Gordon Guoen Liu, PKU BOYA Distinguished Professor of Economics at the National School of Development (NSD) and Dean of the Institute for Global Health and Development at Peking University, 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 Liu's interview in Chinese, covering the following topics:

How to Allocate Healthcare Resources
How to Better Respond to Future Pandemics
How to Promote Patent Drugs
How to Balance New Drug Pricing and Government Procurement
How to Address Aging Population
Recommendations for Healthcare Reform in China

The interview's full text 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 www.ghd.pku.edu.cn.

Professor Liu has kindly proofread our translation.

医疗健康的经济学逻辑与改革方向

The Economic Logic and Reform Direction of Healthcare

How to Allocate Healthcare Resources

The 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 remains a central point of discussion and debate among health economists. Based on years of research and observation of policy consultations, my personal experience aligns with the old saying: although both the invisible hand of the market and government intervention are necessary and indispensable, each has its own comparative advantages in different areas.

For example, China's current basic universal medical insurance, which covers all citizens, 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 greater 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 two ways. They can raise premiums across the board, which leads to fewer healthy policyholders towards 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 utilize its administrative authority through mandatory laws and regulations, requiring individuals or employers to uniformly join the system, which can largely prevent adverse selection. Therefore, if politically feasible and economically viable, 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 two major models of healthcare fund allocation.

One model involves directly allocating health insurance funds to medical service institutions, known as the "subsidizing 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. Apparently, lacking direct supervision and market competition provided by consumer choices, the model of "subsidizing supply side” would require extremely high administrative planning and execution capacity. This would include meticulously setting payment standards, execution norms, and clinical pathways, and conducting supervision and inspections. 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, if not impossible. In short, similar to other non-competitive industries, the biggest challenge facing the "subsidizing supply side" model would be the high risk of "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 demand side" model. This model pools the raised medical insurance funds into a shared poor 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 can make choices and adjustments based on their medical experiences and outcomes, which fosters patient-centered market competition among healthcare providers.

Before the issuance of the action plan for Chin's medical services reform in 2009, there was significant debate over whether to adopt the "subsidizing supply side" model or the "subsidizing demand sider" model for the country's basic medical security scheme. The decision ultimately favored the "subsidizing demand side" model, leading to the current national policy covering more than 95% of the population.

Of course, the improvement of China's universal health insurance system has been gradual. Before 2019, the country's national medical security included three different systems: the Employees' Medical Insurance System, Urban Residents-Based Basic Medical Insurance (URBMI), and the New Type of Rural Cooperative Medical Scheme (NCMS). Through continuous efforts, the URBMI and NCMS were further integrated after 2019, eliminating the urban-rural duality and establishing the Urban and Rural Residents' Basic Medical Insurance (URRBMI) system, which ensures that people in the same region receive the same level of protection. From an institutional perspective, the URRBMI has systematically eliminated identity-based discrimination between urban and rural areas, marking a significant milestone set in China's modern public policies.

How to Better Respond to Future Pandemics

Since the COVID-19 outbreak, experts and scholars in China and abroad have placed greater emphasis on the risks of future pandemics. Pandemic preparedness encompasses too many aspects to be fully detailed here, but one key issue deserves in-depth discussion: how to optimize prevention and control strategies to reduce transmission more effectively, harmoniously, and at a lower cost.

Non-pharmaceutical interventions (NPIs) include individual protection, testing, contact tracing and isolation, and even lockdowns. Among these, individual protection is particularly crucial. People's willingness to participate determines the level of engagement and consequently, the effectiveness of prevention and control. To increase engagement, there are two alternative approaches: mandatory measures or individual incentives. As the economic principle states, "There is no free lunch." While mandatory measures can be implemented swiftly, they also come with significant costs, such as resistance, evasion, and conflict, all of which can undermine the quality of prevention and control.

In hindsight, exploring alternative approaches to individual protection could further enhance people’s motivation and participation. Behavioral economics offers valuable insights in this regard. While complete laissez-faire is certainly impractical in the face of a sudden pandemic, rigidly uniform, mandatory measures also come at a cost. Many experiments in behavioral economics have found that a more effective compromise can be found between laissez-faire and paternalism. This involves the concept of a "nudge," where guidance is provided without making it mandatory, allowing individuals to make their own decisions. This approach can potentially achieve better results than either laissez-faire or strict mandates.

