Investigating hospital efficiency in the new NHS: the role of the translog cost function

The reforms to the United Kingdom's National Health Service (NHS) of recent years have greatly increased the role of economic incentives in the hospital sector. Hospitals now have to compete for the business of GP and health authority purchasers and are assumed to have an incentive to minimise costs. This makes the analysis of cost functions much more relevant than has previously been the case. The objective of this paper is to assess the potential usefulness of the translog cost function applied in the NHS internal market. Three main issues are identified that limit the role of this type of cost function in the internal market: the adequacy of the econometric model (including data quality); the assumptions underlying the model, and; the interpretation of economies of scale, marginal costs and economies of scope that can be derived from such a cost function. It is concluded that at present the application of translog cost function analysis in the NHS is of limited usefulness, but that it does indicate areas for further methodological research.