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date: 20 June 2018

Market Failures, the Environment, and Human Health

Summary and Keywords

Knowledge of the important role that the environment plays in determining human health predates the modern public health era. However, the tendency to see health, disease, and their determinants as attributes of individuals rather than characteristics of communities meant that the role of the environment in human health was seldom accorded sufficient importance during much of the 20th century. Instead, research began to focus on specific risk factors that correlated with diseases of greatest concern, i.e., the non-communicable diseases such as cardiovascular disease, asthma, and diabetes. Many of these risk factors (e.g., smoking, alcohol consumption, and diet) were aspects of individual lifestyle and behaviors, freely chosen by the individual. Within this individual-centric framework of human health, the standard economic model for human health became primarily the Grossman model of health and health care demand.

In this model, an individual’s health stock may be increased by investing in health (by consuming health services, for example) or decreased by endogenous (age) or exogenous (smoking) individual factors. Within this model, individuals used their available resources, their budget, to purchase goods and services that either increased or decreased their health stock. Grossman’s model provides a consumption-based approach to human health, where individuals purchase goods and services required to improve their individual health in the marketplace. Grossman’s model of health assumes that the goods and services required to optimize good health can be purchased through market-based interactions and that these goods and services are optimally priced—that the value of the goods and services are reflected in their price.

In reality, many types of goods and services that are good for human health are not available to purchase, or if they are available they are undervalued in the free market. Across the environmental and health literature, these goods and services are, today, broadly referred to as “ecosystem services for human health.” However, the quasi-public good nature of ecosystem services for human health means that the private market will generate a suboptimal environment for both individual and public health outcomes. In the face of continued austerity and scarce public resources, understanding the role of the environment in human health may help to alleviate future health care demand by decreasing (or increasing) environmental risk (or benefits) associated with health outcomes. However, to take advantage of the role that the environment plays in human health requires a fundamental reorientation of public health policy and spending to include environmental considerations.

Keywords: demand for health, human capital, public goods, environment

Introduction

Among the numerous goals pursued by human beings, a healthy and long life is undoubtedly of the utmost importance (Lo & Hsieh, 2013). Knowledge about the important role that the environment plays in determining human health predates the modern public health era (Morris & Saunders, 2017). However, the individualization of public health and its focus on individual risk factors meant that the role of the environment in human health was seldom accorded sufficient importance during much of the 20th century (Morris & Saunders, 2017). As the negative implications of environmental change on human health becomes clearer, the closing decades of the 20th century and the early years of this century have seen a rekindling of public interest in the role of the environment in human health outcomes (Morris & Saunders, 2017; Watts et al., 2015, 2017; Whitmee et al., 2015). Notably, water and air pollution as well as lack of access to green space have been associated with poor physical and mental health outcomes in both developed and developing countries. The WHO estimates that, in 2012, 12.6 million deaths (23% of all deaths worldwide) were attributable to modifiable environmental factors (Prüss-Ustün, Wolf, Corvalán, & Niera, 2016). Conversely, recent research has demonstrated the wide variety of positive health outcomes associated with nature-based experiences. This includes improved physical health, improved mental well-being, greater social well-being, and the promotion of positive health behaviors (e.g., physical activity) (Shanahan et al., 2016; Ward-Thompson et al., 2012). The socio-economic patterning of residential opportunities means that individuals who are constrained financially face limited choices of where to live, and they are more likely to reside near major sources of pollution, including roads with high traffic density, industrial facilities, waste disposal facilities, or airports (Gunier, 2003; Perlin, 1999). The effects of environment on health outcomes are therefore heterogeneously mediated across different populations, with poorer populations disproportionality impacted by poor environmental conditions (Watts et al., 2017; Whitmee et al., 2015). Within this context, research has also evidenced that a positive environment can also mediate health outcomes across poorer populations (Roe et al., 2013; Ward Thompson et al., 2012).

