The Economic Logic and Reform Direction of Healthcare
Editor’s Note: Gordon G. Liu, PhD, Peking University’s Boya Distinguished Professor of Economics at the National School of Development and Dean of the Institute for Global Health and Development, is a leading figure in health economics in China. In one of a series of interviews with Chinese economists conducted by NetEase Finance Think Tank, Liu offered his analysis and recommendations for China’s healthcare reforms. The following is an excerpted translation of his interview.
The full text in Mandarin is available on the official WeChat blog of the Peking University Institute for Global Health and Development. The interview video can also be accessed online or at the school website https://www.ghd.pku.edu.cn/.
How to Allocate Healthcare Resources
Allocation of healthcare resources is a critical focus of healthcare economics. Whether to prioritize government administrative measures or market price mechanisms in resource allocation is a highly complex issue, and it remains a central point of discussion and debate among health economists. Although both the invisible hands of the market and government intervention are necessary and indispensable, each has its advantages in different areas.
For example, China’s current basic universal medical insurance is a government-led institutional arrangement. But if healthcare were to rely solely on individual purchases of commercial medical insurance based on personal need without administrative measures, achieving universal coverage would be much more challenging. Moreover, this approach would lead to strong selection bias, making health insurance unsustainable. Young and healthy individuals who face lower disease risks are less likely to buy insurance, while older individuals and those with chronic conditions are more inclined to do so. This phenomenon, known as adverse selection, would drive health insurance providers to respond in 2 ways. They may raise premiums across the board, leading to fewer healthy policy holders and toward a “death spiral” until the system collapses. Alternatively, they could charge prohibitively high premiums for high-risk groups, a practice that undermines the principle of risk-sharing in health insurance, is politically unfeasible, and would fail to address the burden of disease in modern society.
To achieve universal health insurance, the government should use its administrative authority through laws and regulations requiring individuals or employers to join the system uniformly, which can largely prevent adverse selection. Therefore, the government can be more effective in pooling the funds for universal health insurance.
However, raising funds for universal health insurance is one thing, and allocating those funds is another. In the case of the former, the government has clear advantages; for the latter, market competition may be more effective. This has led to a discussion in China regarding 2 major models of healthcare fund allocation.
"To achieve universal health insurance, the government should use its administrative authority through laws and regulations requiring individuals or employers to join the system uniformly, which can largely prevent adverse selection."
One model involves directly allocating health insurance funds to medical service institutions, known as subsidizing the supply side. This approach primarily relies on administrative measures to distribute funds to healthcare providers before the public pays for services, aiming to offer subsidized or “free” medical services to the public. Lacking direct supervision and market competition provided by consumer choices, the model of subsidizing the supply side would require extremely high administrative planning and execution capacity. Additionally, it may also rely on the professional ethics and moral standards of service institutions and their medical staff, which would be a very difficult task. In short, like other noncompetitive industries, the biggest challenge facing this model would be the high risk of the tragedy of the commons, leading to inefficiency, corruption, and waste.
The second model involves directing medical insurance funds to patients, with the advantage of group buying, known as the subsidizing the demand side model. This model collects medical insurance funds into a shared pool for the public, creating a strong platform to purchase medical services on behalf of the enrollees. This model offers several advantages, including enhancing collective group buying and negotiation power, sharing disease risks and burdens, and amplifying consumer influence by empowering patients to decide where and when to seek medical treatment. Patients make choices and adjustments based on their medical experiences and outcomes, which fosters patient-centered market competition among healthcare providers.
Before China’s medical services reform in 2009, there was significant debate over whether to adopt the subsidizing supply-side model or the subsidizing demand-side model for the country’s basic medical security scheme. The decision ultimately favored the demand-side model, leading to the current national policy covering more than 95% of the population.
Recommendations for Healthcare Reform in China
China’s healthcare reform is a vast and systematic project, characterized by continuous improvements. Two aspects merit further exploration.
