Document of

The World Bank

Report No. 15399-MK

STAFF APPRAISAL REPORT

FORMER YUGOSLAV REPUBLIC OF MACEDONIA

HEALTH SECTOR TRANSITION PROJECT

May 24, 1996

Human Resources Sector Operations DivisionCountry Department IEurope and Central Asia Region

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CURRENCY EOUIVALENTSCurrency Unit = Macedonian Denar (MKD)

EXCHANGE RATES

June 1995 December 1995 February 199637. 1 MKD/US$ 38.0 MKD/US$ 38.0 MKD/US$

WEIGHTS AND MEASURESMetric System

ABBREVIATIONS AND ACRONYMS

ALOS Average Length of StayAMPPHC Assistant Minister for Primary and Preventive Health CareCAS Country Assistance StrategyCEE Central and Eastern EuropeDALY Disability-Adjusted Life YearDHIF District Health Insurance FundDoP Department of PharmaceuticalsEME Established Market EconomiesFESAC Financial and Enterprise Sector Adjustment CreditHSTP Health Sector Transition ProjectIDA International Development AssociationIPU International Project UnitLDP Letter of Development PolicyMKD Macedonian DenarMOH Ministry of HealthNHIF National Health Insurance FundNIPH National Institute for Public HealthPHC Primary Health CarePHRD Policy and Human Resources Development GrantPIP Project Implementation PlanPPF Project Preparation FacilitySDR Special Drawing RightTC Technical CommitteeUNICEF United Nations International Children's Emergency Fund

FORMER YUGOSLAV REPUBLIC OF MACEDONIA - FISCAL YEAR

January 1 - December 31

STAFF APPRAISAL REPORT

FORMER YUGOSLAV REPUBLIC OF MACEDONIA

Health Sector Transition Project

TABLE OF CONTENTS

Page

Credit and Project Summary ............................................. i

I. HEALTH SECTOR BACKGROUND ..................................... I

A. Introduction .................................................. IB. Issues for Health Sector Reform ...................................... 3C. Government's Reform Strategy for Health .............................. 11

11. PROJECT DESCRIPTION .......................................... 14

A. Project Objectives .............................................. 14B. Project Components ............................................ 14C. Project Justification ............................................. 19

III. PROJECT COST, FINANCING, MANAGEMENT AND IMPLEMENTATION ........ 27

A. Project Cost .. . 27B. Project Financing .. 27C. Project Management and Implementation.. 28D. Project Supervision .. 28E. Procurement Arrangements .. 28F. Disbursements .. 29G. Project Audits and Reporting .. 29H. Status of Preparation .. 30

IV. PROJECT BENEFITS AND RISKS ................................ 31

A. Benefits .................................................... 31B. Risks .......................... 32

V. AGREEMENTS REACHED AND RECOMMENDATIONS .................... 33

This report is based on the findings of a preappraisal mission which visited Skopje in September/October 1995.The mission was comprised of: Ms. E. Goldstein (Sr. Human Resources Economist/Task Manager); Dr. R.Castadot (Sr. Population & Health Specialist); Dr. Denis Broun (Pharmaceutical Specialist); Dr. Olusoji Adeyi(Health Economist); Mr. Suwat Pananon (Information Technology Specialist); Ms. Sabrina Huffman (OperationsAnalyst); Mr. R. Anthony (Consultant/Health Finance and Management); Dr. E. Lauridsen(Consultant/Pharmaceutical Policy and Supply); Dr. C. Collard (Consultant/Basic Health Services); and Ms. A.Kadihasanoglu (Consultant/Project Implementation). Details concerning project scope, content, costs, and financingwere finalized during the visit of a Government delegation to Washington in December 1995. Ms. Alvire Paul wasresponsible for document processing. Peer Reviewers were: Messrs. M. Over, A.Preker, and G. Schieber. Mr.Ralph W. Harbison is the Division Chief, and Mr. Kenneth Lay, Country Director.

Table of Contents (Continued)

TEXT TABLES

Table 1. 1: Comparative Demographic and Health Indicators ......................... 2Table 1.2: FYR Macedonia: Fetal and Infant Death, 1991-1994 ...................... 4Table 1.3: Age-Standardized Mortality Rates, Selected Causes and

Countries, 1991 ......................... 5Table 1.4: Health Revenues and Expenditures, 1991-1995 .......................... 6Table 1.5: FYR Macedonia: Health Services, 1991-1994 .......................... 7Table 1.6: Average Length of Stay in Hospitals, 1993 ............................ 8

ANNEXES

Annex 1: Letter of Development PolicyAnnex 2: Project Implementation Plan - Policy Matrix: Progress BenchmarksAnnex 3: Selection Among Alternative Project DesignsAnnex 4: Statistical Data

MAP IBRD 25501

FORMER YUGOSLAV REPUBLIC OF MACEDONIA

Health Sector Transition Project

STAFF APPRAISAL REPORT

Credit and Project Summary

Borrower: Former Yugoslav Republic of Macedonia

Beneficiary: Ministry of Health (MOH), National Health Insurance Fund (NHIF), National Instituteof Public Health (NIPH) and selected district health facilities.

Credit Amount: SDR 11.8 million (US$16.9 million equivalent)

Tenns: Standard IDA; 35 years, including 10 years grace.

Project Obiectives: The dual objective of the Health Sector Transition Project (HSTP) is to: (i) improve thehealth of the population by enhancing the quality of basic health services; and (ii) supportan initial phase of policy reforms to increase cost-effectiveness, fiscal sustainability andpatient choice within the health system.

Project DescriDtion: Project objectives will be achieved through activities under the following threecomponents, each designed around a core policy agenda:

(i) Health Finance and Management (base cost US$3.8 million): The objective is to buildcapacity to analyze and apply information for policy-making and health systemmanagement. Support will be provided fortechnical studies, strengthening of managementskills in the MOH, NHIF and health facilities, and the development of managementinformation systems.

(ii) Basic Health Services (base cost US$7.0 million): The objective is to strengthenprimary health care and health promotion, particularly in rural areas. Support will beprovided to equip rural primary health care centers, upgrade skills of primary carepersonnel and supply essential materials to five high-priority disease prevention programs.

(iii) Pharmaceutical Policy and Supply (base cost US$5.7 million): The objective is toreduce the cost of essential drugs through reforms which create a more competitivepharmaceutical market. Essential drugs for primary care will be provided, along withtechnical advice, training and equipment to improve public procurement, reimbursementand quality control.

Total project cost is estimated at US$ 19.4 million equivalent (including contingencies).This includes US$ 0.9 million to support establishment of an International Project Unit(IPU) within the Ministry of Health (MOH) responsible for coordinating theimplementation of project activities. The Project will be implemented over three yearsby the Ministry of Health and associated health institutions.

Project Benefits: The economic benefits of the Project include better quality basic health services and amore cost-effective use of public resources for health--both of which will counteract thenegative impact of recent economic and fiscal contraction on the health of the population.

Health Finance and Management: This component provides economic and fiscal benefitsthrough its impact on the allocation of public resources for health. It will result in areallocation of public resources toward more cost-effective health interventions, as wellas limitation of health expenditures to fiscally sustainable levels. The component

ii

implements a basic benefits package for health insurance based on cost-effective treatmentof national health priorities, and tailored to available resources. It also creates incentivesfor efficiency and quality of care, through the establishment of new provider paymentmechanisms; and improves resource management through strengthening of managerialskills and provision of management tools.

Basic Health Services: Cost-effective reduction in the burden of disease, throughimproved preventive and curative primary care, is the major economic benefit of thiscomponent. With continued high levels of infant mortality due to infectious diseases andmaternal mortality due to high-risk pregnancies, as well as rapidly rising prematuremortality due to chronic diseases associated with unhealthy lifestyles, it is clear thatpreventive and curative primary care is the most cost-effective way to reduce multipleelements of the burden of disease. The component will result in adequately staffed andequipped rural primary health care centers, and more effective reduction of the leadingcauses of infant, child, maternal and other premature mortality through support fornational prevention programs.

Pharmaceutical Policy and Supply: The benefits of this component lie in its economy-wide impact on the price of essential drugs, as well as the direct provision of essentialdrugs for more effective primary care. Provision of drugs will be linked to reforms aimedat increasing the affordability and availability of essential drugs. Legislative andregulatory reform will ease market entry and create incentives to market lower-costdrugs. Reform of public sector procurement and reimbursement procedures will lowerunit costs for drugs, and channel public resources toward more cost-effective drugs. Theeconomic and fiscal gains of the component far outweigh its economic costs, with fiscalsavings in the three-year period conservatively estimated at ten times the investment cost.These large economic and fiscal benefits will continue beyond the life of the Project.