Taking nucleic acid testing as an example, during the COVID-19 pandemic, there were mandatory requirements to present a health QR code for entering public places or using transportation. Without this code, individuals were denied access to restaurants, shopping malls, and normal travel, leading to intentional evasion and public conflict. In light of behavioral economics, a "non-compliance tax" akin to a Pigouvian tax could be applied to encourage individual protection. Instead of outright denial, individuals without a health QR code could still participate in activities, but prices for goods, restaurant bills, or transportation fares could systematically increase by 30% or more.

Compared to rigidly uniform or mandatory measures, the "non-compliance tax" approach has several advantages. First, individuals pay a clear and uniform economic cost, making them more aware of the consequences of non-compliance, and potentially improving the effectiveness of prevention and control. Second, increasing non-compliance taxes can supplement public funds that are in short supply during the pandemic. Third, the non-compliance tax preserves a limited range of choices for individuals as the first to be held accountable for their own health, which helps to raise the personal sense of responsibility and reduce and avoid conflicts.

In fact, after mandatory control measures were lifted at the end of 2022, the proportion of people voluntarily wearing masks in supermarkets and stores increased rather than decreased. This is a very interesting case observed reflecting possible roles of behavioral economics.

How to Promote Patent 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?

I believe a comprehensive understanding of patents is essential for pharmaceutical innovation. According to international norms, the patent period typically lasts 20 years. 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. As Mr. Bi Jingquan, Chairman of the China Center for International Economic Exchanges (CCIEE) [and former director of China Food and Drug Administration and the State Administration for Market Regulation] said, drug development has an extremely low success rate, making it particularly deserving of heightened attention and support of society.

In the United States, it takes an average of over 10 years and an investment of more than $2 billion for a new drug to develop from basic research to successful market entry. Based on field research conducted by a research team from Peking University in China, the R&D duration for patent drugs in China is similar to that in the United States, also around 120 months, but with an average investment of about $200 million. Additionally, in terms of the staged investment structure, China focuses more on post-trial investment, while the United States invests more in pre-trial 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. As President Abraham Lincoln famously stated, "The patent system added the fuel of interest to the fire of genius," displayed at the entrance of the U.S. Department of Commerce.

The core of patent protection consists of two indispensable aspects. First, during the patent period, no one is allowed to copy the patented technology without compensation. Second, the patent company has exclusive market pricing power during the patent period. The former serves as the technical basis for the latter, while the latter guarantees returns for the former. These two aspects can be considered the essential "binary attributes" of patent protection. In practice, however, the understanding and implementation of these "binary attributes" are not always adequate, leaving considerable room for policy improvement.

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. According to contemporary economic theory, 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 take into account 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.

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 on December 23, 2016, Nusinersen is the world's first targeted therapy for SMA. This genetic disorder primarily affects children; once a child inherits the autosomal recessive trait, they are generally unable to stand, and their development is severely affected or even halted. Most children with SMA also face a significant risk of death.

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 six injections, totaling 4.2 million RMB [$586,044]. Subsequently, patients need two to three injections annually for lifelong medication. In late 2021, through negotiations, Nusinersen was successfully included in China's national insurance drug list, reducing the cost per injection from 700,000 RMB to 33,000 RMB [$4,605]. This negotiation, dubbed "cut-to-the-bone bargaining," resulted in a substantial price reduction and has sparked various opinions in society. The primary concern among critics is 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, but rather 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 three 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 on the basis of clinical necessity to meet 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 Clinical Expert Group, the Fund Calculation Group, and the Pharmaceconomics Group 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 three expert groups are also arranged to avoid overlap.

In the Pharmacoeconomics Group, each drug is independently evaluated by two experts, who are strictly prohibited from communicating during the evaluation process. As the chair of the Economics Group, my primary responsibilities, along with the two vice chairs, were to supervise and train the experts involved in the evaluation, ensuring standardized methods and judgment criteria. Chairs do not directly evaluate any drugs but instead, listen to independent reports from experts and provide necessary recommendations.

