Healthcare as
Market Failure

1.1 The Myth of the Health Market

In a well-functioning market, buyers and sellers freely exchange goods at prices that reflect their true value. The buyer has choice, information, time, and the freedom to walk away. This mechanism generally works for tomatoes, mobile phones, and construction materials. It does not work for healthcare, and economists have long recognized this failure. Healthcare is unique in several structural ways that make the normal rules of the market not just inadequate, but actively harmful to the population it is supposed to serve.

The simplest way to understand this is through a contrast. When you go to a market to buy a mango, you can look at it, smell it, press it, compare its price to the mango next to it, and walk away if the price is too high. You are the boss of that transaction. But when you arrive at a hospital with severe chest pain, you cannot look around for a better deal. You cannot wait a few weeks. You cannot verify whether the proposed treatment is truly necessary. You are entirely dependent on the knowledge, honesty, and availability of the person treating you. This fundamental asymmetry transforms health from a commodity into something that requires a completely different system of governance.

1.2 The Three Core Reasons Healthcare Fails as a Market

1.2.1 Information Asymmetry

The doctor knows what is wrong with you. You do not. This gap in knowledge — described in economic literature as information asymmetry — is the root cause of healthcare market failure. When a mechanic tells a car owner who knows nothing about engines that five parts need replacing, the owner cannot challenge this. The same dynamic applies even more powerfully in healthcare, where the stakes are not a car but a human life.

This asymmetry destroys the bargaining power of the patient. In any other market, the buyer can comparison-shop, research independently, or seek a second opinion at low cost. In healthcare, particularly in low-income settings and emergency situations, these options are absent. The provider sets the terms, and the patient, in pain and fear, accepts them.

1.2.2 The Unpredictability of Illness

Markets function when buyers can plan their purchases. Health crises do not arrive by appointment. A surgery needed today cannot be saved for when money is available next month. This inability to smooth consumption over time means that illness strikes with full financial force at the moment of lowest resilience for most families. Poor households, by definition, lack the savings buffers to absorb sudden large expenses.

The result is predictable and documented globally: families sell productive assets such as livestock, land, or tools; withdraw children from school; borrow at exploitative interest rates; or simply forego necessary care and accept preventable deterioration or death. All of these consequences represent not just personal tragedy but broader social and economic harm.

1.2.3 Catastrophic Financial Impact

The World Health Organization defines catastrophic health expenditure as health spending that exceeds 10 percent of total household consumption, or 40 percent of non-food household expenditure. For households near or below the poverty line — the majority in Dili, Timor-Leste — even a modest hospital admission, a single imaging study, or a short course of specialist medicines can cross this threshold.

No one should suffer financial hardship as a consequence of using health services.

— World Health Organization, World Health Report, 2010

The WHO and World Bank joint monitoring report of 2023 documents that approximately two billion people globally face financial hardship due to health costs, with one billion pushed into extreme poverty by out-of-pocket health payments annually. Least Developed Countries and Small Island Developing States are disproportionately represented in these figures. Timor-Leste belongs to both categories.

1.3 Supplier-Induced Demand: When the Provider Creates the Need

A particularly dangerous consequence of information asymmetry in a commercialized health system is what health economists call Supplier-Induced Demand (SID). First formally described by Robert Evans in 1974, SID occurs when healthcare providers recommend services not primarily because of clinical need but because of financial incentives tied to service volume.

In a fee-for-service model — where a clinic, laboratory, or specialist is paid per exam, per procedure, or per consultation — the financial interest of the provider is served by doing more. The patient, lacking medical knowledge, cannot distinguish between a clinically necessary MRI and one ordered to generate revenue. They comply, pay, and may be harmed by the financial consequence even when the procedure itself is harmless.

SID is not merely a theoretical concern. It has been documented across both high-income and low-income health systems wherever fee-for-service payment dominates. The WHO explicitly warns that fee-for-service creates incentives for providers to increase service volume in ways that generate unnecessary care and push patients into financial hardship.