Prolect Risks: The Project faces two key risks--one political, the other institutional. The political riskis that the country cannot muster the political will necessary to implement fundamentalhealth sector reform, particularly with respect to limiting insurance benefits, squeezingeconomic rents out of the pharmaceutical market and consolidating the public sectorfacilities network. Government has only the health care consumer on its side, facingpowerful medical and pharmaceutical interest groups. To reduce this risk, the followingstrategy has been pursued. First, technical working groups with broad stakeholderparticipation were formed at an early stage for strategy formulation and projectpreparation. Second, the project preparation team engaged in early interaction with themedia. Third, early efforts were made to market the emerging reform strategy to keyeconomic policymakers. Finally, and most importantly, resources have been included inthe Project to support a vigorous communications strategy, in order to inform andpersuade major stakeholders.

A secondary risk lies in the weak institutional capacity of the MOH, and its limitedexperience in implementation of internationally funded projects. The MOH has a directstaff of only 25, with mostly medical--as opposed to managerial--training. To alleviatethis risk, the Project will invest heavily in building managerial capacity within the MOHand NHIF, as well as supplementing implementation capacity by providing localmanagement consultants to support the IPU. Although the reform agenda supported bythe Project is substantive, project investments are simple, and organized into a smallnumber of procurement packages. Medical equipment and drugs accounting for morethan 40 percent of the IDA credit will be procured by a local agent with sophisticatedinfrastructure and a strong track record of international purchasing and local distribution.

iii

Estimated Proiect Costs "Local Foreien Total-----------------US$ million---------------

Health Finance & Management 1.2 2.6 3.8

Basic Health Services 1.7 5.3 7.0Primary Health Care 0.6 2.4 3.0Prevention Programs 1.1 2.9 4.0

Pharmaceutical Policy and Supply 1.0 4.7 5.7

Project Management 0.7 0.2 0.9

Total Base Costs 4.6 12.9 17.5

Physical Contingencies 0.2 1.2 1.4Price Contingencies 0.1 0.4 0.6

Total Project Costs 4.9 14.5 19.4

Financine Plan

Government of FYR Macedonia 2.5 0.0 2.5IDA 2.4 14.5 16.9

Total Financing Requirements 4.9 14.5 19.4

IDA Fiscal Year Estimated Disbursements(US$ million equivalent) 2/

FY97 FY98 FY99Annual 6.2 8.2 2.5Cumulative 6.2 14.4 16.9Cumulative as % of total 37.0 85.0 100.0

1/ Figures may not total due to rounding.2/ Assumes project effectiveness by September 1996.

I. HEALTH SECTOR BACKGROUND

A. Introduction

Economic and Political Context

1.1 Former Yugoslav Republic of Macedonia (FYR Macedonia), the poorest republic in theformer federated state, has spent the five years since independence struggling to avoid internal conflictand gain full political and economic recognition from the international community. The country has beenforced to address structural problems in the economy which it inherited from Yugoslavia, while externalforces--notably regional conflict, trade embargo and transport blockade-- severely constrained economicperformance. As a result, real income dropped by nearly 40 percent between 1990 and 1994, to anestimated per capita GNP of only US$790 in 1994. The deterioration in living standards has beenexacerbated by an inevitable fiscal crisis, which has undermined the social safety net and provision ofsocial services. Now, with tentative resolution of the regional conflict, and lifting of the trade embargoand transport blockade, FYR Macedonia can begin to move beyond the crisis stage, deepening thestructural reforms necessary for resumption of growth. Key to the success of economic reform and tolong run economic growth will be provision of a fiscally sustainable social safety net and the effectivedevelopment of human capital.

Health Status, Services and Financinrg'

1.2 By Central and Eastern European (CEE) standards, FYR Macedonia has a youngpopulation and relatively high fertility rate, resulting in positive population growth. During the 1960-90period, the population enjoyed steadily improving health status, with rapidly declining infant and maternalmortality. The infant mortality rate dropped from 112 per 1,000 live births in 1961 to just 28 in 1991,with life expectancy rising from 61 to 72 years. Since the advent of the transition, improvement in healthstatus has stagnated--a key issue for health sector reform, as discussed below. Although life expectancyin FYR Macedonia falls below that in established market economies (EME) countries, it equals or exceedsthat in other CEE countries and far surpasses that in developing countries at similar income levels. Whilelife expectancy is on par with higher income CEE countries, the determinants differ considerably. Infantmortality in FYR Macedonia is twice the CEE average, while premature adult death due to chronicdisease and injury is far lower. In short, the country is not as far along in the demographic andepidemiologic transition as other CEE countries--with both positive and negative implications for health.

11 See Annex 4: Statistical Appendix. For a more detailed discussion of health status, services and financing, see the sector note"Former Yugoslav Republic of Macedonia: Health Services in Transition", September 1993.

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Table 1.1: Comparative Demographic and Health Indicators, 1991

FYRM EME CtEE Developing Countries

Weighted Weighted Columbia Morocco CongoAverage Average

Per capita income (US$) 1150 21,183 1,390 1,260 1,030 1,120

Crude birth rate 17 13 I l 24 32 49

Crude death rate 7 9 9 6 8 16

Crude rate of natural increase 10 4 2 18 24 33

Pop. growth 1980-91 (% p.a) 1.1 0.6 -0.2 2.0 2.6 3.4

Population age 0-14 (%) 24.0 19.4 20.0 35.0 41.0 45.5

Life expectancy (male) 70 73 67 66 61 49

Life expectancv (female) 74 80 75 72 65 54

Total fertility rate 2.3 1.7 2.1 2.7 4.3 6.6

Infant mortality rate 28 8 17 23 57 115.0

Maternal mortality ratio 11 7 29 -- Estimated at 100-200 --

"Excluding Albania and the former republics of Yugoslavia.Source: Statistical Office, WHO World Health Statistics and World Bank, World Development Report 1993.

1.3 Real income growth was not the sole determinant of improving health status in pastdecades. The health system also made a positive contribution, offering universal coverage, broad risk-pooling, wide access to facilities, abundant and relatively well-trained personnel and effective publichealth activities, such as immunization and vector control. FYR Macedonia inherited a highly-decentralized and locally-funded health system (based on the former "Self-managed Communities ofInterest") which tended toward fragmentation, duplication and interregional inequities in the quality ofcare. The country was divided into 33 districts (five in the capital, Skopje), each of which had its ownnetwork of facilities which were "socially owned" by health workers and communities. In 1994, thesesocially-owned facilities were converted into a single network of public sector health facilities under thesupervision of the MOH. The 33 districts remain, with 17 medical centers (each a complex of secondaryhospital and outpatient polyclinic) and associated primary health care (PHC) centers. The country alsohas 14 disease-specific or chronic care treatment hospitals, as well as a university complex of tertiary carefacilities in Skopje. The public sector network consists, on average, of a PHC center per 6.,000inhabitants and a general secondary hospital per 110,000 inhabitants. Private health services wereauthorized in 1991, and have grown most rapidly in pharmaceuticals (wholesale and retail) and dentistry,where private expenditures tend to be concentrated.

1.4 To overcome regional inequities in the quality of care, and maximize risk-pooling for apopulation of only 2.1 million, the district health insurance funds were unified into a centralized NationalHealth Insurance Fund (NHIF) in 1991. Reimbursement of private health services by NHIF, as well asthe development of private health insurance, were also authorized at that time. Despite decentralized

financing in the past, the insurance system had uniformly offered universal coverage and a comprehensivebenefits package (preventive, curative, rehabilitative and chronic care), with no out-of-pocket costs. Theinsurance system was, and is, financed predominantly through payroll contributions equaling 8.6 percentof gross wages (payroll contributions as a whole--not including personal income tax--equal 31 percent ofgross wages). Health insurance contributions from the active labor force (wage earners and self-employed) have provided around 60 percent of public revenues for health in recent years, with anadditional 23 percent from the Pension and Unemployment Funds to cover pensioners and registeredunemployed. Approximately 15 percent of revenues derive from user fees and other sources, and another2 percent from the central budget, to cover MOH administrative costs and support national diseaseprevention programs. Public expenditures for health (not including cash transfers for sick pay) havefluctuated at around 7-8 percent of GDP in the past four years, contracting roughly in proportion to theeconomy. This contraction in spending--35 percent in real terms since 1990--has undermined the qualityand availability of basic health services, and given great urgency to the need for structural reform in thefinancing and provision of health services.

B. Issues for Health Sector Reform

Preventable Burden of Disease

1.5 FYR Macedonia has succeeded in long-run improvement of health status, but continuesto suffer from a burden of disease which is largely preventable through cost-effective interventions at theprimary level. Two areas merit particular attention. Infant mortality (at 28 per 1,000 live births in 1991)remains twice as high as the average for CEE countries, and three times the average for EME countries.The long-term downward trend in infant mortality stagnated during the early transition, reflecting generalsocioeconomic decline and the breakdown of basic health services-'. Approximately 40 percent of infantdeaths occur after the first month of life, largely as a result of infectious diseases. More than one quarterof infant mortality is attributable to diarrheal disease and acute respiratory infection--both preventable ortreatable through cost-effective primary care. High-risk populations (generally poor, rural and/ormembers of ethnic minorities) in FYR Macedonia have infant mortality rates of 40 or more, and a largershare of infant deaths due to infectious disease and malnutrition. These high rates reflect differences inmaternal education, as well as more high-risk pregnancies and lower rates of prenatal care, attended birthsand immunization coverage among these populations. More effective health promotion, prenatal care,nutrition education and clinical services for maternal and child health are needed at the primary level tofurther reduce infant mortality.

if Recent declines in the infant mortality rate result from a sudden and implausible 30 percent decline among certain high-riskpopulations, which is likely to be attributable to declining participation in vital registration, rather than a significant improvement inhealth status.