As the negative implications of environmental change on human health become clearer, the closing decades of the 20th century and the early years of this century have witnessed a renewed focus on the environment as a public health concern. Within the academic literature, this focus is highlighted by the emerging One Health (Whitmee et al., 2015), Planetary Health (Mi, Mi, & Jeggo, 2016), and EcoHealth (Gibbs, 2014) initiatives. Each of these three initiatives reflects a growing concern that rapid and irreversible rates of environmental degradation will harm human health and well-being in ways that cannot be undone and “cured” by medical treatments. The capacity for the environment to mediate health outcomes, particularly in developing countries and poorer communities within developed countries, means that understanding the role of economics and the free market in determining environmental outcomes is of vital importance to health policy. This relationship is particularly relevant given that nearly a decade has passed since widespread global austerity measures were introduced in response to the great recession of 2007 (Stuckler et al., 2017), which saw large increases in the risk factors associated with poor health (unemployment, poverty, homelessness, etc.) at the same time that large cuts were made to health care services (Stuckler et al., 2017).

The Economics of the Environment and Human Health

The standard model for health and health care in the economic literature is the Grossman model (1972). In this model, an individual’s health stock may be increased or decreased by both individual (endogenous) factors such as age and exogenous factors such as health care services. Within this model, individuals used their available resources, their budget, to purchase goods and services that either increased or decreased their health stock. The capacity to invest (or disinvest) in one’s health through the purchasing of goods and services highlighted the importance of the “free market,” the system in which goods and services are traded, in mediating individual health outcomes.

However, Grossman’s model of health assumes that the goods and services required to optimize good health can be purchased through market-based interactions and that these goods and services are optimally priced—that the value of the goods and services are reflected in their price. In reality, many types of goods and services that are good for human health are not available to purchase in the free market, or if they are available they are undervalued in the free market. In economics, this is referred to as “market failure.”

The Free Market and the Environment

One of the first principles of free markets is that for them to work effectively, the full costs of a good or a service must be borne by the involved parties (Scorse, 2010). However, in reality, many types of goods and services are undervalued in the free market, and this can lead to the under- or overproduction of these goods and services. The market fails to allocate and price the goods and services associated with the environment and human health due to externalities and public goods.

An externality exists when a person or firm does not receive all of the benefits or bear all of the costs of their actions. The “polluting factory” is a classic example of a negative externality whereby the social costs of air pollution are not covered by the polluter or reflected in market prices, but these costs (including health impacts) are imposed on everybody. This results in a suboptimal price and thereby excessive production (or consumption) of the good that generates the externality (Kougea & Koundouri, 2011). While the polluting factory presents a neat example for students new to the discipline of economics, its (negative) externality is fundamentally true of all environmental goods and services. In terms of human health, many of the goods and services provided by nature (e.g., carbon sequestration) provide positive externalities that are not reflected in market prices—nobody pays for carbon sequestration, but everyone enjoys the health benefits.

Most goods are private in nature: their consumption can be withheld until a payment is made in exchange, and once consumed they cannot be consumed again. These goods are exclusive and rivalrous in nature. That is, if one person buys that good or service, then no other person can purchase that good or service. In contrast, a public good is one where, once the good is provided, it cannot be restricted and is therefore available to all (i.e., non-excludable), and consumption by one individual does not limit consumption of that same good by others (i.e., non-rival in consumption). Because people can enjoy the benefits of public goods whether they pay for them or not, they are usually unwilling to pay for them. Consumers acting in their own self-interest have no incentive to voluntarily pay for these goods. This in turn creates what is known as the “free rider problem.”

Public goods are rarely “pure,” as both excludability and rivalry are relative, not absolute, concepts (Woodward & Smith, 2003). For example, rivalry in consumption may be relative to capacity, particularly in the case of the built environment. For example, if a sewage system has spare capacity, its use is non-rival, but as its capacity is approached, the use of the infrastructure becomes rivalrous. Between the extremes of pure private and public goods lie two further categories of goods and services (Woodward & Smith, 2003). First, “common pool goods,” such as forests, are non-excludable but rivalrous in consumption: the environmental benefits of forests are not excludable, but if they are used for logging these benefits are forgone. Second, “club goods” are, conversely, excludable but non-rivalrous, with the benefits spread among a subgroup of the population, whose membership may be controlled by the providers of the good or others. An example with regard to the environment includes private parks, which have the characteristic of non-rivalry for those who subscribe to them, with non-subscribers being excluded. Thus, the classification of a good as public or private may be somewhat misleading (Woodward & Smith, 2003). Rather, it is more appropriate to discuss the degree to which these goods may be subject to excludability and/or the degree to which their consumption is rivalrous.

