A socio-legal and economic analysis of contracting in the NHS internal market using a case study of contracting for district nursing

Social Science & Medicine 54 (2002) 255–266

A socio-legal and economic analysis of contracting in the NHSinternal market using a case study of contracting for district

nursing

Pauline Allen*

Health Services Research Unit, London School of Hygiene and Tropical Medicine, Keppel Street, London WC1E 7HT, UK

Abstract

The introduction of an internal market in the National Health Service (NHS) in the United Kingdom necessitated theuse of contracts between purchasers and providers. Little thought was given to the nature of these contracts by policy

makers, who appeared to assume that the contracts could conform to the classical, complete model. This paper usessocio-legal and economic theories of contract (which provide an alternative model of relational contracts, in contrast toclassical contracts) to explore how realistic that assumption was. An analysis of the institutional context in which the

contracts were made is provided, including a legal analysis of the relevant legislation. Contracting by health authoritiesand GP fundholders is examined, using the results of a recent case study of contracting for district nursing servicescarried out in a health authority in Greater London. The results show that classical contracting is an inappropriate

model for NHS contracts, but that relational contracting is not an entirely appropriate model either. Contracting wasfound to have increased the accountability of providers in respect of some financial matters, but not in respect of thequality of district nursing services. There are negative implications for the use of contracting in publicly financed healthservices}hierarchies may be more efficient (as lower transaction costs can be incurred) and possibly more effective in

improving quality of care. # 2002 Elsevier Science Ltd. All rights reserved.

Keywords: Contacting; Internal markets; Purchaser-provider split; GP fundholding; Transaction costs; District nursing; UK

Introduction

Contracting has been introduced into various publicly

funded health systems in an attempt to improveefficiency (OECD, 1992). The NHS was establishedinitially in 1948 as a hierarchical public organisation. By

the late 1980s an internal market was seen by thegovernment as the best form of governance structure forthe NHS. Its new features resembled those of the other

reforms in the welfare state at the time (Le Grand &Bartlett, 1993). An internal market for community,secondary and tertiary health care was introduced bymeans of a split between the purchasers of care and its

providers. There were two categories of purchaser:district health authorities and certain ‘fundholding’

general practitioners (fundholders). The remit of thehealth authorities was to purchase all types of NHS carefor their resident population with monies which were

allocated by central government. Fundholders wereallocated a budget by the district health authority inwhich their practice was located. Fundholders used their

budgets to purchase certain categories of non-urgentcare for the patients registered with them, includingcommunity services. The providers of health care were

constituted into independent ‘self governing Trusts’,who were supposed to compete with each other, therebyenhancing technical efficiency (Department of Health,1989a). Thus, two models of commissioning health care

were introduced (Day & Klein, 1991). The differenteffects of these two models will be a major concern ofthis paper.

Contracts were the fulcrum of the internal market.The separation of purchasers and providers could work

*Tel.: +44-207-612-7840; fax: +44-207-612-7843.

E-mail address: [email protected] (P. Allen).

0277-9536/02/$ - see front matter # 2002 Elsevier Science Ltd. All rights reserved.

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only if there was agreement over what health care shouldbe provided and at what price. The use of contracts can

be seen as an attempt to tackle the problem of agency inthe public sector. The principal–agent relationship canbe defined as ‘a contract under which one or more

persons (the principal(s)) engage another person (theagent) to perform some service on their behalf whichinvolves delegating some decision making authority tothe agent’ (Jensen & Meckling, 1976). The principal’s

problem is ensuring that the agent acts in the principal’sinterests, overcoming any different or conflicting inter-ests. Agency relationships are central to all complex

organisations, be they private firms or public sectorbureaucracies, because, in such organisations, manypeople are needed to carry out the aims of the

organisation. In circumstances of imperfect information,once any significant degree of decision making isdelegated, it is possible for the agent to make decisions

which will further their own ends, rather than those ofthe principal (Propper, 1995). In the case of the internalmarket, there was a chain of agency relationships.Purchasers were acting as agents of the public (in the

case of health authorities, via central government; in thecase of fundholders, in direct relationship with theirpatients). Provider Trusts were acting as agents of the

two types of purchasers. NHS contracts were seen as away of enhancing the accountability of provider Trustagents by making what performance was required of

them explicit (Harden, 1992). Purchasers in the NHSinternal market were supposed to operationalise theirobjectives, including those relating to quality standards,through contractual specifications (Department of

Health, 1989b). The question of the type of contract tobe used in the NHS internal market did not appear tooccur to NHS policy makers. But an understanding of

the insights provided by socio-legal and economicanalysis would have been instructive, as this paper willdemonstrate.

The paper will analyse the nature of contracts in theNHS internal market using related socio-legal andeconomic theories of contracts. First, the relevant

theories will be explained. Then the institutional contextin which the contracts operated will be analysed and acase study contrasting health authority and fundholdercontracting for district nursing services will be reported.

Finally, conclusions will be drawn about the effective-ness of contracting for health services and the effects ofdifferent governance structures on publicly funded and

provided health services.

