PHN Technical Notes
GEN 3
THE WORLD BANK
ECONOMIC APPRAISAL IN THE HEALTH SECTOR
January 4, 1982
Population, Health and Nutrition Department
* This paper is one of a series issued by 'the Population, *
* Health and Nutrition Department for the information and *
* guidance of Bank staff working in these sectors. The *
* views and opinions expressed in this paper do not neces- *
* sarily reflect those of the Bank. *
sassasswww www.w......AA.................*..*...***.****


GEN 3
ABSTRACT
This paper discusses the role of economic appraisal in the
formulation of health sector policy in less developed countries.
Specifically, it focuses on the application of economic analysis to public
investment decisions in the health, sector, that is to the design, selection
and financing of projects which constitute the health component of a
development plan. Topics covered include financial analysis of health
projects with particular reference to the problem of.recurrent cost
financing, the techniques of cost-effectiveness and cost-benefit analysis,
the treatment of uncertainty and shadow pricing in health project analysis,
and alternative approaches to resource mobilization in the health sector.
The underlying theme of the paper is the desirability of integrating the
health sector more closely with the overall framework of development
planning through a systematic process of project appraisal based on clearly
specified objectives and resource constraints.
Prepared by: Nicholas Prescott and Jeremy Warford
Population, Health and Nutrition Department
January 1982


ECONO'IC APPRAISAL IN THE HEALTH SECTOR
by
- Nicholas Prescott and Jeremy Warford
1. Introduction
This paper discusses the role of economic appraisal in the formulation
of health sector policy in less developed countries (LDCs). Specifically, it
focuses on the application of economic analysis to public investment deci-
sions in the health sector, that is to the design, selection and financing of
projects which constitute the health component of a development plan. The
underlying theme is the desirability of integrating the health sector more
closely with the overall framework of development planning through a syste-
matic process of project appraisal based on clearly specified objectives and
resource constraints.
Generalizations about LDCs as a group are inevitably heroic when - as
described by the World Bank - they comprise countries as diverse as India,
Lesotho, Fiji, Korea, Brazil and Chad. However, by definition, all of these
countries share the characteristic of a relatively low level of per capita
income (World Bank, 1981), typically associated with a limited tax base due
to weak tax administration and low ratios of taxable surplus to GNP (Tait et
al, 1979; Meerman, 1980). The combination of these factors produces an acute
shortage of resources to finance public expenditure, thus emphasizing the im-
portance of achieving efficient investment planning in the public sector.
This is particularly true today when the prospects for per capita income
growth in LDCs have deteriorated markedly (World. Bank, 1981) and the adoption
of structural adjustment policies is enforcing a more rigorous review of
public investment programs (Balassa, 1982). Other characteristics commonly
observed in LDCs include overvalued exchange rates, substantial unemployment


-2-
or underemployment and a skewed income distribution, together with a variety
of constraints which limit the ability of their governments to increase pri-
vate savings and redistribute income with the conventional instruments of
fiscal and monetary policy.
These factors have important implications for project selection in the
health sector. Resource allocation decisions have in the past been notori-
ously inefficient and inequitable, and are now reflected in an emphasis on
expensive urban and hospital-based curative care which is not directed at the
major causes of ill-health in the majority of LDC populations. bbreover,
health has tended to claim a low and often declining share of public expendi-
ture (IMF, 1981), and the prospects for a substantial increase in real budge-
tary allocations to the sector are poor. At the same tirde, recent interest
in basic needs and the efforts by WHO and UNICEF to promote 'Health for All
by the Year 2000' have created ambitious objectives for health improvement in
LDCs. The Director-General of WHO has suggested that an infant mortality
rate of less than 50 per thousand live births, and a life expectancy at birth
greater than 60 years, should be minimum objectives for health improvement by
the year 2000 (Mahler, 1977). These contrast with infant mortality rates
higher,than 200 per thousand, and life expectancies lower than 40 years, ob-
served in some low-income LDCs. The financial implications of these objec-
tives are enormous. A recent WHO estimate implies that their achievement
would require up to an eight-fold increase over the present level of public
expenditure on health in low-income LDCs of approximately $2.5 per capita
(WHO, 1981). However, the health sector continues to operate, to an extent
that is unmatched in any other sector, without the guidance of systematic
project appraisal criteria which could help to reconcile these health objec-
tives with other development objectives in the face of increasingly severe
resorce constraints.


