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HC Economist diagnosis: A case of Baumol’s Disease

Written By: Jason Shafrin - Mar• 18•06

The American health care system seems ill.  Prices for medical services have continued to outpace inflation during recent history.  What is the Healthcare Economist’s diagnosis?  Simple, its a case of Baumol’s cost disease.

Baumol’s cost disease is a phenomenon which appears in industries which have slow productivity growth over time (see “What ails us” in The New Yorker).  Fine arts performances, education, and health care all fall into this category.  For instance, it takes about the same amount of time for a doctor to examine a patient as it did 100 years ago.  As productivity in other industries (such as manufacturing, technology, etc.) marches upwards, the relative price of health care services increases.  Jane Galt’s blog has a succinct review of the problem (“What’s happening on health care?“)

So, are increased health care prices going to destroy the American way of life?  I do not think so.  A precondition for Baumol’s cost disease is that productivity in other sectors is increasing.  With increased productivity, wages should increase and allow consumers to be able to afford more health care.  I do, however, expect health care services to take up a larger share of the average consumer’s income as the relative price of all other goods continues to fall over time.

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  1. Paduda says:

    Jason – Starting out with a caveat – I am no economist.

    OK – I’m not sure I agree w your central premise – which seems to be predicated on physician/nurse/staff time as the key determiner of health care cost. What about technology adoption rates, the rise in pharmaceutical utilization and prices, the aging population’s increased demand for services, etc. While I will grant that labor costs are a major driver of hospital expenses (see California’s minimum nurse staffing headaches), and hospital costs are one of the biggest influences on total medical expense, there are so many other factors that one cannot attribute the sickness of our system to one single factor.

    I’d also point out that physician cost inflation has held relatively steady at abotu 7.7% for several years, while Rx and hospital costs have varied widely. And, as physician expense is a relatively small part of the overall health care cost equation, I don’t see how Baumol’s cost disease is the over-riding factor here.

    That said, I certainly agree with your conclusion that health care costs will continue to grow as a percentage of individuals’ expenditures.

  2. […] I made my debut in the Health Wonk review with an article on Baumol’s Cost Disease. […]

  3. […] Baumol’s disease: See my post on this phenomenon. […]

  4. […] The authors estimates are simply derived.  Health care costs are assumed to be constant (as a percentage of national income) for each age grouping and the total cost is just a function of the predicted demographic changes in each age category.  While it is unlikely for costs to be constant for each age group–due to Baumol’s cost disease–it is not possible for health care costs to continually increase ad infinitum as a percentage of national income or else the costs will eventually overtake a society’s total wealth.  The authors use the government demographic projections, but assume 2004 labor force participation rates for each age-sex group (as opposed to the Japanese government estimates which assume increased Labor Force Participation).  A novel approach the authors use is to include the fact that the government often subsidizes providers to reduce the price.  Increased medical spending will also increase the size of the government subsidies. […]

  5. Jason Shafrin says:

    The Jochen Hartwig’s article in the Journal of Health Economics (May 2008) reviews Baumol’s arguments. Data from more recent years confirms Baumol’s predictions.