Sticker Shock

Health care costs are now an estimated 17.9% of GDP in the US, far higher than the next highest country (the Netherlands, at 12.0%), and projected to top 20% in the next 5 years.  You’ve all heard the outrage expressed in various media.  But what if health care spending were over 60% of GDP?  This is what economist William Baumol predicts will happen by 2105.  But the more shocking point he makes, in his book “The Cost Disease: Why Computers Get Cheaper and Health Care Doesn’t,” is that it is OK if the share of our national spending devoted to health care rises to that level – that it is to be expected, and is not at all a problem.  [I must admit that while the concept is fascinating, the book is overly repetitious, and a bit sloppily written and edited; it could easily have a been a Harvard Business Review or New Yorker article – in fact, it was a New Yorker article back in 2003.  That said, it’s fairly quick and easy reading, if the discussion below leads you to want to know more.]

The central concept, the “cost disease,” was first described by Baumol and William Bowen in the 1960s, in the context of higher education costs.  Here are the main points:

  • Productivity increases over time.  We learn more efficient ways of doing things – assembly lines replace artisanal shops; robots replace humans.  (I’m talking strictly about economic efficiency, not quality, human dignity, etc.)  As overall productivity in the economy rises, it leads to higher wages, since more productive workers can command greater pay.
  • With higher productivity, a business can create more with less.  Even after rewarding workers with higher pay, costs may remain stable or even decline.  So overall, an increasingly productive economy leads to a more prosperous society.
  • Productivity rises unevenly.  Some sectors of the economy, such as manufacturing, agriculture, telecommunications, retail (scanners and self checkout lines at the grocery store), and finance (ATM’s, on-line banking), are more amenable to mechanization and outsourcing.   Others, such as health care, education, police and other public services, and entertainment, rely more on a handicraft, or human, element that is harder to replace.  The former will have above average productivity increases; the latter, below average.
  • Because those productivity increases are unequal across parts of the economy, prices in the higher productivity sectors will tend to decline, or go up relatively slower than those in the areas where productivity gains are more stagnant.  Hence, computers and cell phones get cheaper, while education and health care get more expensive.

One of his important points is that the relative rise in health care costs is not primarily because of the usual suspects: rising demand (there has been an even greater increase in demand for computers than for health care), lack of competitiveness in the health care sector (there is probably even less in big agriculture or telecom), or malpractice costs.  It is a consequence of the inherently human dimension of health care.   Thanks to technological advances, productivity in the computer industry rises about 60% per year.  Can you imagine a physician or nurse seeing 60% more patients each year?

But here’s where the argument gets interesting.  Over time, on average, wages will go up faster than prices, and people will be able to buy more of everything .  The standard of living for a middle class American in 2012 is substantially greater than in 1960, and he or she has lots more stuff.  Because of the cost disease, the goods and services that have a greater need for personal contact with real people – what Baumol calls the “stagnant” sectors of the economy – will be relatively more expensive, and therefore consume a greater proportion of all spending.  So health care goes from almost 18% of all spending now to 20% in 5 years to 63% in another 90.  But at the same time, we can easily fit all the rest of the stuff we need and want – and more – into the other 37%, because we’ll benefit from the awesome productivity changes in  those other sectors, leading to higher wages and crazy low prices on tablets and phones and food and so on.  In other words, spending almost 2/3 of all of our money on health care is not a problem.

Baumol argues that there are important policy implications:

  • We should stop trying to control health care costs by decreasing demand for services, or by cutting per unit costs (i.e., payments to providers).   This will only lead to shortages and poor quality, especially for those of limited means, as has happened to public services of many types.
  • While it is reasonable to be as efficient as possible – following evidence-based practice, developing personalized medicine, leveraging information systems, and investing in prevention and wellness – politicians and voters need to understand that this will only shift the cost curve, but not bend it.  The rate of increase will continue to outpace other areas because the human-centric basics of health care delivery will always be subject to the cost disease.
  • The focus needs to be on redistribution – making sure that either wages for all continue to keep up with the cost of essential services, or that there is some subsidization for those whose earning power is slipping.

All quite provocative, and in some ways reassuring.  What health care crisis?  But there are a few crucial questions we need to ask ourselves before we get too complacent. (What, me worry?)

  • How little room for productivity increase is there really?  More and more health care interventions are becoming automated (from self-service blood pressure screenings and medical Web sites as sources of information instead of physicians, to remote sensing and electronic ICU capacity that allows one intensivist to staff several ICUs), and outsourced (teleradiology in India, medical tourism).  The centrality of the face-to-face human contact is diminishing.
  • How much does the increasing income disparity in the US undermine the “on average this is logical and a good thing” argument?  For example, it is precisely in those parts of the economy where productivity has been growing the fastest that wages have been most stagnant and ability to afford health care has declined.  And the concept of income redistribution has never been an easy sell in this country.  What makes sense in the economic abstract does not always translate into political reality.
  • How willing are politicians and the public to engage in the sort of sophisticated analysis required to move our public policy in this direction?  It’s a whole lot easier to complain about overuse, waste, and fraud than to ask philosophical questions about the allocation of benefits in society.
  • At a certain point, isn’t sticker shock going to set in and people are going to freak out?  It’s all well and good  to rationalize that we can afford, as a society, to spend 63% of our income on health care, but come on, it’s 63% of our income!

 In this last point, Baumol may be onto something.  Let’s look at music – specifically, recorded (technology-driven, fast productivity growth) vs. live (human-centered, stagnant productivity).  In 1980, the average price of a record album* was $8, and now an equivalent CD goes for around $16.  On the other hand, a ticket to a Springsteen concert was $9.50 in 1980, but averages around $95 today.  And nobody seems to flinch at paying that cost to see the Boss.

*an ancient sound recording technology similar to a CD but harder to fit into the dashboard of a car

3 Responses to Sticker Shock

  1. […] are challenged by many changes in the healthcare environment.  Spending on healthcare has reached unsustainable levels, and while it is leveling off, we will continue to get paid less for what we do.   Which is why […]

  2. […] Fields like education and medicine, being relatively reliant on the human element, typically have much smaller increases in productivity than industries like manufacturing that are amenable to automation.  That appears to be changing, […]

  3. […] (though there are numerous examples of both).  Economist William Baumol refers to this as the “cost disease” that helps explain why healthcare costs (along with those of education and live entertainment) […]

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