It is, therefore, essential to develop ways of improving the efficiency
of public expenditure on health in LDCs, and also of mobilizing additional
revenue to finance increased levels of expenditure. This paper examines
these issues in the following framework. Section two discusses the basic
elements of financial analysis which provide the starting point for analysis
of efficiency and resource mobilization. Sections three and four review al-
ternative forms of efficiency criteria, namely cost-effectiveness and cost-
benefit analysis, with special attention to the treatment of uncertainty and
shadow pricing in health projects (section five). Section six concludes with
a consideration of cost recovery options to mobilize additional resorces from
outside the public sector.
2. Financial Analysis
Health ministries, using conventional public accounting procedures in
LDCs, are generally unaware in detail of the allocation of public resources
between different interventions and its relationship to stated health objec-
tives, or of the unit costs of different interventions, or of the full poten-
tial of available sources of finance. The situation is complicated by the
activities of numerous other agencies, both public aid private, that affect
health, major examples being those agencies concerned with water supply,
nutrition and pharmaceutical production and distribution. This lack of basic
financial data severely limits the ability of health ministries to make sys-
tematic judgements about the merits of existing and proposed expenditure
patterns and financing policies in the public sector, and reform of their
financial accounting systems is clearly indicated. The starting point for
economic analysis of investment decisions should be a detailed analysis of
total public and private health-related expenditures in terms of expenditure
patterns and sources of finance. Another paper is devoted to this set of
issues, but it is appropriate here to highlight a few of the main features.


-4-
Expenditure patterns. Analysis of the allocation of public expenditure
between different interventions indicates the extent to which the current ex-
penditure pattern responds to a country's major health problems and pro-
claimed objectives. Thus, it helps to signal the desirability of reallocat-
ing existing expenditures or undertaking new investments. If, as rhetoric
suggests, distributional objectives are also important, analysis of the dis-
tribution of expenditure by beneficiaries in different income classes
(Meerman, 1979; Selowsky, 1979, Tan, 1975), or simply by region (Ofosu-Amaaih,
1975), will be similarly revealing.
Estimates of the unit costs of different interventions, making an appro-
priate - if not scientific - allocation of joint costs, provide additional
signals. Ideally, these should be estimated in terms of long-run marginal
costs, which relate capital expansion and recurrent (i.e. operating and re-
placement) costs to the volume of additional services provided (Saunders et
al, 1977). Differences in the unit cost of interventions suggest the possi-
bility of efficiency gains by switching expenditure to lower cost interven-
tions if these are equally effective. The same applies to unit cost differ-
ences for similar interventions delivered by different facilities. For
example, a study in Malaysia found that the unit cost of outpatient services
in rural clinics exceeded those provided by hospitals, suggesting the exist-
ence of significant excess capacity in the rural clinic system (Meerman,
1979). Similar comparisons can be made between the public and private sec-
tors. Data collected in Lesotho (Smith, 1980) indicate that the public sec-
tor is a relatively inefficient producer of health services. The average
cost per inpatient was almost three times higher in public than private hos-
pitals, and similar differentials existed for hospital and clinic outpa-
tients. Although unadjusted for case-mix and labor cost differences, it is
improbable that these factors fully accounted for such high unit cost differ


-5-
entials. Finally, with the objective of ct containment in mind, trends in
the unit costs of similar interventions at different points in time may be
used to monitor efficiency in service provision.
Source of finance. In a similar way, analysis of the sources of finance
of existing healtbexpenditure patterns - by public revenues, external
donors, private consumers, employers and charity organizations - can provide
important signals to more efficient methods of mobilizing resources for the
health sector. For example, available data showing that a major porticn of
total health expenditure is financed by private consumers (WHO 1977) suggests
the existence of a high level of private willingness (and ability) to pay for
health services which remains largely untapped by the public sector. This
type of analysis relates intimately to the analysis of expenditure patterns
since the potential role of various financing mechanisms, ranging from direct
user charges at one extreme to full subsidy from public revenues at the
other, tends to vary across different interventions.
Recurrent cost financing. A critically important aspect of the analysis
of health sector financing, and one which emphasizes the importance of devel-
oping alternative cost recovery mechanisms, concerns the future availability
of fiscal resources to subsidize the recurrent costs generated by new invest-
ment projects in the health sector. The availabil.ty of public funds to sub-
sidize ongoing operating and maintenance costs is typically the binding
constraint on health investments. The reason is that external finance from
aid donors is often forthcoming to cover capital investment costs, while
future recurrent costs have to be financed from domestic revenues after
project implementation.


-6-
The problem of recurrent cost financing for social sector projects was
recognized a long time ago (Stopler, 1966), and has recently attracted atten-
tion throughout the public sector in LDCs (Heller, Club du Sahel, 1979).There
are a number of reasons why it is especially important in the health sector.
First of all, the neglect of project analysis criteria for health projects
has tended to preclude attention even to elementary financial appraisal
Second, the amount of recurrent expenditure generated per unit of investment
in the health sector is typically higher than in most other sectors, princi-
pally because of the labor and pharmaceutical requirements of health facili-
ties. Nbreover, the amount of recurrent public subsidy paid per unit of
recurrent expenditure is also relatively high in the health sector. Mbst
public sector health projects are financed exclusively, or largely so, from
public revenues. Health sector pricing policies are such that user charges
are frequently nominal and recover only a low proportion of operating costs.
In addition, the revenues generated by this or other cost recovery mechanisms
usually accrue directly to the central goverment Treasury, without any ear-
marked allocation to the health sector or to the project itself. Thus the
allocation of investment resouces to health tends to have more onerous im-
plications for recurrent expenduture financing in government than in other
sectors.
Public finance constraints have clear implications for the analysis of
project choice in the health sector. Whether partially or totally financed
by public subsidy, every project requires a cash flow of revenues to cover
its financial costs in order to operate at optimal scale. Analysis of expec-
ted future financial costs and revenues of the project is critically impor-
tant to determine the feasibility of a project over its planned operating
life. Indeed, analysis of long-run financial feasibility itself provides


