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Why Due Diligence In China Is Local

In thinking about how to approach China's healthcare space, the two fundamental things to always keep in mind are that (1) China's government expenditure is highly decentralized; and that this contrasts with government revenue collection, which is highly centralized. As a consequence, in thinking about healthcare in China, we need to disabuse ourselves of the notion that there is a "Central Planner". Healthcare in China is almost exclusively local.

Not only do the consequences of this dual-nature model directly influence the opportunities available to foreign investors in China's healthcare market, they also set the basic parameters for evaluating investment opportunities once they present themselves.

China is popularly thought of as a "Centralized" nation-state for a variety of reasons, which are widely talked about and easy to find for anyone interested, and which I won't go into here. For our purposes, the important thing to know is that there is a popular conception of China that presents the country as an orderly top-down administrative super-organ that can do anything on a whim if it so pleases. China's system does, in fact, allow for a flexibility to carry out big changes that is unmatched by other economies of similar size. But this flexibility is arguably greater for projects where the primary factor that influences success or failure is the mass mobilization of labor and marshaling of resources, and where dependence on sub-national governments for anything other than oversight is minimal.

Therefore, the ability to create big changes in little time does not necessarily extend to areas of the economy dependent on the intense involvement of sub-provincial level government officials in areas of management and revenue collection, and where success is dependent on instituting changes in organization management culture. This latter category includes both education and healthcare, neither of which exhibit the characteristics of uniformity that the "Centralized" label applies, or that popular conceptions would imply (i.e. the Gaokao is not necessarily an equal opportunity for all across China, and, in fact, heavily favors students in the biggest cities). Nevertheless, in public health school courses across the country in the US (it was certainly true in my public health and health system courses at the University of Michigan and at Duke University) China's healthcare system is often described as a "Single Payer" system.

The connotation "Single Payer" in America at least, is that a Central planner of some sort meticulously administers and pays for the costs of the entire system. But the reality is that China is a multi-payer system, in large part funded and, in reality, managed by sub-provincial and sub-city governments (see chart below). And, the majority of China's hospitals and other institutions that provide healthcare services are managed by these sub-provincial governments.


Specifically, in the social sector, sub-national governments account for around 90% of all spending, which encompasses all spending in the health sector (Brixi et al., Engaging sub-national governments in addressing health equities: challenges and opportunities in China's health system reform, Health Policy and Planning 2012, 1-16; National Bureau of Statistics 2011). The brunt of the burden for providing essential social services, including preventive and primary care health services, is borne by the lowest two tiers of government, the County and Township level. Hospitals administered by these government levels, if any, are almost always Class I hospitals (20-99 beds) and less often Class II hospitals (100-500 beds). The primary unit of care allocation at these levels is the Community Health Center ('Community Health Center' [CHC] is a term that has been adopted in the new healthcare reforms to encompass what were formerly known as village clinics, and what were formerly known as community wellness centers. In addition, some Class I and Class II hospitals have been converted to Community Health Centers since 2009.)

The problem for these local governments, and from the perspective of residents who have to decide whether or not to access care at the Township or County level healthcare access is points, is that the initial allocation of funds given to the Provincial governments is distributed by a cascade method, and by the time it gets to the Township and County level there is a funds shortfall. As a result, hospitals and CHCs are underfunded.

This is significant for investors because while China has opened up the healthcare sector to foreign investment, that opening comes with a very important caveat - the health sector is opened in areas that are perceived as having a shortfall of public funds and therefore need a shot in the arm from private investors. As a result of China's highly decentralized resource expenditure, as described above, and the resultant impact on local government, also described above, those opportunities earmarked for foreign investment, are largely going to be at the sub-provincial level, and as a result, will largely involve Class I and Class II hospitals, of between 20 and 500 beds, give or take.

One of the lesson's of America's hospital building heyday after The Hill-Burton of 1946 is that small hospitals tend to be inefficient hospitals, and the last few waves of hospital privatization and consolidation in the US, including the current one, have largely been concerned with expanding and or closing the hospitals built during the post-WWII boom. It is reasonable to assume then, that the Class I and Class II hospitals that are open for investment to foreign funds are going to involve more than simple face-lifts and management restructuring in order to create a reasonable ROI. Of course, there are also bound to be good opportunities out there, and this is where strong due diligence comes in. Understanding the financial position of the government organ responsible for funding the particular hospital opportunity will be the key aspect of that diligence prospect.