In reality, many public goods are only non-excludable to those who have the requisite private goods to access them (Woodward & Smith, 2003). For example, a car may be required to visit a park. Such private goods are referred to as “access goods.” The need for access goods not only reduces the overall benefits (making the balance between costs and benefits less favorable) but may also lead to perverse targeting: those who have access goods are likely to be the better off, so that the benefits of providing public goods will tend to be skewed away from the poor (Woodward & Smith, 2003).

In theory, the goods and services offered by the environment—clean air and water and aesthetic beauty—should be both non-rivalrous and non-excludable. However, in reality, the environment from an economic perspective is an imperfect or quasi-public good. The spatial pattern of housing prices is an important example of how the environment can be an imperfect public good and display both excludable and rivalrous attributes. Healthy places usually cost more to live in, and this price difference effectively represents the value of a healthy environment to that homeowner or renter. However, many reasons exist as to why individuals cannot necessarily always live in a healthy environment. This can be due to factors at the individual level (e.g., poverty or work requirements) or wider societal factors (e.g., a housing price bubble or lack of housing stock). Individual wealth and income become “access goods” to a healthy environment in the free market. This relationship was further intensified in response to the great recession and the austerity measures that followed, with increases in homelessness and poor housing and housing environments becoming widespread (Stuckler et al., 2017).

Outlining the economic theory of market failure, this section documented why the goods and services offered by the environment that benefit human health are unlikely to be produced if left to the private/free market. The standard economic model for human health is the Grossman model of health and health care demand. Within this model, individuals use their available resources to purchase goods and services that either increase or decrease their health stock. Grossman’s model provides a consumption-based approach to human health, where individuals augment their endogenous health by purchasing goods and services in the marketplace. With its implicit focus on the private market, the next section introduces Grossman’s demand-for-health framework and highlights the framework’s failure to provide a healthy environment for public health.

Grossman and the Demand for Health

According to traditional demand theory, each consumer has a “utility” or “preference function” that allows him or her to rank alternative combinations of goods and services purchased in the market. Consumers are assumed to select that combination that maximizes their utility function subject to an income or resource constraint. While this theory provides a satisfactory explanation of the demand for many goods and services, Grossman was the first to articulate that health is a consumptive good because it has value (it makes people feel better), while simultaneously acting as an investment good (since good health enhances earning capacity and the amount of time available for leisure activities).

Extending Becker’s (1965) human capital formation model, Grossman stated that an individual’s health capital is determined by the initial level of the “stock” (given at birth); it depreciates with the time elapsed and can be increased (decreased) by positive (negative) investment in health over time (Lo & Hsieh, 2013). When the stock of health capital falls below a critical level at some point of time, death occurs. According to Grossman’s human-capital framework, individuals invest in health (e.g., medical care, exercise) for the consumption benefits (health provides utility) as well as production benefits (healthy individuals have greater earnings) that good health provides (Galama, 2015; McCarthy, 2006). The input of market goods and the individual’s own time determine the production of additional health capital, subject to each consumer’s budgetary constraints.

Within this framework, good health is demanded and supplied as a commodity in the free market. Since the most fundamental law in economics is the law of the downward sloping demand function, the quantity of health demanded should be negatively correlated with the price of health-inducing goods and services. As the price for health-inducing goods and services increase, the demand for these goods and services will decrease.

Figure 1 illustrates the determination of the optimal stock of health capital at age t, given an individual’s budget constraint. The demand curve, referred to as the marginal efficiency of (health) capital (MEC) by Grossman (1972), shows the relationship between the stock of health and the rate of return on an investment. The supply curve S shows the relationship between the stock of health and the cost of capital. Provided the MEC schedule slopes downward, the equilibrium stock is given by H*, where the supply and demand functions intersect. Efficiency is defined as the amount of health obtained from a given amount of health inputs. Importantly, shifts in individual-level endogenous variables (such as age, socio-economic status, income, etc.) will alter the optimal amount of health and also alter the derived demand for health inputs. For example, older people will demand higher levels of health inputs. The cornerstone of health economics, Grossman’s demand-for-health model, posits that human health is a product of these endogenous factors that can be bought and sold in the free market.