-7-
a partial test of efficiency simply because future underfinancing of recur.-
.rent costs will result in the operation of the project at less than optimal
scale and, hence, .in a reduction in the net benefit of the investment.
A useful way of summarizing the recurrent expenditure implications of
health projects is to estimate the ratio of annual recurrent costs to total
investment costs, the so-called 'r-coefficient'. For example, $1,000 in-
vested in the health sector in Malawi is expected to generate, on average,
$250 of incremental recurrent costs per year, compared with only about $100
resulting from the same investment in education or agriculture, and less than
$30 for roads (World Bank, 1982) . Mbreover, the recurrent cost implications
of health investment are higher at lower levels of the health sector. Esti-
mated recurrent cost ratios in Malawi average 0.5 for clinics and primary
iealth care compared to 0.2 for hospitals. Similar patterns have been
observed in Kenya and Malaysia (Heller, 1974, 1975) and the Sahel countries
(Over, 1979).
Consideration of financial feasibility leads directly into the analy,sis
of efficiency criteria. Clearly, the objective of planners is not just to
ensure a financially feasible choice of health projects but the best choice
from various possible alternatives. One approach, using cost-effectiveness
analysis, is to select the mix of feasible projects which yields the largest
expected improvement in health status, relative to cost. Ideally, the use of
cost-benefit analysis would be preferable, to select those projects wtich
have the largest net social benefit, defined in terms of a wider set of
development objectives. Some of the key problems involved in cost-
.effectiveness and cost-benefit analysis are considered below.


-8
Cost-effectiveness analysis
The least controversial efficiency criterion for health project selec-.
tion, that of cost-effectiveness, is to choose projects which yield 7he maxi-
mum health improvement subject to available resources. Alternatively, the
problem can be inverted to choose projects which minimize the cost of meeting
a specified objective or objectives. Cost-effectiveness analysis (CEA) is
freqently used in sectors where problems of benefit valuation occur. For
example, electricity investment planning models are typically specified in
cost-minimization form, to find the least-cost solution to meeting an exogen-
ous future demand upon which a value may or may not be placed (Turvey and
Anderson, 1977). The method lends itself naturally to the health sector
where the concept of meeting basic needs suggests that quantifiable minimum
standards exist and can serve as planning objectives. Unfortunately, the
basic needs literature is still distinguished by an absence of concrete sug-
gestions as to what these standards should be (see, for example, Streeten,
1978, or Richards & Leonor, 1982).
A fundamental problem in applying CEA to the health sector lies in the
choice of an appropriate unit of effectiveness to measure the output of
health projects. It may seem obvious that health improvement is the primary
objective of public expenditure on health. Effectiveness measures framed in
terms of intermediate service outputs, such as provision of  tH services, are
therefore inadequate tests since they do not measure actual improvements in
health status. However, a central difficulty in measuring health status is
that it is not homogenous, since the health project outputs comprise reduc-
tions in both morbidity and mortality. These two types of health improvement
can be measured in different ways or aggregated into a composite measure
which can itself be constructed in different ways. Examples of alternative
approaches are discussed below.


-9-
Mbrbidity reduction. The most straightforward, but limited, measure of
health impact is the reduction in the prevalence or incidence of a .specific
disease. An example is provided by Rosenfield et al (1977), who used a
simple model of schistosomiasis transmission to simulate the effectiveness in
Iran of different control techniques (mollusciciding, engineering measures,
chemotherapy, and a combination of these) subject to a given resource con-
straint over seven years. Maximum output, specified in terms of the greatest
reduction in the prevalence rate obtained by the end of the seven year per-
iod, was achieved with a combination of chemotherapy and mollusciciding.
This intervention reduced the prevalence rate from 64% to 20%, whereas the
next best alternative, chemotherapy, achieved a terminal prevalence rate of
60%.  This measure of effectiveness did not take into account the prevalence
reductions achieved during the period. A more appropriate measure, in terms
of the total number of cases of schistosomiasis prevented over the period,
changed the ranking of alternatives. Chemotherapy yielded the greatest out-
put at a cost per case prevented of $1.26, followed by the combination of
controls with a unit cost of $1.29.
Yhasures of effectiveness specified in terms of cases of a disease pre-
vented tend to limit the application of CEA to the.choice between different
methods of controlling that disease, and preclude its use to evaluate the
choice between interventions directed at different diseases. This is so be-
cause different diseases have different effects on the duration and extent of
morbidity, and also mortality, which are not obviously captured by measures
of cases prevented.


