There is serious concern that the ageing of populations, abating economic growth and ever costlier medical innovations do not square with the sustainable finance of healthcare. But what should health policy do when faced with this conundrum? The MEDPRO project of the Austrian Science Fund FWF seeks to deliver answers by untying the Gordian knot between medical progress, health expenditure and population ageing.
After almost two decades of research into the impact of population ageing and medical progress on health expenditures a consensus has emerged that morbidity – or simply the closeness to death – rather than age is in the driving seat of health expenditures. But then it seems clear that the culprit behind the seemingly unabated growth of the health expenditure share in GDP must surely be medical progress rather than population ageing. But is it really? All too many macro-projections reveal the impacts of population ageing on aggregate health expenditures after all, even when controlling for the morbidity of the population. And indeed, recent studies have revealed that medical progress and population ageing themselves are closely aligned. Researchers around MIT’s Daron Acemoglu, for instance, have shown how pharmaceutical innovation followed the US baby boom.
Finally, it is easy to lose sight of the benefits of healthcare and medical innovation. If we really perceive it as a cost-driver alone, what keeps us from making serious efforts to curtail medical progress? A number of prominent studies have recently argued to the contrary, however. Health and longevity are luxury goods and so is the medical care that is advancing them. As Stanford’s Robert Hall and Charles Jones have argued, it is alright under economic growth – optimal in fact – to see a growing proportion of income being spent on healthcare. Chicago’s Kevin Murphy and Robert Topel have calculated the value of saving lives from cancer and heart disease to be huge. These results are complemented by insights from a research programme by Harvard’s David Cutler and colleagues on the life cycle costs and benefits of innovations in the treatment of heart disease within the US. According to this research, much of what new technologies have to offer is worth it. None of this is withstanding the view that a large chunk of healthcare spending is devoted to the purchase of ineffective treatments and wasted in sheer inefficiency. Yet, at the end of the day, it is a matter of organising medical progress efficiently rather than a matter of having it at all.
The economic impact of medical innovation
What is missing is a solid theoretical understanding of the mechanisms at the heart of the dynamics of medical progress, healthcare expenditure and population ageing. This is the gap we are seeking to fill with the research carried out within the MEDPRO project (http.//medpro-project.eu). Based on micro-economic modelling of the demand for and the supply of medical care, we are tracing the dynamics of the population and health expenditures. Ultimately, we are seeking to explain medical progress by deriving a demand and supply function for medical technology. In the early days of the project, we are content, however, with studying the impact of exogenous medical innovation on the provision of healthcare and economic performance.
A large chunk of healthcare spending is devoted to the purchase of ineffective treatments and wasted in sheer inefficiency
Here, I will report and discuss some of the results we find within a simulated model of the US economy, calibrated to the year 2003. We are considering an innovation that is raising life expectancy at age 50 by about one year and induces about $20,000 in additional healthcare expenditure over a representative individual’s remaining lifespan. In magnitude, this is broadly comparable with the impact of revascularisation as an innovative treatment of heart attacks when first introduced in the US during the late 1980s.
In our numerical simulation, health expenditure per capita increases by some 13% in response to the innovation. About 1 percentage point of this increase is due to an increase in the price of medical care, about 2 percentage points are due to the survival of individuals to ages with higher healthcare spending, and the remaining 10 percentage points are due to an increase in individual demand. Although this amounts to a substantive impact, we find that about half of the potential increase in individual demand is absorbed by the price increase for medical care.
Healthcare and economic performance
With the health expenditure share in GDP increasing by some 1.7 percentage points in response to the innovation, it may come as a surprise that the level of GDP per capita itself remains unaffected. This is because the drop in the employment rate that comes with the disproportionate increase in survival among the retired population is neutralised by the accumulation and use of additional capital. This is because individuals are saving more in order to cover expenses over their prolonged lifescan and for the purchase of more effective healthcare in their old age.
Our analysis suggests that the saving response is stronger when individuals are anticipating a medical breakthrough. As individuals are actively deferring the consumption of healthcare to post-innovation times to the furthest extent possible, and as they are cutting down on final good consumption already in the run-up to the innovation, the resulting boost in saving is strong enough to generate a temporary ‘mini-boom’ to the economy. Interpreting medical progress as a driver of economic growth may perhaps be too optimistic, but our results suggest that concerns about it may be exaggerated.
Finally, mortality-reducing medical innovations tend to come with a reduction in the statistical value of life, a measure for the willingness-to-pay for healthcare. This may look puzzling at first glance, but it simply reflects that the innovation lowers the price of medical care per life-year gained, a result well in line with earlier empirical evidence provided by David Cutler and colleagues. As individuals are reallocating expenditure from consumption to the purchase of larger quantities of more effective healthcare, their relative valuation of healthcare declines. This is basic microeconomics, but it carries the important message that researchers and policy-makers need to be careful when assessing changes to the value of health and medical care. There is, however, a worrying aspect to our finding of individuals assigning a lower valuation to their health when effective medical care is available: Would this not tempt them to adopt unhealthier lifestyles?
A large research agenda ahead
The fact that medical innovation and the resulting increase in the healthcare sector does not reduce economic performance may come as good news. Two caveats apply, however. By absorbing capital and skilled labour, research and development efforts in the medical sector may slow down technical progress toward productivity growth in other parts of the economy. In addition, the question as to whether additional savings are induced by a medical innovation very much depends on the design of the social security system. If expenditures during retirement are financed through public transfers, as they typically are in European welfare states, then the savings response is prone to be weaker and may not be enough to offset the increase in economic dependency.
Addressing these caveats is high on our research agenda together with analysing the longer-term dynamics of medical progress. Other gaps in knowledge to be filled relate to the direction of medical progress, the distribution of its fruits across social strata, and the role in health policies in all of this. There is still a lot of work ahead.