External Costs of Poliomyelitis

Weisbrod’s evaluation of polio was one of the studies (number 8) in the Hannum survey of the literature. But its importance lies in the fact that it was the pioneering CBA in the field and it laid down the blueprint that was followed by many of the subsequent studies.

Even the CBA criterion used by Weisbrod has special significance for a chapter devoted to evaluating external effects. Weisbrod evaluated the

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research expenditures devoted to developing a vaccine for polio. The ben-efits of the research B_R entailed finding a way for avoiding the treatment costs and forgone output that accompanies contracting the disease. The costs were not just the research expenditures C_R. They include also the costs of applying the research C_Aassuming that it provided positive net-benefits.

The application costs were the expected vaccination costs. The Weisbrod criterion for evaluating the polio research effort took the form:

BRC_RC_A (4.7)

One way of thinking about the application costs is to consider them to be external costs to the research. Thus it is like there were two linked proj-ects to be evaluated, i.e., doing the research and then applying it. The general principle for evaluations pertaining to joint projects is that, if they are inextricably linked, then they should be evaluated together, but not otherwise. Hiring an anesthetist is not an option one can avoid if one is paying for a surgeon. The cost of the anesthetist and the cost of the surgeon need to be combined to make up the cost of the operation. In the same way, there is no point in spending on research if one does not intend to apply it.

Using forgone earnings to measure the benefits of vaccinations is one feature of the Weisbrod analysis that many have emulated. But the way he included indirect costs has led to some confusion among those applying Weisbrod’s methods. Weisbrod (1971, p.531) deducted the lifetime expen-ditures on consumption from the forgone earnings when valuing a life that is saved by the vaccine because ‘mortality involves the loss of a consumer as well as a producer’. This makes sense if one wishes to evaluate the loss of a life from the point of view of others. But, strictly, this is an external benefit that ignores the private benefits. Only in the case when private ben-efits are thought to be zero, as we observed in analyzing drunken driving, does subtracting consumption from lifetime earnings make sense. The point is that one does not really have a choice of two alternative methods for measuring indirect costs, as some evaluators believe. Lifetime earnings is the only method to use unless one particularly wants to isolate just the external effects.

Because there is no good reason to deduct lifetime consumption in the case of childhood immunization programs, Hannum added back consump-tion expenditures to make the polio study consistent with the rest of the lit-erature. In addition, in line with the adjustments outlined earlier to bring all vaccination studies onto a common basis, Hannum altered Weisbrod’s estimates by using a 5% discount rate (instead of 10%), using 1983 dollars rather than 1957 dollars, and converting costs to year 1 in which it is

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assumed that the vaccination decision is being made. The result of these adjustments is what appears in Table 4.2 for Study 8.

Apart from the way Hannum summarized Weisbrod’s results, we can learn something from the way the original Weisbrod (1971) study was pre-sented – see Table 4.4 below (which is derived from Weisbrod’s Table 2 by focusing only on the 1930–80 time horizon and where actual research costs are equal to reported research costs). Weisbrod was the first to calculate the internal rate of return for a medical research program. The internal rate of return is that rate of discount for which the net present value equals zero.

(In terms of equation (2.7), one is finding the value for r that makes the PV equal to zero when S is defined as net benefits.) For most purposes, showing the net benefits is the most useful way to view the outcome. The internal rate of return is the best index when there is a capital constraint: see Brent (1998), ch. 2.

Table 4.4: Internal rates of return on polio research under a variety of assumptions

Growth Savings per Vaccination costs Rates of return projection case prevented ($ millions per year) (%)

In 1957 After 1957

I Constant 350 9 8.4

I Constant 625 19 0.4

II Growing 350 0 13.4

II Growing 625 0 7.9

III Growing 350 9 11.7

III Growing 625 19 4.5

Source: Weisbrod (1971)

Weisbrod includes more than one rate of return estimate in Table 4.4 because he recognized that forgone lifetime earnings due to mortality from polio can be expected to grow over time. He assumed that labor productiv-ity increases at the rate of 3% per year and these are factored into the rates of return listed as II and III (estimates III are more pessimistic about the need for inoculating newborn babies after 1957). Estimates I assume no productivity growth. The use of productivity growth for indirect costs makes Weisbrod one of the first to carry out a dynamic health care CBA.

Because Weisbrod puts most faith in a dynamic framework, he judges that although the rate of return for polio generally lies in the range 4–14%, his

‘most likely’ estimate was about 11–12%.

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4.5 FINAL SECTION

We now present the problems, summary and looking ahead sections.

4.5.1 Problems

One technique for dealing with uncertainty about the reliability of esti-mates concerning crucial ingredients in an evaluation is to use the switch-ing value method (outlined in section 4.1.3). An alternative approach is to carry out a ‘sensitivity analysis’. This involves raising or lowering the best estimates of the key variables by some specified proportion (e.g., 10%

higher and lower) and seeing whether the evaluation criterion is affected by (is ‘sensitive’ to) the alternative values. If the alternative values do not change the desirability of the intervention, then one can proceed with the recommendation based on the best estimates. However, if the alternative values do affect the desirability of the intervention, then the recommenda-tion based on the best estimates is to be considered provisional until one obtains better estimates. The purpose of the problems is to illustrate how to undertake a sensitivity analysis and to develop an understanding of the link between carrying out a sensitivity analysis and using the switching value technique.