Socio-legal and new institutional economic theories of

contract

Socio-legal theory (Macneil 1981; Campbell, 1996)demonstrates that contracts can be divided into two

main types: classical and relational. The classicalcontract has the following features: freedom of contract,

so that contracting parties choose whether to enter intoa contract at all, and who to contract with; freedom asto the terms of the contract; settlement of disputes by the

courts, using the contract’s original terms and theprinciples of contract law; it is a discrete transaction(i.e. ‘‘sharp in by clear agreement; sharp out by clearperformance’’, Macneil, 1974, p. 738) where the identity

of the parties does not matter; and, most importantly,full advance allocation of risk. The full advanceallocation of risk requires the parties to be capable of

writing a complete contract, in which all future mattersare specified at the outset (this is known as‘presentiation’) (Macneil, 1978). This socio-legal model

of classical contract accords with the model of the‘complete’ or ‘comprehensive’ contract used in newinstitutional (or transaction costs) economics (William-

son, 1975, 1985).But both economic and socio-legal analysis demon-

strate that the classical form of contract is not alwaysthe most appropriate model for long term contractual

relationships. Socio-legal theorists (Macneil, 1978;Campbell, 1996) identified a contrasting model ofcontract, the ‘relational’ contract, derived from research

evidence demonstrating that the classical model is notalways a true representation of actual long termcommercial contractual relationships. (Macaulay, 1963;

Beale & Dugdale, 1975). Parties to long term contractsdo not plan and specify their contractual relationshipscompletely, so presentiation does not occur, and thecontract is not therefore complete. Disputes are often

resolved without resort to the letter of the agreement,let alone resort to the courts and thus the letter of thelaw. Macneil’s theory of relational contracts (Macneil,

1978, 1981) analyses long term contracts as relationshipsover time, rather than discrete exchanges, as envisagedin classical contracts.

In relational contracts trust develops between theparties and there is a commitment to good faith. In otherwords there are co-operative efforts to realise their joint

and several goals in the face of contingencies that ariseduring the course of the performance of the contract(Campbell & Harris, 1993). Litigation is not used, notonly due to its high cost, but also to the parties’

willingness to sacrifice ‘immediate exchange gains toincrease relational security’ (Macneil, 1981). Table 1 setsout the main differences between relational and classical

contracts.Williamson has incorporated the relational theory of

contracts into his theoretical economic work (often

known as transaction costs economics) because herecognises that, in many circumstances, classical, com-plete contracts will not occur. Contracts are likely to be

incomplete if the transaction costs are too high(Williamson, 1985). Transaction costs are the costs of

P. Allen / Social Science & Medicine 54 (2002) 255–266256

making contracts, in other words, the costs of searchingfor a suitable trading partner, and of negotiating andwriting the contract, and the costs of subsequently

monitoring and enforcing contracts. In the case ofhealth care, it has been suggested that the existence ofhigh transaction costs means that contracts are unlikely

to be complete (Bartlett, 1991; Roberts, 1993; Ashton,1998; Croxson, 1999).Williamson argues that there are behavioural and

informational factors, as well as characteristics of theproduct which will affect the level of transaction costsand thus the contractual characteristics. The two key

behavioural assumptions about people in general arebounded rationality and opportunism. Bounded ration-ality means that people are assumed to try to makerational decisions but their ability to do so is constrained

by limits on their capacity to receive, process, store andretrieve information (Simon, 1961). Opportunism isdefined as ‘interest seeking with guile’ by Williamson

(1975).The first crucial characteristic of the product is the

specificity of the assets used. That is, the extent to which

the resources required are deployable to some alter-native use without reducing their productive value. Insuch circumstances, the owner of the asset would have astrong interest in continuing the transaction and the

buyer would find it costly (or impossible, in some

circumstances) to turn to a new supplier. The secondcharacteristic is uncertainty, which refers to the extent towhich it is possible accurately to predict future

circumstances, and is, therefore, related to the thirdcharacteristic, which is the complexity of the productand its environment. In these circumstances it will be

impossible to write complete contracts, as one cannotknow all possible future contingencies. Furthermore,complexity of the product means that it is difficult to

specify or measure its quality, and possibly also itsquantity and cost.Closely related to uncertainty (and bounded ration-

ality) is the distribution of information about the product.Informational impactedness (or ‘informationalasymmetry’) exists ‘when true underlying circumstancesrelevant to the transaction or related set of transactions,

are known to one or more parties but cannot becostlessly discerned by or displayed for others’ (William-son, 1975, p 31). In circumstances where opportunism is

feared, lack of information on the part of purchasers is aproblem as they will not only be unable to specify indetail the terms of the contract and, in addition, they

will not be able to monitor the provider’s performanceof the contract.Like Macneil, Williamson (1985) recognises that other

mechanisms are used to deal with the underlying

informational and behavioural problems which can

Table 1

Taxonomy of classical and relational contract modelsa

Ideal type classical, complete contract Ideal type relational, incomplete contract

Discrete i.e. Not discrete i.e.

Identity of person irrelevant, transferable Unique to individual, untransferable

Sharp in by clear agreement (in the form of written documenta-

tion), sharp out by clear performance

Commencement and termination each likely to be gradual and

not determined by the availability of written contractual

documents

Presentiation i.e. Incomplete i.e.

