Published in Applied Health Economics and Health Policy. Final version of the article.

Keywords: Governance; Health; Political Economy and History

Abstract: The New Zealand health sector reforms of the 1990s have to be seen in the context of the long term development of the New Zealand health system. The evolutionary change between 1938 and 1990 was abruptly replaced by the revolutionary policy of commercialisation from 1991 to 1993. …

… This proved unsatisfactory, with the promised benefits such as significant productivity increases not occurring. In some ways the system functioned even more imperfectly, although this was in part due to the funding cutbacks which took place at the same time. The policy shifts from the mid 1990s have largely taken the New Zealand health system back to where it would have been, had the evolution up to 1990 continued. There remains unfinished business, the largest of which is that the tensions between the managers and the health professionals have not been resolved. The New Zealand experience provides strong evidence that comprehensive commercialisation – business practices within, market relations between institutions – will not make a significant contribution to the design of effective health systems.

Introduction

Toni Ashton’s (2002) account of the reorganisations of the New Zealand public health system in the 1990s requires a background of the developments which preceded it. In particular, what may appear in decadal terms to be a couple of bouts of reforms, really involved a set of revolutionary reforms with a commercialist intent in the early 1990s, followed by a return (a counter-revolution) to the long-term incremental changes, which had been going on since the 1930s when the New Zealand government began to take over the previously private and part-charitable health system.

The reforms of the early 1990s, like many other New Zealand reforms of the time, thus becomes an experiment – albeit one driven by the ideology that there would be substantial efficiency gains from the uncritical application of business practices. Although there was very poor monitoring and evaluation, it is clear they failed, providing strong evidence that the underlying theory that commercialisation works in a health system has grave weaknesses.

The development of the New Zealand public health system to 1984

The initial plans in the 1938 legislation for the almost total nationalisation of the system were never completed – in part because of private sector resistance, especially by general practitioners (Lovell-Smith 1966; Sutch 1966; Hansen 1980; Easton 2001, p 109–12). It was underpinned by the implicit belief that there was a finite quantity of health care to be delivered, an assumption that was undermined by the post-war explosion of technological innovations in medicine, which placed an increasing pressure for public funding (Cooper 1978).

The response to the incomplete reforms and the innovations was incremental (Bowie and Shirley 1994). Eventually in 1974 the (Labour) government issued the White Paper, A Health Service for New Zealand, whose conclusions are summarised by ‘in short, the fragmented pattern of health care delivery means that New Zealand lacks a national health service’ (New Zealand Government 1974, p 75). It set down three principles which were present in the reforms of the late 1980s and the late 1990s but not, as we shall see, of those of the early 1990s:
– that the community, acting through the State, has a responsibility to provide for the health needs of its members
– that the lines of administrative control of health services should follow finance to its source
– that health services should be organised on a basis so that their administrative districts should be capable of meeting the health needs of the community.

And it added three further principles to reflect the evolutionary needs of the health services …
– that the various components of the health service should be functionally integrated
– that the future development of the health service should be rationally planned
– that there should be a national health service.
(New Zealand Government 1974, p 83–4.)

The White Paper proposed 14 Regional Health Authorities (RHAs), replacing the 30 existing Hospital Boards (HBs), which ran the public hospital system and whose existence reflected history rather than population or administrative rationality. The largest HB was Auckland serving more than 800 000 people while the smallest, Maniototo, served just 2600. The new RHAs would be more accountable for their funds which came almost solely from central government They would take responsibility for various providing then carried out by the Department of Health, such as population based health and psychiatric hospitals. They would also be better integrated with primary care services, generally provided by independent general practitioners who were subsidised by the state on a per visit basis, with an additional charge to the patient, plus (generally) free-to-the-patient subsidised pharmaceutical and laboratory services.

There was significant resistance to the proposals from localities, which feared the loss of the local HBs would mean the loss of the local hospital, and from general practitioners and other private sector doctors who saw the changes as a threat to their professional independence and their privately sourced remuneration (that is, a rerun of the concerns of the 1940s). The National government, newly elected in 1975, formally abandoned the proposed reforms.

However, the Department of Health continued with the proposals where it could, including an experimental development of an Area Health Board (as the new institution was now called) in Northland. But the HBs and the primary care integration remained largely untouched. The traditional method of proportional increases of public funds to HB could not cope with differential population growth between regions and variations of health need within populations. Methods to better share the available funds were developed, and a reallocation process began in which the underfunded were given a greater share of the additional resources.

1984–1990

The first term of the third Labour government, elected in 1984, was largely concerned with incremental change and consolidation, but two major reports concerned with structural issues were commissioned. Choices for health care is an options paper concerned with alternative approaches to health benefits, the most contentious of which was the funding of general practice (Health Benefits Review Committee 1986). The second major report, Unshackling the hospitals, is discussed below.