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Table 1.2: FYR Macedonia: Fetal and Infant Death, 1991-1994(per 1,000 live births)

1991 1992 1993 1994

Stillborn rate 8 9 9 10

Perinatal mortality rate 19 22 20 20

Infant mortality rate 28 31 24 23

Neonatal mortality rate (0-28 days) 16 16 14 14

% of which due to premature delivery and (39)low birthweight

% of which due to respiratory conditions (16)

Post-neonatal mortality rate (28-364 days) 13 14 10 9

% of which due to diarrheal diseases (25)

% of which due to acute respiratory (17)infection

Source: Statistical Office.

1.6 The second area of concern is the long-term buildup in premature death due to chronicdiseases associated with unhealthy lifestyles. FYR Macedonia is beginning to see chronic disease deathrates usually seen in far wealthier, post-industrial societies. This is particularly true for cardio- andcerebrovascular diseases, which are by far the leading causes of premature death in both men and women,and are associated with risk factors such as high-fat diet, lack of exercise, smoking and alcoholconsumption. Stress and social dislocation associated with the economic transition have undoubtedlyexacerbated this situation. Age-standardized death rates for cardio- and cerebrovascular diseases are 20-40 percent higher than in much wealthier neighboring countries such as Greece and Italy, and are risingtoward the extreme levels seen in countries such as Hungary and Poland. Age-standardized rates forother leading causes of death for men (lung cancer, liver disease) and women (breast cancer, stomachcancer) are still below most EME countries, but rising steadily. Improvement in health status in FYRMacedonia has ground to a halt during the transition as a result of trends in infant mortality and deathdue to chronic diseases. If the country does not use health resources more cost-effectively for primaryand secondary prevention, it may soon face the worst of both worlds: infant mortality rates reminiscentof developing countries and death due to chronic disease on par with wealthy post-industrial countries.

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Table 1.3: Age-Standardized Mortality Rates. Selected Causes and Countries. 1991(deaths per 100,000 inhabitants)

Aocue Trachea Breat Stonach Diabetes Chronic Liver/ PulmonaryMyocdial Brhu/_ _ = C r Melfita Cirrhosis Tuberculoses

Aurit 131.7 64.7 n.a 23.9 16 9 41.5 2.4

Greece 94.0 71.2 n.a 14.3 5.9 12.1 1.9

Italy S1.6 82.5 n.s 26.4 21.4 341 1.3

BulPria 101.2 52.6 n.s 27.1 16.9 22.1 3.5

FYRM 110.2 36.5 n.1 27.3 14.8 9.9 6.2

Hwnary 174.0 109.6 n.a 34.6 14.0 79.8 7.5

FemaleAuetris 90.6 18.0 37.4 18.8 25.6 15.7 0.4

Greece 58.3 13.6 24.0 10.3 12 1 5.5 0.8

laly 49.6 13.9 35.2 19.2 39.1 18.1 0.5

Bulari 48.5 12.0 24.1 19.8 25.0 7.9 0.9

FYRM 71.2 7.5 22.8 18.1 26.7 3.1 3.1

Huigay 110.9 27.7 39.7 21.5 22.2 32.6 26

boumce: blatist I a Elce of FYR Maedonia. WHO World Heald Siustics. Based on siaix rdized European population.

IneMfcent Rsoure fU

1.7 Adiustment to declining resources. Between 1991 and 1995, public revenues for healthdeclined by 40 percent in real terms, and have shown no sign of recovery. This decline is the result ofroughly proportional econornic contraction and a shrinking payroll tax base, as socially-owned enterprisesreduced wage payments and employment, emerging private enterprises evaded fiscal obligations andstatutory budget transfers were unfulfilled. The magnitude of the resource decline would have dramaticconsequences in any health system. In FYR Macedonia, ad hoc adjustment in spending resulted in thevirtual elimination of all capital expenditures and slashing of recurrent expenditures for personnel, drugs,medical supplies and maintenance. This ad hoc adjustment was far from optimal, exacerbating long-standing misallocation of resources. Personnel expenditures fell by 45 percent in real terms and drugs by40 percent or more (partially compensated in some years through humanitarian aid), with similar spendingcuts across-the-board. Despite the cuts, arrears in the health sector have mounted to MKD 1.4 billion byend-1995.

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Table 1.4: Health Revenues and ExpDeditures, 1991-1995(000 MKD)

1991 1992 193 1994 195

Health Revenues 81,315 845,222 4,436,759 9,710,745 10,415,654

as % of GDP 9.0 7.2 7.4 7.9 7.6

in real terms (1991 =100) 100 70 62 63 59

Health Expenditures 103,397 986,526 4,835,428 10,420,690 11,391,071

Health Expenditures without cash 917,988 4,651,227 8,758,567 10.413,813transfers

Personnel 48,496 422,345 2,164,327 5,006,289 5,680,552

Drugs 10,805 88,340 328,016 1,190,686 1,497,982

Capital Investment 1,180 10,112 40,622 130,856 197,582

AS A PERCENTAGE OF GDP:

Health Expenditures 11.4 8.4 8.0 8.4 8.4

Health Expenditures without cash 11.4 7.9 7.7 7.1 7.6transfers

Personnel 5.4 3.6 3.6 4.1 4.2

Drugs 1.2 0.8 0.5 1.0 1.1

Capital Investment 0.1 0.1 0.1 0.1 0.1

IN REAL TERMS (1991 = 100)

Health Expenditures 100 64 53 53 50

Health Expenditures 100 60 51 45 46without cash transfers

Personnel 100 59 51 55 54

Drugs 100 55 35 58 63

Capital Investment 100 58 39 59 77

source: National Health Insurance Fu of 5839c77

1.8 While critical operating and investment expenditures have been cut, no fundamentalrestructuring of the public sector health network has occurred. As with other socially-owned enterprises,health facilities have protected employment at the expense of real wages and working capital. To an evengreater extent than in other socially-owned enterprises, public health facilities have not been restructuredor liquidated, but rather have limped along in a largely inoperable state for lack of working capital. Thecombination of poorly paid personnel and shortages of critical drugs and medical supplies has underminedproductivity and the quality of care--particularly at the periphery. Even core public health functions, such

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as childhood immunization, are at risk. In 1992, measles immunization coverage fell from over 90percent to only around 60 percent--with measles epidemics following in 1993-94. Although humanitarianassistance has temporarily shored up the immunization program in recent years, it is clear that the healthsystem needs to adjust to reduced public resources--but in ways which do not jeopardize the health of thepopulation.

1.9 Poor capacity utilization. With 2.4 physicians, 5.5 nursing staff and 5.4 beds per 1,000population, staffing ratios and inpatient capacity in FYR Macedonia are on par with EME countries. Thisis in contrast to many former socialist countries (e.g., Bulgaria, Russia) which have egregious excesscapacity. Nonetheless, FYR Macedonia cannot afford EME standards, and existing capacity in the systemis poorly organized and recent events have reduced demand for health services and shifted basic care upthe network to less cost-effective levels. Decentralization of health financing and management in the pastled to separate district networks of health facilities, with considerable fragmentation and duplication ofservices. District secondary hospitals generally have catchment areas which are too small, and havedramatically different ratios of physicians and nursing staff to occupied beds--implying widely varyingstandards of care for similar acute care needs. Many specialized hospitals were established for treatmentof chronic diseases which today can be handled more efficiently in a general acute care or outpatientsetting.

Table 1.5: FYR Macedonia: Health Services. 1991-1994

1991 1992 1993 1994

Physicians per 1000 pop. 2.2 2.2 2.2 2.2

Qualified nurses per 1000 pop. 2.7 2.7 2.7 2.7

Hospital beds per 1000 pop. 5.45 5.35 5.25 5.2

Hospital admission rate (%) 9.4 9.7 9.2 9.3

Average length of stay (days) 14.4 16.1 17.6 14.1

Hospital occupancy rate (%) 68.2 80 84.2 68.5

of which: general hospitals 59.2 63.5 62.4 62.5

of which: specialized hospitals 75.4 102.9 119 73.2

% children immunized

DPT 94 87 89 91

Measles 90 60 94 91

Polio 94 93 85 95

Tuberculosis 98 87 n.a. n.a.Source: Natio-nal Institute of Public Health and Satstical Office.