- 10 -
A more useful measure which would permit comparison of the morbidity ef-
fects of the prevention of different types of diseases is the number of days
of disability prevented. This can be expressed as the number of days on
which individuals would have experienced some degree of dysfunction,due to
the relevant disease, and can be weighted to reflect the degree of impair-
ment. Paqueo (1975) illustrates the use of a weighted measure to show higher
morbidity rates below the poverty line in the Philippines. An unweighted
measure has been used in Indonesia by Grosse et al (1979) and Grosse (19.80)
in a detailed simulation of the effectiveness of alternative health interven-
tions directed at 31 diseases, and subject to seven alternative resource con-
straints. The choice of activities comprised 48 possible combinations of
curative and preventive interventions based on*health centers, health sub-
centers and village health workers, and sanitation, immunization and nutri-
tion programs. Resource constraints varied from $2.06 to $30.00 per capita
year. Simulations at each level of resource availability identified the mix
of interventions which minimized the number of days of incapacitating illness
per person per year from all causes. At all resource levels health centers
were selected but with varying combinations of other inputs. At $5.00 per
capita these included village health workers and an immunization program; at
$15.00 a sanitation program only; and at $30.00 village health workers to-
gether with sanitation, immunization and nutrition programs.
Mbrtality reduction. As is the case with morbidity, mortality reduction
can be quantified in different ways. The simplest measure, the number of
deaths prevented, has the advantage of not being disease-specific and there-
fore can be used to compare interventions against different diseases. How-
ever, in the aggregation of deaths prevented it implicitly assigns the same


. - 11 -
weight to all deaths regardless of the age at death, whereas a social premium
may be attached to the productive age groups. Social preferences of this
kind can be introduced by using methods which weight deaths prevented at dif-
ferent ages by the additional years of life accruing to the survivors.
One approach is to assume that all survivors live to some arbitrarily
determined age. For example, Romeder and tWhinnie (1977) suggest a measure
of potential years of life lost (gained) given by taking the difference be-
tween age at death and 70 years. Other methods take the terminal year as
life expectancy at birth, or the life table age at which fewer than arbitrary
proportion, such as 10%, of the original radix are survivors. These methods
are unsatisfactory because they do not take account of the probability of
survival from the age at death to the hypothetical terminal year. It is more
appropriate to measure the potential years of life gained by the expectation
of life at the age at which death is averted, estimated from the relevant
life table. Other refinements have also been suggested, particularly to take
account of selective biases which cause the survival changes of survivors
from some causes of death to differ from the cohort average (Shepard and
Zeckhauser, 1980), as may be the case with measles vaccination in LDCs (The
Kasongo project Team, 1981). Preferential weighting for specific age groups
can be made even more extreme by simply giving zero weight to certain age
groups. Thus planners may be interested exclusively in minimizing infant and
child mortality, or adult mortality. The conventional arguments for popula-
tion control in LDCs could, of course, imply a very low weight for infant and
child mortality reductions (depending on one's view of the child survival
hypothesis).


- 12 -
The optimal choice of interventions indicated by mortality-based effec-
tiveness measures tends to be different 'from that resulting from morbiuity
criteria. For instance, the Grosse model also simulated the effectiveness of
intervention alternatives in reducing mortality. For five of the seven dif-
ferent resource constraints the optimal combination of inputs differed sub-
stantially according to the choice of objective. For example at $15.00 per
capita, the minimum crude death rate was obtained with a health center com-
bined with village health workers and nutrition and immunization programs;
this compared to the health center plus sanitation program choice which mini-
mized days of illness. Adopting the minimization of infant mortaility in-
stead of total mortality as the planning objective apparently altered the
choice of interventions by introducing nutrition programs more frequently
into the optimal solutions. A similar analysis using a programming model to
determine the optimal mix of activities to minimize infant and child mortal-
ity has been carried out by Barnum et al (1980) with data from Colombia.
Composite measures. Since morbidity and mortality objectives tend to
have different implications for the best choice of health interventions, it
seems preferable to construct a composite measure of health improvement, that
is one which aggregates morbidity and mortality reductions. Attempts to con-
struct a so-called health status index have generated a considerable litera-
ture relating to developed countries (Culyer et al, 1979; Berg, 1973) but
very little concerning LDCs. The central concept underlying this approach is
that at any point in time an individual occupies one of a continuum of pos-
sible health states ranging from good health to death. For estimation pur-
poses the continuua is divided into discrete health states, j = 1 ...n. Each
state is assigned a value Uj on a utility scale ranging from 0 to 1. Health


- 13 -
interventions alter the probability of occupying different health states.
The effectiveness of an intervention is measured in terms of the increment in
health status units, defined as the discounted sum over all years of the
number of days changed from state j to k in each year, multiplied.by the
utility weight of state k net of the utility weight-of state j (Torrance,
1976). Methods which have been.used in attempts to derive utility weights on
the basis of individual preverences, including the Von Neumann-Mbrgenstern
standard gamble approach, are reviewed in Culyer (1978). Effectiveness mea-
sures of this type are sometimes called quality-adjusted life years. An ill-
ustration of the application of this approach to measurement of the health
benefits of the reduction in schistosomiasis and cholera prevalence attribut-
able to water supply improvement in LDCs is presented in Saunders and Warford
(1976).
A variant of the health status index approach has been developed and
applied in Ghana by the Ghana Health Assessment Project Team (1981). Preven-
tion of death from a specific cause results in a gain of healthy days of
life: this gain is computed as the life expectancy at age at death from that
cause, converted to the equivalent in days. Prevention of disability from a
given cause yields an increase in healthy days equivalent to the expected
duration of disability in days weighted by the degree of disability-per day
(assigned arbitrarily). The sum of both the mortaility and morbidity compon-
ents then provides a measure of effectiveness in terms of healthy days of
life saved. An empirical application of this method of ranking 48 causes of
morbidity and mortality in Ghana showed the dominant effect of mortality on
the selection of disease prioritites.