Complete}all elements are specified and measurable (no

bounded rationality)

Incomplete}not all elements can be specified or measured

(bounded rationality)

Opportunism can be dealt with by completeness. Therefore trust

not crucial.

Therefore opportunism is possible and trust is important if the

relationship is to work

Risk is attributed at commencement and that agreement is

binding

Not all attribution of risk can be agreed at commencement and

any agreement may not be entirely binding

No adjustments or further planning once contract commences Likely to be extensive post commencement planning and

adjustments. Success entirely dependent on further co-operation

in performance and further planning

Source of obligations is external to parties and transaction, but

they trigger them by consent

Source of obligations is external and developed as relationship

progresses

First order is knowledge of legal enforceability of specific

promises. Second order is threat or use of binding adjudication

by a third party (the court) (trilateral)

Enforcement dealt with by the parties internally to the relation-

ship (bilateral)

As all can be measured, opportunism and trust irrelevant As cannot measure all, opportunism could occur and trust is

crucial

aSource: derived from Macneil (1978).

P. Allen / Social Science & Medicine 54 (2002) 255–266 257

make complete contracting impossible. In the absence offull knowledge either of the future circumstances and of

the actual performance of the agent, trust and co-operation (replacing the lack of capacity to specify andmonitor fully) are crucial for effective relational

contracts.In the context of contracting, trust has several

dimensions (Sako, 1992): ‘contractual trust’ refers tothe expectation that parties will keep their promises; and

‘goodwill trust’ refers to mutual expectations of opencommitment to each other. While they both imply theabsence of opportunistic behaviour, ‘goodwill trust’ is

particular to relational, as opposed to classical, con-tracts. There is also a third type of trust}‘competencetrust’}which refers to the expectation that one party

will competently carry out tasks whose technicalities areoutside the capabilities of the other party.In order to understand the nature of any contractual

relationship, it is necessary to look at both the microcharacteristics of the relationship itself (which is whatboth the socio-legal and transaction costs economicapproaches do, using models of classical and relational

contracts) and also the wider institutional context inwhich the individual relationship occurs (Macneil, 1980;Deakin, Lane, & Wilkinson, 1994; Ashton, 1998; God-

dard & Mannion, 1998).The research presented in this paper was designed to

investigate the nature of contracts in the NHS internal

market by applying the relevant legal and economictheories, first to the institutional context of the NHSinternal market and then to an in-depth case study ofcontracting for district nursing. Previous studies of

contracting in the NHS internal market have eitherfailed to use any theoretical framework at all (e.g.Appleby, 1994; Glennerster, Matsaganis, Owens, &

Hancock, 1994; Checkland 1997; Spurgeon et al.,1997); have used insufficiently clear theoretical modelsof contract (e.g. Williams et al., 1997; Flynn, Williams,

& Pickard, 1996); or have used clear models of contract,but had failed to take sufficient account of theinstitutional context (e.g. Bennett & Ferlie, 1996). The

sole study of contracting in the NHS internal marketwhich dealt with the socio-legal issues adequately wasthat of contracting in Wales (Hughes, McHale, &Griffiths, 1996). But that study did not address the

economic aspects of contracting.

The study methods

An analysis of national policy documentation relating

to contracting in the NHS internal market was under-taken as part of the process of investigating theinstitutional context. This included an analysis of the

formal legal status of NHS contracts under the NHSand Community Care Act 1990 (the ‘1990 Act’).

Following the analysis of the institutional context ofcontracting in the NHS internal market, an in-depth

case study was selected as the most suitable form ofresearch strategy to use in order to investigate the natureof contracting for district nursing. District nurses work

in the community, as opposed to in hospitals, and at thetime of the study reported here, were employed by NHSTrusts, not GPs. They go into people’s homes and carryout nursing care in that setting. The detailed type of

investigation required adequately to explore the range ofconcepts of interest could only be undertaken on thebasis of looking closely at various aspects of a real life

phenomenon, thus a case study was the appropriatemethod (Keen & Packwood, 1995). This approachallowed the collection of rich, in-depth data about the

inter-relation of various phenomena, both in the casestudy site itself, and generated by its institutionalenvironment (Yin, 1994). It was only possible to carry

out the type of empirical work necessary to explore thequestions raised in respect of one case. This may be seenas limiting the generalisability of the findings. The use ofonly one case can be mitigated as long as the

methodology used in this research is sufficiently clearlydescribed. It would then be possible for the type of studyundertaken here to be replicated elsewhere, and thus

increase the power of the findings (Yin, 1994).The study site was a district health authority which is

part of the London conurbation. There were two

community health care Trusts (Trust A and Trust B)holding contracts for the provision of district nursingservices to residents of the district: one for thepopulation of each of the two London Boroughs

contained in the health district. As the area was inLondon, there were other community health care Trustsin the close vicinity. There was a high level of

fundholding among the local GPs, at the time of thefield work. A case study of the district, therefore, offeredthe possibility of comparing the contracting styles of at

least two providers of district nursing (Trusts A and B)and that of the district health authority purchaser with arange of GP fundholder purchasers.