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1.10 The breakup of the Yugoslav Federation and the economic impact of transition rneant aloss of non-Macedonian patients in the system, as well as reduced national demand resulting fror, redu, edincome, increased out-of-pocket costs and dissatisfaction with the lack of drugs, supplies and eqL6prn!_nt.In 1991, the hospital referral system was abolished, allowing patients to seek care at any level of thesystem. In search of higher quality care, patients have since moved up the hierarchy, flooding high-costhospital services with basic primary care needs. As a result, the average number of consultations per dayfor a general medicine physician dropped from 20 in 1990 to 10 in 1993. Hospital occupancy rates arelow, with rates in secondary hospitals which serve populations of over 100,000, averaging only 59percent in 1993. At the same time, at the Department of Medical Faculty in Skopje--the top of the healthnetwork pyramid--patient admissions from outside Skopje increased by 40 percent between 1991 and1993, and occupancy rates remain around 100 percent.

1.11 Occupancy and utilization rates are low for all but tertiary care facilities, despite averagelengths of stay (ALOS) which are high and rising. In contrast to a sharply declining international trend,in FYR Macedonia ALOS has remained between 14 and 18 days for the past decade. For most of themajor diagnostic categories, ALOS in FYR Macedonia are two to four times longer than in the UnitedKingdom (see examples below). Thus, the system has both excess capacity and poor utilization ofcapacity--inefficiencies which existing health financing mechanisms fail to squeeze out.

Table 1.6: Average Length Of Stay in Hospitals (days): 1993 data

Reason for Admission FYR Macedonia United Kingdom

Infectious & Parasitic Diseases 22.0 7.3

Neoplasms 18.0 9.5

Complications of Pregnancy & 16.0 3.5Childbirth

1.12 Lack of fiscal sustainability. Like most socialist health systems, that of FYR Macedoniahad offered universal coverage for a comprehensive benefits package with no out-of-pocket costs. Since1991, modest progress has been made in limiting public sector liability to finance health services. TheHealth Protection Law adopted in 1991, and amended in 1993 and 1995, has begun to trim the benefitspackage provided under compulsory national health insurance, and introduce copayments and user feesfor insured services. Services such as cosmetic surgery, thermal baths and certain prosthetic devices areno longer reimbursed through the NHIF. The law also establishes the right to purchase supplementalinsurance for broader coverage, and the obligation to pay out-of-pocket for services not covered byinsurance. The 1993 amendment introduced copayments on insured services, ranging from 10 percentfor hospitalization to 50 percent for certain drugs and supplies. However, copayments are subject tobroad exemptions (children, the elderly, pregnant women, chronic disease patients) which undermine boththeir revenue and incentive purposes. While some progress has been made to limit public sector liability,it has obviously been insufficient to ensure fiscal sustainability, and has not involved a reallocation of

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public resources toward the most cost-effective health interventions. A process is needed to identifyhealth priorities, based on the national burden of disease, and evaluate cost-effective strategies foraddressing these priorities. Coverage and reimbursement rates under the basic benefits package wouldthen need to be further limited, within the envelope of expected resources.

1.13 Lack of incentives for efficiency and quality of care. The financing mechanisms currentlyin place offer no incentives to control costs, increase efficiency and improve quality. The NHIF relieson input-based budgeting (staff, beds) to allocate funds to public sector facilities, without regard forservice volume, efficiency or quality. This budgeting system is a fallback method, following thebreakdown of an earlier "German-style" points system. A lack of cost accounting in public sectorfacilities prevented the accurate valuation of points, rendering the system increasingly irrelevant. Whiletechnically still in operation, the points system currently serves no allocative purpose. The existingbudgeting mechanism transfers no financial risk to providers, and, therefore, provides no incentives forefficient behavior. The lack of appropriate payment mechanisms also prevents the NHIF fromreimbursing private providers, despite its legal mandate to do so. Thus, not only does theunderdevelopment of provider payment mechanisms fail to provide explicit incentives to public sectorfacilities, but it also hinders privatization and private sector development which would offer competitionto the public sector.

1 .14 Inadequacy of managerial skills and tools. Despite past decentralization of the system,many decisions (e.g., staffing ratios, wage levels) were centralized or made by the community council.The managerial function--with managers taking risks and reaping the rewards of autonomous decision-making--was nonexistent. Today, the MOH is committed to increasing managerial autonomy within anappropriate regulatory framework, but facility directors tend to be physicians with no managementtraining. They also have little relevant information on which to base decisions, and few staff with thenecessary capacity to analyze information for decision-making. Health facilities lack a modem costaccounting system, and there is little integration of medical and financial information needed to evaluateefficiency and effectiveness. A systematic assessment of data needs has not been undertaken, nor astrategy developed for the collection and use of data to improve health system management.

Poor Oualitv Services

1.15 Breakdown of primary health care. The quality and availability of PHC services havedeteriorated severely in recent years, particularly in rural areas. More than 40 percent of the populationresides in rural areas, and tends to be older and poorer than the general population. In the most isolatedborder districts, the elderly constitute 10-19 percent of the population. The PHC budget is integrated inthe allocation to the district medical center--with rural PHC centers at the bottom of a budgetary hierarchywhich includes both the general hospital and outpatient polyclinics. Thus, the contraction in resourceshas pinched hardest at the periphery. Separation of budgetary allocations and financial accounting forhospital care, primary care and pharmacies is a badly-needed first step in clarifying financial priorities.In a survey of 247 rural PHC centers, one quarter of those in need of a full-time physician were withoutone. Virtually every center surveyed lacked some basic equipment for routine examination, minor surgicalintervention, sterilization and waste disposal. For example, around 30 percent lacked blood pressuregauges and stethoscopes; 70 percent lacked infant scales and refrigerators; 90 percent lacked an otoscopeor a padded examination table. All were without health promotion materials. PHC staff are also toonarrowly trained, with doctors and nurses lacking a broad preventive and curative approach to familymedicine. Particularly damaging has been the lack of essential drugs at the primary level--a result of poor

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procurement, distribution and reimbursement policies in the public sector.

1.16 Obstacles to affordable drugs. At an estimated three percent, the share of national incomespent on drugs in FYR Macedonia is extremely high by global standards. Approximately half of thisis financed by the public sector. For a small set of tracer drugs (all of which were common, essentialprimary care drugs), it was found that market prices in public and private pharmacies in FYR Macedoniawere five to twenty times world market prices--a differential unjustified by distribution or other costs.Such a situation is not surprising in the lucrative and imperfect pharmaceutical market, and calls foreffective government policy and regulation. Among the current problems: (i) a lengthy registrationprocess which requires cumbersome testing even for generic equivalents of registered drugs; (ii) aprohibition on generic substitution by pharmacists; and (iii) pricing policies which encourageexaggeration of production and import costs and favor the marketing of higher-priced specialty drugs.The public sector's purchasing and reimbursement practices are equally flawed. The public sector doesnot limit its own purchasing or reimbursing to a list of essential drugs for primary and hospital care (theexisting "positive list" includes most drugs registered in the country). The public sector would alsobenefit from bulk procurement of drugs and from a competitive bidding process, both of which wouldlower unit costs. Finally, the NHIF places no ceiling on the amount of reimbursement for a particularproduct (minus the copayment). Thus, the current policy framework provides no incentive to marketlower-cost drugs at competitive prices, and the existing financing mechanism permits this inefficiency toflourish.

1.17 Inadeguate health promotion. Rising death rates from lifestyle-related chronic diseasesand persistent high rates of post-neonatal infant mortality speak to the need for more effective healthpromotion. However, the modern concept of multi-sectoral and multi-media health promotion is largelyundeveloped. FYR Macedonia has some history of health education through a network of Public HealthInstitutes whose dominant function is currently the collection of health statistics. Past health educationefforts were viewed with suspicion by the population, which saw them as a coercive, propagandistic armof the socialist state. Most health education efforts have not benefited from modern techniques of marketresearch and social marketing in order to select appropriate messages and media. Finally, healtheducation and other disease prevention activities have functioned with minimal resources, with spendingamounting to less than two percent of total health expenditures in recent years.

1.18 Since the start of the transition, laudable efforts have been made to reorganize healthpromotion activities according to health priorities, identify alternative funding and collaborate withnongovernmental organizations (e.g., Red Cross) working at the community level. In 1993, governmentactivities were reorganized into eight national disease prevention programs, with funding for non-salaryexpenditures from the central budget, in order to relieve pressure on the NHIF. However, budgetaryfunding has fallen short of expectations, and NHIF resources have too often been channeled to short-termcurative needs by a medical community whose training is overwhelmingly oriented toward curative care.Even the most basic disease prevention programs, such as maternal and child health care, are faltering,and a medium term process of institutional development and resource reallocation is needed before healthpromotion can fully play its role in reducing the burden of disease.

