Are Health-Care Costs Too Low?

It defies the conventional wisdom, but studies show that expensive medical care is more than justified by the economic benefits

By Christopher Farrell

The numbers tell the story: America is confronting a health-care crisis. Medical insurance premiums are skyrocketing at double-digit rates, with overall medical-care costs rising at a 4.6% pace vs. a year ago. Hospital services prices are advancing at a 8.6% rate, as measured in the consumer price index. And a survey of 13 health maintenance organizations by investment bank UBS Warburg found that they expect drug costs to increase 13% in 2002.

Some 40 million Americans are without health insurance, and hundreds of thousands more will join their ranks as employers eliminate costly coverage in a slow-growth economy. The nearly $400 billion that federal and state governments spend annually on the Medicare and Medicaid programs is straining the public purse at a time when budget deficits are returning or rising. The nation will spend some 16% of gross domestic product (GDP) on health care in 2010, up from 13.4% currently and 7% in 1970, calculates the 2002 Economic Report of the President.


  The blame game is in full swing. Among the popular villains for the cost spiral are greedy drug companies, heartless managed-care organizations, avaricious senior citizens, insatiable consumers, and rapacious lawyers. Yet often lost in the heated rhetoric about surging medical costs are the quality-of-life benefits that come from spending more money on health.

Considering the unprecedented wealth of American society, consumers may well end up spending as much as a third of GDP on medical care, as the surest way to improve living standards. It sounds heretical, but Americans should probably be spending more on health care.

For one thing, on close scrutiny, many expensive medical treatments more than pay for themselves. That's what economists David Cutler of Harvard and Mark McClellan of Stanford found when they delved into the returns from medical technology used to treat a number of illnesses, including heart attacks and cataracts. They found the net economic gain of treating heart attacks was some $60,000 per person.


  Economist Frank Lichtenberg of Columbia University studied the returns on medical technology and medical-care spending between 1960 and 1997. He calculated it cost $11,000 in medical spending and $1,345 in pharmaceutical research and development to gain one year of additional life. Meanwhile, the economic return for a year of life added up to $150,000.

At the same time, medicine ranks high among America's most technologically innovative and globally competitive industries. The sector is also a major employer. The Bureau of Labor Statistics reports that more than 9 million people -- or 7% of the total workforce -- work as health-care practitioners, technical workers, and support staff.

Then there's the myth that America can't afford to spend more on health. It all depends on the rate of economic growth. Here's an illuminating calculation from economist Paul Romer of Stanford: The economy's underlying trend of growth from 1870 to 1992 was 1.8% (measured as income per capita). If that rate could be increased to 2.3% over the next half century, say through productivity improvements, the budget problems forecast for Social Security, Medicare, and Medicaid would disappear.


  Strong economic growth could resolve all the budget difficulties associated with the aging of the Baby Boom generation, while leaving ample resources for dealing with any number of pressing health-care problems.

None of this is meant to say there is no need for health-care reform. There is. Period.

The patchwork quilt of employer-based private insurance, public programs, and nonprofit organizations is badly broken. Major health-care reform has moved to the top of the political agenda six times over the past century. Each time, the political climate eventually proved inhospitable to creating a universal system that would provide access to basic medical care, regardless of income level.


  The latest big push for an overhaul took place in the early '90s, when President Clinton stumbled badly with his ambitious Clinton Health Security plan. At the moment, the political will isn't there to do much more than tinker around the edges.

There are other, more pressing issues confronting Washington at this time, but the impetus for fundamental change will inevitably push reform back into the headlines. When that happens, don't be fooled by claims that America can't continue to spend so much on health. We can, and my guess is we will.

Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over Minnesota Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BusinessWeek Online

Edited by Beth Belton

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