The case study consisted of the following elements:1. Observation of district nurses at work.2. Semi-structured interviews with the following

categories of people: district nurses and their line

managers; chief executives of the two community Trustsand the health authority; commissioning and contract-ing staff in the health authority and the two community

Trusts; fundholding GPs and their fund managers;financial staff in the health authority and both commu-nity Trusts; and clinical advisors to the health authority

(medical and nursing). In order to obtain a range ofviews from each occupational group, 57 people wereinterviewed, out of a total of approximately 300. The

interviews took place over a period of 8 months, fromApril 1997 to December 1997.


3. Observation of contract negotiation and monitor-ing meetings between the health authority and each of

the two community Trusts over the period November1996 to March 1998. (A total of 22 out of 30 meetingswere observed.)

4. Analysis of the contractual documentation usedduring the study period by the health authority and thefundholders with the two community Trusts. A total of14 contractual documents were collected from relevant

interviewees and analysed.The interview and observational data from the case

study were analysed in the following manner: the

theories on which the project was based were used togenerate an initial set of categories, which were used tocode the data. An iterative process was used, under

which the categories were applied to the data andamendments to them were made in accordance withwhat the data revealed. Careful notice was taken of

deviant cases, as they can be particularly helpful intesting a hypothesis (Silverman, 1993). Where necessary,the hypothesis generated was revised or the classificatorysystem was amended.

The contractual documents were subjected to a socio-legal analysis. The content of the documents wasinvestigated in order to ascertain the completeness and

technical competence of the documents. (Details of thetype of analytical method employed are set out in Allen,1995.) Note was taken of the issues in respect of which

effort was made to achieve full advance allocation of riskand issues where no such attempt was made.

Results of the study

Institutional context and its effect at local level

Analysis of NHS policy documents concerning con-tracting (such as the Working Papers for the 1989 WhitePaper, ‘Working for Patients’, Department of Health,

1989b, c) revealed that there was an implicit beliefamong policy makers that complete contracts could bemade. Although it was recognised that detailed con-

tracts could not be written immediately, it was thoughtthat contracts would become more specific as theinternal market bedded down. ‘Over time, as the parties

gain experience in operating them, all contracts willbecome more specific.’ (paragraph 4.4, ‘Contracts forHealth Services: Operational Principles’ Department ofHealth, 1989b) This policy encouraged purchasers to

attempt to write complete contracts.1

On the other hand, analysis of the legal framework ofthe contracts used in the internal market demonstrated

the continuing salience of central government control.

When compared to the classical model of contract, NHScontracts appeared idiosyncratic and highly regulated.

This analysis, when combined with the other datareported here concerning their lack of completeness,indicated that the model of classical contract was not an

appropriate one to use for NHS contracts. The firstthree features of a classical contract identified in thetheoretical section of this paper were missing. The act ofmaking a contract was not voluntary in the NHS

internal market}health authority purchasers and pro-vider Trusts had to be in the ‘business’ of health care andwere obliged to make some kind of agreement with each

other about health services to be provided to the localpopulation. Moreover, if the parties could not reachagreement, terms could be imposed on the parties by the

Secretary of State for Health. Finally, disputes aboutconcluded contracts could not be resolved in the courts.Instead, the Secretary of State was given much wider

powers than the courts would have had, including thepower to change the terms of the contract or toterminate it. Table 2 summarises the differences in theregulatory framework for classical and NHS contracts.2

In addition to the attenuated nature of the contractitself, the hierarchical chain of relationships startingwith central government remained intact to a large

extent}decision making was not decentralised. Therewas an extensive national performance managementsystem, dominated by an emphasis on financial matters,

such as keeping within cash limits and providing suitablefigures for the Efficiency Index. The latter required everincreasing volumes of activity to be reported (seeAppleby (1996) for an analysis of its deficiencies). There

was little measurement at national level of the quality ofcare, other than the Patient’s Charter, which dealt with asmall selection of process issues, and included the highly

politically visible measure of waiting lists for electivesurgery (which was not applicable to district nursingservices).

But the effectiveness of the agency relationshipsbetween central government and local health authoritypurchasers should not be overestimated. Due to the

asymmetry of the information between the centre andlocal districts, in order to further their own interests,local agents were able to subvert some elements of thenational performance management system by supplying

inaccurate data.HA Finance Officer B: It’s like Soviet planning...We

have been under enormous pressure to report an efficiency

figure. So there are a lot of ‘estimates’ of the activity asthe data is not complete. We obviously estimate on theright side of the figures. But then you set yourself up with

a problem because the next year you have to be evenhigher.

1See Allen (1999), for further details. 2See Allen (1995), for further details.


In contrast to the health authority purchasers, theagency relationships between central government and

fundholders were less strong. Unlike health authorities,fundholders did not constitute a key part of the nationalperformance management system (NHS Executive 1994;Mays & Dixon, 1998). Moreover, the nationally led

political imperative of maintaining local health serviceswas not the primary responsibility of fundholders, but ofhealth authorities. These factors, coupled with the

smaller purchasing power of individual fundholderscompared to health authorities (who were responsiblefor purchasing all types of care for whole districts),

meant that there was a real possibility of fundholdersexiting from contracts with their local Trust and takingtheir business to a rival Trust. (This will be discussedbelow in the section on contracting with fundholders.)