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C. Government's Reform Strategy for Health

1.19 Reform of the health system since independence has included: (i) establishing a centralizedNHIF; (ii) introducing copayments, user fees and penalties for non-contribution; (iii) trimming theguaranteed benefits package; (iv) increasing patient choice (although without retaining an appropriatereferral system); and (v) authorizing private health and insurance services, as well as NHIFreimbursement of private services. The MOH and NHIF also enforced a radical--albeit insufficient--downward adjustment in expenditures in response to fiscal crisis. Government quickly recognized,however, the need for more fundamental reform and restructuring of the health system, in order toreallocate resources toward cost-effective care and ensure fiscal sustainability of public spending. TheMOH took the decision to engage in a process of strategic planning--not only to define the health sectorreform program, but to identify the sequence of reforms most likely to ensure success. In mid-1994,as part of the preparation process for the Health Sector Transition Project five technical working groupswere established consisting of MOH/NHIF personnel and representatives from other ministries, academiaand the medical community3 '. Working together with World Bank and World Health Organizationsupport, these groups began to elaborate a strategy for medium-term health sector reform, includingappropriate sequencing of reform measures. They then identified the core policy agenda to beimplemented during the first phase of reform (1996-99), with support from an IDA project.

1.20 The overriding objective of Government's strategy for health system reform is toovercome the current stagnation in health status by addressing high-priority health problems contributingto infant, maternal and premature adult mortality. To achieve this, reforms will be aimed at: (i)providing universal access to high-quality, basic preventive and curative health services and essentialdrugs; (ii) promoting diversity and patient choice in the provision of services; (iii) establishing moreappropriate roles for the public and private sectors; (iv) ensuring the fiscal sustainability of publicspending for health; and, most importantly; (v) increasing the efficiency of resource allocation and use.In the next three years, the core policy agenda will be implemented in the following areas: (i) HealthFinance and Management; (ii) Basic Health Services; and (iii) Pharmaceutical Policy and Supply.4'

Health Finance and Management

1.21 The objective for health financing reform in the next three years is to ensure universalaccess to basic health services while introducing appropriate financial incentives, ensuring fiscalsustainability and increasing the efficiency of resource use. Central to this goal will be the introductionof a process to identify health priorities and cost-effective interventions, leading to the redesign of thebasic benefits package in order to address key health needs within a sustainable resource envelope.Technical studies have been launched during the project preparation phase to examine the national burdenof disease and the cost-effectiveness of treatment. In redesigning the basic benefits package, supplementalpackages and premia will also be identified for those desiring broader coverage. Establishing an analytic

1/ The five working groups consisted of: (i) Health Finance; (ii) Hospital Care; (iii) Primary Health Care; (iv) Health Promotion; and(v) Pharmaceutical Supply.

F For a more detailed discussion of the nature anid titning of specific policy measures, see the Government's Letter of Development Policyfor Health, included as Annex 1.

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process within MOH for allocating resources will permit periodic adjustment of benefits packages andpremia in line with changing health priorities and resource availabilities. In conjunction with reform ofbenefits, copayment, user fee and penalty policies will be reformed with an eye to eliminating excessiveexemptions, simplifying administration and minimizing barriers to essential health services.

1.22 Health financing reform will also focus on introducing appropriate incentives forefficiency and quality care. The current budgeting system will be superseded by provider paymentmechanisms which: (i) transfer some financial risk to health care providers; (ii) reward providers for theirlevel of effort and efficiency; (iii) remunerate public and private sector providers equally for equalservices; (iv) allow patient choice of physicians; and (v) establish predictable financial outflows from theNHIF. Efforts will focus initially on the design, testing and nationwide implementation of a capitationpayment mechanism for primary health care. At the same time, pilot cost accounting data will begenerated which will permit the introduction of a case-mix based payment mechanism for hospital care.Key to the success of the hospital payment mechanism, as well as to improved facilities management, willbe the design, testing and phased implementation of an integrated medical and financial informationsystem for public sector facilities, with appropriate linkage to the NHIF. This will involve a process ofidentifying data needs, designing data collection mechanisms, developing an appropriate automation planand building analytic skills among future users of the information system. In addition, managementcapacity will be enhanced througli training of MOH, NHIF and health facilities personnel. Intensivetraining of trainers will ensure a core group for dissemination of management techniques and appropriatefeedback to line managers.

Basic Health Services

1.23 The objective of planned reforms in this area is to establish cost-effective, preventive andcurative primary health care as the backbone of the health system. Recently, Government took animportant step in this direction by reestablishing a mandatory referral system, in which individuals arerequired to select a primary physician to serve as the first point of contact for routine care, and thenecessary referral for specialist outpatient and hospital care. In the next three years, Government intendsto redeploy public sector plysicianis to ensure adequate staffing of rural PHC centers, and invest in basicequipment and in-service traininig for PHC staff to provide a broader, family medicine approach.Streamlined PHC teams will be organized in urban areas, and disease prevention programs will bestrengthened and modernized.

1.24 The complex task of restructuring and consolidating the public sector facilities networkwill begin. Measures will be taken to reduce the number of public sector physicians, and limit the futuresupply of doctors, dentists and pharmacists. The essential prerequisites to consolidation of the facilitiesnetwork--an appropriate referral system, adequate cost accounting and financial mechanisms in whichfunds follow patients--will be put in place, followed by development and implementation of aconsolidation plan (to extend into the next phase of reform). An appropriate regulatory framework andpayment mechanisms will be established to promote voluntary and efficient development of private sectorhealth services.

Phannaceutical Policv and Supply

1.25 The goal of pharmaceutical reform in the 1996-99 period is to increase the availabilityand affordability of essential drugs by creating a more competitive pharmaceutical market, establishing

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efficient public sector procedures and promoting rational prescribing practices. A draft Drug Bill hasbeen reviewed by IDA, and will be considered by Parliament in the near future in order to support thereform agenda. It establishes a streamlined registration procedure for generic equivalents, authorizesgeneric substitution by licensed pharmacists and eliminates restrictive pricing policies which favored high-priced drugs. Supporting regulations are being developed, as well as essential drug lists which will serveas the basis for public sector procurement and reimbursement. The public sector will also developcompetitive bidding procedures for bulk procurement of essential drugs for public sector facilities, inorder to lower unit costs. The NHIF will place a ceiling on reimbursement of essential drugs based ona low-cost reference price, as is comnmonly done in many western countries. A National DrugInformation Center will be established to serve as a clearinghouse for global information onpharmaceuticals, as well as to promote rational prescribing practices among physicians and develop mediacampaigns to educate the public about low cost alternatives to branded specialty drugs currently on themarket.

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II. PROJECT DESCRIPTION

A. Proiect Obiectives

2.1 The dual objectives of the Health Sector Transition Project (HSTP) are to: (i) improvethe health of the population by enhancing the quality of basic health services; and (ii) support an initialphase of policy reforms to increase cost-effectiveness, fiscal sustainability and patient choice within thehealth system. These broad objectives will be achieved through activities and reforms under three projectcomponents. The specific objectives of these three components are as follows:

(a) build capacity to analyze and apply information for policy-making and health systemmanagement;

(b) strengthen primary health care and support high-priority disease prevention and healthpromotion programs; and

(c) reduce the cost of essential drugs by creating a more competitive pharmaceutical market.

2.2 Project outcome indicators, as agreed with the Government, to measure the success inachieving these objectives are defined in the Project Implementation Plan (Annex 2, para. 42).

B. Proiect Commonents

2.3 Each component of the HSTP (estimated total cost of US$19.4 million) is defined arounda core policy agenda. Project activities are designed to support implementation of this policy agenda,while reversing recent declines in the quality of basic health care. Therefore, the description of eachcomponent begins with a summary of the core policy agenda, which is outlined in detail in theGovernment's Letter of Development Policy (LDP) for the health sector in Annex 1. Progress infulfilling the agenda set out in the LDP will be subject to joint annual review by the MOH and the IDA.

2.4 During negotiations, Government gave assurances that it will implement the policyreform agenda detailed in the Letter of Development Policy, and will review jointly with IDA progressin carrying out the agenda on an annual basis.

Component I: Health Finance and Manayement (estimated base cost US$3.8 million)

2.5 Core policy agenda. The MOH and the Health Insurance Fund (NHIF) have diversifiedrevenues and reduced public spending for health care in line with reductions in national income and fiscalresources. This has been achieved through dramatic reductions in real wages, drugs, medical supplies,maintenance and investment--but has not been sufficient to avoid the accumulation of arrears in the sector.This ad hoc fiscal adjustment must now give way to a planned adjustment focusing on reallocation ofresources toward more cost-effective health care, appropriate limitations on public sector reimbursementand introduction of financial incentives for efficient and effective care in both the public and privatesectors.