Market Failures, the Environment, and Human HealthClick to view larger

Figure 1. Determinant of the optimal stock of health capital at any age i.

However, in reality, both public and private goods can affect the profile of health capital accumulation and therefore determine the timing of death (Lo & Hsieh, 2013). As mentioned, the important role that the environment plays in human health is once again becoming a focal point of research on in human health. However, what of the role of the goods and services provided by the environment in Grossman’s demand-for-health model? Many of the health benefits provided by nature are intangible or provided outside the private market. Point A in Figure 2 represents the equilibrium demand and the supply of health inputs subject to an individual’s budget constraint without the value of the positive externalities associated with the environment for human health taken into consideration. The market equilibrium of environmental goods and services for human health are underproduced (H1). H2, the intersection at Point C, represents the efficient level of goods and services required to ensure human health. If the goods and services provided by the environment for human health were a perfect public good, P1 would represent a price ceiling due, and the triangle represented by Points A, B, and C would represent the welfare loss from the under-production of an environment conducive to human health.

Market Failures, the Environment, and Human HealthClick to view larger

Figure 2. Market failure in the private market for the environment and human health.

However, as outlined previously, public goods are rarely “pure,” as both excludability and rivalry are relative, not absolute, concepts. The role the residential housing market plays in maintaining human health is an important example of how the environment can be an imperfect public good. Houses in healthy places, neighborhoods free of air and water pollution with ample green space, cost more to live in. The price difference for houses in healthy neighborhoods and those in less healthy neighborhoods represents a proxy of the value of a healthy environment to that homeowner or renter. Thus, H2, better health, can be achieved in an indirect manner through the private market, and P2 becomes the new equilibrium price.

Many reasons exist as to why individuals cannot necessarily always live in a healthy environment. This can be due to factors at the individual level (e.g., poverty or work requirements) or wider societal factors (e.g., a housing price bubble or lack of housing stock). Individual wealth and income become “access goods.” Thus, there will be individuals without the necessary access goods to move to P2. These individuals remain paying P1, and their health status becomes H1. The imperfect or quasi-public good of the environment outlined earlier means that the free market is unable to provide an optimal level of environmental goods and services required to maintain human health for the entire population. This in turn can lead to geographically based health inequalities due to environmental inequalities (Briggs et al., 2008; Crouse et al., 2009; Gunier, 2003; Perlin, 1999; Richardson et al., 2011).

The importance of the free market in Grossman’s demand-for-health model provides an economic perspective on why interest in the physical environment as a component of human health waivered in the 20th century (Morris & Saunders, 2017). This is not to say that Grossman’s model influenced public policy on the environment and human health. Instead, it signified the manner in which public policy and researchers began to think about human health whereby the focus centered on the “individual + free market” as the ultimate equation for human health. Within the context of market failure, the next section discusses the use of a subsidy to incentivize the market to produce a healthy environment.

Individual Health as a Public Good and the Rationale for Government Intervention in the Environment

Although health is an individual attribute (Morrissey, Clarke, Ballas, Hynes, & O’Donoghue, 2008) and generally is not considered a public good, consider another popular first-year economics example, the role of individual health and vaccinations in controlling infectious disease. A person without an infectious disease or someone who is vaccinated bestows a “public externality” on those around them. From a market perspective, this healthy person is more productive and the economy benefits. Furthermore, a vaccinated person will not infect others, and they too benefit from this vaccination because they can continue to lead a healthy and productive life. The benefit of a healthy individual is thus greater than the economic return that that individual receives from their healthy status.