-14-
These experiments with different approaches to cost-effectiveness analy-
sis in LDCs suggest two important observations. First; since the most effec-
tive choice of health interventions appears to be quite sensitive to changes
in resource constraints, however health objectives are formulated, accurate
specification of these constraints is critically important to avoid getting
locked into inefficient strategies. As noted previously, an assessment of
the future availability of recurrent cost financing is especially critical.
Second, because the optimal mix of interventions is also sensitive to the
choice of health objectives, it is equally important that these should be
clearly articulated. This presents particularly formidable problems in prac-
tice. 1bst health plans formulate health objectives in terms of desired re-
source inputs or intermediate outputs rather than health improvement targets,
in part because the health impact of particular inputs and interventions is
often not known with any certainty. 1brevover, specification of the trade-
off between morbidity and mortality objectives necessarily raises fundamental
questions about the relative value of different types of health improvement
which policy-makers are notoriously reluctant to confront explicitly, even
though such trade-offs are implicit in all resource allocation decisions they
make. Yet those value judgements have to be. made explicit in order to deter-
mine, through CEA, an efficient allocation of resources between the full
range of potential interventions.
4. Cost-benefit analysis
The usefulness of CEA in project selection is strictly limited by its
measurement of project outputs in physical units which cannot be compared
directly with costs. The fact that a least-cost solution exists to meeting a
given health objective says nothing about the desirability of achieving that


- 15,-
objective in terms of the relationship between social benefits and costs.
bbreover its necessarily limited.focus on health benefits alone implies that
other objectives are unimportant, whereas policy-makers typically seek to
pursue several social objectives of which health improvement is only one.
The idea that the social benefits of a health improvement project should be
measured in terms of its contribution to different social objectives such as
increased per capita income and equity in addition to health improvement is
advocated by Feldstein (1970, 1972), Paglin (1974) and Barlow (1976, 1980),
though a dissenting note is offered by Loucks (1975) who excludes health im-
provement from a long list of development policy objectives. This section
examines in the context of LDCs the distinctive problem which arises in
applying the CBA approach to health projects, namely the choice of.an appro-
priate measure of the value of health benefits.
The conventional approach to benefit valuation in project analysis is to
rely on individual valuations as revealed by consumer behavior. In a per-
fectly competitive economy, consumers' willingness to pay for a project ouput
is equal to the prevailing market price. Thus in many cases project outputs
can be valued directly at market prices. However, health projects generally
cannot be handled in this way. First, the prevalence of zero or heavily sub-
sidized market prices in health sector results in an absence of observable
market data from which to deduce willingness-to-pay. Second, where such data
are available they may underestimate the true social benefits of intervention
if, because of externalities, the consumer is not the sole beneficiary of the
ouput. Preventive interventions directed at communicable diseases, such as
immunizations, present a classic example of where the benefits to society are
greater than those which accrue to their immediate consumers. Third, market


- 16 -
price data may also be unsatisfactory if consumers are not well informed
about the benefit to themselves of health services. This again may be
especially true of preventive interventions. Finally, even if acceptable
measures of private valuations are available from market data, consumer pref-
erences might be rejected in favor of socially-determined consumption pat-
terns, not least because the consumption patterns of individuals will reflect
a particular distribution of income and welath. The notion that health and
certain other goods such as nutrition and education merit higher levels of
consumption than would normally occur without public intervention underlies
the basic needs approach to development planning.
Consideration of these conceptual and empirical difficulties has neces-
sitated resort to indirect methods of the valuation of health improvement.
At least five major alternatives have been attempted: human capital valua-
tion, implicit and explicit private valuations, and implicit and explicit
public valuations. It should be noted parenthetically that the savings in
costs that would have been incurred if a proposed project was not undertaken
has often been recommended as a measure of benefits additional to the value
of the health improvement provided by the project. This recommendation is
strictly incorrect since a consistent analytical treatment would also require
metting out the benefits which are foregone as a result of saving the costs
that would have been incurred under the without-project alternative. Al-
though this elementary point has long been recogn, ;ad in the general case
(Steiner, 1965) the error is surprisingly persistent in the health economics
literature. For a more detailed analysis, see Butler & Doessel (1981).
The most common method is the human capital approach. Health improve-
ment is treated as an investment in human capital formation which yields an
incremental flow of future income or output (Grossman, 1972).


