Stimulate excessive spending or encourage innovation? Healthcare economist

Based on a study by Frankovich and Kuhn (2022), the answer is both. However, the value of increased innovation — as measured by longevity gains — more than makes up for the shortcomings of excessive spending. Specifically, the authors use an intergenerational model whereby individuals can purchase health insurance and medical progress depends on the health care sector’s return on investment. The authors calibrated their model using longevity data from the Human Mortality Database from 19,650 through 2005, earnings data from the Current Population Survey (CPS) and healthcare spending data from the National Center for Health Statistics (NCHS). This time frame is appropriate because 1965 was the year Medicare was implemented in the United States.

Using this methodology, the authors found the following:

…more comprehensive health insurance accounts for a large part of the rise in health spending in the United States but also boosts the rate of medical progress. Well-being analysis shows that while subsidizing healthcare through health insurance creates excessive healthcare spending, the gains in life expectancy resulting from induced medical advances more than make up for this.

In general, increasing levels of health insurance reduce consumption as more money is spent on health care. At the same time, capital increases — particularly capital invested in research and development — as health insurance increases returns on investment as more patients can afford treatment. The authors note that:

One explanation for why the benefits from medical advances increasingly outweigh the loss from moral hazard lies in the continuous growth of income: as long as an individual’s consumption increases over time, individuals tend to assign an increasing value to life (Hall and Jones, 2007; Chen et al., 2021). This argument extends to the assessment of moral hazard, whereby individuals are willing to tolerate increased distortion from health insurance in exchange for increased lifespan, so long as this only slows but does not reverse consumption growth.

The authors also note that drug prices increase over time due to Baumol’s cost disease; Namely, the combined effect of productivity growth in the final-goods sectors and medical progress itself leads to higher prices.

Courtesy of Journal of Health Economics.

You can read the full paper here.

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