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2.6 The MOH will carry out a comprehensive review of sources and uses of funds in thehealth sector, including existing and potential revenue sources and expenditures for primary care,ambulatory specialists, diagnostic and laboratory services and hospital care. This will provide a broadbasis for carrying out reform of health financing mechanisms. In this first phase of reform, the corepolicy agenda supported under this component will be:

(a) definition of a fiscally-sustainable benefits package (on the basis of burden of diseasepriorities and cost-effectiveness of treatment) to be covered by mandatory national healthinsurance, as well as supplemental premiums and packages;

(b) revision of copayment/user fee policies and penalties for non-contribution to healthinsurance;

(c) adoption of a capitation payment mechanism for public and private sector primary healthcare; and

(d) adoption of an integrated medical and financial information system for the public sectorhealth network, as a prerequisite to defining a new payment mechanism for hospital care.

The nature and timing of these reforms is described in detail in the LDP (Annex 1, paras. 5-9).

2.7 Activities. The Project will provide technical support for preparation and implementationof the health financing reforms summarized above, as a continuation of technical work begun duringproject preparation. Technical support would include a resident Health Financing Advisor responsiblefor coordinating short-term teams of local and foreign consultants to carry out policy studies related toeach reform. The Project will also provide support for public information/advocacy campaigns usingsocial marketing techniques, to enhance understanding and acceptance of health sector reforms amongpolicy-makers, interest groups and the general public.

2.8 The capability of NHIF personnel to analyze and implement policy options would bestrengthened through fellowships and in-country training workshops in health economics, principles ofinsurance, health system planning and public advocacy techniques, as well as a study tour of comparativehealth financing systems. Capacity building for the NHIF office would include technical and financialsupport to develop trainers and training seminars for staff of district HIF offices. The Project will alsosupport a study tour, initial training seminars and development of a continuing education program infacilities management for hospital administrators and medical directors.

2.9 To provide the tools for effective management, and allow for the future introduction ofa case-mix based hospital reimbursement system, the Project will support development and testing of anintegrated medical and financial management information system for public sector health facilities. TheProject will implement the first phase of a medium-term automation plan for this integrated informationsystem. The management information system will be tested in two pilot districts, each of which willreceive an automation package--tailored to the size of the population served and existing hardware--forthe participating Medical Centers (general hospital and polyclinic), two primary health care centers,district Institutes of Public Health (responsible for national health statistics), and district HIF offices.Information technology will also be provided to the NHIF and NIPH offices. The necessary electroniclinkage for data transfer and processing within the NHIF network will be established.

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2.10 Prior to negotiations, Government selected two pilot districts according to agreed uponcriteria for testing of: (i) the medical and financial management information system; (ii) the healthstatistics information system; and (iii) the capitation payment mechanism for primary care.

Component 11: Basic Health Services (estimated base cost US$7.0 million)

2.11 Core Policy Agenda. Government's decision in 1991 to centralize district insurance fundsinto a unified health insurance fund has helped to maintain universal access to care, while allowingmaximum risk-sharing and alleviation of regional inequities in the quality of basic care. In 1992,national disease prevention programs were reorganized, and funding for materials and supplies was shiftedfrom the NHIF to the central budget, as an attempt--with mixed success--to ensure adequate support forhigh-priority prevention and health promotion activities. Greater success was achieved in securinghumanitarian assistance to supply vaccines and essential drugs for health services during the transition.However, this source has dwindled as donors await reform aimed at reorienting public sector resourcestoward primary care. Under the Project, this reform will focus on providing cost-effective primary careas the backbone of the health system, through:

(a) reinstatement of a hospital referral system through mandatory annual enrollment with aprimary care physician;

(b) assignment of full-time physicians to selected rural primary health centers;

(c) adoption of a simplified staffing structure for primary health care teams in urban areas,and of a guaranteed package of primary health services which provides cost-effective care(based on successful models from other countries);

(d) net reduction of at least 200 public sector physicians through attrition (retirement,voluntary privatization) over the three year period;

(e) reduction of enrollments in medical faculties for physicians, dentists and pharmacists; and

(f) provision of adequate central budget funding for selected disease prevention activities.

The nature and timing of these reforms are described in detail in the LDP (Annex 1, paras. 10-16).

2.12 Activities. The MOH working group on basic health services undertook a needsassessment and established a standard equipment list for rural PHC centers. Under the Project, basicequipment kits corresponding to these needs will be distributed to all rural PHC centers in the country(the list of basic equipment proposed is found in the PIP). In the first year of the Project, kits will bedistributed to 150 centers with one or more full-time physicians. The following year, kits will bedistributed to 50 additional PHC centers to which a full-time physician will be assigned. A more limitedequipment kit, appropriate for 50 centers without full-time physicians, will also be distributed in thesecond year of the Project. In addition to equipping rural PHC centers, the Project will provide technicaland financial support for workshops and study tours to help MOH and professional associations developtheir own permanent programs for: (i) continuing education of primary care personnel; (ii) broadeningthe skills of primary care physicians; and (iii) identifying and enforcing quality assurance standards forprimary care. Short-term fellowships will also be provided to develop capacity within the MOH for

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planning and implementation of primary care strategies.

2.13 The Project will provide material support for five national disease prevention and healthpromotion programs for: (i) immunization, (ii) maternal and child health; (iii) tuberculosis prevention;(iv) AIDS prevention; and (v) blood donation and supply. These programs were selected on the basisof their potential impact in reducing the national burden of disease and on the cost-effectiveness of theproposed interventions. With respect to the immunization program, the Project will contribute tomaintaining coverage rates at 95 percent or more. While UNICEF will provide parallel financing formost vaccines needed to combat childhood diseases and control epidemics, the Project will supplynecessary hepatitis B vaccines. In the area of maternal and child health, the Project will provide materialsupport for reproductive health services, as well as drugs and equipment for prevention and treatment ofdisease in neonates and infants. Support will also be given for restructuring and expanding the existingcervical cancer screening program. For prevention of tuberculosis, the Project will improve screeningcapacity through provision of spare parts for x-ray equipment, photographic film and replacement of twodecrepit mobile clinics with one new mobile van. Under the AIDS prevention program, test kits will beprovided for HIV screening. To increase blood supply, the Project will build on the early success ofpublic campaigns aiming to restore donation levels to 60,000 units per annum, by providing support forpromotional materials in several local languages. Finally, the Project will provide equipment andmaterials to strengthen laboratory diagnostics for the prevention and treatment of infectious diseases.

2.14 Prior to negotiations, Government gained parliamentary approval for amendments to theHealth Protection Law reinstating the hospital referral system through annual enrollment with primarycare physicians.

Component III: Phannaceutical Policy and Supply (estimated base cost US$5.7 million)

2.15 Core Policy Agenda. The share of national income spent on drugs in FYR Macedonia isamong the highest in the world. Prescribing practices favor overconsumption, while procurement, pricingand reimbursement policies favor high-priced specialty drugs and limit competition. Private sector activityhas grown rapidly within a largely unregulated environment. An estimated half of national consumptionis financed by the public sector through the NHIF (US$28 million in 1994). Past public spending patternsfor drugs have been difficult to maintain as NHIF revenues have declined by 40 percent in real termssince 1991. Public spending was supplemented with humanitarian assistance in the 1992-94 period, butthis source has dwindled rapidly. The time has come for Government to work within its real resourceconstraints, and focus on more efficient procurement, pricing, reimbursement and prescribing in orderto ensure an affordable supply of essential drugs. With technical support from the World HealthOrganization, the MOH has begun revision of drug legislation, as well as organizing seminars on rationaldrug use and national drug policy. The Project will build on these past efforts, emphasizingimplementation of key reforms in the following areas:

(a) streamlining of registration procedures for equivalent products and authorization ofgeneric substitution;

(b) adoption of pricing policies which favor lower-cost drugs;

(c) adoption of appropriate essential drug lists for primary care and hospital care;

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(d) introduction of competitive bidding for public sector drug procurement;

(e) establishment of a reference price reimbursement system for essential drugs; and

(f) promotion of rational prescribing practices.

The nature and timing of these reforms are described in detail in the LDP (Annex II, paras. 17-24).

2.16 Activities. The Project will provide technical support for further revision of the DrugBill and accompanying regulations with respect to registration, pricing and generic substitution, as wellas establishment of essential drug lists for primary and hospital care. It will build local capacity forcompetitive procurement and for implementation of a reference price reimbursement system for NHIFwhich would place ceilings on allowable payments according to drug type. Capacity-building wouldoccur through external internships in international procurement offices, coupled with follow-up technicalsupport and studies to establish reference prices and carry out initial international tenders for drugs.Essential drugs and supplies from the agreed lists would be procured in the second year of the Project,to ease NHIF resource constraints and provide practical experience in international competitive biddingfor pharmaceutical products.