In its second term, the Labour government reorganised the public delivery system in the spirit of the 1974 White Paper, modified by the lessons learned in the intervening years. There were 14 Area Health Boards (AHBs), which were responsible for public hospital and population based health care. The boards to which the chief executive reported were two-thirds elected, continuing the practice of local representation of HBs, and one-third appointed by the minister to ensure that there were the skills for the management of the complex agencies the HBs had become. Although the halving of the districts was radical, most of the changes were incremental and based in part on lessons learned in the intervening 15 years. The intention was there would be further experiment and change. For instance within the (now) Ministry of Health, increasing attention was being given to defining what services the Boards were expected to provide, moving towards a separation of funding from provision.

New problems were arising. The Māori, the indigenous people of New Zealand argued, with some justification, that the majority-focused institutions overlooked the characteristics of the ethnic minority. Secondly and more technically, the State Sector Act 1988 and the Public Finance Act 1989 intended to regulate the core public sector, had also to be applied to the public health sector. It soon became clear that the balance sheets of the new entities were inadequate, with assets valued at historical cost, excessive debt at high interest rates and great variation between different HBs, which would complicate, among other things, the funding formula.

A third problem was the public’s demands for more public health care in a tight fiscal environment, brought about by a stagnant economy. Confusion arose because improper deflators (the consumer price index) in a highly inflationary environment appeared to imply that the government had markedly increased its funding of public health without any marked improvement in outputs. In fact, the additional funds had been absorbed in higher pay (a consequence of an economy-wide pay freeze a little earlier, which had been particularly onerous on public sector employees). Thus, there had been no significant increase in available resources and, not surprisingly, no significant increase in health care outputs either (Scott 1990; Easton 1988).

The commercialisation reforms of the early 1990s

The Labour government lost power at the end of 1990. The incoming National government was elected on a platform of continuing incremental change, but abandoned this strategy for a radical reform, whose ultimate destination appeared to be the privatisation of both the funding and delivery of the public health system (Easton 1997, p 156–64). Funding was split from providing with four Regional Health Agencies (RHAs) charged with purchasing health care services from providers on a (broadly) competitive basis. This meant that the public providers no longer had privileged access to public monies over similar private providers (a small private hospital sector having continued and expanded since the 1940s). The AHBs were transformed into 23 Crown Health Enterprises (CHEs) which were to be run on commercial principles by boards of government-appointed (mainly) business men and women. The 23 CHE structure was not a move back to the 30 HB pattern, since in the three main cities a total of seven CHEs were established, presumably to allow the RHAs to have a choice of public funder in those regions. To facilitate the CHEs’ behaving as private corporations, as was required, there was a reconstruction of the balance sheets, with the central government taking over much of the debt left over from the AHBs.

It was hard, even at the time, not to see the primary driver of the reforms as ideological, for the commercialist (neo-liberal) philosophy was then rampant. In so far as there was a pragmatic justification, it might have come from the earlier report, Unshackling the hospitals, which had commissioned Arthur Andersen, the Chicago accounting firm, to evaluate the efficiency of the public hospital system. The data were never released, so it has not been possible to verify the results or even the methodology. This latter seems to have been to look, procedure by procedure, at the lowest cost HBs and calculate the cost savings if all hospitals operated at that cost level. If so, there has been no allowance for case mix, for different costing procedures by hospital (eg in terms of the allocation of overheads – a hospital might appear to be low cost in one procedure and high cost in another because of its accounting conventions), whether the low cost hospitals were medically effective, or the degree of cost shifting to the private sector that was involved (as when patients are discharged too early). The average length of stay used in the calculations used long-stay patients (Devlin 2002). The consultants concluded that costs could be lowered by between 24% and 32% of current operating expenditure if these ‘best’ practice costs were attained (Gibbs et al 1988; Arthur Andersen 1988).

But even were the estimates reliable, the report’s conclusions that the ‘efficiency’ gains would be attained by managing hospitals on business principles did not logically follow. It is not theoretically obvious, and no empirical evidence was provided (like low cost hospitals followed business practices and high cost ones did not, or that the private sector hospitals were lower cost than public sector ones). Even so, the mantra to justify the reform of the early 1990s was in terms that making the public hospital system more business-like would give productivity gains of 20% –30% percent. Such gains would be very attractive in a time of fiscal austerity, since the same funds would produce more health care outputs.