- 17 -
Health improvement exerts both quantity and quality effects on the effective
supply of labor. bbrtality reduction increases the stock of potential work-
ers and hence the potential flow of labor services. Mbrbidity reduction in-
creases the potential number or efficiency of the flow of labor services.
This increment in labor units over time can be estimated and multiplied by
their marginal product in order to provide an estimate of the incremental
output attributable to -any given health improvement (Mushkin, 1962). Classic
applications of this method are estimates of the economic cost of disease in
the United States by Weisbrod (1961), and Rice (1966). In the context of
LDCs, the theme of the output-augmenting effects of disease control has been
expanded to include its impact on the effective supply of land (attributable
to migration induced by the elimination of disease vectors) and accumulation
of the capital stock (resulting from a reallocation of private and public ex-
penditure-from consumption to .savings and investment). For a general review,
see Barlow (1979) and Ram and Schultz (1979).
Application of the human capital approach faces certain empirical diffi-
culties, notably in estimating the increment in effective labor supply re-
sulting from morbidity reduction and the marginal product which should be
assigned to it. As it is rather easy to apply compared with other approaches
it has been used extensively, although there is widespread dissatisfaction
with it on conceptual grounds. The method values health only to the extent
that it is an investment good which increases aggregate output; it assigns no
value to health as a consumption good. Accordingly, it implies that the
value of health is greater for those with higher earnings and therefore can
be said to discriminate against the young, the aged, females and the poor.
Two alternatives to the human capital approach reflect a desire to base
health benefit valuation on consumer preferences. Implicit private valua-
tions have been sought in analyses of revealed market preferences in the


- 18 -
United States. Blomquist (1979) derived a value of life equal to $378,000
from an analysis of the use of automobile seat belts which yielded a small
reduction in the statistical probability of death. In an analysis of risk-
compensating wage differentials in the labor market, Thaler and Rosen (1975)
estimated the implicit value of life at $176,000. An alternative approach
using questionnaire surveys designed to elicit an explicit private valuation
of mortality reduction has been applied by Acton (1973) to changes in the
risk of cardiovascular mortality. He obtained a value of life ranging be-
tween $28,000 and $43,000. For a review of these and other consumer prefer-
ence models see Linnerooth (1979). This approach has not yet applied to
changes in morbidity or in an LDC context.
Other approaches attempt to replace individual valuations by social
preferences. A number of attempts to elicit implicit public values, as re-
vealed by government choices in the UK, are summarized by Card and mboney
(1977). The range of implicit values placed on human life by various pro-
grams or regulations were as follows: * 50 in screening maternal oestriol
concentration to prevent stillbirths; i1,000 in the provision of child-proof
drug containers; C100,000 in legislation on tractor cabs; (20,000,000 in
building regulations for high-rise apartment blocks. The extreme inconsis-
tency revealed in implicit values across these different public policy areas
clearly suggests that this approach serves more as an indicator of the unde-
sirable consequences of ad hoc decision-making rather than as a reliable
guide to valuing benefits. Feldstein (1970) has suggested instead that
explicit public values could be obtained by direct questioning of public
policy-makers. This idea is similar to the general procedure proposed by
Dasgupta et al (1972) for the derivation of social weights in project ap-


- 19 -
praisal, A variation of this approach, involving social specification of a
basic needs standard for calorie consumption, has been developed by Scandizzo
and Knudsen (1980).
The health economics literature offers many examples of cost-benefit
analysis (Culyer et al, 1977, Griffiths et al, 1980; Drummond, 1980a,b), but
there have been few applications to LDCs. All of these concern communicable
disease control projects, mainly immunization programs or parasitic disease
control. Such analyses, especially of parasitic disease control, exemplify
many of the empirical difficulties encountered in benefit valuation. For ex-
ample, various studies have assumed that schistosomiasis entails, on average,
an impairment of working efficiency ranging from between 4% to 100%. This
upper limit is inconsistent with epidemiological evidence that only a minor-
ity of infected cases sustain infections of sufficient intensity to provoke
clinically severe morbidity, and corrobotative physiological evidence from
Sudan that significant reductions in physical performance capacity (up to 20%
of maximum aerobic power output) are obtained only at very high levels of in-
fection intensity (2,000 eggs/g faeces in S. Mansoni infections) (Prescott,
1979a). Similarly, analyses of malaria control have included assumptions
about the duration of disability associated with the acute clinical attack
(varying from 6 to 44 days) in excess of that which has been observed empir-
ically (2.4 to 5.7 days depending on the species of parasite and the level of
host immunity). Such studies have also generally failed to recognize the
zero marginal product of additional labor inputs at seasonal periods of labor
surplus (Prescott, 1979b, 1980). Most fundamentally, these analyses have not
made realistic predictions of the epidemiological effectiveness of disease
control interventions. Like many estimates of the economic cost of disease
in developed countries, they are really abstract measures of the gain that
could be attributed to hypothetical elimination of a given disease for a


