An article co-published on May 22 by China Social Science Literature Publishing house and China Medical Industry Magazine, entitled “Healthcare Greenpaper,” reviews a series of problems associated with China’s healthcare reforms over the past 10 years. Of the five biggest problems identified by the paper, the worst one is prohibitively expensive treatment. As a result, many people can not afford to go to the hospital when they fall ill.


Consider the dispute that stirred up the whole nation at the end of last year. A cancer patient in Harbin found out that the hospital he has been receiving treatment from wanted to charge him more than 5 million yuan ($625,743). It’s a complicated case, and the patient’s family was not blameless, either, as they had tried to interfere with the hospital’s process. Still, the 5 million yuan bill was so stunning that it triggered a round of national debate over ever-rising healthcare costs.


A survey by the Health Ministry two years ago showed that per capita income grew at a much slower pace than healthcare costs over the same five-year period. Healthcare has become the third biggest expenditure for Chinese. According to the survey, 48.9% of the respondents said they would choose not to see a doctor even if they should, while 29.6% said they would prefer not to be hospitalized even if they should be. The ever-growing healthcare cost is deterring many patients from getting professional treatment. Knowledge at Wharton interviewed a variety of experts and officials to examine the reasons behind the problem.


Why So Expensive?


One reason is the high cost of medicine. Medicine currently accounts for 50% to 60% of a hospital’s income, and for some low-level hospitals, the percentage reaches as high as 80% to 85%. Ding Chun, a researcher at Fudan University in Shanghai, explains that lower-level hospitals tend to be more dependent on medicine revenues because people with serious diseases are more likely to go to bigger hospitals for treatment.


As of the end of 2004, there were more than 5,000 pharmaceutical manufacturers, about 12,000 wholesalers and more than 120,000 retailers. Given that supply exceeds demand, the price of medicine should be coming down. However, in reality, the price keeps going up. Ironically, the more expensive a drug is, the more popular it is. “Drugs are very profitable, but pharmaceutical companies can only get part of the profit,” says Ding Chun. “That’s because there are many middlemen between the manufacturers and consumers, including wholesalers, drug stores and hospitals. Each one of them wants to have a slice of the pie, leading to ridiculously high drug prices.”


The high price is also a result of certain policies currently in place. The Chinese government, for example, allows hospitals to buy medicines at wholesale prices, sell them to patients at retail prices and pocket the difference as profits. The thinking is that the government should give hospitals some policy support now that it no longer offers them funding. However, the policy now has become the main revenue source for most hospitals. The more expensive the drugs are, the more profitable the hospitals become.


Statistics show that today, 85% of the medicines in China are sold through hospitals. China’s hospitals have always been allowed to have their own drug outlets. Patients usually buy their medicines there once they get their prescriptions. “There is competition among manufacturers, but there is a lack of competition when it comes to selling drugs to patients,” says Ding Chun.


In addition to high medicine prices, the cost of maintaining medical equipment is on the rise, too. According to Hu Suyun, a researcher at Shanghai Social Sciences Institute, “medical equipment actually presents a bigger problem than medicine. People always think that it’s normal to have very high equipment costs. But that’s not true. Medical equipment generates even bigger profits.”


According to current government policies, the cost of maintaining medical equipment is directly determined by the equipment’s price, which, in turn, is set by the manufacturers. Manufacturers, therefore, set artificially high prices to ensure big kickbacks to hospitals, while hospitals have the tendency to shop for expensive equipment.


In contrast to high medicine and equipment costs, hospital treatment charges are relatively low. For instance, a doctor at Shanghai’s Renji Hospital noted that “for a 13 yuan treatment fee charged by the expert clinic, only 2.5 yuan goes to the doctor. And a young doctor can only get 0.5 yuan.” “Healthcare has always been viewed as a kind of public service, so it’s very difficult to charge more for medical treatment. You see that those who charge 100 yuan for treatment have already been [heavily] criticized by patients.”


Medical services are always charged based on different items, such as registration fees, hospital fees and operation fees. Any upward adjustment of those fees could be viewed by patients as unacceptable and would have to be reviewed by the Pricing Bureau. But when it comes to some new items – like CT scans — hospitals usually can charge those services based on the cost, and in some cases, they can make a profit.


Because doctors don’t get fairly compensated based on their services, the shortfall is then transferred to the costs of medicine and equipment. Hu Suyun notes that “the government tries to limit how much hospitals can charge for their medical services so that healthcare remains a public service, but this kind of control leads to unfair compensation for doctors, thereby resulting in higher non-medical charges.”


Who’s Paying the Bill?


Prior to healthcare reform, the government basically paid for people’s healthcare needs, while individuals only had to cover between 5% and 10% of the cost. Now, however, it has become a shared responsibility between employers and employees. According to the healthcare insurance rules currently in place, employers and employees both contribute to the medical insurance fund, with employers contributing up to 6% of an employee’s salary and employees on average contributing 2% of their salary.