On these promises the reforms were rushed though in less than two years. This was an achievement all the more impressive because, in order to avoid ‘professional capture’, the agencies which administered the reforms hardly involved the Ministry of Health or any reputable health economists and associated professionals. This made it easier for the advocates to give more outrageous promises out of ignorance. For instance, specific productivity improvements were promised, but they had already been implemented in the old system. (Easton 1987, p 169)

In fact, limitations were seen in the reforms from the beginning. Rather than a white paper, they were announced in the Green and White Paper, Your health and the public health (Upton 1991). This declared some decisions (like in the White Paper), but other decisions – especially funding ones – were set forward for public discussion. Presumably, cabinet was uneasy with the proposals for funding, which would have led to private insurance outcomes. Cabinet’s caution was justified by the overwhelming public rejection of any of the proposed changes earmarked for discussion, and they were never pursued. Private collateral payments for public hospital care were briefly imposed and then withdrawn, following public resistance and payment boycotts.

More progress was made on the provider side of the reforms with the business oriented CHEs beginning on 1 July 1993. This involved considerable internal upheavals, only a few years after the lesser ones from the AHB reforms. Many experienced administrators were made redundant, walked out, or took jobs in Australia (a hard currency demonstration of their competence even if it was not appreciated by the new management). The majority of the new chief executives came from outside the health sector, and appointed generic managers who were equally inexperienced. Few stayed more than three years – perhaps the task proved much more difficult that they expected. (Easton 1997, p 165–72)

The reforms were expensive, with estimates ranging between 2% and 10% of the total annual health vote. There was also a perception that they added more layers of management, one at the RHA level and another between chief executives and clinicians.

The promised productivity improvements did not occur, and there has been no evidence of the sector’s productivity increases accelerating. The public were deeply suspicious of the reforms, seeing them as an attempt to ‘privatise’ their much trusted public health system. The dissatisfaction may have been exacerbated by cost-shifting. There is not the space to list all the problems associated, sometimes unfairly, with the reforms. The bottom line was that the public saw difficulties and threats, but no significant gains. The situation was exacerbated by the government cutting the public funding on health relative to gross domestic product (GDP) from 1991/2 to 1995/6 (Devlin 2002). From a seemingly impregnable parliamentary position after the 1990 election, the National Party almost lost the 1993 election. Immediately after the election the Prime Minister, Jim Bolger, opined that the health reforms were the major reason for this, although undoubtedly some of the other reforms and the weak state of the economy made a contribution.

Reversing commercialisation

At an early stage in its new term the National government began, as surreptitiously as it could, to modify the public health system, softening and even reversing its changes. Initially the responses were reflexive, but by 1996 the government began talking about how the system was evolving to where it would have been had there been no reforms. Government spending on health was increased sharply in the 1996/7 (election) year, and the Minister of Health promised that, if his government was returned, it would reduce the four RHAs to one Health Funding Authority (HFA), combine the portfolios of Minister of Health and Minister for CHEs (which were a part of the funder-provider split) and reduce the number of CHEs by about half (a policy issue still to be addressed). This backdown was reinforced when, after the election, National formed a coalition government with the New Zealand First Party. The latter insisted on policies which further shifted the system away from its commercialist stance towards the track that it would have followed had the 1989 reforms continued. Additionally, there was another large increase in public spending on health in the 1997/8 year and continuing high levels after (Easton 1989, 1999; Devlin 2000).

The shift continued with the Labour-led coalition government, elected in 1999 and headed by Prime Minister Helen Clark, who, as the Minister of Health, had instigated the 1989 reforms. District Health Boards (DHBs) as they were now called, were two-thirds elected, and one-third appointed as before 1991. The HFA was absorbed back into the Ministry of Health, giving a system close to what might have been envisaged had the commercialisation reforms not been attempted in the early 1990s. There were further increases in public spending on health, in effect reversing the cuts of the first half of the 1990s to the prior trend relativity as a proportion of GDP.

Unfinished business

Because incremental development of the public health system is now accepted, there are a number of acknowledged issues to be addressed. A major one is that the primary and secondary sectors are still not integrated. There was some development in the 1990s, but the DHBs have been charged with this objective. It seems unlikely that the 21 DHBs can find a national solution and, repeating their fears of the 1940s, many general practitioners see excessive state interference. The role of the private secondary sector is uncertain. Private surgical hospitals flourished under the RHAs and the HFA who contracted them for certain procedures. That seems less common under the post-1999 regime, and some private hospitals may be in financial difficulties. Private medical insurers also seem to be suffering, with their market share falling from about one-in-two New Zealanders in 1991 to about one-in-three today. This is apparently because one effect of the reforms was to raise the price of health insurance, and New Zealanders chose to opt out. More generally, the problem of public demand for health care exceeding the public funds available, and rising with the introduction of new expensive medical technologies, remains as unresolved in New Zealand as elsewhere in the rich world.

