Vol.2, No.9, 1120-1133 (2010) Health
Copyright © 2010 SciRes. Openly accessible at http://www.scirp.org/journal/HEALTH/
The need for a new framework for the economic
evaluation of health services in a national health
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.
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 threethe net pre-
sent value criterion, the willingness to pay cri-
terion and moral hazardarise 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
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
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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-
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.
2.1. 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
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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
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
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
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
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
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
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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
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
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
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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,
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.
Obser ved
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.
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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]
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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.
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
Pat i e nt 1
Pat i e nt 2
Pat i e nt 3
Pat i e nt 4
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
Copyright © 2010 SciRes. Openly accessible at http://www.scirp.org/journal/HEALTH/
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
A.5 People are ‘rational’ and well-informed implying
that their choices reveal their utility maximising strate-
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
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
Re d istribution
increase d
Indiv idual
utilitie s;
Thisdo e s
Definition(only) Onlyifallnon
Box 1. The logic of cost benefits analysis.
(Individual )
benefitposs ible
eg QALYs
costs=budg etary,
obj ectivesig nored
<(co s t/ LY
Box 2. The logic of cost effectiveness analysis.
J. R. Richardson et al. / HEALTH 2 (2010) 1120-1133
Copyright © 2010 SciRes. Openly accessible at http://www.scirp.org/journal/HEALTH/
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
Copyright © 2010 SciRes. Openly accessible at http://www.scirp.org/journal/HEALTH/
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
Non-rational behaviour
Unwanted distribution of benefits
Moral hazard
Potential compensation
Ex-ante (pre-outcome) benefits/costs
Non transferable benefits
Inequitable distribution of benefits
Economic costs Sacrifice by a
person = resource loss
Health budgets not resources are the constraints in an
Tax burden to an individual = transfer, not a resource cost
Equity and efficiency Separability of equity, efficiency
Unfair to high CB patients
Sharing, duty, procedural justice
Distribution of benefits excludes high CB patients
Sharing Individualism
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.
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
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
Copyright © 2010 SciRes. Openly accessible at http://www.scirp.org/journal/HEALTH/
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:
/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
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
Copyright © 2010 SciRes. Openly accessible at http://www.scirp.org/journal/HEALTH/
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.
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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