The data for the problems come from a study by Siraprapasiri et al.

(1997) – see their Tables 1 and 2. They carried out a CBA of a vaccination program in Thailand for Japanese encephalitis (JE), a mosquito-borne arboviral disease. We focus only on the results of the 18-month program and they are listed in Table 4.5.

Table 4.5: Sensitivity analysis for JE vaccination program in Thailand

(1) (2)mll (3)mll (4)mll (5)mll

Cost

Unit cost of immunization $2.16 $2.16 $2.16 $2.16

Population affected 900 000 900 000 900 000 900 000 Overall cost of program $1 944 000 $1 944 000 $1 944 000 $1 944 000 Benefit

Per case prevented $72 922 $72 922 $72 922 $72 922 Number of cases prevented 123.700 82.375 41.321 24.793 Overall benefit of program $9 020 451

Net benefit of program $7 076 451

Source: Based on Siraprapasiri et al. (1997)

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The second column of Table 4.5 records the costs, benefits and net benefits using the best estimates (see their Table 1). For our exercise, we regard the cost estimates as accurate and treat the benefits as problematic.

In particular, we question whether the number of JE cases prevented is as high as the best estimate of 123.700. The three alternative values to be sidered are 82.375, 41.321 and 24.793. The benefit per case ($72 922) is con-sidered to be accurate. The overall benefit of the vaccination program is the product of the benefit per case times the number of cases.

1. Calculate the benefits and net benefits for each of the alternative benefit per case values (i.e., fill in columns 3–5).

2. Which of the alternative benefit per case values give the same recom-mendation as the best estimates?

3. Calculate the switching value for the benefit per case variable.

4. What then is the relationship between finding the switching value and carrying out a sensitivity analysis? (Hint: Compare your answers to questions 3 and 4.)

4.5.2 Summary

External effects are those costs or benefits related to persons or firms other than the main two parties to a trade or transaction. Private markets ignore external effects and hence their outputs can be either below or above the optimum level. Market prices would then not be good measures of social values. When external costs exist that affect others on an individual basis the external marginal costs MC_E will most likely rise with output. The optimum is where MB_S⫽MC. A tax equal to MC_E could internalize the externality and bring about the social optimum.

However, when external effects exist that affect others in an indivisible way (as when a person who gets vaccinated prevents spreading the disease to all persons unvaccinated), then the MC_Ecurve falls with output. The MB

⫽MC rule may fail to lead to optimal outcomes in these circumstances. We saw that the optimum could occur with MB⬎MC. In another case, the output where MB⫽MC led to lower net benefits than at either very low or very high levels of output.

The rule of thumb that we suggested was that, when carrying out an eval-uation, one should compare outcomes at the minimum and maximum levels of output as well as at the particular output level under review. One should then choose from among these output levels the one with the highest difference between total benefits and total costs.

Apart from the need to compare net benefits at different levels of output, we also saw the importance of comparing net benefits at different points of

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time, i.e., undertaking a dynamic evaluation. This is especially necessary when one is evaluating resource use that is affected by population growth, as was the case with vaccination and disease control programs. Evaluations at a single point of time fail to capture the element of change that is inher-ent in such programs.

The first case study illustrated the principle that it is not necessary to spend money in order for a viable program to be initiated. A tax could act as a signal to induce private individuals to produce less of the activity that generates the external cost (a subsidy could be used to promote activities that have external benefits). Just like projects that directly involve resource use, taxes that discourage drinking (and hence driving under the influence of alcohol) lead to benefits and costs. An optimal alcohol tax is one where the net benefits are greatest.

In the second application we saw that there is an optimum amount of an externality, which need not be zero. Childhood vaccinations do not have to be administered to everyone, even though it would be technically possible to eradicate the communicable disease. The optimum vaccination rate depended on the probability of getting the disease and how this probabil-ity fell with the number vaccinated. It also depended on the number of people who were left unvaccinated and the time and expense involved with getting vaccinated. Because these determinants varied by the childhood disease being considered, the optimum vaccination rate was different for different diseases.

In both the studies related to alcohol taxation and childhood immuniza-tion it was found that there was some doubt that individuals were the best judges of their own welfare. Information deficiencies led to behavior that questioned whether individuals were equating MB_Pwith MC_P.

Many times in connection with public policy decisions, outcomes are assumed rather than empirically tested. This is the case with the old health care adage that ‘prevention is better than cure’. As was demonstrated in the analysis of the control programs for schistomiasis, cure was used in con-junction with prevention, and could optimally be implemented before pre-vention. There are no simple substitutes for actually carrying out a health care evaluation.

The applications closed with the pioneering immunization study by Weisbrod. This was one of the first studies to apply the human capital approach to measure the benefits of not being affected by communicable diseases. It stressed the need to check whether a project was inescapably linked to another. With linked projects, constituting a special kind of exter-nality, a joint evaluation is required. Again one is using the principle that, in a social evaluation, one adds all the relevant benefits and subtracts all the relevant costs.

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4.5.3 Looking Ahead

In this chapter we showed how taxes can be used to remedy the non-optimality of private outcomes when externalities exist. In the next chapter we explain how taxes that are used to finance health care projects can have a distortionary effect on outcomes for other markets subject to the taxes.

Taxes therefore can cause externality problems as well as solve such prob-lems.

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