Friday, May 27, 2011

Medical expenditure and technology growth

People are running scared about the relative increase of health care costs. As discussed recently, there a many potential explanations out there, my preferred one being that service goods that rely heavily on labor are bound to become relatively more expensive than manufactured goods that become cheaper to produce with technological progress. But one may also worry that this progress does the exact opposite for healthcare, if more technology makes it more expensive. Two recent papers look at the connection of technological progress and health care costs.

Justin Polchlopek wants to understand better medical technology and break away from using total factor productivity. Basically, he goes back to good old input-output modelling because he wants to avoid issues with capital aggregation that may matter. New technology in the medical sector is then equivalent to new capabilities in the model. Unless the use of existing capabilities is reduced, it is then obvious that efficiency will be reduced. This means that how new technologies are diffused and how they replace old ones is critical. Add in poorly designed insurance, and you have a recipe for disaster, but it can be largely reversed.

Amitabh Chandra and Jonathan Skinner take a very different approach, focusing on demand and supply. They use a more aggregate health care production function and study what determines health care productivity. They categorize three types of technologies: (I) highly cost-effective with little risk of overuse; (II) highly effective for some people/diseases; (III) uncertain treatments. Of course, focusing on (I) will increase productivity, while (III) is very costly for potentially little effect. The health care costs balloon if patients ask for the latest technology, which often falls into (III). Insurance systems, whether public or private, need to resist accommodating all such requests.

All in all, both papers show that new technology can become very costly if it is mismanaged. This can be corrected with insurance schemes that let patients feel in their pocketbook some of the consequences of their choices. Incentives through the budget constraint remain powerful disciplining devices.

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