Serious contractual difficulties

Using a transaction costs analytical framework(Williamson, 1975, 1985), it was found that completecontracts for district nursing could not be written.

Firstly, it had to be assumed that, like others in similarsituations, the contracting parties were only boundedlyrational (Ashton, 1997). Secondly, there was informa-

tional asymmetry between the purchasers and providers,greatly favouring the providers. Purchasing staff wereaware that they did not know what was going on inside

the provider Trusts. It should be noted, however, that inthe absence of information about how money was spent,the health authority did not attempt to increase itsmonitoring to obtain more information. The HA

Finance Officer B explained that it was not necessarilyin the health authority’s interests to know more abouthow money was spent, as it might reveal that more

money was needed to meet demand. As the main aim ofthe finance arm of the health authority was to keep totalexpenditure within cash limits, irrespective of local

needs. Knowing there might be legitimate claims foradditional resources would be counter productive.

HA Finance Officer B: We are trying to screw down,top down, globally a number and we are not interested in

whether they have got enough money.Thirdly, it was found that contracting agents feared

opportunistic behaviour on the part of their contractingpartners. Several staff in the case study health authority

indicated that they thought the local Trusts werebehaving opportunistically and taking advantage ofthe health authority’s lack of detailed knowledge of the

Trust’s activities. For example:Interviewer: Do you feel that [Trust A] are honest with

you?

HA Commissioner D: It is impossible to know. I amsure they are not absolutely honest. The need to be honestto me is superseded by the need to protect the service. Thisoperates at various levels. If they were dishonest about the

big picture for their Trust, it would come out. But aboutsmaller things, like aspects of actual services, they do notneed to be as honest.

And this suspicion appeared justified. Some concreteexamples of opportunistic behaviour were actuallyuncovered during the study. Trust B contract officer A

admitted that if the provision of a service ended beforethe end of the financial year, the Trust would keep themoney for the whole year. Also they would not tell the

health authority if a post had not been filled. Moreimportantly, she claimed that the failure of the Trust’scomputer system accurately to record activity had beencovered up. Trust A Finance Officer A admitted that the

Trust was arranging to be paid twice for the sameactivity on one ward, by using block billing and alsocharging for Extra Contractual Referrals.

And fourthly, health authority purchasers saw them-selves as ‘locked into’ the relationships with the Trustswith whom they currently contracted. The possibility of

exiting from the contracts with each Trust was not realto the health authority, irrespective of whether therewould actually have been alternative suppliers of district

nursing services to contract with. There were severalreasons why the health authority behaved as if it had no

Table 2

Comparison of regulatory framework for classical contracts and NHS contractsa

Classical contract NHS contract

Freedom to contract or abstain Contractual regime imposed (little choice of partners)

Freedom to agree any terms Financial regime for Trusts

Imposition by NHS of contract in the event of failure to agree

terms

Disputes adjudicated by the courts, according to Disputes adjudicated by NHS which may rewrite or terminate the

contract

(a) the law of contract

(b) terms of the original agreement (each known in advance)

aDerived from Allen (1995).


alternative contractual partners. The centrally dictatedimperative of not ‘destabilising’ local Trusts was

important. This phenomenon can also be seen as thepersistence of an older organisational culture, whichpredated the introduction of the internal market, as well

as being an accurate reading of one of the many,sometimes conflicting, requirements of central govern-ment. Furthermore, the costs and benefits to individualhealth authority staff members of exiting from the

current contract were relevant. Because of the financial(and acute waiting list) preoccupations of the nationalperformance management scheme, there was no clear

mechanism to induce them to enhance the quality ofcare delivered by community providers by using thethreat of exit. On the other hand, the cost to the staff of

looking for a new provider of district nursing would bein terms of the time and effort it would take up, at theexpense of other tasks, which were prioritised at

national level.Fifthly, the economic characteristics of the product

(i.e. district nursing), were such that it was not possiblefully to specify the nature of the services, nor to monitor

them fully. District nursing is a complex product, whichconsists of a wide range of continuing activities, asopposed to a single intervention, like surgery. Some

activities, such as leg ulcer treatment, are aimed atcuring the patient; some activities, such as care of peoplewith diabetes, are aimed at maintaining the patient in a

particular state of health; and some activities, such aspain relief and general support, can be concerned withcare of the dying. In addition, there was a moderatedegree of uncertainty about the future. Due to possible

changes in patterns of care affecting older people (suchas earlier discharge from hospital and changing relation-ships with social care providers), it was not possible

accurately to predict future circumstances concerningthe demand for district nursing services. Finally, despitethe fact that district nurses could, in fact, have been re-

deployed in a variety of other health care settings, it wasfound that the providers believed that these humanassets were specific to the transactions with their current

purchasers. The Trusts saw the nurses as assets whom itwould have been impossible for them to re-deploy ifpurchasers had exited from contracts. This is becausethe Trusts thought there was, effectively, a finite income

available to them and they could not afford to continueto employ all staff currently employed if that incomewere diminished. Neither Trust took the view that

additional income could be raised from other sourceswhich could have allowed district nursing staff to carryout other roles (either as district nurses in other

geographical areas or as other types of nurses). Thus,the district nursing staff were seen as specific to thecurrent transactions with the individual purchasers.