Under the UHI framework, medical services are primarily funded through third-party health insurance premiums. This system involves the responsibilities, rights, and interests of 3 key stakeholders: patients, medical suppliers, and payers. Therefore, payment reform should focus on aligning the incentives of these parties to ensure mutual benefit through more efficient payment methods.
Different countries employ a variety of continually evolving health insurance payment methods, from basic fee-for-service to pay-per-visit, diagnosis-related group, capitation, hospital global budgets, pay-for-performance, and various bundled payments like China’s diagnosis-intervention package. Each of these methods seeks to balance the responsibilities, rights, and interests of the stakeholders. However, no “best” model has been found that fully satisfies all parties, and such a model may never be found.
The fundamental reason lies in the incentive compatibility problem described in economics. Despite their unique features, these various models share one commonality: Payments are based on illness. The demand side (patients) does not want to be ill but desires generous health insurance; the supply side (providers) prefers more patients and generous health insurance payments; the insurance side (payers) wants fewer patients and lower charges from providers. Given this disease-medicine-insurance relationship with conflicting goals and interests, how can there ever be an incentive-compatible payment solution for all 3 parties?
Could there be an alternative model? With comprehensive universal health records and fully interconnected information systems, combined with analysis by digital technology and artificial intelligence, it may be possible to create individualized health passports. These passports would include essential information that determines personal health, such as biological data, behavioral patterns, socioeconomic status, and medical service records.
Adjusting for the risks shown in health passports, health insurance could allocate an annual routine budget for each individual, based on an overall budget, with exceptional cases (such as accidental injuries) handled separately. Individuals would then sign contracts with healthcare providers based on their personal preferences, with customized health insurance payments. These risk-adjusted payments would be guided by health-based key performance indicators, as graded by the information in individual health passports.
"With comprehensive universal health records and fully interconnected information systems, combined with analysis by digital technology and artificial intelligence, it may be possible to create individualized health passports."
Compared to the disease-medicine-insurance service model, health passports form a health-medicine-insurance model, with the latter paying for health, which can promote incentive compatibility among the 3 parties. Individuals (demand side) want to be healthy, while medical service providers (supply side) and insurers (payers) also want people to be healthy because as long as people are healthy, all parties benefit.
In this way, healthcare institutions would have greater motivation to engage proactively in health promotion activities, such as public education, exercise, diet, behavior modification, and disease prevention. They would also be incentivized to systematically reduce unnecessary healthcare because all parties would share the benefits of improved health and cost savings. As former Harvard president Larry Summers once noted, if medical providers can be paid based on how healthy their patients are, they would have enormous incentives to do all the right things.
Besides the role of medical and health services, personal behavior and lifestyle have a more decisive impact on health. Therefore, the Healthy China 2030 issued in 2016 explicitly emphasizes that individuals should be primarily accountable for their own health. Of course, translating policy documents into individual actions is a challenging task. In this regard, it may be beneficial to explore insights from behavioral economics.
Behavioral economics argues that the mainstream economic assumption of the “economic man” is too rigid, as people’s behavior is not always rational. This provides a rationale and possibility for appropriate behavioral interventions. Behavioral economics aims to find a more appropriate relationship between laissez-faire behavior and coercive paternalism, thereby providing a “nudge” to individuals. Individuals maintain their autonomy while achieving more rational outcomes.
For example, to encourage exercise habits, personal health exercise points—adjusted for the previously mentioned health passport information—could be redeemed for discounts on goods and services. Additionally, to promote healthy eating, dining expenses could qualify for health-specific discounts at checkout, and businesses offering these discounts could be exempt from related taxes. Furthermore, national health insurance could leverage big data analysis to explore ways to link proactive health behaviors with discounts on insurance premiums and benefits, thereby promoting proactive health behaviors among the populace.
How to Address an Aging Population
The aging population is a global trend that reflects both increased human longevity and declining fertility rates. Despite the challenges it poses, it should largely be seen as a sign of human civilization’s progress. In China, the aging transition occurred rapidly, driven by factors like globalization, high economic growth, urbanization, and enhanced social security systems, with the retirement and healthcare systems playing particularly significant roles.
