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A Consuming Health-Care Conundrum

By Michael Mandel My two teenage kids have braces -- several thousand dollars of gleaming mouth metal. The orthodontist and my wife tell me it's an investment for the future. The kids will look better, feel better, and, if economic research is to be believed, become more successful. For example, physically attractive workers in the U.S. appear to get paid 10% to 15% more than their less attractive counterparts. (For a listing of papers by Daniel Hamermesh, the top expert on the economic impact of attractiveness, go to "My Beauty Papers").

But here's a question: If orthodontics is an investment in the future, why do government economists insist on calling it consumption? After all, investment by definition is spending that's supposed to provide a future payoff, while consumption by definition makes you better off today. And my kids will tell you, without being asked, that their quality of life today is certainly not improved by being all wired up.

YIN AND YANG. The truth is, economists classify virtually all health-care spending as consumption. This classification decision -- made in the 1930s, when the concept of gross domestic product was first invented -- has far-reaching consequences. It means that spending on public health programs, roughly $20 billion worth a year, goes into the consumption basket despite its long-term value. So does funding for prenatal and early-childhood health care, plus all the money that goes to ensure the continued good physical and mental health of the working population.

Such spending can have an enormous long-run positive return. Just imagine what would happen to worker productivity over time if the entire health-care system suddenly disappeared.

The treatment of health care as consumption isn't just a technicality or a matter of semantics. In the mind of economists -- and in the public perception, for that matter -- investment and consumption are two very different things, almost the yin and yang of economics. Buying a new machine for a factory is investment. Buying a toy for your 3-year-old son is consumption. Investment is virtuous. Consumption is indulgent.

MORE SAVINGS? Thus, terming health care "consumption" goes right to the heart of critical policy decisions. For one, about $1.9 trillion a year is spent on health care in the U.S. Is that too much or too little? The answer partly depends on whether you think medical spending is mainly driven by indulgent spending on unnecessary tests and treatments or by prudent, farsighted investment in the health of our population.

Second, if a percentage of medical spending should really be counted as investment, then the nation's astonishingly low savings rate is actually much higher. Why's that? Savings, by definition, is the money left over after you've finished consuming. If investment is higher, then consumption is lower. If consumption is lower, then more savings are left over.

So suppose that 20% of health-care spending is really investment -- that's an arbitrary but reasonable-sounding number. A little spin of the calculator shows that would have increased the personal savings rate in the third quarter to roughly 3% of disposable income, rather than the -1% that the government reported. What's more, the rapid growth of health-care spending means that the savings rate -- adjusted to count some portion of health care as investment -- may have increased over time, rather than fallen.

COMPETITIVE EDGE? Unfortunately, the mislabeling of much of health-care spending isn't an anomaly. Our way of thinking about the economy is still stuck in the 20th century, when investment in physical capital, like machinery and buildings, reigned supreme. Thus spending on new-home construction, including such frivolities as 10 bathrooms, is counted as investment in the national income accounts because it involves the erection of a building.

Meanwhile, spending on human and intellectual capital is generally counted as consumption, even though that's what mainly powers our economic growth. Government spending on education and research and development -- America's competitive advantage -- goes on the consumption side of the ledger, rather than the investment side, because that's the way it has always been done. And medical care, one of the crucial inputs to human capital, is treated as an economic drain.

What we really need is a complete rethink of these government statistics for the 21st century. We need a system of national accounts that gives equal weight to physical, human, and intellectual capital, in order to make the best policy decisions.

For now, I'll keep writing checks to the orthodontist, and wait for my personal payoff: the kids' wonderful smiles when the braces finally come off.

Mandel is BusinessWeek's chief economist

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