Due to the providers’ views on the asset specificity ofthe nursing staff and the finding that the health

authority purchasers saw themselves as ‘locked in’ tothe relationship with the providers, not only were

contracts likely to be incomplete but, in the case ofhealth authorities, the market discipline of the threat ofexit could not be used either. Thus, exchanges concern-

ing district nursing services were likely to come intoWilliamson’s category of ‘serious contractual difficulties’(Williamson, 1985).

Classical and relational aspects of the contracts

The finding that classical contracting would not be

possible, arrived at by applying principles of newinstitutional economics to the facts of the case studysite, was confirmed by analysing the contractual

relationships themselves. Some aspects of the contrac-tual relationships were found to resemble characteristicsof the relational model of contracts, but the institutional

context had to be taken into account fully to understandthe nature of contracts in the NHS.Effort was put into the negotiation and drafting of

formal documents by contracting staff in the healthauthority and the Trusts. This can be seen as attempts toadhere to the classical model of contracts in somerespects. In particular, attempts were made to allocate

risk in advance (in the case of the health authority, toput this risk fully onto the Trusts). The health authorityalso made attempts to specify the volume of activity

provided.But the analysis of the contractual documentation

(both fundholders’ and health authority contracts)

revealed that the contract documents were far fromcomplete and were poorly drafted. The terms of thecontracts differed from the standard of a classicalcontract. Most importantly, specification of the services

to be performed and the standard of performance (thatis the quality of both outcomes and processes) was notas clear as would be required in a classical agreement.

(In the health authority contracts there was no descrip-tion of district nursing. The only evidence that it wasincluded in the contract was a line in the financial

schedule setting out how much was to be paid for acertain number of district nursing ‘contacts’, i.e. visits.)As a consequence of the poor specification, arrange-

ments for monitoring were not (and could not be)sufficiently specific. Moreover, there was confusion insome of the provisions designed to allocate financialrisk, although classical standards were aspired to in this

respect. (For example, the health authority’s contractscontained contradictory provisions concerning howunder performance by the Trusts in terms of the volume

of care provided would be dealt with. In one place, thiswas not to be penalised by the withdrawal of funds, butin another, it was stated that the marginal costs of under

performance would be deducted.) Methods for enforce-ment of performance of contractual obligations were


limited and dispute resolution provisions reflected theunique arrangements in the NHS, thus differing

fundamentally from classical contracts.The reason for the deviation from the classical model

of contract (in health authority and fundholders’

contracts) is, to a large extent, due to the nature of theproduct, as predicted in the theoretical economicliterature discussed earlier. District nursing services weretoo complex to specify fully. Moreover, the idiosyncratic

regulatory framework for NHS contracts meant that thepoor drafting was not as significant as it would havebeen in a commercial market where normal legal rules

applied. Many of the deficiencies in the documents couldbe ignored due to the existence of overriding adminis-trative structures. Nevertheless, the effect of the national

promotion of an inappropriate classical model ofcontract was to induce those drafting the documentsto include unnecessarily ‘legalistic’ material, such as

‘force majeure’ clauses,3 which had the general effect ofmaking the documentation longer, more complex andharder to use than the actual circumstances required.The contractual relationships also contained aspects

which could have been interpreted as evidence ofrelational, as opposed to classical, contracts. In accor-dance with the model of relational contracts, the

relationship was not discrete. Instead, commencementwas gradual and not determined by the availability ofwritten documents. Each Trust delivered services con-

tinuously despite the fact that contract with both thehealth authority and various fundholders were notsigned at the ostensible beginning of the annual contractterms in each year. Presentiation required for classical

contracting did not occur: as discussed above, thecontractual documents did not specify all relevant futurematters, as they failed to address significant aspects of

performance (in particular the quality of services). Therewere no disputes concerning district nursing during thestudy period, so it was not possible to see if another

characteristic of relational contracting}the bilateralresolution of disputes without resort to the terms ofthe original agreement or to a third party (i.e. the courts)

as adjudicator}occurred. But, as the 1990 Act hadtaken disputes out of the realm of the courts, only theresort to the original document could occur, in anyevent. Macneil’s observation that parties to relational

contracts can be willing to ‘sacrifice immediate exchangegains to increase relational security’ does not appearrelevant for contracts with the health authority, as

neither party envisaged exit as possible. But, as will bediscussed below, this characteristic was observed incontracts with fundholders.