2.1 Why the State Must Intervene

The case for state intervention in healthcare is not ideological — it is structural. When a market fails, meaning it systematically produces outcomes that harm participants and society, the standard economic justification for leaving it to private actors collapses. Healthcare markets fail by their own internal logic. They exclude the poor, reward overtreatment, punish the vulnerable at their most vulnerable moment, and generate incentives that are misaligned with health outcomes.

The WHO's articulation of Universal Health Coverage (UHC) — reaffirmed in the 2019 United Nations Political Declaration on UHC — places two core obligations on governments: first, to ensure that all people have access to the health services they need; and second, to ensure that the use of those services does not expose people to financial hardship. These are not aspirational wishes. They represent the minimum standard of a health system that a modern state is expected to deliver.

2.2 The Pooling of Risk: Making Everyone Share the Burden

The most powerful tool governments have for financial protection in healthcare is the pooling of risk across the entire population. This is the foundational logic of health insurance, whether public, social, or mandatory: everyone contributes according to their means, and everyone draws according to their need.

In practical terms, this means that healthy people subsidize the sick, and that the economic consequences of illness are distributed across society rather than concentrated on the family of the patient. When functioning well, such a system means that no household is financially destroyed by illness, because the cost is spread widely enough that no individual share is catastrophic.

Thailand's Universal Coverage Scheme, launched in 2002, is frequently cited by the WHO as a model for middle- and low-income countries. By enrolling nearly the entire population and using public funds to cover the poorest, Thailand achieved near-universal financial protection within a decade. The lesson for Timor-Leste is that a national health fund — even modest in scope — is not a luxury but a structural necessity for financial protection.

2.3 Price Regulation: Setting the Ceiling on What Can Be Charged

Without price controls, providers in an information-asymmetric market can charge whatever the market will bear when patients are at their most desperate. A government committed to financial protection must establish maximum tariff schedules for defined health services: what the ceiling price for a blood test is, for an ultrasound examination, for a specialist consultation.

This practice is standard across health systems that have achieved high levels of financial protection. France, Germany, South Korea, and Taiwan all maintain regulated fee schedules for services reimbursed under national insurance schemes. In the context of a regulatory authority such as AIFAESA, establishing and enforcing such tariff schedules would be a direct and enforceable mechanism for protecting patients from predatory pricing.

2.4 No Refusal of Emergency Care

A fundamental protection that government regulation must guarantee is that no person seeking emergency care is turned away on the basis of inability to pay. This principle — codified in law in many countries — recognizes that the immediate threat to life overrides any financial consideration, and that sorting out payment is a secondary concern to be managed by the health system, not by the patient.

Public hospitals and clinics, owned and operated by the state, are the primary vehicle for this protection. Unlike private businesses, public facilities do not close because their neighborhood is poor. Their mandate is defined by need, not by profitability, and they serve as the safety net that catches those who fall through every other layer of the system.

3.1 The Small Market, High Fixed Cost Trap

The case of Dili, Timor-Leste, illustrates a specific and severe version of health market failure that is common to small, low-income economies. It can be described as the small market, high fixed cost trap, and its logic is as follows.

Modern diagnostic and therapeutic equipment is extraordinarily expensive. A computed tomography scanner costs between five hundred thousand and one and a half million US dollars, with a useful operational life of seven to ten years and annual maintenance costs that typically run to fifteen or twenty percent of the purchase price. Laboratory analyzers, ultrasound machines, and surgical equipment involve comparable capital commitments. The cost of reagents, consumables, and medicines adds recurring expense that is largely fixed regardless of patient volume.

Private investment in health services must recover these costs through the revenues generated by services provided. In a large city with a substantial middle class, this arithmetic may balance. In Dili, with a population of fewer than 250,000 and the majority at or near the poverty line, the realistic paying clientele for private specialist services may number fewer than 50,000 people. The investor facing this market has only two options: charge very high prices per service, or push volume aggressively by recommending services beyond clinical need. Both outcomes are harmful.

