20: Welcome to the Health-Care Economy

As time catches up with baby boomers, spending on medical care will skyrocket and set off a vast shift in the nation's resources. New investments in health could be a major engine of future growth

Get ready for the blossoming of the New Economy. No, not that New Economy. Information technology may have been the driving force behind the 1990s boom, but in the coming decades, Americans' standard of living will be linked inextricably to a very different trend: a surge in health-care spending. Forget dot-coms. Think little green pills and home health aides. The U.S. is facing a new world of medicine driven by innovation and the needs of aging Americans for ever-more-intense levels of care.

Already, the U.S. spends $1.4 trillion, or 14% of its gross domestic product, on medical care. That's almost twice what it pumps into info tech. Within a decade, however, it could be spending close to $3 trillion, or a staggering 17% of total national output, on health. If that growth continues unabated, medical care by mid-century will absorb almost one-third of the economy.

The consequences of this shift of resources will be enormous for companies, workers, and the government. It will mean a massive transfer of the nation's income--whether profits, wages, or tax dollars--to medical care. "The transformation will be as big as anything the computer has produced," says Harvard University economics professor David Cutler.

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This shift has enormous potential benefits. It will generate a boom in well-paying health-care jobs. It will provide opportunities to develop new technologies. Billions of dollars will become available for advances in biotechnology, medical devices, and fresh techniques to prevent or control disease. Many of these new products and services could lead to a spurt in exports. Most important, all this spending should make Americans healthier.

But these exploding costs could have severe negative consequences. Businesses will have to rethink the way they spend their resources, since every dollar devoted to health care will be a dollar not available to augment profits, purchase productivity-enhancing equipment, or hire workers. Employees will face an increasingly stark situation: The more they receive in on-the-job health benefits, the less they'll see in wages, pensions, or vacation time. Without continued productivity growth, the recent rise in real incomes will come to an end, and the nation will become markedly poorer.

Government will wrestle with similar choices. Washington and the states are facing an era in which providing health care for the elderly and the poor could come to absorb nearly all tax revenues. By mid-century, two-thirds of the entire federal budget will be spent on medical care, estimates the U.S. General Accounting Office. That is as large a share of tax dollars as Washington has ever pumped into any program save one: fighting World War II. The exploding expense of Medicare, the health program for seniors, and Medicaid, which provides care for the poor, represents "an unsustainable burden on future generations," warns U.S. Comptroller General David M. Walker.

Why is this big hike in health-care spending so troublesome? Think of it this way: Most of us would breathe a great sigh of relief if we learned that the current slump in IT spending were about to end and that business would once again pump gobs of money into computers, telecommunications gear, and software. The nation would look forward to another '90s-like era of booming capital spending, powerful productivity growth, and strong corporate profits.

By contrast, predictions of huge increases in health-care spending produce a very different reaction: sweaty palms. While there is broad agreement that IT is a valuable investment, comparatively little is known about the benefits of health spending. In tight labor markets, CEOs grudgingly authorize medical outlays as a necessary evil--the cost of hiring and retaining workers. But few view it as enhancing productivity--the key to making everyone wealthier. "The bang from IT is not only more palpable. It is quicker," says Mark Zandi, chief economist at Economy.com Inc. "Health-care benefits are reaped over a long, long time."

If CEOs are looking at traditional measures of economic growth, it's no wonder they fret over runaway medical costs. The productivity of the health-care industry grew at an annual rate of just 0.7% from 1995 to 2000. That's pitiful compared with the 2.6% annual rate for the rest of the economy. And as medical care becomes an ever-larger share of the nation's spending, that lagging performance threatens to drag down the long-term growth of the entire economy.

But recently, a handful of economists have begun taking a different view. They look at health care as an investment, no different from purchasing equipment or training workers. From that perspective, health care has the potential to give the economy a huge boost.

Some benefits are easy to see. Just look at the transformation of once-gritty industrial cities such as Birmingham, Ala., and Pittsburgh--now centers of medical care and health research. The Labor Dept. forecasts that through 2010, health-care jobs will increase faster than any other occupation except data processing. Opportunities for registered nurses, for instance, are expected to grow 58% over the decade.

Moreover, dramatic advances in technology have the potential to generate big bucks in industries such as biotechnology and medical devices. For instance, the Food & Drug Administration estimates that as many as 3 million Americans could benefit from an implantable defibrillator, a device that helps maintain a steady heart rhythm. Products such as this could also be sold to millions of other heart patients around the world, boosting exports. At companies such as General Electric Co. (GE ), medical equipment accounts for 9% of profits and, even in a soft economy, sales are rising at double-digit rates.

The biotech industry, dominated by the U.S., holds similar long-term promise. With an estimated $60 billion worldwide market for biotech products, the opportunity for export growth is tremendous.

But the potential benefits go beyond greater financial returns for one industry or another. The real payoff may come in improving the quality of life. That, however, is tough to measure. Yale University economist William D. Nordhaus has developed a statistical gauge, which he calls "health income," as a way to calculate the economic payoff of medical care. He says society received up to $2 of benefits for every $1 it spent on health care in the 1980s--the last decade for which he has complete data.

