NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

In the past decade, we have seen an increased ability for developing countries to support private enterprises, due to advances in infrastructure, talent development, technology, a growing middle class and access to various forms of capital. In the past few years, we have seen this growth affect the private health care market, causing investors to increasingly look at health care in developing countries as an investable sector instead of one dependent on government or philanthropic subsidy. And why wouldn’t they? Private health care in most developed countries is a trillion-dollar industry, with the sector making up approximately 20 percent of the U.S. economy. There is plenty of precedence for thriving private health care marketplaces.

With this increased interest, and an assumption that there needs to be private sources of health care in developing markets to adequately serve the growing populations, there is an acute need to find the business models that work to ensure the market dynamics are favorable for investment. One way to do so is to understand which market tools should be translated and adapted from developed countries and which should be left behind.

One of the market mechanisms used often in the developed market context is cross-subsidy. So the question I’ll explore today is: Does the global health delivery market need cross-subsidization to survive? And if yes, are investments in goods or services targeted to the middle- or high-income brackets also investments that benefit the bottom of the pyramid?

Cross-subsidy typically comes into play when morality enters the marketplace, in industries or sectors like health care, education and housing. In these sectors, there is a moral obligation of the government and the people to provide goods or services to all, regardless of their ability to pay, and there is a public good created when a greater portion of the population has access to these services. This effect – however noble and just – skews the equation and creates a market flooded with demand without the necessary incentives for adequate supply.

To counter this effect, governments and policymakers tend to set up Robin Hood-esque business models and industry structures to take from the higher income populations to subsidize the services for the poor. The question then becomes one of quality, and whether this cross-subsidization creates one, better system for all or bifurcated systems serving different populations.

In education and housing, at least in developed countries like the U.S., it has skewed toward the latter. In education, the cross-subsidy comes from parents who send their children to private schools, but continue to pay property taxes to fund the local public school system. This model does not promote one, improved system, but creates two types of schools – arguably of much different quality – one that serves families who have the ability to pay and one for those who do not.

Similarly in housing, the government assesses a fee on every home purchase and taxes homeowners to help fund affordable or public housing in the community. Historically, this has also fueled separate systems with differing quality, although there are some interesting trends toward mixed-income housing that attempts to break down the barriers between the two systems.

In health care, cross-subsidy is baked into the current system, with commercially insured patients paying significantly more for goods and services than those on Medicaid or the uninsured, but in most areas this cross-subsidy incentivizes providers of care (medical professionals and hospitals) to increase the quality of care for all populations served. More than education and housing, this attempts to build one system to serve everyone.

This is, of course, nowhere near perfect, and there are plenty of providers who refuse to see the uninsured or those with Medicaid (hopefully this will change as more of the population becomes insured under the U.S. Affordable Care Act), but every person has the right to walk into any hospital’s emergency department for care.

When investors and intermediaries start to think about building more robust, private health delivery systems in developing countries, it is natural to look at existing systems for lessons from past successes and failures. In general, because most of my work experience has been focused on the dysfunctional U.S. health care system, my immediate reaction is to replicate nothing and build a new system from scratch. But it is hard to ignore the effect of income disparity on the health system in developing markets and even harder to imagine a system that does not leverage the cross-subsidy model to ensure that the poor have access to quality care.

If you believe that for the private health care system to thrive, you have to target middle or higher income populations to improve access and quality for poor, then perhaps impact investors and other “field builders” should be thinking more broadly about which investments have the greatest impact on the populations we all want to serve.

As the Calvert Foundation looks to understand the global health marketplace to see if there is a need and role for our capital to build systems, these are the types of questions swirling in our heads. I recognize that there are scores of people out there who have been grappling with these questions for much longer, and with more depth, than I have and I would love to hear about any new or established solutions that address these questions.

Beth Bafford is a senior officer of strategic initiatives at the Calvert Foundation.