More on Rising Healthcare Spending

In a previous post, I quoted economic historian Robert Fogel on the income elasticity of healthcare. Fogel's claim of an elasticity substantially greater than one brought this email from MIT's Daron Acemoglu:

Dear Greg:

We noticed your blog on health care and I thought it might be useful to bring my research with my colleague Amy Finkelstein and our PhD student Matt Notowidigdo to your attention.

In this paper, Amy, Matt and I looked at the relationship between income and health care spending. Unlike the results you reference, our findings suggest that rising income cannot explain much of the rising share of GDP devoted to health spending. (In other words, we do not find evidence of an elasticity of health spending with respect to income that is greater than one). We think that the "assumed" relationship that health-care share of GDP should rise automatically as incomes rise is on much shakier grounds than most people realize.Of course, people with different priors will interpret the evidence differently, but we think in this case the evidence is interesting and informative. The paper is here.

Of course, one may ask, if not income, what is responsible for the dramatic rise in the health-care share of GDP. Amy has a very interesting paper on this, which you may have seen, estimating that the spread of health insurance may have played quite a large role in explaining the rise in health spending. So our view has now evolved,as a result of the empirical evidence in these papers, to the tentative conclusion that much of the rise in the health-care share of GDP may be due to policies and regulations related to private and social insurance and the way that the health market is organized (that dreaded word "incentives"). But again I am sure many people will not agree with this conclusion.

In any case, some quick reactions from us, which may or may not be useful to you.

Daron

Thanks, Daron.

Beyond a large income elasticity and the effects of incentives Daron describes, there is a third logical possibility to explain a rising healthcare share of GDP: an expansion in the range of products available to the consumer due to exogenous* technological change. As doctors figure out new and better ways to prolong and enhance life, we may rationally choose to buy these products. It might be tempting to view this effect as a large income elasticity (which is perhaps what Fogel is doing), for the technological change raises real incomes as well as healthcare spending. But the resulting parameter is not a true income elasticity, which measures how much more healthcare we buy if income rises while the range of products is held constant.

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*Of course, technological change is not completely exogenous. Surely, the incentives offered by such policies as the patent system and government research funding matter for medical advance. Here what I mean by "exogenous" is not driven primarily by the incentives determined by the health insurance system.