- 20 -
single year. Thus they have not addressed the policy-relevant question of
what benefits could be generated over time with the application of feasible
control techniques.
It is clear that the issue of benefit valuation in health projects has
not been resolved satisfactorily, and no single "correct' method exists which
can be recommended to project analysts in LDCs. All of the approaches re-
viewed have some merits and the choice of a benefit measure will vary in dif-
ferent circumstances. At a minimum, efforts should be made to estimate the
unit cost of achieving health improvements with different interventions, so
that at least some sensible judgements may be made in the choice between
alternative expenditures. Even this needs refinement of basic epidemiolog-
ical data and analysis, and is but a first step to more powerful analysis in-
volving benefit valuations.
5. Uncertainty and shadow pricing
The need to take account of uncertainty and to use appropriate shadow'
prices applies to project analysis, both CEA and CBA, in all sectors but
these techniques deserve special mention in the context of health project in-
vestment appraisal.
Uncertainty. Uncertainty over the true value of basic parameters in CEA
or CBA calculations is inherent in project analysis, partly because by defi-
nition the future is unknown and partly because of practical limitations in
the quality of relevant data. For instance, a special feature of health
projects is the degree of uncertainty about the technology of health improve-
ment. Not enough is known about the relevant production functions, that is
the relationship between inputs and outputs, to predict with confidence the
health outputs that will result from health project inputs. This fact partly
stems from the unusual complexity of health sector production functions.


- 21 -
With the exception of preventive interventions which have the characteristic
of 'public' goods, improvements in health are produced jointly by health
service providers and consumers. Consumer demand is therefore one of the de-
terminants of improved health but knowledge about its characteristics is lim-
ited by a lack of empirical data on consumer demand functions for health
services and health-related activities.
Another source of uncertainty relates to the technical efficacy of some
health interventions in compliant populations, for example BCG vaccination
against tuberculosis (Tuberculosis Prevention Trial, 1979), or improved water
supply and sanitation facilities (World Bank, 1975; Saunders and Warford,
1976). In addition, uncertainty exists about the accuracy of much of the
basic epidemiological data on the incidence or prevalence of morbidity and
mortality due to specific causes against which project interventions are
directed. For example, estimates of the health benefits of schistosomiasis
control are sensitive to asumptions about the morbidity and mortality which
it causes, a matter which continues to be the subject of controversy. Apart
from such uncertainty about quantifying the benefits of health projects,
further uncertainty arises over the value which should be placed on them.
In practice, this problem of uncertainty should be handled by basing the
project analysis on best estimates of the basic project parameters, and then
analyzing the sensitivity of the conclusions to plausible variations of the
parameter values around their expected values. The sensitivity analysis will
indicate which, if any, of the basic assumptions have a significant effect on
the acceptability of a project. The converse approach is to estimate how
much different parameter values would have to change before the project
switches from being acceptable to unacceptable (or vice versa), and to check
whether these are plausible. Such an approach is especially well suited to


- 22 -
handling the pervasive uncertainty in health sector projects. Given that in
some projects only costs may be known with any confidence, the minimum health
output (such as lives saved) required to make the project acceptable can
still be estimated and then checked to see whether it is plausible. These
estimates can be done within either a CEA or CBA framework.
Shadow pricing. The idea of 'shadow' pricing is to determine the 'real'
price of a good or service either where no market price exists or where such
a market price is considered to be an incorrect indicator of its 'real' val-
ue. In the analysis of health investments, two kinds of shadow prices need
to be considered: economic (or efficiency) prices which correct for distor-
tions in factor and product market prices; and social (or distributional)
prices which reflect a government"s growth and equity objectives. The two
main systems of shadow pricing are those developed by Dasgupta et al (1972)
and Little and Mirrle e  (1974), later refined by Squire and Van der Tak
(1975). A full account of the justification for, and derivation of, shadow
prices is available ia these original sources; only the major points are sum-
marized here.
The use of economic prices mainly affects the value of foreign exchange
and labor inputs used by projects. In most LDCs it is common to encounter
exchange rates which tend to underestimate the scarcity value of foreign
exchange. Conversely, market wage rates often to overestimate the opportun-
ity cost of labor. In these circumstances, the effect of the use of 'shadow
prices will be to increase the cost of foreign exchange and reduce the cost
of labor. These adjustments will discourage projects which use scarce for-
eign exchange and favor those which are labor intensive. Likewise, if faster
economic growth or income redistribution are key social objectives, then
shadow prices in the form of social prices may be used to bias project selec-
tion against investment projects which rely heavily on public sector financ-


-23-
ing, in favor of those which generate high rates of saving and reinvestment
by, for example, generating additional public revenues from user charges and
those which redistribute income to the poor.
Some features of the health sector make consideration of shadow pricing
of special interest, and the use of economic and social prices has important
implications for the choice of health projects. The penalty attached to for-
eign exchange intensive projects, as a result of the use of economic prices,
gives particular importance to pharmaceuticals and increasing domestic pro-
duction, including primary manufacture which may not rely on imported in-
puts. The mutually reinforcing incentives to employ labor with a low oppor-
tunity cost (for efficiency reasons) and to favor employment of the poor (for
distributional reasons) emphasize the desirability of substituting lower for
higher grade health workers where technically feasible. The disincentive to
using scarce public resources to finance health projects directs attintion to
exploring methods of self-financing. It is pertinent to observe that all.of
these concerns - pharmaceutical policy, the use of village health workers and
community participation in project financing - are currently the subject of
intense policy debate and can each be accommodated through a straightforward
application of shadow pricing in project selection.
6. Resource mobilization
Existing and prospective financial -constraints in LDCs indicate a need
to re-evaluate the traditional approach to health sector financing which re-
lies-heavily on public; subsidies from central government revenues. A signif-
icant increase in the allocation of public revenues to the health sector is
unlikely to be a realistic option, given the traditional strength of compet-
ing sectoral demands and the continuing difficulty of demonstrating that the
marginal social rate of return on health expenditure exceeds the returns