This is also a natural monopoly problem. The market is too small to support competition among multiple providers of expensive equipment-dependent services, but also too small to support even a single provider who is financially stable, charges fair prices, and restricts recommendations to clinically justified procedures. The mathematics of the market in this context do not produce good medicine. They produce extractive medicine or no medicine.

3.2 The Tendency Toward Supplier-Induced Demand in Small Markets

The pressure toward supplier-induced demand is particularly acute in small markets where equipment investment is large. An investor who has spent a million dollars on a scanner and has a population of paying patients insufficient to fill the schedule has a powerful financial motive to fill that schedule by other means. This means pressure on clinicians to order scans, incentive structures that reward referrals, and the gradual corruption of clinical judgment by financial interest.

This is not merely a theoretical risk. The medical literature documents this pattern wherever fee-for-service medicine and high-capital equipment coexist in constrained markets. In the absence of strong regulation, the interests of the investor and the interests of the patient diverge dramatically, and the investor — controlling the facility, the equipment, and the income of the clinicians — is structurally dominant.

The WHO's Private Sector Engagement Framework of 2020 explicitly acknowledges this risk and identifies regulatory oversight, transparent pricing, and the prohibition of self-referral as minimum conditions for private sector participation in a health system oriented toward UHC goals.

3.3 Is Requiring Business Plans from Private Health Investors Reasonable?

The question has a clear answer grounded in health economics, regulatory theory, and WHO policy: yes, it is not only reasonable but necessary. However, a business plan requirement alone is insufficient and must be embedded in a comprehensive regulatory architecture.

An investor whose financial projections assume a patient volume that is three times the realistic paying population is either deceiving the regulator or deceiving themselves. Either way, the result will be a facility that either collapses mid-operation — leaving patients stranded — or survives by predatory practices that harm patients financially. The WHO's framework for private sector engagement supports pre-licensing assessments that include financial sustainability analysis for precisely this reason.

4.1 Certificate of Need Legislation

One of the most directly relevant regulatory instruments for Timor-Leste's context is Certificate of Need legislation. Under CON systems — used in various forms across Europe and other jurisdictions — a private provider must demonstrate that proposed new equipment or a new facility is genuinely needed by the population before receiving a license to install or operate it.

In Dili, this would mean that if a government hospital or existing licensed facility already provides functional ultrasound services, a new investor proposing to install multiple additional ultrasound machines must demonstrate the clinical and demographic justification. Without such a requirement, investors install equipment and then create demand for it — meaning clinicians begin ordering examinations that were never clinically indicated, simply because the machine needs to earn its keep. CON legislation directly addresses the small market problem by preventing the oversupply of expensive equipment that creates irresistible financial pressure toward unnecessary care.

4.2 Prohibition of Self-Referral and Conflict of Interest Controls

A clinician should not financially benefit from the laboratory, imaging center, or pharmacy to which they refer patients. This conflict of interest is one of the most reliably documented drivers of unnecessary health services globally. When a physician earns income from every scan they order beyond their consultation fee, their clinical judgment is contaminated by financial interest.

Regulations prohibiting self-referral — the Stark Law provisions in the United States, similar provisions across the European Union — are a minimum requirement for any licensing framework governing private health facilities. AIFAESA regulations should explicitly prohibit any financial arrangement that gives a referring clinician a direct or indirect financial stake in the facility or service to which they refer patients.

4.3 Regulated Tariff Schedules

The government, through the relevant regulatory authority, should establish and publish maximum tariff schedules for defined health services. These schedules should be developed with reference to the actual costs of providing services at an efficient scale, the affordability constraints of the population, and the need for providers to maintain financial viability. Tariff schedules must be enforced through regular inspection, patient complaint mechanisms, and meaningful sanctions for violation.

4.4 Social Obligation Clauses in Operating Licenses

Private health facilities seeking to operate in Timor-Leste should be required, as a condition of their license, to fulfill defined social obligations. These might include providing a minimum percentage of services — for example, fifteen to twenty percent — at subsidized or zero cost to verified low-income patients. In exchange, the government may offer offsetting benefits such as access to public procurement contracts, referral agreements with public facilities, or expedited licensing processes.

