Why we should spend more on health care

“Is increased health spending optimal?

President Barack Obama, speaking yesterday, says the answer is no:

“If we do nothing, within a decade we will be spending one out of every $5 we earn on health care. And in 30 years, we'll be spending one out of every $3 we earn on health care. And that's untenable. It's unacceptable. I will not allow it as President of the United States.”

Economists Robert Hall and Chad Jones, writing in the QJE [Quarterly Journal of Economics] a couple years ago, say the answer is yes:

“Over the past half century, Americans spent a rising share of total economic resources on health and enjoyed substantially longer lives as a result. Debate on health policy often focuses on limiting the growth of health spending. We investigate an issue central to this debate: Is the growth of health spending a rational response to changing economic conditions—notably the growth of income per person?

We develop a model based on standard economic assumptions and argue that this is indeed the case. Standard preferences—of the kind used widely in economics to study consumption, asset pricing, and labor supply—imply that health spending is a superior good with an income elasticity well above one. As people get richer and consumption rises, the marginal utility of consumption falls rapidly. Spending on health to extend life allows individuals to purchase additional periods of utility. The marginal utility of life extension does not decline. As a result, the optimal composition of total spending shifts toward health, and the health share grows along with income. In projections based on the quantitative analysis of our model, the optimal health share of spending seems likely to exceed 30 percent by the middle of the century.””

Greg Mankiw, “Is increased health spending optimal?”, Greg Mankiw's Blog (12 June 2009).

http://gregmankiw.blogspot.com/


N. Gregory Mankiw is professor of economics at Harvard University and a former
Chairman of President George W. Bush’s Council of Economic Advisors. His textbook is
used in Regent’s survey of economics course. He is a Republican policy advisor.

Robert E. Hall is Robert and Carole McNeil Hoover Senior Fellow and Professor of Economics at Stanford University. He is President-elect of the American Economic Association. Charles Jones was recently promoted to Professor of Economics, Graduate School of Business, Stanford University.

It is of course common sense that as consumers’ incomes rise over time the quantity demanded of different kinds of goods and services changes, a relationship formalized in economics under the term “Engel curves”, named after the 19th century German statistician Ernst Engel. Broadly, three relationships between income and changes in demand are recognized: For normal goods, as income increases, the quantity demanded increases. The share of the product in a typical consumer’s budget remains about the same over time. For inferior goods, as incomes increases, the quantity demanded decreases as consumers stop buying the good because they can now able to purchase better goods than before. Its share in a consumer’s budget tends to fall steadily as spending on more desired goods and services crowds out spending on the inferior good. In the case of superior goods, as income rises spending on these goods and services rises faster than income, and they make up a larger and larger proportion of consumption than in the past. Health care is a superior good, and its share in the national economy of the United States has risen over time because it is a more desirable kind of spending than other kinds of consumption.

It is perfectly sensible that people want to spend more and more of their rising income on health care. They certainly have the added income to do so. A tremendous increase in material wealth and living standards has taken place in the United States in recent decades. The real per capita income of the average American has risen by 70 per cent since 1980, for example, and many Americans have chosen to take much of that increase in purchasing power in the form of increased benefits, such as better health care insurance and services, rather than in other kinds of goods and services. Hence, the share of health care in the U.S. economy has risen greatly. As it did so, it created well-paying jobs for millions of workers and improved the lives of hundreds of millions of Americans.

For reasons beyond my comprehension, President Obama and his allies in Congress see this perfectly natural process of income growth and structural change as a problem that must be somehow “solved” immediately by government interference in the health care industry. They have embarked on a crusade to “reform” one-sixth of the U.S. economy by October of this year in an attempt to suppress people from spending their income on a superior good consumers regard as more desirable than the other things they might buy with their money (or, more to the point, giving their money to the government in taxes to spend on things they don’t want). It boggles the mind why the Administration and Congress want to put a cap on the benefits that come from this kind of spending.

Now, restructuring a large part of any economy is a process that takes decades, not months, and involves tremendous complexities and hidden interrelationships that no one understands or could understand. That is why it must be done slowly and with great care. Even in a tightly planned economy such as the former Soviet Union many years would be spent preparing for a task of this magnitude. What is frightening is that the Administration is not only proceeding blindly and hastily but that it clearly has not the slighted idea of what it is doing. Other than vague words and statements of pious intentions, the Administration has put forward no concrete ideas as to how it proposes to reform this huge sector of the economy. Instead, a small group of Congressional aides (mainly from Senator Kennedy’s office) and a few people from the Office of the White House are at this very moment yelling and screaming at each other as they try and hash out a plan in secret for Congress to vote on. In the end, the same thing will happen that happened with the Stimulus Plan: At the very last moment, a bill hundreds of pages in length and understood by no one, will be pulled out of a hat for a up or down vote in Congress before anyone has had a chance to read and seriously consider it.

The process by which legislation is draw up and passed in Congress has become a farce. It is unworthy of the American people and the American people should object to it.