In the past, nobody would complain about high medical costs because it was the government that footed the bill. But now, individuals have to set aside their own money to meet their healthcare needs. From 1980 to 2004, the amount of money the government spent in covering individuals’ medical needs dropped 50%, while individual expenditures jumped to 53.6% from 21.2%. In other words, any increase in healthcare cost now is being covered by individuals.


However, private healthcare insurance coverage is very low in China. Farmers, who account for the majority of China’s population, typically don’t have any health insurance. But the problem has existed for a long time, even prior to healthcare reform. Hu Suyun notes that those who don’t have health insurance are usually low-income groups; the poorer you are, the more unaffordable medical services are to you.


On average, about 30% of the contributions made by employers goes to the individual accounts, which means that an average employee only gets between 60 yuan and 100 yuan in insurance per quarter. That amount can’t even cover the fees charged for treating the flu. As a result, there have been instances where patients teamed up with doctors to deal with insurers.


One of the roles played by the administrator of the medical insurance fund — the Medical Insurance Bureau — is to control medical costs. In theory, the relationship between the bureau and hospitals should be like this: The bureau is the buyer of medical services, while the latter provides such services. According to Ding Chun, “if individuals could choose medical insurers based on the fees they charge and the services they provide, the insurers most appealing to individuals would be in a great position to negotiate with hospitals, and that would help promote cheap but also quality service.”


However, there are always gaps between reality and theory. At present, the Medical Insurance Bureau is in a dilemma, too. An official at the bureau says that “because public hospitals still corner the market, we have very little choice [but to use] those often big hospitals.” Adds Hu Suyun: “The fact that the Medical Insurance Bureau is in a passive position is also due to its late start. As a newly established organization, it’s very difficult for them to negotiate with hospitals.”


While the insurance bureau has had some success establishing price controls, “the relationships among the insurance bureau, hospitals and local governments are so intertwined that the insurance bureau can’t exert its responsibility independently,” says Ding Chun.


Less Government Funding


Hospitals, as the healthcare provider, make an easy target for people who are unhappy about the high medical costs. There are many reasons for the expensive treatments, some the fault of hospitals, but others out of their control.


An official at the Shanghai Medical Insurance Bureau believes that technological advances and an aging population are part of the reason. The more effective the medicine is, the more expensive it is. The amount of money an individual spends on healthcare after age 65 usually represents half of the total healthcare expenditure during this person’s lifetime.


According to American researchers, in France, it takes 115 years for its 65-and-above population to grow from 7% of the country’s population to 14%; in Sweden, it’s 85 years; in the U.S., it’s 68 years; in the U.K., it’s 45 years; in Japan, it’s 26 years; in China, it’s 27 years. In the next decade or two, China will see its medical expenditures grow dramatically.


But technological progress and aging populations are universal phenomena, not something unique to China. So in addition to those factors, decreased government funding to hospitals has led to higher medical costs in China. Statistics released by the Health Ministry show that from 1980 to 2004, the healthcare expenditure in China jumped from 14.32 billion yuan to 759.03 billion yuan, or from 3.17% of GDP to 5.55% of GDP, while government expenditure declined from 36.2% to 17.1%.


What does decreased government funding mean to hospitals? According to Hu Suyun, “currently, government funding is less than 10% of hospitals’ revenues, and that means hospitals have to depend on themselves to make ends meet.” Hospitals have resorted to borrowing from banks and other methods to expand their operations.


An official at Renji Hospital in Shanghai says that “in the past, hospitals were funded by the government, and doctors were paid a fixed amount every month. They didn’t have the incentives to prescribe expensive drugs or to do more. After the reform, hospitals must find a way to survive, and they have transformed themselves from public-service institutions to for-profit organizations.”


In China, most medical services are provided by public healthcare organizations. Statistics released in 2004 showed that there were more than 300,000 healthcare organizations in China, with 90% of them public hospitals. The Chinese healthcare green paper pointed out that a main problem associated with the healthcare reform is the lack of guidance and supervision by the government. Given the low quality of China’s healthcare services, Ding Chun suggests that it’s crucial for the government to increase its investment in this sector.


Targeting Hospitals


In addition to dwindling financial support from the government, the hospitals themselves are also to blame for high medical costs. Hu Suyun explains that although the government has scaled back on its direct funding to hospitals, the tax-exempt policies should serve as a kind of financial support to public hospitals. Private hospitals have to pay 30% of their income as taxes. Public hospitals should take into account their tax-exempt status while setting prices, but they don’t usually do so.


According to Ding Chun, “in every country, both hospitals and doctors represent very powerful interest groups. Patients usually don’t know much about medicine and have to listen to doctors, so there is not much bargaining going on.” He says that unlike other businesses, where an excess of supply can pressure prices, the healthcare business field is one where doctors can generate demand. In many cases, adds Hu Suyun, “because of doctors’ instructions, patients seek treatment they don’t necessarily need.”