The 1951 Labour Law of the People’s Republic of China set the retirement age at 50 for women and 60 for men, which was significantly higher than the average life expectancy of 43 years at that time. However, by 2023, China’s average life expectancy had risen to 77 years. Given this increase, the policy should be updated to align retirement policies with current realities.
In modern society, the gap between biological aging and functional aging is widening, with functional aging often occurring much later. Unlike previous generations, where individuals were considered “old” after 60, many of today’s 60-year-olds are still robust and active.
If people were forced to retire based solely on their biological age and collectively exit the labor market at a certain time, it would result in a significant waste of human capital and labor productivity. Additionally, this approach would directly reduce pension fund income while simultaneously increasing pension expenditures. Moreover, early retirement is detrimental to the physical and mental health of the elderly. Research both domestically and internationally indicates that forced early retirement increases the risk of chronic diseases and mortality among retirees, with men being particularly affected. Of course, retirement has its benefits as well. For instance, the retired can enjoy pursuing their interests and engaging in activities they wanted to do earlier in life but couldn’t. These advantages are undeniable.
"In modern society, the gap between biological aging and functional aging is widening, with functional aging often occurring much later. Unlike previous generations, where individuals were considered “old” after 60, many of today’s 60-year-olds are still robust and active."
In many developed countries, the retirement age is often used as a “minimum age” requirement for receiving pensions. For example, in the United States, retiring before the minimum age of 65 usually significantly reduces pension benefits. In China, with its large population and diverse individual physical conditions, preferences, and family situations, some people may wish to retire on time, while others may want to continue working. In this context, a flexible retirement system might be an option. The age for receiving legal pensions can remain unchanged, but individuals may have the freedom to decide whether to retire on time or continue working. From many perspectives, a flexible retirement system is worth exploring.
Regarding the healthcare system, we can divide China’s healthcare services into 2 categories: therapeutic services and care services. While therapeutic services are usually provided by large hospital systems, care services can be better offered by community-based primary care facilities with greater accessibility and cost-effectiveness. For the elderly population, medical services and care services are complementary and closely intertwined. As the body inevitably declines with age, timely and adequate care and health maintenance can reduce or even prevent the need for hospital-based therapeutic services. Conversely, without proper care services, the demand for therapeutic interventions increases, leading to avoidable or premature treatments that can harm the patient’s physical and mental health and place an additional burden on families and society.
Developed countries have led the way in addressing the challenges of an aging population, creating numerous actionable models and practices worth emulating. For instance, these countries actively promote “de-institutionalization” by establishing out-of-hospital service platforms and enhancing the functionality of community healthcare. This approach provides more suitable working and living conditions for residents in elder communities while significantly advancing the development of community-based, accessible, and affordable long-term care services.
How to Promote Patented Drugs
Pharmaceutical innovation is the main theme of the 21st century. Across different industries, investment in pharmaceutical innovation almost always leads, whether in terms of absolute scale or growth rate. How can China guide, promote, and support pharmaceutical innovation to provide sustainable advancements in human medicine?
A comprehensive understanding of patents is essential for pharmaceutical innovation. Patents play a crucial role because technological innovation in the pharmaceutical sector is characterized by significant uncertainty, substantial investments, long development timelines, and high risks.
In the United States, it takes an average of more than 10 years and an investment of more than $2 billion for a new drug to progress from basic research to successful market entry. Research and development duration for patented drugs in China is similar to that in the United States, around 120 months, but with an average investment of about $200 million. Additionally, in terms of the staged investment structure, China focuses more on posttrial investment, while the United States invests more in pretrial basic research.
Given the high investment and significant uncertainty involved in new drug development, drugs that successfully reach market entry require patent protection to ensure a reasonable return on investment. This provides the incentive and economic foundation for continued pharmaceutical research.
