Duke 2008 | ASHE | Equity and Efficiency in Health and Healthcare

Background: According to Baumol's theory, goods producing sectors become more productive with the adoption of technology, and then labor shifts to the service sector. The service sector suffers from a 'cost disease', in which the innate reliance on labor and inability to substitute in productive technologies slows the productivity growth in the service sector. Triplett proclaimed that Baumol's cost disease had been cured since several sectors experienced accelerating productivity growth in the 1990s and early 2000s. What is clear from Triplett's work is that not all service sectors are alike. The healthcare sector, with one of the slowest productivity growths over the last few decades, is still afflicted by Baumol's cost disease. In this study, I argue that that this affliction explains most of the healthcare expenditure growth in industrialized countries.

Data and Methods: I model the growth of healthcare expenditures using well-known theoretical macroeconomic growth frameworks. The model assumes a Cobb-Douglas production function of capital, labor, and technology. I separate capital into physical and human, and proxy human capital with wages as estimated by an exponential function of rate of return to schooling and years of education. I analyze thirty-five years of data from six industrialized countries in the Organization for Economic Co-operation and Development (OECD). I primarily use the OECD Health Dataset, 2007 with supplemental data from the OECD Economic Outlook Dataset, 2007 and statistical agencies within particular countries.

Results: The healthcare sector is consuming more than a fair share of the service sector labor force, particularly in the US. Healthcare has adopted many more labor producing technologies such as new surgical techniques rather than labor augmenting technologies such as electronic medical records. The healthcare labor share is further exasperated in countries with third party insurance companies that increase administrative complexity and require more support staff. However, healthcare labor growth is slowing down in all industrialized countries. The slow down is a reflection of the other service sectors' continued reliance on human inputs and limited ability to further adopt labor augmenting technologies. Healthcare wages do not account for a large share of the differences between countries. However, differences that exist in wage rates are due to societal decisions about the reward to the investment, or rate of return, in education. The growth of healthcare wage rates follows GDP growth, which indicates that healthcare wages are not the reason for the faster growth rates of healthcare expenditures compared to GDP.

Conclusions and Implications: The rapid growth of healthcare expenditures is not as drastic in the context that all service sectors have consumed increasing shares of the labor force, and hence the economy, over time. Healthcare wages and labor are the key variables that determine the growth of healthcare expenditures; the presence of Baumol cost disease in healthcare provides explanation for the faster healthcare labor growth compared to other sectors. The slow down in healthcare labor growth will eventually lead healthcare expenditures to asymptote as a share of the economy in all countries.