Implications of basing health-care resource allocations on cost-utility analysis in the presence of externalities

Cost-utility analysis is increasingly being advocated as a tool for helping to establish funding priorities among programs and services in the health-care sector. As currently conducted, however, cost-utility analysis is problematic as a basis for achieving allocative efficiency because it excludes externalities. The exclusion of externalities may bias program ranking in unpredictable ways, leading to a non-optimal allocation of resources. Consideration of externalities also raises a number of distributional issues for the evaluation of health services and highlights the important of developing economic evaluation methods that are consistent with the conceptual basis for allocating resources.