Feature

Good news for Labour on capital

Which is more efficient: the public sector or the private sector? Labour shouldn’t take the answer for granted, argues Jean Shaoul

The debate about restructuring public services assumes that they are less efficient than those offered by the private sector. Since efficiency, something everyone agrees is a good thing, means better services, reforms introduced to improve efficiency will benefit all service users. Unlike the Lottery, we all get a winning ticket that comes free.

Capital charging was brought into the NHS under the efficiency banner.¹ It means that trusts have to include the cost of capital when charging their purchasers and take responsibility for repaying past capital and future maintenance and enhancing their infrastructure and equipment. These charges are represented in accounts as the charge for depreciation (for the consumption of capital), interest on the debt which has been assigned to the trusts, and dividends to the government on the public dividend capital, the equivalent of the government’s shares in the trusts. So hospitals must find a surplus out of their already meagre funds to finance these charges.

Previously the capital for new buildings and equipment came in the form of a government grant with no dividend or repayment obligations. It was argued that as a ‘free’ good, hospitals had no incentive to use capital efficiently. Therefore charging for capital would make trusts more efficient and managers more aware of the cost of capital; and would enable comparisons to be made between different parts of the NHS and between the NHS and the private sector. But the last government provided no evidence to either support the validity of these assumptions, or to examine the outcomes, and hence evaluate the claims and promises that were made.

But it is not very difficult or time consuming to produce the evidence if we use the kind of numbers and measures accountants use when they talk about efficiency — inputs to outputs as measured in financial terms.²

If we define capital as being the sum of depreciation, interest and dividend on the public dividend capital, then capital accounts for 9 per cent of total income received, bought-in goods and services account for 29 per cent and labour 65 per cent. The most important cost to control is not capital but labour. Yet the government introduced capital charging because capital was assumed to be a major cost.

Although it is small as a percentage of total income, it is a significant item in a cash-strapped service. Since it is a charge that must be met, and since purchases are already low, it is labour that must be squeezed to provide the surplus to cover the capital charges. This is its real significance.

The three major private hospital groups, which account for 50 per cent of private beds, are Nuffield, BUPA and General Healthcare. BUPA, part of a mutual insurance group and the largest of the private sector groups, pays no dividends or interest charges and has a policy of reinvesting the surplus. Nuffield is a charity, a non-profit making organisation which therefore pays no dividends. These hospitals do not pay the full cost of capital and their capital is, to some extent, a free good. Only General Healthcare hospitals operate on a ‘for profit’ basis and pay the full cost of capital.

Two points follow. First, the government confused the private sector with profit for distribution to shareholders and assumed that all private sector hospitals paid for capital. Second, examination of the accounts shows that BUPA could not break even if it had to pay interest and dividends on its capital, neither could General Healthcare make an adequate profit if its assets were valued on the same basis as the trusts.

If the trusts are to be compared with private hospitals, how similar are they? Private hospitals are much smaller, with income derived largely from the insurance policies of their patients. Their prices per case are usually higher than those in the public sector — as one finance director implicitly admitted when he said that they do not normally seek work directly from GP fundholders or health authorities. They do not carry out a full range of medical and surgical treatments but concentrate on elective surgery and acute care, usually of the less complex variety. But the public hospitals, at least on a regional basis, carry out a full range of treatments, including accident and emergency, and are required to have contingency plans to meet a wide variety of disasters, epidemics, and so on. The private hospitals perform fewer services ‘in house’ and buy in more goods and services, often from the public hospitals.

Asset utilisation can be measured in various ways: as income over total fixed assets or, better, value added or net output over total fixed assets. The nearer the ratio gets to one, the better is asset utilisation.

We have compared the trusts with: private sector hospitals, despite their different mix of activities; hotel groups because most hospitals are hotels for the ill; and the giant food retailers because they use expensive space to deliver a service and, as befits a nation of shopkeepers, they are considered to represent the best of British private sector management.

But a word first about the basis of asset valuation. Private sector companies record their assets at their purchase price or historic cost with occasional revaluation. Hospitals, however, were required to value their assets at current replacement cost which is much higher than the original purchase price. Second, the trusts’ income is set, in effect, by the government, and not even the government admits that trusts are overfunded.

The net result is that both parts of the asset utilisation ratio handicap hospitals. Nevertheless, the table shows that the results of comparison are really quite devastating.

Contrary to popular opinion, asset utilisation in the acute trusts is exemplary, and superior to that in private sector organisations like Marks and Spencer, Forte and BUPA.

Despite the private sector’s advantages of historic cost valuation and commercial freedom of manoeuvre, the public sector’s margin of superiority over private sector operations such as Forte and Tesco is greater than 2:1.

The comparison with private sector hospitals is particularly interesting: asset utilisation in acute trusts is arithmetically the same as General Healthcare and twice as good as BUPA hospitals. Despite the triple handicap of current cost asset valuation, low income and a huge demand for their services, the trusts performed better than BUPA and the same as General Healthcare — a truly heroic achievement.

The private hospitals spend less of their value added on labour: BUPA spends 64-75 per cent, General Healthcare spends 61 per cent, while the trusts spend 85 per cent. How have the private hospitals been able to achieve a lower ratio?

Their wage costs per employee are more or less the same, even though they employ few or no senior medical staff as patients pay their consultants and anaesthetists directly, or via insurance, without the payments going through the hospital books. So they are not actually achieving a lower labour share of value added via lower wages.

Their staffing levels are much lower than would be expected on the basis of income — about one third the level of trusts. But finance directors are adamant, as indeed are their nurses, that there are more staff per comparable case than in the public sector. This means that the lower staffing levels are not achieved via different and more efficient work practices.

Rather they are achieved by concentrating on activities which maximise throughput with conveyor belt treatments: hips, hernias and hysterectomies; and cases with a lower labour content. This is a result of concentrating on elective surgery rather than providing a full service. So their lower labour costs depend upon their ability to choose their case mix — like the privatised buses — and not technically superior efficiency.

For trusts to increase the surplus to cover capital charging, the answer is to improve flow or alter activity mix to improve throughput via conveyor belt treatments.

But the results are perverse from two points of view. First, only those treatments which can maximise patient flow and income will be given; this will mean concentrating services at certain sites, and closing others, especially the more expensive inner city sites, to reduce costs. There will be ever larger and fewer hospitals, increasingly inaccessible to those without cars.

Second, it involves a policy of early discharge and short stay. So the increased efficiency is achieved by passing costs on to primary care and patients’ families. The government may represent this as an efficiency gain (for the trusts), but it is hard to reconcile this with the notion of social healthcare provision and social efficiency.

The logic of a financially driven system entails forms of treatment which are high-tech and short-stay; favouring those living in suburbs rather than inner cities; and those who are basically well rather than those who are chronically sick.

Capital accounting was justified on the basis that it would allow NHS hospitals to be evaluated alongside the private sector. But evidence shows that the public hospitals have little to learn from private hospitals in terms of cost management or asset utilisation.

Finally, we should perhaps be grateful to the last government. By raising the question of the relative efficiency of the public and private sector, and by reconfiguring the public sector on a quasi private sector basis, we are able to demonstrate its superiority and put paid to the myth of inferior efficiency. The public policy implications that flow from that are truly revolutionary.