For a functional relational contract to have evolvedbetween the parties, trust would have been essential. In

fact, none of Sako’s three forms of trust was observed toany large degree (either in health authority or fund-holder relationships). Although the failure to monitor

services adequately could be interpreted as competencetrust, there was little evidence to support this view. Abetter explanation appears to be that there was a relativelack of concern about the quality of district nursing. As

discussed above, the incentives operating on healthauthority purchasers deterred them from expendingeffort on both quality issues generally and on commu-

nity services (as opposed to acute services). HAConsultant in Public Health Medicine B remarkedabout the atmosphere in respect of district nursing

services at meetings with Trust A:You don’t actually feel it was important, really.The contracting staff at the health authority did not

make any significant effort to find out more about thequality of the district nursing services either. Thereappears to be some circularity in the following reasonsgiven for paying little attention to district nursing:

HA Commissioner E: Part of the problem is that theyare hard to monitor in performance terms and this leads toa fluffy discussion. For example, we are not sure of the

effect of cutting nurses. We don’t have experts in the fieldto look at what they are doing.Although it might be thought that fundholders would

be in a better position to monitor the quality of servicesthan the health authority, as they could have clinicalaccess to patients shared with the district nurses, inpractice, they did not all appear to do this. Instead, they

reported they relied on patients’ complaints, whichcould either be seen as competence trust, or lack ofconcern.

Fundholder H: It’s too hard to monitor what they aredoing and too costly. Part of me says ‘‘I don’t care’’. Theygo to my patients, no patient ever complains they aren’t

getting adequate services and the block contract covers thecost.Neither contractual trust nor goodwill trust appeared

to exist in large measure in the study site, and there waswell grounded fear of opportunism, as discussed above.Contractual trust was relevant to the extent that theTrusts agreed the price for each service in the

contractual document. (The costing rules of the internalmarket laid down that prices should equal cost, NHSManagement Executive 1993.) One could ask whether

the purchasers, in the absence of any means ofindependently verifying this fact for themselves, trustedthe providers to allocate the amount of money indicated

in the contract to the services indicated, thus keepingtheir promises. But, as none of the contracting or financeofficers in the health authority actually believed that the

contractual sums set out did represent how the moneywas to be allocated, this would not be an indication of

3These are complex clauses found in commercially drafted

legally binding contracts which deal with certain circumstances

in which contractual obligations cannot be performed.


contractual trust. In this way, the relationship betweenthe health authority and the Trusts was fundamentally

different to that of parties to contracts in commercialmarkets. The price mechanism was not being used toallocate resources efficiently. Budgets were being allo-

cated in a hierarchy, where only a fixed amount ofmoney was available to the purchaser.HA Director of Finance: I see our role as managing

expectations so that their prices are basically disarmed.

We negotiate away the relationship between price andcost. We tell them how much money is available and try toget them to use this global amount to work backwards to

prices.Thus, if there were any trust evident in relation to this

issue, it would have to operate at the level of goodwill

trust. However, there was little evidence that the healthauthority staff did have goodwill trust in the providers inrespect of the use of money internally. Instead, as

discussed above they (rightly) feared opportunisticbehaviour. Moreover, the Trusts did not appear to trustthe health authority either.Trust B Chief Executive: ‘We have the great myth they

are out to get us and they have the great myth we cheatthem. And they are both true.’Although the models of classical and relational

contracts were very useful as heuristic devices, they didnot provide an adequate explanatory framework for thetypes of relationships found to exist between the health

authority and the Trusts. There were elements of eachmodel present, but the overriding importance of theNHS hierarchy needs to be taken fully into account. Thecontractual relationships with providers were better

understood as part of the centralised planning structuresof the NHS, rather than as resembling the results of theaction of market forces. Health authority contract

officers were attempting to fulfil their obligations tohigher tiers in the hierarchy by delivering financialaccountability at the aggregate level of the health

authority global budget. (They also needed to ensurethat sufficient volumes of care could be reported, inorder to meet the requirements of the national Efficiency

Index.)The elements of informality in the contractual

relationships (such as the marked lack of clarityconcerning the commencement of contractual relation-

ships and the incompleteness of the documentationused) could therefore be understood as informalelements of a hierarchical system (Williamson, 1975),

rather than relational elements of contracts. Theincomplete nature of contract documents used neednot be interpreted as evidence of trusting relation-

ships between purchasers and providers, as mighthave been the case if relational contracts had evolved.Instead they were continuing relationships in a hier-

archy, upon which an internal market structure hadbeen imposed.

Differences in contracts with fundholders

In the case of contracts with fundholders, fewerhierarchical elements were discernible. Some aspects ofcontracts with fundholders could be seen as relational,

as they were types of behaviour designed to preserve therelationship between the parties, in the context of a moremarketised atmosphere. Trusts did fear fundholderswould cease purchasing care from them, which was

lacking in their relationships with the health authority.And, indeed, some fundholders had exited.Interviewer: Do the fundholders try to drive down the

prices you charge?Trust A locality manager A: Yes, there are a few

consultants, such as [X] and [Y], who give advice to

fundholders on how to get the best deal. Sometimesfundholders want us to provide inappropriate things suchas in-house clinics by district nurses. We are pandering to

fundholders and trying to keep contracts. If any of thefundholders left the Trust, we would not be able to survive.Interviewer: How realistic is this fear of exit?Trust A locality manager A: They could take their

business elsewhere. They have to give 6 months notice.Some have left}[practice X] did. In [area G outside thestudy site] a large consortium took about £500,000 or so

to [R Trust] and some [area S outside the study site]GPs are going back to [W Trust]. The [B GPs who docontract with Trust A] threaten and so do [S GPs].

