Implications of Basing Health Care Resource Allocations on Cost-utility Analysis in the Presence of Externalities

The application of economic evaluation methods to the analysis of health care services and programs has grown steadily over the past two decades. One form of economic analysis in particular - cost utility analysis (CUA) - is receiving considerable attention from researchers and policy makers. Although CUA was originally applied primarily as a technique for choosing among treatment options for a defined disease or patient population, it is now increasingly being advocated as a tool for helping to establish funding priorities across a wide variety of health care programs and potential beneficiaries. In this paper we argue that CUA, as currently applied, is insufficient for providing information on allocative efficiency because it excludes externalities, a potentially significant source of societal utility (and disutility). The exclusion of externalities may bias the priority ranking of programs in unpredictable ways and ultimately lead to a systematic non-optimal allocation of health care resources.