Tuesday, October 02, 2012

The Cost Disease

The Economist has an article based on The Cost Disease: Why Computers Get Cheaper and Health Care Doesn’t by William Baumol. Baumol is a good economist who writes very good books.

The "cost disease" is a key concept. A growing economy increases productivity at different rates in different sectors. Thus automation has been improving productivity in manufacturing rather quickly, while health services and educational services are still limited in productivity increases by their person-on-person processes. Remuneration of people involved in the sectors with rapid increases in productivity tend to grow relatively rapidly as the worker productivity grows.

That growth tends to induce comparable rates of increases in remuneration in industries in which productivity is not increasing. Barbers tend to take as long cutting a head of hair as they did in my youth, but they are paid many times as much, even in constant dollars.

As the graph shows above, inflation has been much greater in education and health services than in the economy in general. I think that is because some of the increases in productivity in the fast improving sectors are shared with consumers (as other marginal benefits are shared between labor and capital).

So in health care, we have an aging population, and older people have more health problems, notable more chronic health problems, and consequently demand more health services. We also have a population that is in many ways living a more unhealthy life style -- gaining weight, not getting enough exercise. We also have more technology, and many of the new technologies are expensive (e.g. medical imaging). And the sector suffers from the cost disease.

On the other hand, we know more about preventive medicine and public health interventions and can increasingly use low cost interventions to forestall or prevent conditions requiring expensive interventions if we so choose. We also have the possibility to reduce waste in the health care industry -- eliminating costly procedures that do not lead to better outcomes for example.. We can bring some automation to health care, in areas such as health education. We can delegate services to less expensive personnel (who even may sometimes perform them better than doctors).
But that still leaves a rump of services within medicine, education and the arts that are resistant to productivity gains. For these, Mr Baumol offers his most intriguing prediction: although their costs will grow alarmingly high, they will remain affordable. In a way, the disease produces its own cure. If America’s economy grows by 2% per year (its long-term rate), it will be eight times bigger in 100 years. In addition, goods and services in innovative sectors will become much cheaper.
And of course, some of us will be willing to give up a few luxuries to keep grandma live a longer, healthier life, and to give little Johnny a better education. 

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