The "Cost Disease" of Health Care: William Baumol's Surprising Perspectives on Why It's Unavoidable and Not That Bad

Disease Management Care Blog readers know that its three favorite themes are:

1. While health care costs have gone up, patients are benefiting from relatively greater parallel increases in value. For example, compared to just a few years ago, cancer and heart attack survival rates are much better.

2. As societies grow more affluent, they are more willing to pay more for that higher value health care.  While the U.S. is an outlier in absolute per capita costs, all developed countries have the same rate of year over year cost increases.  In fact, some countries are higher health care inflation rates than the U.S.

3. The ability of government to referee the cost, value and affordability dimensions of health care is doubtful.

William Baumol's book "The Cost Disease: Why Computer Get Cheaper and Health Care Doesn't" suggests the DMCB may have two out of three correct.  The DMCB was alerted to this book thanks to an Economist review and is about half way through it.  What it's read so far is eye opening.

According Professor Baumol, a nation's health care costs should be contrasted with the rest of its economy.  Using that perspective, two national economic sectors are:

1) progressive, which uses innovations to reduce labor costs and

2) stagnant, which relies on personal services and will always have fixed labor costs.

Examples of progressive goods are automobiles and computers.  In inflation-adjusted terms, their costs have dropped precipitously. That's because fewer workers are needed per car (translating into lower labor costs), technology has made them more efficient, safe and fun.  Not only do we feel wealthy, the drop in progressive costs of transportation, housing and food means we really are more wealthy.

Examples of stagnant goods are education and health care. In inflation-adjusted terms, their costs have remained stubbornly elevated. There have been some attempts at "do it yourself" learning or treatment. There have been stunning advances in the science health care.  Distance learning is a growing option.  Yet, teaching and doctoring remain remain highly personalized, Human resource costs rule when it comes to individualized care.

In simple mathematical terms, the falling costs of the progressive goods and services translates into a shrinking fraction of an economy.  While the absolute number of computers and cars is increasing, their absolute dollar value - which is the metric used to measure a nation's gross domestic product (GDP) - is lower.  As a result, the denominator is smaller, making the percent of GDP going to health care (the numerator) relatively larger.  Health care costs aren't really going up, the cost of everything else is going down.

But wait, it gets worse. As labor gets squeezed out of the progressive economic sector, two things are happening:

a) the value of progressive manual labor is dropping, leading to falling wages for millions of unlucky Americans who are not "knowledge" workers (like engineers and technologists);

b)  because less of everyone's income will be spent on stuff like cars and computers, they'll see a greater percent of their income going toward - you guessed it -  health care and education.  That means the unlucky manual workers unable to find jobs in progressive manufacturing will find that education and health care are unaffordable.

Enter government.  Whether we planned it or not, government has traditionally supported stagnant services. This not only includes health care and education, but others that are fundamentally personal, like policing, sanitation and the military.  As a result, even if the U.S. government doesn't change a thing, it's inevitable that health care will occupy a greater portion of a nation's GDP.  And since displaced workers from the progressive sector can't afford it, it makes sense for government to expand what it's been doing all along.

Bottom line?  "Rising" health care costs are a function of its highly personal nature surrounded by an increasingly efficient economy that enables us and our government to pay for it.  Dr. Baumol calls this phenomenon "cost disease."

Dr. Baumol makes two other points:

1) The fundamental danger to society is not the rising costs of education and health care.  It's the falling progressive price of weapons (from AK-47s to nuclear bombs) and the pollution from expanded manufacturing (from oil spills to global warming).

2) Many decade's worth of past attempts to blunt health care costs as GDP rises have failed and will continue to do so.