Other economists have tried to measure the costs and benefits of treating specific illnesses. Cutler figures that great strides in treating low-birthweight babies, for instance, have added 12 years to their life expectancy, producing a net benefit to the economy of $200,000 per child. "I do not agree that health spending is a dead-weight loss," says Helen Darling, president of the Washington Business Group on Health, a consortium of large employers. "There have been distinct improvements in both health and productivity."

To test that theory, a few businesses are starting to ask tough questions about the return they can expect on health-care spending. Ford Motor (F ), Wells Fargo (WFC ), Bank One (ONE ), Marriott International (MAR ), and others are trying to link the payoff from health care to its costs. "We want to understand what our return on investment is," says Sally Welborn, vice-president for corporate benefits at Wells Fargo & Co., which spends close to $400 million annually to provide health benefits for its 130,000 employees.

Bank One Corp.'s medical director, Wayne N. Burton, has measured the costs in lost productivity of several common health problems, including migraines and allergies. He estimates that the nation spends $1 billion a year treating migraines. But for corporations, the real pain comes from lost work days and reduced employee productivity. The price tag: a hefty $13 billion annually.

Giving migraine sufferers effective treatment would cost a fraction of that, although reliable estimates are hard to come by. But the key word is "effective," and--like other corporate purchases--not all health spending is created equal. A quick look at the wild overinvestment in telecommunication gear in 1999 and 2000 is powerful evidence of what happens when companies waste their dollars.

The risks are even greater when it comes to health care. And the price is in more than dollars. Nobody ever died from buying the wrong fiber-optic cable, but hospital errors kill as many as 100,000 people every year, according to the National Academy of Sciences Institute of Medicine.

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Perhaps one-third of all medical spending--some $600 billion--may be for unnecessary, out-of-date, or even dangerous treatments. A powerful example: surgery for arthritic knees. The procedure was thought to be a simple and highly effective method for treating achy knees, and the nation spent $3 billion a year to do it. Now, a report by Houston Veterans Affairs Medical Center says the treatment is essentially worthless. "The performance we get for what we currently invest in health care is probably the biggest business failure in American history," says Kevin B. "Kip" Piper, director of the National Health Care Purchasing Institute. "I can't imagine this [happening] in any other industry."

One reason for the problem: It takes years to determine the long-term impact of a particular course of treatment. But there is another, more manageable issue: The financial incentives for quality health care are totally skewed. Doctors and hospitals are paid for the volume of business they do, not the results of their care. Health experts say that changing those incentives will be critical to boosting the payoff from health-care spending. "If we spend more efficiently," says Cutler, "we can be both richer and have a better quality of life."

As a result, many American companies are looking at ways to put such incentives in place. One solution: pay higher fees to doctors who spend more time running critical diagnostics on patients with chronic illness, such as diabetes. The hope is that proper testing and early intervention will save billions in costs down the road.

But managing health costs is more complicated than simply determining the most cost-effective tests. Many dollars are spent on care for the elderly or those chronically ill and unable to work. Today, 3% of the population consumes 40% of health-care dollars, says Roberta Goodman, a health-care analyst at Merrill Lynch & Co. There are surely ethical reasons for funding such care, but it is harder to find economic benefits.

As the population grays, those issues--as well as spiraling costs--will come into sharper focus. Age-related illnesses, such as heart disease, strokes, arthritis, and back problems already account for 20% of U.S. health spending. That proportion will rise as 65 million baby boomers age.

The other big driver of rising health-care costs is technology. Medical advances often make treatment cheaper, less painful, and more successful. As a result, the unit cost of care drops, but the number of people getting treatment explodes--and so does the overall price.

Consider advances in heart attack treatments. Bypass surgery, in which doctors cut open a patient's chest and replace blocked arteries, was the treatment of choice in the '80s. But the procedure was complicated, relatively risky, and expensive: $40,000 in today's dollars.

Today, heart attack victims are most likely to be treated with angioplasty (unclogging the arteries with a balloon catheter and using sophisticated drugs and tiny mesh tubes to keep them from blocking again). It's simpler, less risky, and, at about $23,000, cheaper than a bypass.

These innovations are one reason why heart-attack deaths have declined by 20% during the past decade. But they have also driven up the overall cost of cardiac care by nearly 50% since the mid-'80s. Among Medicare patients, largely because of greater use of angioplasty, costs have skyrocketed over the period, from $3 billion to nearly $5 billion.

The real key to future cost savings and the efficient use of health-care dollars may come from some modest initiatives on the detection and prevention front. Reducing high levels of obesity, cutting smoking, and early diagnosis and treatment of diabetes and high blood pressure would all have a dramatic impact on the costs of health care. "The big productivity gains come from the low-tech stuff," says Jon Gabel, vice-president of the Health Research & Educational Trust in Washington, an arm of the American Hospital Assn.

Such savings will be critical. The U.S. can't afford to continue writing unlimited checks for health care. By spending wisely, the richest nation on earth can improve the quality of life for its people, helping them to live longer, more productive lives. But until it can distinguish efficient care from wasteful spending, it runs the risk of becoming both poorer and sicker. For $3 trillion, the U.S. can do better than that.

By Howard Gleckman

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