Photo above: The Hertford Bridge in Oxford, England. Used by Permission. © Tom Ley 01302 782837

Saturday, January 23, 2010

How a Mozart string quintet helps explain high health care costs. by Dr. Douglas O. Walker

A recent article in the New York Times discusses the problem of high and rising health care costs and traces the problem to what is referred to in economics as “Baumol’s cost disease”.

William Baumol (1922-) was for many years a professor at Princeton and New York universities. He made contributions in many areas but is best known for the theory of contestable markets, the Baumol-Tobin model of transactions demand for money, and Baumol’s cost disease. A major influence on Professor Baumol was Joseph Schumpeter, and he claims that the object of his lifetime work was to develop a place in economic theory for Schumpeter’s entrepreneur.

In a famous 1967 article, Professor Baumol used the Mozart String Quintet to point out that the productivity of Classical music performers has not increased in 200 years. He noted it takes the same number of musicians and the same amount of time today to play the quintet as it did in 1787.

Professor Baumol did not directly address the economics of health care but rather looked at the general effects of automation on the U.S. economy.

At the time (and continuing today), the U.S. was undergoing a revolution of factory automation where the introduction of new technologies and processes was rapidly raising productivity in many lines of manufacturing production. Other sectors, however, such as education, health services, and government services, among many others, were more labor-intensive, and there was less scope to automate and substitute new technology-embodying capital for labor. Consequently, the more labor-intensive sectors did not experience much productivity growth. As a result, costs and prices (and total income and employment) tended to fall in those activities conducive to technological progress (such as manufacturing) while costs and prices remained relatively high in non-manufacturing sectors (especially services).

While many people who work in sectors experiencing high-productivity growth such as manufacturing lose their jobs to automation, those that remain are paid more and average incomes rise. The huge and growing output of manufactured goods resulting from the growth in productivity tends to saturate the market for these products and the income elasticity of manufactures -- their responsiveness to increases in income -- falls with time.

In contrast, in the more service-oriented sectors productivity gains are difficult to realize. Workers in these sectors nonetheless experience rising wages because they have the option of working in other occupations, and will leave if they are not adequately compensated. Moreover, many of these workers are also highly educated and would be difficult to replace should they resign. This also tends to keep their wages high. The service sector also benefits from a high income elasticity of demand as people choose to spend a growing proportion of their rising incomes on health care, education and other labor-intensive services where productivity gains are difficult to generate.

What this means is health care costs are high and rising because they involve high labor skills and direct personal attention and cannot be easily reduced by automation or spreading the costs over more people. Like a Mozart string quintet, a certain number of workers must be involved and the time taken to treat a patient, like the time it takes to play the music, is fixed and cannot be reduced. (But, let me note, that while it costs the same to produce the music from the string quintet, once recorded music it is much cheaper to consume today than it was in 1787, where once heard the music was lost. Now, the recording can be replayed at almost zero marginal cost. Unfortunately, this is not the case with health care where each “performance” is tailored to a specific individual and their unique condition.)

It is a mistake for Congress and the Administration to imply that public policy can do much to reduce health care costs or the general efficiency of the health care sector. Compared to other sectors of the economy the potential for productivity advance in health care is low and any expansion in the delivery of health care services will inevitably raise the share of health care in the economy and the expenditures of government to support it.

Talk by politicians about lowering health care costs is easy. Because of the nature of these costs, they will find actually accomplishing this goal is very, very difficult.

No comments:

Post a Comment