2.17 Under the Project, equipment, short-term fellowships, in-country training and technicalsupport will be provided to upgrade the present drug quality assurance system. Supply of advanced drugtesting equipment for quality control labs will enable government to match the increasing technicalsophistication of the domestic industry and foreign suppliers. It will facilitate bioequivalence testing topermit rapid introduction of generic equivalents. The Project will also support the establishment of adrug information center, as well as a srnall center for adverse drug reaction monitoring. Parallel fundingfrom EU/PHARE and WHO will contribute to improvements in the drug inspection system, as well asprovide institutional support and training for the drug information and adverse drug reaction centers.Through the drug information center, the Project will support information campaigns directed atprescribers, dispensers and the public to promote more rational use of drugs.

2.18 Prior to negotiations, Government submitted to IDA a satisfactory draft Drug Bill,reflecting the Government's drug policy reform strategy.

2.19 As a condition of effectiveness of the proposed credit Government will sign a contractwith a procurement agency to ensure procurement and distribution of pharmaceutical products, medicalequipment and supplies under the Project in accordance with IDA's Guidelines for Procurement(January 1995). As a condition of disbursement of the pharmaceutical component a Drug Law,satisfactory to IDA, regulating the registration, trade and distribution of drugs in the territory of theBorrower, will be enacted, and all provisions for implementation of this legislation completed.

International Proiect Unit (estimated base cost US$0.9 million)

2.20 The Project will support establishment of an IPU in the Ministry of Health. The IPU willbe responsible for coordination, management and monitoring of the Health Sector Transition Project, aswell as coordination of other donor-funded activities in the health sector. The IPU will be headed by aDirector, with support from a core staff funded under the Project. This core staff will consist of aProcurement Officer, Disbursernent Officer/Accountant, and Office Administrator/Interpreter employed

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full-time for the Health Sector Transition Project.

2.21 IPU responsibilities will include: (i) project administration and coordination (includingliaison with the World Bank and agencies/institutions involved in implementation of the Project);(ii) follow-up and reporting; and (iii) maintaining project records and accounts. It is also expected thatthe IPU will provide a focal point for coordination of health sector reform activities, and assist indissemination of information about the reform program to policy-makers, interest groups and the generalpublic. To facilitate the work of the IPU, the Project will make available funding for short-term foreignand local consultancy services, in project-related areas such as procurement and project management, aswell as policy-related areas such as health economics and private sector development With additionalstaff, the IPU could also serve to coordinate implementation of other donor-funded activities (e.g.,EU/PHARE, UNICEF) to ensure that all externally-funded activities support the MOH's medium-termstrategy for health sector reform.

2.22 Prior to negotiations, Government established the International Project Unit within MOHand appointed a full-time director and procurement officer with authorization to carry out the projectactivities.

2.23 During negotiations, Government gave assurances that the MOH will maintaincontinuous staffing of the IPU to include a Director and staff devoted full-time to the Health SectorTransition Project consisting of a procurement officer, disbursement officer/accountant and officeadministrator/interpreter. It was further agreed that decisions would be taken jointly during projectimplementation for recruitment of additional IPU staff, if necessary to entsure effective implementationof the proposed Project.

C. Project Justification

Proiect Alternatives

2.24 As noted above, the dual objectives of World Bank intervention in the health sector inFYR Macedonia are to: (i) improve the health of the population by enhancing the quality of basic healthservices; and (ii) promote reforms to increase cost-effectiveness, fiscal sustainability and patient choicein the health system. To achieve these objectives, alternative project designs were considered, andultimately rejected for the following reasons-'.

2.25 Improving health status. The known determinants of health status are--in descendingorder of importance--(i) economic status; (ii) lifestyles/behaviors; (iii) quality of the health system; and(iv) environmental risks. Socioeconomic conditions in FYR Macedonia have declined dramatically in thepast five years, exerting a negative impact on health status. Despite strong efforts by Government andthe World Bank to encourage stabilization, structural adjustment and capital investment, economicrecovery is expected to be slow--even if ideal policy and investment decisions are taken. Therefore,improvement in health status must be through countervailing action on other determinants: lifestyles, the

51 See Annex 3, Selection among Alternative Project Designs for a more detailed discussion of options considered.

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health system and the environment. World Bank efforts are already underway to identify and alleviateenvironmental risks, leaving to this Project the task of reducing the burden of disease through behavioralchange and improved health services. Rapid assessment of the leading causes of morbidity and mortalityin FYR Macedonia indicates that no one vertical program would be more cost-effective than broad-basedprimary care in reducing the overall burden of disease--hence support for comprehensive preventive andcurative primary care. Thought was given to investing solely in health promotion programs (which arecost-effective in changing lifestyles in the long run) but ultimately the Project seeks a broader reallocationof public resources toward health promotion--not just an IDA investment--which necessitates restructuringand investment in the health network as a whole. Furthermore, it was not a politically acceptable option.

2.26 Promoting reforms to enhance cost effectiveness, fiscal sustainability and patient choice.The Government has adopted one alternative to increasing the fiscal sustainability of the health system:across-the-board budget cuts which have undermined the cost-effectiveness, quality and availability ofcare. Another alternative--increasing the payroll tax burden--would have a negative impact on the costof labor, and is to be avoided. FYR Macedonia spends a relatively high share of national income (around7 percent) on health, pointing to a need for more effective expenditures, not higher revenues. At thispoint, the only alternative to achieving the goals of fiscal sustainability, cost-effectiveness and patientchoice simultaneously is to reallocate public resources toward more cost-effective health interventions,set limits to public sector financial liabilities and create incentives for efficient and competitive behavioramong health care providers. The Project has been designed to maximize the likelihood of success incarrying out these difficult reforms. Each component was designed around a core policy agenda, withinvestments to support implementation of reforms according to a carefully designed sequence.

Financial Impact

2.27 Public sector. The project investments generate minimal incremental recurrent costs,equal to less than one percent of recurrent health expenditures. Incremental costs associated with theProject are dwarfed by the fiscal savings resulting from reforms supported by the Project. Among thereform measures which will generate fiscal savings are:

(a) definition of a basic benefits package for health insurance within the limits of expectedpayroll contributions (workers, pensioners, registered unemployed);

(b) shifting of care to less expensive levels, through an appropriate referral system;

(c) reduction of public sector health personnel, and reduction of public sector support formedical training;

(d) introduction of financial incentives to prevent unnecessary medical procedures andexcessive lengths of stay; I

(e) establishment of lists of essential drugs for procurement and reimbursement, andadoption of competitive bidding procedures and reference price reimbursement ceilings;

(f) elimination of broad exemptions on copayments and user fees; and

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(g) consolidation of the public sector facilities network (to continue into the next phase ofreform).

The extent of fiscal savings will depend on future decisions about the scope of the benefits package, theessential drug lists and the reduction in staffing and capacity. Initially, the objective will be to reducepublic spending for health in line with expected revenues, preventing further accumulation of arrears andeliminating the existing stock of arrears. Whether there is a further reduction in public resources forhealth--rather than an expansion of cost-effective interventions--is a political decision. One cannot argueon economic grounds that FYR Macedonia is spending "too much" on health, but rather that the countryis not getting enough for its money. The Project will substantially increase the cost-effectiveness ofpublic spending for health, providing the opportunity to reduce the overall resource envelope to asustainable level.

2.28 Private sector. The reform agenda for pharmaceuticals will lower the cost of drugs (thegreatest source of private health expenditures) for everyone by creating a more competitive market andrevising pricing policies. Strengthening of primary care in rural areas will lower the out-of-pocket costsof care for rural populations by reducing travel and waiting costs, as well as eliminating hospitalcopayments and fees for routine care. Elimination of broad exemptions on copayments will raise out-of-pocket costs for patients in specific groups, but care will be taken to reinforce the progressive nature ofcopayments (higher rates for less essential services) and to define a means-tested basis for guaranteeingaccess to basic services for the poor.

Rationale for Public Sector Involvement

2.29 Imperfections and failures in the health care and pharmaceutical markets (externalities,uncertainty, asymmetry of information, market power), as well as societal equity considerations, justifya strong--albeit changed--role for the public sector in the financing, regulation and, in some cases,provision of health services. Public sector financing of health services allows broad risk-pooling(especially in a country as small as FYR Macedonia) to overcome the inefficiency of financial uncertainty.It also allows redistribution to achieve equity objectives. Public sector health financing also serves as aregulatory tool, through payment mechanisms which curb supplier-induced demand for unnecessaryservices and other inefficient behavior by public and private sector providers. For these reasons, theProject supports reform of the existing public sector financing mechanism in FYR Macedonia.

2.30 Many personal health services can be provided efficiently by the private sector once anappropriate incentive structure and regulatory framework are in place. Reforms supported by the Projectaim to eliminate obstacles and create an environment conducive to privatization and private sectordevelopment of health services. However, international experience demonstrates that the private marketwill not offer sufficient incentive to provide socially desirable services in poorer, more isolated areas.For this reason, most governments offer special incentives and/or direct public sector provision of basichealth services in poor, rural areas. Likewise, this Project will strengthen public sector provision ofprimary health care only in targeted rural villages, where public sector intervention is justified.

