David R. Henderson  

Health Care: Costs, Spending, and Choices

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Social Security is widely believed to protect its recipients from inflation because benefits are indexed to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). However, the CPI-W may not accurately reflect the experience of retirees for two reasons. First, retirees generally have higher medical expenses than workers, and medical costs, in recent years, have tended to rise faster than the prices of other goods. Second, even if medical costs did not rise faster than the prices of other goods, as retirees aged, their medical spending would still tend to increase as a share of income; that is, each cohort of retirees would still see a decline in the real income left over for non-medical spending. We show that Social Security benefits net of average out-of-pocket medical expenses have declined relative to a price index for non-medical goods by almost 20 percent for men, and almost 27 percent for women, in the 1918 birth cohort.
This is from the abstract of "How Well Are Social Security Recipients Protected from Inflation?" by Gopi Shah Goda, John B. Shoven, and Sita Nataraj Slavov, NBER Working Paper No. 16212.

The title plus a quick reading of the abstract will cause many readers (indeed, I think, most readers) to conclude that Social Security benefits, inflation-adjusted, are declining. But that's probably false and, just as important, the authors don't say that--they just leave that impression.

Consider, first, prices of medical care. Yes, prices are rising, but, as Joseph Newhouse pointed out in a 1993 classic in the Journal of Economic Perspectives, medical prices don't adjust for quality and quality has increased significantly. Think of the drugs, for example, that have replaced long days in the hospital.

Second, the medical care system can do so much more for us now than it did in 1983. (They consider the time period from 1983 to 2007.) Because of that fact, people choose to spend more of their own money on health care. When quality-adjusted price falls and people buy more (law of demand), if the elasticity of demand > 1, then people will spend more. I think it's true that people spend a substantially higher percent of their income on air travel now than they did in 1977, the last year before de facto regulation under Alfred Kahn began. But the fact that they don't spend as high a percent of their budget on "non air travel" doesn't mean that they're worse off.

The authors recognize this. On page two, they write:

Higher medical costs may reflect the consumption of better quality medical care, and retirees may be better off even if they are left with less to spend on other nonmedical goods. Therefore, we emphasize that we cannot draw any conclusions about changes in the utility of Social Security recipients from this analysis. All we show is that Social Security benefits may not be fully inflation-indexed in the sense that recipients with average out-of-pocket medical spending cannot, from one year to the next, purchase the same bundle of non-medical goods with their Social Security benefits. (emphasis added)

It's important that their readers recognize it too.

Comments and Sharing

COMMENTS (7 to date)
Robert Johnson writes:

Good points about rising effectiveness of health care, and elasticity of demand.

For a person my age (30s), the main take-away from Goda and Shoven is in planning for the future, consider that your spending preferences may change in the light of new technology.

steve writes:

1) You assume increased utility without proof. It is just as likely that these same elderly are being subjected to more tests of procedures w/o improvement of care. We really have no idea how these folks are spending their money.

2)Think of a common procedure like cardiac stenting. It can be performed many times on the same patient. It often has few benefits over medical management. Each individual treatment is cheaper than a CABG, but in sum they cost more with, again, little or no outcome advantage.


Lori writes:

Sure people have more and better medicine available, which indubitably makes them better off by some measures. But they are also -expected- to spend more on medicine. And who if not the libertarians and other conservatives will make condescending comments about personal responsibility when people underconsume health insurance, preventive medicine, etc.? Or liken consumption (or provision) of medical care at 1983 levels to killing grandma? At best it is a treadmill, or the inexorable trend by which former luxuries are magically converted to necessities. Relative poverty really is poverty.

David R. Henderson writes:

No I didn't assume it. I said "probably."

Hyena writes:

Prof. Henderson,

Is there a dataset which allows good, discrete comparisons across time? For example, I'd like to know both how much it costs over time to, say, perform a heart surgery and changes in the cost of the more abstract idea "fixing a heart problem".

Currently, getting a cast seems to cost about $150. If I think about that as a percentage of my income, it seems unlikely that it has gotten more expensive. I'd wager, in fact, that it's gotten cheaper because newer casts use faster-setting materials, reducing exposure to wage inflation.

How much would it cost to cover the medical expenses possible to 90% of the population in 1980? How much if you discount by the value of preventative medicine like heart pills that lower the risk of needing heart surgery?

Maniel writes:

A couple of quick points: 1) like any other war, the War on Mortality is costly; and 2) Medicare was designed to fund that war.

Matt C writes:

"Because of that fact, people choose to spend more of their own money on health care. When quality-adjusted price falls and people buy more (law of demand), if the elasticity of demand > 1, then people will spend more."

That is one possible explanation, but as your co blogger has pointed out, the great majority of medical expenses are paid at point of service by third parties, and the market (so called) is cartelized and heavily subsidized, and that can also account for rising expenditures.

When I was looking at getting a stomach endoscopy, I called around to find out what the price was going to be. Everywhere it was a hassle to get an answer, getting shuffled around from person to person. Some places seemed baffled by the very concept of explaining the price in advance. I got prices ranging from $600 to $4000, and no one was very confident that the price they were quoting me was what I was actually going to pay. (I ended up not getting the endoscopy.)

When my daughter was having asthma, I went shopping for a nebulizer. I had several places offer me a monthly rental at, I forget exactly, but over $100/month. I eventually found a place that sold me a nebulizer outright for around $30. Yes, these were the same nebulizer.

We really don't have a market in health care, at least not in the areas normally paid for by insurance. It's some other thing.

I don't deny that we have had improvements in medical care, in some areas considerable ones, but that is not the same as the value per *average* health care dollar increasing, and I don't see a good reason to believe that is actually happening.

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