Another implication arises from the sacking of managers who ran the system before 1993. Their expertise and the institutional memory were lost, and they were replaced by a new cadre, many of whom are generic managers with little knowledge of the health system or health care. There may also have been an increase in the numbers of managers. In one DHB there is one manager for every consultant. An even bigger cost may be the resulting tensions between the new managers and the health professionals, with the professionals mistrustful and the managers not comprehending their problems. As one illustrative anecdote, a manager reduced the number of beds in a ward without consulting the professional staff: two of the ward’s professionals resigned as a consequence.

The issue of managerial–professional tension goes back to the state sector reforms of the late 1980s, and is not peculiar to the health sector. However, it is perhaps more acute because of the expertise, authority and power of the medical professional. Essentially it involves a conflict between two paradigms – one from the ‘scientific’ management/school of management approach with its emphasis on external control, hierarchy and accountability, the other from the human relations approach which gives great emphasis to internal self-discipline, collegial networks and responsibility (Etzioni 1964; Mannion and Goddard 2002, p 20). Each has merit and, undoubtedly, good governance is a nice mix of the two. But the commercialisation reforms imposed ‘scientific’ management over the health professionals, with resulting underlying tensions which occasionally result in direct conflict. The investigation of the Accident and Emergency Department of Canterbury Health Ltd by the Health Commissioner was one of the most prominent consequences of such a conflict (Health And Disability Commissioner 1998).

Extraordinarily, there is little evidence of any real gains from this new management style. Note, for example, the failure of the CHEs to stay within the funds allocated to them. Almost all ran financial deficits which would have bankrupted the private sector corporations they were meant to be modelled on. Apparently even the hard-headed and experienced business men and women on the CHE boards, and the business executives they appointed, were unable to restrain the health professionals and the public to keep within the financial caps of external funding. The health professionals’ and popular vision is that health services should be delivered on the basis of need, with little regard for (the resource) costs. There is still no coherent integration of the clinical decisions that the professionals take and the resources they use. The commercialisation reform’s attempt to generate one by imposing managers who could control the professionals and their use of resources failed because the professionals’ expertise and ethics overrode those controls.

The call to impose business methods on public institutions goes back almost a century in New Zealand (Henderson 1990, p 37). Commercialisation involved the assumption that putting managers under market pressures would encourage business-oriented managers to eliminate inefficiency. The record is that the application of commercial methods to the New Zealand health system in the early 1990s largely – and spectacularly – failed. One is reminded of the aphorism that, even supposing there was a higher rate of inefficiency in the public sector than in the private sector (which is unproven), the fat is stippled through like in prime beef, not in layers as in mutton.

There is no magic way to remove such inefficiencies that exist. Any resolution probably involves a combination of shrewd controls by managers and a commitment from professionals who use the resource. Current arrangements seem unlikely to generate that commitment.

Lessons from the New Zealand reforms

One negative lesson of the 1990s experience is that this sort of commercialisation is unpopular with the public (although with a little more care there could have been less antagonism) and with the professionals involved. It also failed to deliver the promised benefits – it is possible that it did not deliver any health benefits at all – while the disruption from the change resulted in health dis-benefits (including higher costs and therefore less production of medical outputs).

However, the commercialisation reforms solved a couple of problems which did not, until then, have an obvious solution. The conversion of the AHBs into legal corporations enabled the HBs to be put on a viable financial footing (albeit by the central government taking over most of their debt). Meaningful balance sheets provide financial discipline for managers, and enable some (limited) assessment of their performance. The other gain was that the change freed up the pay rates for professional staff. Without this, the system would have been unable to pay internationally competitive rates and even more medical professionals would have migrated. One of the sources of financial success of other commercialisations in New Zealand has been the cutting of pay and conditions of workers. This was not possible with internationally mobile health service workers.

It seems likely that another long-term detrimental effect of the commercialisation reforms was that the ensuing mismanagement of health services resulted in unnecessary deaths. Documented cases include the under-staffing of an emergency service and deaths from cross-infection as a result of overcrowding in wards. Both cases were the result of management initiatives overruling professional judgements. (Health And Disability Commissioner 1998; Quaintance 2000) There are probably other examples of inferior health outcomes as a result of the reforms, and a growing backlog of unprovided care in the 1990s, which may well have long-term health consequences. However, some of this may be better attributed to the cuts in public spending rather than the structural reforms themselves, although the cuts were in part justified by the promised productivity gains that never materialised.

It could be argued that the commercialisation of the New Zealand health system was badly managed, and that an introduction of a business approach inside the institutions, and market relations between them, which are more practical and less ideological, would lead to fruitful improvements. From this perspective, the New Zealand experience is an example of how not to undertake reforms. But there is so little evidence of any gains from commercialisation that it seems unlikely that even with appropriate implementation the policy has a major contribution to the resolving of the problem of designing effective health systems. The experiment is New Zealand’s gift to the international study of health systems: New Zealanders paid its cost.

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