Medical Costs over the Long Run: 1850–2050

Tuesday, January 6, 2015

The creation of modern medicine was both costly and valuable, raising spending (from 4% of GDP to 15%) and longevity (from 47 to 78 years) during the last century (Fogel, 2004). Examination of events over 10–20 years is not sufficient to understand a “medical transformation” that arose from a demographic transition and industrial revolution that took centuries to unfold, nor to forecast the likely path of spending over the next 50 years [[Figure 1: S-curve]].

This rising curve has three elements:

Table 1. Contributions to the Health Spending Curve

 1. Health System Change (a.k.a. “Technology”)

 2. Business Cycles

 3. Secular Economic Growth Trend

The secular trend is a steady rise largely attributable to the growth of wages and wealth. Early empirical studies by Brian Abel-Smith (1964, 1969) and Joseph Newhouse (1977) confirmed the dominant role of per capita GDP in national health spending. Subsequent analyses provided support for the position each rise in income would lead to some extra spending on medical care could be expected as the requirements for food, shelter, and clothing would take a smaller percentage as wages rose (Hall and Jones, 2007; Murphy and Topel, 2006). Discretionary spending would flow toward better “care,” whether in a hospital, nursing home, hotel, or restaurant.

Business cycles are imposed over the basic secular trend of GDP+ 0.5%–1%. However, recessions and booms affect medical spending only slowly and with a lag, so careful analysis is required to trace cyclical effects; note how long the effects of the 2008 recession have lingered (Roehrig, 2014; Roehrig et al., 2012). Rather than comparing health expenditures to monthly, quarterly, or yearly fluctuations in GDP, medical cost increases are better matched with “smoothed” income as in [[Figure 2: Smoothed GDP & NHE]] (Friedman, 1957; Getzen, 2000, 2013, 2014a). Although business cycles do not change the long-run trend, the distributed lag effects of booms and recessions do tend to create noise and eddies that are frequently misattributed to disease outbreaks, policy shifts, or organizational restructuring, even when these events are mainly concurrent rather than causal. Using smoothed income helps to filter out the cyclical effects so that the excess growth in health spending can be seen more clearly.

Growth accountants decompose spending into components: regular increases in population, inflation, per capita income, and an extra element of “excess” growth” often attributed to technology or tastes (see Figure 3 below). It is “excess growth” in medical costs that increases the health share of GDP and causes fiscal problems, such as health insurance premiums that persistently rise faster than wages or tax revenues (the percentage growth in the health share of GDP is mathematically identical to excess cost growth calculated by the growth of health spending net of the growth in GDP, whether in total or per capita).

Having isolated excess cost growth as the crucial element, the tremendous surge in health care costs that began in the late 1950s becomes evident [[Figure 4: Excess Growth, 1930–2012]]. Although costs have been rising rapidly as long as most health policy experts can remember, this was not always the case. Physicians and economists writing in the 1950s considered costs to be stable at about 4% of GDP, having risen modestly if at all during the prior 25 years. Extending the record back to 1850 via U.S. Census records of employment in medical fields and the few consumer expenditure studies available for that period reinforces the conclusion that health spending was rising only slowly during the century before 1950, keeping pace with wages or perhaps exceeding them by 0.5% a year (i.e., doubling every 75–150 years rather than in less than 25 years, as costs did from 1955 until recently) (Seale, 1959; Stigler, 1957; Getzen, 2015).

Table 2: Medical Spending Growth Rates over Two Centuries

before 1850 + ?                    < 0.5%       annual growth

1850 – 1900 +1/3        + 0.5%       ?? (varies locally)

1900 – 1950 +2/3        + 1.0%       (estimated)

1950 – 2000 x3           + 2.0%       share of GDP grows from 0.05 to 0.134

2000 – 2050 x2 ?        + 1.0% ?    (maybe 0.5%–2.5%, depending on limits)
Sources: U.S. Census Occupational Statistics, 1850–2000; BLS workforce statistics, 1950–2014: CMS NHE, 1929–2012.

The sudden rise in expenditures after 1955 was due to multiple factors. It flowed from the continuing economic and technological development that raised the United States to postwar global eminence and four concomitant gains in human development: (1) sufficient longevity and reduction in random mortality due to infectious disease that the incremental effects of treatment made a meaningful difference to patients, (2) sufficient discretionary income to fund research and implement new medical technology, (3) a financing mechanism capable of gathering and channeling billions of dollars, and (4) sufficient gains in medical technology that the public was willing to invest in the potential of wonder drugs and organ transplants. The federal government played a major role, investing in the future health system by financing construction (Hill-Burton Act of 1948), professional training (Health Professions Educational Assistance Act of 1963), and insurance (Medicare and Medicaid, 1965). Yet the most highly leveraged investment in advancing medical technology may have come through the National Institutes of Health [[Figure 5: NIH Budgets, 1938–2012]]. From a relatively small $87.4 million upon inception in 1938, budgets grew ten times faster than national income over the next decade and again by 1957, and they continued to expand until reaching a peak 0.14% of GDP in 1963—still a very modest amount, considering the tremendous change in medical technology driven by this investment in research. The shape of the American health system was transformed by these postwar investments. The doctor with a black bag back was replaced by the “academic medical center” as the new and expensive core at the center of medical practice [[Figure 5: NIH budgets (% of GDP), 1930–2012]].

Conclusions and Extrapolations

From this review of the growth in health expenditures over the last century and a half, several conclusions can be drawn:

  • Excess growth exceeded 3% annually during the 1960s and 1970s and then slowed.
  • Medical technology continued to advance from 1929 to 1955, with very little rise in health spending relative to wages.
  • Spending surged after 1955, and proximate causes may have included expansion of hospitals under the Hill-Burton Act (1946); of workforce under the Health Professions Educational Assistance Act (1963); of public insurance under Medicare and Medicaid (1965); and especially of research funding for new medical technology under the NIH, where budgets grew tenfold from 1938 to 1948, grew tenfold again by 1960, and doubled by 1963 but then remained relatively stable as a share of GDP until 2000.

Projecting the future is more uncertain and difficult than tracing the past, but some tentative extrapolations appear justified. It is unlikely that that the rate of excess growth will again exceed 3% for any extended span, although a rebound from the great recession may temporarily drive the numbers higher for a year or two. A reasonable range for projections might be 0.5%–1.5%, with an expectation that excess spending will eventually be forced down to 0% as limits are reached with respect to tax burdens and wage growth. Problematically, the bulk of spending will be increasingly concentrated on the those aged 65 or older, even though the relative rate of medical cost increases for the elderly, which was much higher than average from 1955 to 1985, is now much lower and likely to be increasingly constrained (note the unprecedented fall in Medicare spending per beneficiary that occurred recently (Getzen, 1992, 2014b). Returning to Figure 1 above, it appears that the worst of the U.S. health care cost crisis may have passed, even though unfunded liabilities for retiree health benefits will linger for a long time, contributing to fiscal difficulties or even bankruptcies among some large employers, municipalities, and states.


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