Measuring economies of scale and scope in the english secondary care

OBJECTIVES: In 2000 the English government announced a ten-year programme of reforms to increase value for money in a health system shaped around patient choice and population needs. This programme included the shift in the reimbursement system from cost-based to fixed-tariff (termed Payment by Results, PbR, and implemented in 2003) and the creation of new providers enjoying new freedoms and flexibilities (Foundation Trusts, FTs introduced in 2004). One of the aims of the FT reform is to increase efficiency in production and delivery of health care: FTs’ freedoms combined with PbR provide the ground for efficiency improvement. The FT reform has been implemented in a phased manner with only the best performing trusts being able to apply for foundation status. Since non-FTs generally have a higher installed capacity with guaranteed levels of activity, they might exploit scale economies and be able to produce at lower costs. On the other hand, non-FTs are expected to offer a broader mix of services than FTs, which implies investing on services with a volatile demand. Being locked on their capacity, non-FTs might either supply care far below their capacity, and therefore incur into high costs for unused capacity, or produce unnecessary care by inducing demand. FTs, on the other hand, are able to choose the mix of services to be provided and therefore can profit from scope economies. Estimating cost functions and testing for the existence of economies of scale and scope for FTs and non-FTs is therefore relevant for policy design as it could have an impact on the future developments of PbR. Namely it could affect the design of the tariff payable to different types of providers in order, not only to better achieve PbR efficiency targets, but also to avoid discrimination and inequitable treatment between providers. METHODS: We use a unique dataset of English hospitals from 1994/95 to 2006/07, which includes variables on activity, expenditure and staffing from numerous sources (e.g., the Department of Health, the Hospital Episodes Statistics). We address some methodological shortcomings affecting the measurement of scale and scope economies (existence of weak cost complementarities, choice of the functional form, output measurement and output aggregation) and design a hybrid multi-product function (Pulley and Braunstein, 1992) for hospital costs. This function has the advantage to decompose scope economies into the component arising from the spread of fixed costs and the component arising from complementarity. Moreover, whether heteroskedastic disturbances were found in the empirical analysis, it would be the only function suitable for unbiased cost estimates (Preyra and Pink, 2006). We use Maximum Likelihood estimation. RESULTS & CONCLUSIONS: We find that only FTs experience economies of scale. We also find that FTs experience scope economies by operating jointly outpatient visits and inpatient admissions or emergency and inpatient admissions, while non-FTs experience scope economies by operating any kind of hospitalisation. The methodology developed in this paper is quite powerful and general enough to be applied to systems where hospitals have achieved more freedom and are being reimbursed according to the activity they deliver (e.g., USA, Italy, Australia). REFERENCES: Preyra, C., Pink., G., 2006. Scale and scope efficiencies through hospital consolidations. Journal of Health Economics 25, 1049-1068. Pulley, L.B., Braunstein, Y.M., 1992. A Composite cost function for multiproduct firms with an application to economies of scope in banking. Review of Economis and Statistics 74, 221--230.