2.31 The pharmaceutical market is notoriously noncompetitive, particularly in small markets,where monopoly or oligopoly is common. The public sector generally relies on both regulation (e.g.registration procedures, pricing and substitution policies) and direct provision of essential drugs to createcompetition for the private sector. Unfortunately, the public sector itself is often very inefficient in

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providing drugs, so that government failure may equal or exceed market failure. Thus, the Projectsupports not only reforms aimed at creating a more competitive private market, but also measures toincrease the efficiency of Government procurement and distribution.

Rationale for IDA Involvement

2.32 Public sector investment in the health sector is justified on grounds that much of theeconomic benefit of improved health status accrues to society at large, rather than providing a financialreturn to the investor. In the absence of low-cost, domestic capital for public sector investment in humandevelopment, IDA resources are a good choice for FYR Macedonia. The country has also turned to theWorld Bank for assistance in this area because the Bank can provide high-quality technical advice onhealth sector reform from a broad, international perspective. IDA involvement in health sector reformin FYR Macedonia through this Project is consistent with the Country Assistance Strategy (CAS)discussed by the Board of Directors during presentation of the Financial and Enterprise Sector AdjustmentCredit (FESAC; Credit 2721, Report No. P-6539) on April 19, 1995. Key objectives of the CAS includemaintenance of a fiscally sustainable social safety net during the transition period and restoration of long-run economic growth. Broad access to basic health services is an essential element of the social safetynet, while improvement in health status will increase the productivity of human capital in the long run.Health financing reforms also contribute to controlling fiscal deficits which undermine economic growth.Hence, a health sector project has been included in the lending program, even under a low-case scenario.

2.33 Sector work was carried out at an early stage to identify priorities for health sector reformand investment.t' Consultant reports produced in collaboration with the technical working groups duringproject preparation addressed the following topics: (i) health finance; (ii) hospital care; (iii) primary healthcare; and iv) health promotion." FYR Macedonia also participated in the Social Challenges of TransitionExercise, which has provided a comparative view of health systems in nine other CEE countries, greatlyfacilitating strategy formulation. The resulting health sector reform strategy is now serving not only asthe foundation for the Health Sector Transition Project, but also as an input in the definition of thecountry's Policy Framework Paper and the proposed Social Sector Adjustment Loan (FY97).

Cost-Effectiveness of the Project

2.34 Project components were carefully selected not only for the cost-effectiveness of theproposed investments, but also for the impact of associated reforms on the cost-effectiveness of publicresource use in the health sector as a whole. Rigorous cost-benefit or cost-effectiveness analysis of eachcomponent was not carried out during project preparation for two reasons: (i) a broader collaborativeprocess of assessing health priorities and evaluating cost-effectiveness of alternative interventions is anintegral part of the Project itself; and (ii) rigorous analysis was deemed unnecessary to provide anadequate economic justification for the proposed investments. Justification of each component is asfollows:

2.35 Component 1: Health Finance and Management. This component provides economic and

FYR Macedonia: Health Services in Transition, September 1993.

Consultants' reports available in the project files.

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fiscal benefits through its impact on the allocation of public resources in the health sector. During projectpreparation, a process was initiated to assess health priorities by carrying out a national burden of diseaseanalysis, to be followed by use of cost-effectiveness analysis as a tool to define a more appropriatebenefits package for national health insurance. This, more than any other reform, will channel publicresources toward more cost-effective health interventions. The process will continue under thiscomponent, with the objective of not simply revising the initial benefits package, but of buildingpermanent capacity in the MOH to assess health priorities and use cost-effectiveness analysis to makechoices among alternative treatments. The component also supports the introduction of financial incentivesfor efficient behavior by health care providers, and strengthens the management skills and informationtools needed to ensure cost-effective use of resources.

2.36 Component 11: Basic Health Services. The component invests in primary health care asthe backbone of the health system, strengthening, in particular, disease prevention and health promotionactivities. The project preparation team assessed the leading causes of morbidity and premature mortalityin FYR Macedonia--providing a rough indication of the burden of disease. With continued high levelsof infant mortality due to infectious diseases and maternal mortality due to high-risk pregnancies andabortions, as well as rapidly rising premature mortality due to chronic diseases associated with unhealthylifestyles, it was clear that reduction in the burden of disease could be achieved most cost-effectivelythrough preventive and curative care at the primary level. The body of international evidence on the cost-effectiveness of primary health care in addressing multiple elements of the burden of disease made thecalculation of potential disability-adjusted life years (DALYs) gained in FYR Macedonia unnecessary.Cost-effectiveness of prevention efforts such as childhood immunization, family planning and prenatalcare--all supported under this component--are well established internationally, and no factors are presentwhich would significantly alter in FYR Macedonia the high ratio of benefits to costs.

2.37 Support for combatting infectious diseases which lead to disability and death in youngadults--AIDS and tuberculosis--also has a high DALY payoff, particularly given FYR Macedonia'selevated incidence of tuberculosis (among the highest in the CEE). A proposal to intervene in the areaof smoking prevention would have been highly cost-effective, but was rejected by MOH as toocontroversial at this time. The project preparation team (both IDA and client members) believes thatinvestment in less controversial disease prevention programs under this first Project, and demonstrationof success in applying modern social marketing techniques, will build a solid relationship upon which tobroach the more controversial smoking/tobacco issue under future projects.

2.38 Component III: Pharmaceutical Policy and Supplv. The benefit of this component liesin its economy-wide impact on the price of essential drugs, as well as in the provision of essential drugs,vaccines and medical consumables for effective primary care. The second most important determinantof quality in primary health care--behind well-trained staff--is the availability of essential drugs. In recentyears, the Government has relied on humanitarian aid to supplement its own dwindling resources fordrugs, but these flows have largely dried up as a result of both regional events and resistance by donorsto continuing the supply in the absence of more meaningful reform of the pharmaceutical sector. TheProject will provide funding for essential drugs and vaccines--as an input into strengthening primaryhealth care--but will link investments to the implementation of a difficult reform agenda.

2.39 At an estimated three percent of national income, the rate of spending on pharmaceuticalsin FYR Macedonia is among the highest in the world. More than half of the estimated US$60 millionper annum in drug spending is funded by the public sector. Market prices of five to twenty times world

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market levels indicate a noncompetitive market unrestrained by appropriate public sector regulation orintervention. The reform agenda aims at improving the affordability and availability of essential drugsby creating a more competitive policy environment and increasing the efficiency of public sector drugprocurement and reimbursement. If one makes a conservative estimate that implementation of the reformagenda will lower prices by one-third, then the economy would save US$60 million during the three-yearproject implementation period alone. Fiscal savings would total around US$30 million, against an initialinvestment cost of US$6.4 million. These large economic and fiscal benefits would continue beyond thelife of the Project. This high benefit-cost ratio amply justifies the component--although success inimplementing the reforms may be politically difficult (see Risks, below).

Impact on Poverty

2.40 By reallocating public resources towards provision of high-quality basic health services,the Project will benefit the poor, who cannot currently afford to pay out-of-pocket for private sectorservices. By creating insurance payment mechanisms which reimburse public and private sector providersequally for equal services, the Project gives patients--particularly poor patients--choice, and with choice,the power to influence the quality of care provided. Investments in strengthening primary health care inrural areas and in disease prevention (equal to 44 percent of the IDA credit) will also benefit the poor,who live disproportionately in rural areas. Thus, the proportion of beneficiaries is significantly largerthan their proportion in the overall population, qualifying the Project for inclusion in IDA's Program ofTargeted Interventions. Replacing broad copayment exemptions for specific patient groups with a means-tested basis for exempting the poor should also result in a better-targeted system of ensuring access tobasic health services.

IDnact on the Environment

2.41 The Project is expected to have a marginally beneficial impact on the environment. Byproviding appropriate equipment for medical waste disposal at the primary care level, the Project willhave a small positive environmental impact. Otherwise, the Project will not have a direct impact on theenvironment, and has been assigned to Environmental Category C.

Proeect Risks

2.42 Sustainabilitv of Political Commitment. The risk which dominates all others vis-a-vis thesuccess of the Project is political. It is the risk that the country cannot muster the political will necessaryto implement fundamental health sector reform, particularly with respect to limiting insurance benefits,squeezing economic rents out of the pharmaceutical market and consolidating the public sector facilitiesnetwork. Government has only the health care consumer on its side, facing politically and economicallypowerful medical and pharmaceutical interest groups. One of every seven parliamentarians is a doctorwhich heightens the need for careful marketing of the reform strategy to lawmakers. Much will dependon the leadership of the Minister of Health, and his ability to articulate to the public and the parliamentthe objectives and strategies underlying the reform program.

2.43 To overcome this risk, the following strategy has been pursued. First, technical workinggroups with representatives of relevant ministries, academia and the medical community were formed atan early stage. This ensured broader participation of stakeholders in both strategy formulation and projectpreparation. Second, the project preparation team encouraged early interac