Ebook Will the Slowdown in U.S. Health Cost Growth Continue? A Factor Market Perspective
There is a widely held expectation that the share of total U.S spending devoted to health care is poised to rise dramatically some might say traumatically in the coming decades. This belief is so engrained that the focus of long-term government budget analysis is increasingly shifting towards pursuing policies that will help restrain expected growth in public health spending (Congressional Budget Office, 2007b; General Accountability Office, 2007).
The attention being paid to health costs is underscored by the following calculation: if the growth rate differential between health spending and overall economic output remains at the average value observed since 1970 a gap of just over two percentage points health spending will account for 100 percent of GDP by 2080 (Congressional Budget Office, 2007a).
Simply extrapolating average historical health cost growth differentials forward through time obviously becomes nonsensical at some point, but at the same time there is no convincing reason to expect that the growth of health spending will slow of its own accord. Studies that have attempted to explain why health costs grew so rapidly in the past have been inconclusive; the consensus seems to be that medical technology is the primary driver of costs. Given that and barring a reduction in the rate of technological improvement it is reasonable to assume that health spending will continue to grow as a share of total spending. The historical average of the health cost growth differential is arguably the best guess to use for the near to medium-term, even if the long-run implications don’t make sense.
Recent trends have added an important wrinkle to this way of thinking about future health cost growth. Between 1970 and 1992 growth in U.S. spending on health care services (doctors, hospitals, and nursing homes) outpaced total consumption growth by 3.5 percent per year, and the share of spending devoted to health doubled from 7.3 percent to14.6 percent. Since 1992 the growth rate of health services has averaged only 0.5 percentage points faster than the total, and thus the share of consumption in health rose much more modestly, to 15.6 percent as of 2006. Choosing to extrapolate the average growth gap over the whole period since 1970 (2.3 percentage points) instead of just the last fifteen years (0.5 percentage points) leads to wildly different implications for government budgets, employer-provided health benefits, the structure of health insurance markets, and other issues. Even a 0.5 percentage point gap will eventually become nonsensical, but the share of output devoted to health does not approach the absurd levels in the foreseeable future that one obtains by assuming a gap of 2.3 percentage points.
The goal of this paper is to shed some light on these observed differences in health cost growth over time. The approach here is referred to as a “factor market perspective,” which means analyzing health cost growth in terms of the quantities and prices of factor inputs. Rather than trying to understand how possible determinants like technological change, demographics, insurance coverage, or income affect people’s willingness to pay for health care, the focus here is on what happened to those health care dollars after they were spent. Measuring factor payments does not provide any direct answers about spending determinants, but the approach does shed light on the differential growth rates during the periods before and after 1992, and thus indirectly improves our understanding of factors that drive health cost growth.
The factor market perspective starts with a simple set of identities that apply to any sector of the economy. The value of health sector output equals total spending on health services, which means we can look at the same transaction from the perspective of what is purchased or in terms of how the receipts were distributed. On the receipts side, health sector output is the sum of factor payments (which is value added) and the cost of intermediate inputs (like medical supplies and machines) used to produce health services. In the health sector, about two-thirds of output is value added, and value added itself is almost entirely accounted for by payments to labor (the sum of compensation and proprietor’s income).
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