

Another literature, however, is helpful in this context.

The broad principles of decision theory provide a flexi-

ble and ‘commonsense’ approach to decision making.

[39]. In this, objectives or dimensions of the choice set

are independently obtained and weighted to reflect their

relative importance. CBA can be viewed as an example

of its simplest application. The two objectives, maxi-

mising benefits and minimising costs are each given a

unitary weight. However, weights need not be unitary

and the objective function need not be additive. In the

context of multi-attribute utility instruments for com-

bining dimensions of a health state - the independently

determined objectives—both the Health Utility Index

(HUI) and Assessment of Quality of Life (AQoL) in-

struments employ multiplicative models [40,41]. Eco-

nometric methods may also be used including the new

advanced methods of discrete choice modelling [42].

A major challenge to modelling is the inclusion of

sharing as an objective. In the sharing study described

in Section 2 Richardson et al. employed the economet-

ric approach (a logit model) to predict the probability

that a particular life-extending service would be se-

lected from the four options when each option favoured

a different person. The model took the form:













123

/1 /ii

LnppabCostLYbBudgetbLEb X

Where b is the probability of a person/disease receiving

resources; LE is the person’s life expectancy (severity

of condition) and Xi included variables for the share of

the budget already received and life expectancy relative

to that of others in the choice set. If the selection crite-

rion for a service is a 50 per cent or more probability

that it will be selected by the panel of respondents, the

left hand side, LN p/(1-p) = 0, and a threshold cost/LY,

may be calculated as:

If LE and Xi were unimportant—as in CEA—then b3

= bi = 0 and the threshold at which there was a 50 per-

cent chance of service selection would be





/1/CostLYbab Budget

That is, the threshold would depend entirely upon the

budget. When other variables are important, cost/LY is

a function of these variables. Thus in the problematical

case discussed in Section 2, where orthodox theory

would leave a person to die (LE=0) if the cost/LY ex-

ceeded the threshold, the effect of the imminent death

would increase cost/LY threshold according to the

weight b3/b1.

Results from the analysis of 41,000 observations

generated from 544 subjects indicated that the impor-

tance of LE resulted in very significant sharing. The

results, more generally, show respondents, adopting a

social perspective, were prepared to sacrifice almost

one third of potential life years to achieve optimal

sharing.

This exercise was illustrative. A wider range of so-

cial values could be tested and different combination

rules employed. The general result would be the re-

placement of the fixed cost-effectiveness threshold of

present CEA with a variable threshold which was de-

J. R. Richardson et al. / HEALTH 2 (2010) 1120-1133

1131

pendent upon the attributes of these receiving the ser-

vice and the extent of sharing.

The chief obstacle to the development of such a

framework, of course, is agreement upon health-related

social goals and the creation of instruments for their

measurement. The task is problematical in large part

because, to date, there has been virtually no discussion

in the mainstream literature of how social goals should

be determined—i.e. what should be the criteria for the

adoption of objectives.

4. CONCLUSIONS

There is an adage that for every complex problem there

is always a simple solution which is wrong. The eco-

nomic evaluation of health services is a complex prob-

lem and welfare theory is simple, elegant and beguiling.

Minimalist extra-welfarism and CEA as practised en-

capsulate a single assumption with respect to the pur-

pose of an NHS. We have argued here that this simplic-

ity is, at best, misleading. Its perpetuation is undoubt-

edly related to three factors. First, there is an obvious

need to ration the use of finite resources and current

economic evaluation methods provide one way of do-

ing this. Second, the implied methods and rationale

incorporate elements that are undoubtedly important.

Costs, budgetary costs and benefits, as presently de-

fined, must clearly play a very large role in the decision

process. Third, and as noted in the introduction, errors

in theory will not lead to dramatic events. Bridges will

not fall down and the stock exchange will not collapse.

Rather, we will treat people unfairly but neither deci-

sion makers or patients will notice this. Very few Aus-

tralians are aware of the huge discrepancies in the pro-

vision of services across the country but their distribu-

tion is nevertheless unfair.

We have argued that the root problem is a method-

ology based upon misleading and over-restrictive as-

sumptions. The assumptions of welfare theory purport

to be universally true and therefore applicable to the

health sector. But direct evidence contradicts the uni-

versality of the behavioural assumptions and other as-

sumptions needed to operationalise the theory are

deeply problematical. The assumption of only health

maximisation in extra-welfarism is even more restric-

tive than the assumptions of Welfare Theory. It is sim-

ply easier to operationalise. However, in this article we

have not focused primarily upon the assumptions.

Rather, the article has challenged the validity of the

current approach another way. It has looked at some of

the consequences of the assumptions and demonstrated

that they are anomalous. As Popper [43] notes, theories

may, in principle, be falsified not verified and the iden-

tification of anomalies is therefore an important chal-

lenge to a theory. However he also notes in practice,

falsification can always be avoided by changing defini-

tions, objectives or by making ad hoc repairs. The ar-

gument embedded in Figure 1 for example and varia-

tions of it can allow welfare theory to evade falsifica-

tion indefinitely, if that is the objective. However this

will result in the type of disjunction between theory and

practice which, we argue, already occurs as decision-

makers approve services with a high cost/LY for a vari-

ety of “pragmatic reasons”.

Finally, our critique does not imply that current work

is worthless. The variables included in economic

evaluation costs and benefits as measured are evidently

of some importance. Rather, our criticism is that they

are based upon a bad theory which is highly restrictive

in the elements that it permits to be considered and

which claim a universality that is not justified. We have

suggested that a more pluralistic framework based upon

some of the insights of decision theory will be less co-

ercive and more flexible. Many- and possibly the ma-

jority of the recommendations of economic evaluation

would remain unchanged. A more realistic framework

could also overcome the anomalies discussed here.

A theory that is not true in one context may be appli-

cable in another. In particular, a theory that is satisfac-

tory in the supermarket (based upon self-interest, will-

ingness to pay and consumer sovereignty) cannot simply

be assumed to be true in the health sector. Deriving the

authority of economic evaluation from the authority of

‘economic theory’ is unsatisfactory if the assumptions

are not universally true in the context of positive analy-

sis and if they lead to anomalies in normative theory.

Despite this, present methods and theory satisfy the im-

mediate goals of theorists and decision makers and are

unlikely to change quickly. Policy makers want answers;

their advisors benefit from the authority they have ac-

creted from the theory. However, for the reasons outlined

here, we believe that a better approach to theory exists

and that decision makers should retain their pragmatism

and treat with scepticism assertions that they should be

guided exclusively by the net present value or cost/

QALY rule. The evidence and argument here suggests

that the underlying assumptions have implications that

conflict with people’s moral preferences and, in some

instances are absurd.

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