Although the private housing market may provide a method by which individuals can pay for a healthy environment, the role of “access goods” (i.e., wealth) means that not all individuals are currently able to live in healthy areas. While acknowledging individual health from a public good perspective, there is a strong rationale for governments to ensure a socially optimal level of health inputs. Indeed, the positive spillover effect created by a healthy individual to the wider society is one of the key arguments for a free universal health system (Lo & Hsieh, 2013). Within this context it can be argued that given the well-established role that a healthy and safe environment plays in individual and public health, there is a rationale for government intervention to ensure a healthy environment for all. However, due to the quasi-public good nature of the environment, the private market will fail to reflect a socially optimal price for environmental goods and services. Economic instruments, such as taxes, subsidies, and the introduction of charge systems, can be employed in order to internalize externalities into the decision process. Given the role of the housing market in determining where people live, one example could be the subsidization of better-quality housing in healthy areas for poorer households. However, in order to incorporate the price of the environment within a public health framework, the monetary benefits (or conversely damages) to the public health of a good (poor) environment must be calculated (Kougea & Koundouri, 2011).

While the current monetary benefit of a healthy environment to individual health outcomes is unknown, methods such as willingness to pay (WTP) are available to provide monetary estimates for non-market goods and services. (See Kougea and Koundouri (2011) for a review of methods that may be used to provide monetary estimates for the economic cost of air pollution (an environmental bad) on human health.) Briefly, non-market valuation approaches allow economists to calculate the monetary value of a healthy environment with regard to individual health outcomes. The valuation results from these methods are crucial for the formulation of economic instruments to internalize the externalities created by the public nature of environmental resources. Using a non-market valuation approach means that the cost of a healthy environment can be included with the other market costs (such as the costs of medicine or visiting a doctor) of maintaining an individual’s health. Internationally, the use of monetary valuation techniques in environmental appraisal has increased significantly (Kougea & Koundouri, 2011). Techniques such as the contingent valuation and choice experiments that can estimate values for both users and non-users are being intensively used and are being constantly refined and extended (Dickie & List, 2006; Kougea & Koundouri, 2011).

Within the public health sphere, Kougea and Koundouri (2011) provide a review of the economic literature, which has attempted to elicit monetary values associated with air pollution and human health. Based on their review, Kougea and Koundouri (2011) recommend that for the true cost of the environment to human health to be adequately valued, improved scientific information is needed in order to be able to produce more reliable dose–response functions and thus more credible economic estimates of the values. To provide accurate monetary estimates of the benefits of reduced health symptoms associated with environmental hazards (Kougea & Koundouri, 2011), note that interdisciplinary collaboration between economists and epidemiologists, based on real-world circumstances and innovative research methods including the use of mixed methods (Buse et al., 2018), is required.

Discussion

The health of the environment and human health and well-being are intimately linked, and the environment affects health in a variety of ways (Remoundou & Koundouri, 2009; WHO, 2009). As noted by Morris and Saunders (2017), the importance accorded to the environment as a mainstream public health issue arguably reached its lowest point in the decades following World War II when the tendency to regard health and disease as characteristics of individuals, rather than communities or populations, gained prominence. From an economics perspective, the individualization of health is highlighted by the Grossman’s demand-for-health model, which became the cornerstone of health economics from the 1970s. Grossman’s model signified the manner in which public policy and researchers began to think about human health, whereby the focus centered on individuals and their personal capacity to interact with the private market as the key to maintaining human health and well-being.

However, worldwide initiatives such as the Planetary Health initiative (Whitmee et al., 2015), EcoHealth (Mi et al., 2016), and One Health (Gibbs, 2014) reflect a growing concern that the rapid and apparently irreversible rates of environmental degradation will harm human health and well-being in ways that cannot be undone and “cured” by medical treatments. Building on the wealth of evidence that demonstrates the role that the environment plays in maintaining human health, this article argues that protecting human health should be a primary goal of environmental policy. Furthermore, in the face of continued austerity and scarce public resources, understanding the role of the environment in human health may help to alleviate future health care pressures by decreasing (increasing) environmental risk (benefits) associated with human health.

To this end, non-market valuation techniques such as contingent valuation and choice experiments can and should be employed to estimate the value of environmental goods and services to human health (Dickie & List, 2006; Kougea & Koundouri, 2011). The quasi-public good aspects of the environment mean that government intervention is required to ensure a healthy environment for all, and economic valuation techniques can help policymakers choose appropriate policy interventions.

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