How to Balance New Drug Pricing and Government Procurement
Patent holders have the freedom to set prices, while health insurance purchasers can negotiate those prices. This dynamic is natural and consistent with market principles. Value is created not only through production but also through market exchange. As long as both parties are free to participate, the market exchange generates value and benefits both sides; otherwise, the exchange should not take place.
In drug price negotiations, the bargaining mechanism and rules should be as mutually voluntary and equal as possible to ensure that both the supply and demand sides benefit, fostering sustainable market development. These negotiations should consider both the value in use of the patented drug—its effectiveness and impact on health—and its value in exchange, reflecting its scarcity in the market.
"In drug price negotiations, the bargaining mechanism and rules should be as mutually voluntary and equal as possible to ensure that both the supply and demand sides benefit, fostering sustainable market development."
Let me provide a case study about health insurance negotiations.
In 2019, China introduced nusinersen injection, a groundbreaking drug for treating spinal muscular atrophy (SMA). First approved in the United States in December 2016, SPINRAZA (nusinersen) is the world’s first targeted therapy for SMA, a genetic disorder primarily affecting children, leaving them unable to stand and their development delayed or halted.
Nusinersen is administered via injection, with an original market price of approximately 700,000 RMB ($97,674) per injection. The first year of treatment requires 6 injections, totaling 4.2 million RMB ($586,044). Subsequently, patients need 2 to 3 injections annually for life. In late 2021, through negotiations, nusinersen was successfully included in China’s national insurance drug list, reducing the cost per injection to 33,000 RMB ($4,605). This negotiation sparked various opinions; critics primarily point out the potential adverse impact this reduction might have on pharmaceutical innovation.
The price reduction from 700,000 RMB to 33,000 RMB was not an arbitrary decision by the health insurance system, though; rather, it was the outcome of a systematic expert evaluation and negotiation process. Since China’s national health insurance drug list began its annual updates and adjustments in 2018, a mechanism involving 3 expert groups has been formally introduced to evaluate candidate drugs systematically.
First, the Clinical Expert Group is responsible for evaluating drugs based on clinical experience, with its judgment principle based on clinical necessity for unmet demand. Second, the Fund Calculation Group assesses whether the health insurance budget can afford the inclusion of new drugs without excessively impacting payments for other essential drugs. Third, the Pharmacoeconomics Group evaluates the potential clinical benefits and costs of new drugs, comparing them to existing drugs for the same indications, based on objective data and empirical research. In essence, the groups focus on whether the drug is clinically necessary, affordable, and worth the cost, respectively. To ensure independence, objectivity, and fairness, the work locations and schedules of the 3 expert groups are arranged to avoid overlap.
Pharmacoeconomic evaluations align with World Health Organization (WHO) guidelines: a new drug is recommended if the incremental cost of extending a patient’s quality-adjusted life year (QALY) does not exceed 3 times the country’s per capita GDP. Countries may modify this threshold based on country-specific factors like per capita income, disease prevalence, and the disease’s characteristics at different stages of development.
For China’s current health insurance system, on average it sets one times GDP per capita to pay for one QALY gain for most drugs included in the insurance list. In the case of nusinersen, the negotiated payment ended up being much higher than the average for other drugs, suggesting that the Pharmacoeconomics Group’s recommendations considered the added value of nusinersen for its innovation and treatment for SMA as a rare childhood disease.
Having said that, from a pharmacoeconomic evaluation perspective, China’s evaluation and negotiation mechanisms still have much room for improvement. For instance, patented drugs that have been on the market for a short time and have limited usage may not fully demonstrate their comprehensive value in the short-term, potentially leading to undervaluation. Furthermore, the market value of any item should encompass both its value in use and value in exchange, the latter reflecting the item’s scarcity. Without real-world market exchanges, it is indeed difficult for third-party evaluations to fully account for this. On the other hand, as new drugs undergo real-world use, negative issues related to efficacy, side effects, and other complications may also become more visible, which can potentially lower the market expectations and willingness to pay.
