The New York Times had a nice summary of what is known as Baumol’s cost disease for an explanation of why health care costs will always rise faster than inflation. The explanation is quite elegant in my opinion and can also explain why costs for education and arts will also keep increasing at a rapid rate. The example Baumol (and his colleague Bowen) use is that it takes the same number of people to play a Mozart string quartet as it did in the 18th century and yet musicians are paid so much more now. Hence, the cost of music has increased with no corresponding increase in productivity. Generally, wages should only increase because of a net gain in productivity. Hence, a manufacturing plant today has far fewer people than a century ago but they get paid more and produce more. However, a violinist today is exactly the same efficient as she was a century ago. Baumol argued that it was competition with other sectors of the economy that allowed the wages of artists to go up. If you didn’t give musicians a living wage then there would be no musicians.
Applied to the health care industry, the implication is that medicine is just as labour intensive and no more productive as it was before yet the salaries keep going up. I think this is not quite correct and it is the complement or corollary of cost disease, which I’ll call productivity disease, that is the culprit for health care cost increases. Health care is substantially more productive and efficient than before but this increase in productivity does not decrease cost but increases it. For example, consider the victims of a car crash. Fifty years ago, they would probably just die and there would be no health care costs. Now, they are evacuated by emergency personnel who resuscitate them on the way to hospital where they are given blood transfusions, undergo surgery, etc. If they survive, they may then require months or years of physical therapy, expensive medication and so forth. The increase in productivity leads to more health care and an increase in cost. Hence, the better the health care industry gets at keeping you alive, the more expensive it becomes.
I feel that the panic over the rapid increase in health care costs is misplaced. Why shouldn’t a civilized society be spending 90% of its GDP on health care? After all, what is more important, being healthy or having a flat screen TV? I do think that eventually, cost disease or productivity disease, will saturate. Perhaps we are at the steepest part of the cost curve right now because our health care system is good at keeping people alive but does not make them well enough so that they don’t need extended and expensive care. If technology increased to the point that illness and injury could be treated instantly then costs would surely level off or even decrease. For example, a minor cut a century ago could lead to a severe infection that could require hospitalization, expensive treatment and result in death. Now, you can treat a cut at home with some antibiotic ointment and a bandage. We can certainly try to restrain some abuses and overuse of the health cares system by changing the incentive structure but perhaps we should also accept that a continuous increase in health care costs is inevitable and even desirable.