yielded in other sectors. Expansion of the health sector in many countries
may, therefore, depend larg4ly on the implementation of cost recovery mechan-
isms.  Tn general, the relevance of alternative financing methods will vary,
with the type of health intervention. In each case the choice between finan-
cing alternatives can be assessed using the same frame-ork already developed
for ther public sector projects in which efficiency, equity and fiscaj- ob-
jectives ,re traded off for the various services provided (Ray, 1975).
The benchmark for analysis of financig alternatives is given by long-run
marginal cost of each intervention, though departures from marginal cost
pricing can be justified in certain circumstances. In the presence of
externalities or poorly informed consumers, both being characteristic of,pre
ventive interventions aimed at individuals, marginal cost priods will fail to
induce socially optimal levels of consumption, and subdid4zed prices are ap-
propriate. Public health measures, such as molluscicidiig for schistosomia-
sis control and aerial larviciding for onchocerciasis control, have some of
the characteristics of 'public g6ods", whera the benefits of interviention are
not consumed by any one individual and the exlusion princple thereford
fails to apply, in that access to the benefits of intervention cannot be made
conditional on payment of a user charge. Direct charges for such services,
levied separately on each beneficiary, may eithe be co- expensive to admin-
ister, or simply not feasible.
The achievement of equity objectives will also be affected 'by the choice
of financing mechanism. Interventions directed at L'bo income beneificiaries,
for example, a program of primary health care, may be ineffective under a
system of direct user charges if the price elasticity of demand is high,
meaning that potential consumers are deterred from seeking care by the level
of prices charged. Evidence on price elasticities for health services in


I                       - 25 -.
LDCs is scarce, but data from Malaysia indicate that .the total demand is
highly inelastic with respect to cash prices, although there are significant
.ross-price elasticities for the services of different providers (Heller,
1982), implying that consumers do switch between providers according to vari-
ations in pricess  Similar findings have been reported for the Philippines
<',(Akin et al, 1982). If demand is inelastic, the impact of raising charges on
the use of health services will by definition be minor and its fiscal impact
positie but the income transfer from the beneficiary to the public sector
may not'accord with distributional objectives. However, even where these
difficulties apply, there may be no alternative but to generate revenues from
beneficiaries ot- elsewhere in the private sector in order to finance the pro-
vision of health services.
It i. clear, nonetheless, that for some interventions reliance on direct
user -harge$ will not be appropriate and other financing mechanisms will need
to be explored. But whether the very limited resort to user charges in LDCs
is appropriate - less than 10% of public sector costs are recovered by this
means in countries such as Ghana (Brooks, 1981), Malaysia, Malawi, and
Lesotho - require detailed examination. In general, the argumeats against
pricing are stronger for prevrentive interventions and for lower icome bene-
! ciaries.  Thus a ,system of selective charges for curative services, espe-
cially for higher incom6 users, may be justified to cross-subsidize preven-
tive activities and utilizationby the poor. Private sector experience,
notably of mission facilities and traditional practitioners and birth attend-
ants, deinonstrates the feasibility of recovering a high proportion of recur-
rent costs frpmwUser charges without reducing utilization. In Lesotho, some
70% of recurr nt expenditure by private hospitals is recovered from user
charges (Kolobe and Pekeche, 1980).


-26-
Alternatives to charges iii use in many countries itelude earmarked
taxes, social security and insurance schemes, or indirect cost recovery by
self-help (Evans et al, 1981, Stinson, 1982). Experience shows that a wide
range of financing mechanisms can be employed in the health sector in LDCs.
Nevertheless, the approaches generally used are dominated by the tradition of
central government subsidy and the introduction of innovative methods en-
counters very difficult political obstacles. The prevalent view that because
health is good it should be free or subsidized may have to be increasingly
challenged, however, if the goals set by WHO and UNICEF, referred to in the
introduction, are to be achieved.
Conclusion
In general, conventional approaches to investment appraisal in the
health sector are much less rigorous than in most other sectors. A major
reason for this may be that there are greater difficulties of theory and mea-
surement at all stages of project analysis, 'i'or example in the prediction of
effectiveness of health interventions, the valuation of beneifts, and the de-
sign of appropriate cost recovery policies. However, these problems differ
in degree rather than substance from those found in other sectors such as
water supply, energy and education, where considerable analytical progress
has been acheived. They certainly do not justify the prevalent tendency to
avoid rigorous analysis of investment decisions altogether simply because it
is difficult. It may even be argued that many of the problems which are en-
countered are the result of past neglect of economic analysis in the health
sector. The potential role of economic appraisal is therefore very large,
and indeed, essential to attainment of the dramatic improvements in health
status which are now sought by LDCs.


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