Economically speaking: An efficiency drive with a delicate balancing act | Paul Healy

Paul Healy

Economically speaking is a series of blog posts that draw on basic economic principles to understand the challenges facing the NHS. Written by Paul Healy, senior economics adviser at the NHS Confederation, this second edition explores the principle of supply.

supply /səˈplʌɪ/ n. the amount of a good or service produced and available to consume based on a number of factors.

Funding in the NHS does not currently match demand. Forecasts show that acute activity alone is expected to grow annually by around 2.5 per cent, yet NHS funding will grow by a little under 1 per cent each year. These stats alone illustrate a funding gap, even before we account for general price inflation estimated at anything up to 3.7 per cent a year in hospitals.

In the Five Year Forward View, the total funding gap was described as £22bn, which is the upshot of a total potential cost pressure of £30bn minus £8bn of additional funding from the government. The belief is that this will be met through efficiency savings, which in theory allows the NHS to meet anticipated demand growth without costs rising in proportion. This is referred to as ‘doing more for less’ and was the approach taken in the last Parliament, in which the NHS was mostly successful in meeting the so-called ‘Nicholson challenge’ and its £20bn efficiency target.

To understand efficiency, we need to consider the economic nature of supply. The production function for healthcare looks at how inputs, such as doctors and nurses, are turned into outputs, which are actual treatments for patients. Both are relatively easy to measure and modelling helps to identify the optimal level of inputs to produce a specific output.

For example, we might look at a surgical operation and identify the right number of staff needed to deliver this treatment at the accepted standard. This requires us to consider the rate of substitution between using doctors, who are generally more expensive, and using nurses. The same approach would also be taken to assess other inputs, such as drugs and devices used in the process. 

In general, economic theory would suggest a diminishing rate of return as inputs increase, i.e. the more we put into a process the less we get back for each input – at least at an aggregate level. This is technical efficiency and is the focus of recent initiatives like the Get It Right First Time project, specifically on orthopaedic surgery, and of course Lord Carter’s more comprehensive report into hospital productivity

A great deal of faith is being placed on a technical approach to efficiency, with current plans expecting around 60 per cent of the local savings needed coming from NHS provider productivity, at a rate of 2 per cent improvement each year.

It is not the only way to deliver efficiency though. After all, our ultimate objective is economic efficiency, which is the optimal use of scarce resources in providing a public service. As such, inputs could be minimised to deliver a specific output, but this does not consider whether the output itself is optimal given the resources needed compared to other possible outputs. For example, a surgical amputation for a diabetic patient could be technically efficiency, yet might not be the best output when considering resources for diabetic patients overall.

This leads us to consider allocative efficiency, which brings a societal perspective on allocating resources to deliver best value for the whole population. As such, the focus is more on maximising outputs than minimising inputs, although this obviously remains important. A great example of this in practice is the Right Care programme which provides resources, such as the Atlas of variation, that support commissioners to maximise value from health investments. 

The balance between technical and allocative efficiency is crucial as the NHS looks to close the funding gap over the coming years. Certainly, both are needed to get the most value from resources. There is a risk, though, in focusing too much on reducing costs (which seems intuitive for a public service) without establishing the best outputs to deliver the right outcomes for patients. 

The challenge of our age then is allowing time to enable transformation and the development of new models of care, while managing short-term pressures that require a need to demonstrate control over current costs.

Paul Healy is a senior policy adviser on economics and regulation at the NHS Confederation. Follow him and the organisation on Twitter @NHSConfed_PaulH @nhsconfed

Health economics 101

Catch up on all the posts in the Economically speaking series:

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