The basic assumptions of a Walrasian model necessary to establish the desired equilibrium under the mechanisms of competitive market conditions are:
(i) The goods involved behave like true private goods i.e. they are governed by the features of excludability, rivalry and rejectability;
(ii) Rights are perfectly delineated; and
(iii) The transaction costs are minimum.
The application of these assumptions to the services of healthcare sector reveal that while the first of the three assumptions is met by most healthcare goods and services (at least to some degree), the remaining two are generally not met. Further, since our focus is on the production characteristics, it is necessary to understand the optimal organisational arrangements for service production.
The developments relevant to understanding the different arrangements for service delivery derive from four theories of organisation viz.
(i) Principal-agent theory;
(ii) Transaction costs economics theory;
(iii) Property rights theory;
(iv) Public choice theory.
The agency literature surveys the range of contracts observed in the economy with respect to incentives and cooperation. Generalising from a full range of relationships (from employment contracts to the various other more complex relationships that make up the firm), the theory points out to the need for effective incentive alignment. The relationship between patient and physician or governments and contracting agencies are cited as classic examples of the principal-agent structure. On the other hand, pointing out that both the principal and the agent are opportunists seeking to minimise production/transaction costs and maximise their benefits, the transaction costs economics theory emphasises the need for flexible means of coordinating activities. This theory advocates vertically integrated (i.e. unified ownership) organisational structures with features of simple spot contracts, franchises or joint ventures. Claiming that such arrangements provide discrete structural alternatives, the theory holds that governance arrangements can be evaluated by comparing the patterns of costs incurred in production and exchange.
Pooling of risks and rewards for various activities undertaken, facilitating the sharing of information, pursuit of innovation, and promoting a culture of cooperation are considered the positive features of the transaction cost theory. The theory however, it is argued, suffers from characteristic weaknesses like the ‘proliferation of influence activities’. This is illustrated by the presence of provider organisations in the healthcare sector who try to gain advantage by influencing decisions on the distribution of resources (or other benefits) among the providers. Evidence of such activities is cited in the tendency to allocate resources to tertiary and curative care at the expense of primary, preventive and public health activities. The property rights theory attempts to find out why private ownership has strong positive incentives for efficiency. It identifies the prevalence of this feature to the scope for ‘residual rights of control’ which refers to the rights of owners on the revenue remains of the total proceeds once the expenses and the contractual obligations have been met out. The public or the political choice theory focuses on the self-interested behaviour of influential segments (e.g. politicians, bureaucrats, and other interested groups). The theory points out that owing to the capturing of increasing portions of resources by powerful interest groups, institutional rigidities develop impacting adversely on the economic growth.