This approach transforms private providers from purely extractive actors into participants in the national health system with defined equity responsibilities. It reflects the WHO's position that the private sector can contribute to UHC goals, but only under conditions of accountability, transparency, and alignment with equity objectives.

4.5 Pooled Equipment and Shared Services Models

Given the small market constraint, the government should consider actively promoting or requiring pooled equipment arrangements among private providers. Rather than each clinic purchasing its own CT scanner or high-end laboratory analyzer, a consortium of clinics might share access to a single machine on a scheduled basis. This reduces individual capital investment, reduces the break-even pressure on each facility, and reduces the financial incentive to push unnecessary procedures. The WHO has promoted shared service models specifically in the context of Pacific Island nations and Small Island Developing States, recognizing that the economics of small markets require cooperative rather than purely competitive arrangements.

4.6 Mandatory Reporting and Ongoing Audit

A licensing regime that does not include ongoing monitoring is inadequate. Private health facilities in Timor-Leste should be required to submit annual financial and operational reports allowing the regulatory authority to track pricing, service volumes by category, patient volumes by economic status, and any patterns that suggest supplier-induced demand. Anomalous patterns — for example, a facility performing three times the expected rate of a particular diagnostic procedure — should trigger inspection. Sanctions for violations must be meaningful and consistently applied.

5.1 Universal Health Coverage as the Organizing Goal

The WHO defines Universal Health Coverage as a state in which all people can access quality health services without suffering financial hardship. This definition contains two equally important components: access and financial protection. A system that provides access to services that then bankrupt the patient has achieved only half of the goal.

UHC is not synonymous with a fully public health system. The WHO's framework explicitly accommodates mixed public-private systems. What it requires is that the regulatory and financing architecture of the system, regardless of who owns the facilities, delivers both access and financial protection to the entire population, including the poorest.

5.2 The Six Building Blocks of Health Systems

The WHO's health systems framework identifies six building blocks essential to a well-functioning system: service delivery, health workforce, health information systems, access to essential medicines, financing, and leadership and governance. Financial protection is embedded in the financing building block, which the WHO describes as requiring health systems to raise sufficient funds, pool risk across the population, and protect individuals from catastrophic expenditure.

Regulation — the domain of AIFAESA — sits within the leadership and governance building block, which the WHO describes as the foundation of a well-functioning health system. It encompasses the rules, norms, and accountability mechanisms that shape the behavior of all other actors in the system, including private investors.

5.3 The WHO Position on Private Sector Engagement

The private sector is a major provider of health services in most countries. Governments need to engage with, regulate and where necessary harness the private sector to achieve UHC goals.

— WHO, Engaging the Private Sector for UHC, 2020

This statement captures the nuanced position the WHO occupies on private sector participation in health systems. It neither endorses unregulated private markets nor calls for the elimination of private providers. It calls for governance — meaning conditions, obligations, and accountability mechanisms that align private sector behavior with public health goals.

The WHO explicitly identifies the following risks of unregulated private sector health provision: exclusion of the poor through unaffordable pricing; unnecessary services driven by financial incentives; catastrophic payments imposed on vulnerable households; and erosion of public trust in the health system. In small, low-income markets like Timor-Leste's, these are the predictable default outcomes of unregulated private health investment.

5.4 Financial Protection as a Human Right

The 2019 United Nations Political Declaration on UHC, endorsed by all Member States, frames financial protection in health not as a policy preference but as a dimension of the right to health. This framing has practical implications for government: it means that allowing a health system to bankrupt its citizens is not merely a policy failure but a failure of a fundamental obligation to the people.

For Timor-Leste, a country whose constitution enshrines the right to health, this framing should inform every regulatory decision about private sector health investment. The question is not simply whether an investor can make a profit. The question is whether the presence of that investor in the market makes it more or less likely that a poor family in Dili will be pushed into poverty by the cost of keeping their child alive.