Thus, Trusts were prepared to make ‘sacrifices’ tocontinue the relationship by agreeing to the fundholders’demands. Two examples were given by several nursemanagers: Firstly, Trusts agreed that district nurses

would visit far flung patients of a particular fundholder,even though there were other nurses (not contracted tothat practice) based closer to the patients’ homes.

Secondly, Trusts agreed that district nurses wouldprovide service cover, at no additional charge, forabsences of practice nurses directly employed by GPs

in their surgeries, as well as carrying on their own workwith patients in their homes. Neither of these twoexamples of changes to district nursing practice

could be said to be unequivocally in the direct interestsof patients and/or the public at large, but the advantagesfor GPs themselves were clear. In respect of thefirst, while it might have been more convenient for

the GP to deal with fewer nurses (and might besaid to have, therefore, enhanced the quality of caredelivered), it was also clear that travelling to distant

patients was inefficient, as there were other nurses whocould have spent less time travelling to the patients inquestion. In respect of the second, as a proportion of the

salary of directly employed practice nurses (but notdistrict nurses) was met out of the GP’s own pocket,shifting the ‘free’ (to the GP) district nurse into the

practice nurse’s role saved the GP direct personalexpenditure.


The reason for the difference in the nature of thecontractual relationships of fundholders and the health

authority was rooted in their different agency relation-ships. In the case of the former, the role of centralgovernment performance management did not predo-

minate. However, the influence of patients as principalsdid not appear to have replaced the absence of closecentral government control. It is arguable that, at leastin the case of using district nurses to substitute for

practice nurses, where out of pocket expenditure byfundholders was avoided, fundholders were not con-strained from acting in their own interests. Thus, despite

the fact that the contractual relationships betweenfundholders and providers might be seen as containingelements of relational contracts, this did not imply that

those relationships were necessarily more effective inachieving the aims of any of their patients. (This findingthat fundholding did not necessarily benefit patients is

confirmed by, inter alia, (Fotaki, 1999), in respect of thediminished choice of providers for fundholders’ pa-tients.)Moreover, the above discussion of the formal

contractual documents demonstrated that fundholderswere no better at specifying what was required than thehealth authority. In fact, their contracts stated they

would rely on the quality specifications of the healthauthority, thus undermining the view that fundholderscould improve the quality of care more effectively than

health authority purchasers, as argued by Glennersteret al. (1994).

Discussion and conclusion

The research reported in this paper has demonstrated

that the continued existence of the NHS hierarchicalgovernance structure was crucially important to under-standing the nature of contracts used in the internal

market, particularly in respect of contracting by healthauthorities. Accordingly, contracts made by healthauthorities, although clearly not classical, could not be

characterised as relational either. Contracts made byfundholders had some relational elements due to themore marketised relationship they had with Trusts. But

in both cases, contracts did not enhance the account-ability of those providing health care in respect of thefull range of areas which the architects of the internalmarket had envisaged. In particular, specification of the

services and their quality was deficient. At best, fiscalaccountability was achieved at the level of globalbudgets for health authorities and Trusts.

These findings have implications for the organisa-tional structure of health systems. In the case of internalmarkets, where there exists a highly centralised health

care system, together with centralised political account-ability, the lack of incentives on publicly employed

purchasers to seek optimal deals will be a key problem.The conclusions of a recent review of available evidence

concerning the NHS internal market confirm this view(Le Grand, Mays, & Mulligan, 1998) as does a leadingcommentator (Enthoven, 1999). Moreover, this phe-

nomenon has been observed in other highly centralisedcountries, such as New Zealand (Flood, 1998). Char-acteristics of internal markets might, however, varywhere political structures and political culture are

decentralised (e.g. in Italy, see France, 1998). For thisreason, there may be some advantages in having smaller,less centrally politically accountable purchasers, such as

fundholders, who can credibly threaten exit (Dowling,2000). The current changes in the United Kingdom(Department of Health, 1997), ostensibly moving to

more primary care based purchasing, are, however,unlikely to deliver this as Primary Care Groups andTrusts, the successors to fundholders, are much bigger

and more politically accountable than their predeces-sors. Further research is needed to see if the newpurchasing organisations behave more like healthauthorities than fundholders.

Due to the economic characteristics of health care,contracting is likely to incur high transaction costs andthus can contribute to inefficiency in any country’s

health care system. Publicly funded hierarchies may be amore appropriate form of governance than internalmarkets, provided that effort is put into improving the

quality of services by using a sensitive performancemanagement system not entirely focused on financialissues (Goddard et al., 1999; Grout, Jenkins, & Propper,2000). Current developments in the NHS, such as

reform of the performance management system (Na-tional Health Service Executive, 1998a, 1999), theintroduction of a national system of compulsory peer

review called ‘clinical governance’ (National HealthService Executive, 1998b) and the introduction ofNational Service Frameworks specifying patterns and

levels of service for particular care groups (e.g. those atrisk of coronary heart disease Department of Health2000) seem to be moving in this direction.

Acknowledgements

I would like to thank Dr Jennifer Roberts for hervaluable comments, as well as those of the anonymousreferees. The views expressed are my own and any errors

are my responsibility.

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Documents

A socio-legal and economic analysis of contracting in the NHS internal market using a case study of contracting for district nursing