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 three 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 Sodium Injection, its negotiated payment ended up being much higher than the current average for other drugs. This suggests that the Pharmaceconomics Group's recommendations did consider 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, despite numerous value assessments grounded in objective, independent scientific evidence and international standards, China’s evaluation and negotiation mechanisms still have much room for improvement. For instance, patent 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.

How to Address 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 has occurred rapidly, driven by factors such as 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—a reasonable policy then. However, by 2023, China's average life expectancy had risen to 77 years. Given this increase, it 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. For instance, several of my senior colleagues, including Zhang Weiying and myself, at the National School of Development at Peking University, have returned to work post-retirement. Professors Zhou Qiren and Justin Yifu Lin, who are even older, continue to teach energetically at Peking University. They are highly popular among students and can stand and lecture for hours, just as they did in their younger days.

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 early forced retirement increases the risk of chronic diseases and mortality among retirees, with men being particularly affected. Health issues triggered by early retirement are more pronounced in men than in women. Of course, retirement has its benefits as well. For instance, the retired can enjoy more freedom in managing their time, pursue their interests, and engage in activities they wanted to do earlier in life but couldn't. These advantages are undeniable.

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 significantly reduces pension benefits unless there are special circumstances. 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 (excluding administrative positions) might be a choice. 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. Encouraging people to voluntarily continue working in their area of expertise is advisable. From social, political, economic, pension, and health perspectives, a flexible retirement system is worth exploring.

Regarding the healthcare system, it is advisable to divide China's healthcare services into two categories: therapeutic services and care services. While therapeutic services usually are provided by large hospital systems, care services can be better offered by community-based primary care facilities, for their advantages of greater accessibility and cost-effectiveness in most cases. For the elderly population, the relationship between medical services and care services is complementary and closely intertwined. As the body inevitably declines with age, timely and adequate care and health maintenance can reduce or sometimes 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.

Recommendations for Healthcare Reform in China

China's healthcare reform is a vast and systematic project, characterized by continuous improvements. There are two aspects that merit further exploration:

First, continue improving payment methods for China's health insurance. Under the universal health insurance framework, medical services are primarily funded through third-party health insurance premiums. This system involves the responsibilities, rights, and interests of three key stakeholders: patients, medical suppliers, and payers. Therefore, the primary focus of reform should be aligning the incentives of these parties to ensure mutual benefit through more efficient payment methods. This is no easy task. As former Premier Wen Jiabao aptly stated, healthcare reform is a global challenge, a truth that remains relevant today.

Different countries employ a variety of continually evolving health insurance payment methods, from basic fee-for-service (FFS) to pay-per-visit (PPV), diagnosis-related group (DRG), capitation, hospital global budgets, pay-for-performance (P4P), and various bundled payments like China's diagnosis-intervention package (DIP). Each of these methods seeks to balance the responsibilities, rights, and interests of the three key stakeholders involved in healthcare. However, no single "best" model has been found yet that could fully satisfy all parties, and it is possible that 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. Herein lies the problem: 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 triangular relationship with conflicting goals and interests, how can there ever be an incentive-compatible payment solution for all three parties?

If not the disease-medicine-insurance triangular relationship, could there be an alternative model? As a thought experiment, let's imagine that 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 health insurance payments customized for each individual. These risk-adjusted payments would be guided by health wellness-based key performance indicators (KPIs), as graded by the information in individual health passports.

Compared to the disease-medicine-insurance service model, individual health passports form a health-medicine-insurance model. The core difference between the two is that the latter pays for "health," which can promote incentive compatibility among the three parties: individuals (demand side) want to be healthy, medical service providers (supply side), and insurers (payers) also want people to be healthy because as long as people are kept healthy, all three parties benefit.

In this way, healthcare institutions would have greater motivation to proactively engage 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 three 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 on the basis of how healthy their patients are, they would have enormous incentives to do all the right things as we expect.

Second, 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 think outside the box and 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. This approach allows individuals to maintain their autonomy while achieving more rational outcomes.

For example, to encourage exercise habits, personal health exercise points—adjusted for age based on the previously mentioned health passport information—could be redeemed for discounts on goods and services. Cities' fitness and weight loss programs could implement similar personal incentive plans. 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.

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