Will the Slowdown in U.S. Health Cost Growth Continue? A Factor Market Perspective

May 2008

John SabelhausInvestment Company Institute

University of Maryland

Motivation

• Health cost growth has been much faster than overall economic growth since 1970

• Social Security and health program spending expected to increase because of population aging

• But, if health costs continue to outpace economic growth at historical averages, health spending will dwarf any aging-related budget problems

Overview of Presentation• Look at trends in health cost growth, especially

differences in trend before and after 1992

• Focus on quantities and relative prices of labor inputs for health services, especially how those trends are related to spending trends

• Implications of this factor market perspective for making health cost projections

Principal Findings• Extent to which health cost growth exceeded

overall growth changed dramatically after 1992

• Break in trend growth rates can be traced back to relative prices and quantities

– Share of health service providers in labor force grew rapidly 1970 to 1992, more modestly since then

– Relative earnings of health service providers rose dramatically before 1992, then fell or stabilized

Trends in Health Cost Growth

• Three main health spending categories from NIPA annual consumption tables (% of total in 2006):

– Health services (77%)

– Health insurance net premiums (7%)

– Drugs and durable medical goods (17%)

• Focus here on health services—largest, but also component where factor income data available.

Health Services Cost Growth

Average Annual Growth Rate

1970 to 2006 1970 to 1992 1992 to 2006

Total Consumption 7.7 8.9 5.7

Health Services Spending 10.0 12.4 6.2

Growth Differential 2.3 3.5 0.5

Total Health Cost Growth

Average Annual Growth Rate

1970 to 2006 1970 to 1992 1992 to 2006

Total Consumption 7.7 8.9 5.7

Total Health Spending 10.1 12.2 6.8

Growth Differential 2.4 3.3 1.1

Factor Market Perspective

Health Services Consumption =

Health Service Industry Output =

Health Provider Incomes

+ Cost of Health Industry Intermediate Inputs

• Health provider incomes (value-added) include both compensation and business earnings

• Intermediate inputs are purchased goods; costs passed through to patients (machines, drugs…)

Components of Health Cost

• Value added accounts for 62% of gross output, intermediate inputs the other 38%

• Slight upward trend (few percentage points) in share of health costs in intermediate

• Within value added, compensation is 77% and non-corporate business income 12%

Health Sector Factor Incomes

• NIPA industry data shows employment and compensation of workers; no business earnings

• March CPS has industry codes, compensation, and proprietor earnings; sampling variability and top-coding are both potential problems

• The two data sets generally agree about trends in employment and earnings in health services

Relative Prices Versus Quantities

Share of Earnings in Health Sector =

Share of Workers in Health Sector

* Relative Earnings of Health Workers

• Break down earnings share trend using CPS and NIPA data—start with employment

Employment Shares Slowing?

• Some optical illusion because of SIC v. NAICS categories; employment share rose from 3.5% in 1970 to 7.5% by 1992, only +0.9% after

• Employment shares jumped 2001 to 2003; some due to cyclical slowdown in denominator

• In any event, employment is not all (or even most) of the slowdown, so it must be relative earnings…

Relative Earnings

• Clear break in relative earnings trend

• NIPA shows 25% increase 1970 to 1992, but 10% of that reversed next 10 years

• CPS shows same upward trend through early 1990s, break/stabilizing after that

Health Service Occupations

• Alternative way to tabulate CPS is by occupation (no macro occupation data before late 1990s)

• Map CPS detailed occupations into (1) doctors, (2) nurses and therapists, (3) technicians and health administration

Median Relative Earnings

• Overall median earnings of health workers even more dramatic than health industries; rose from 0.9 to 1.3 (40 percent relative increase) between 1970 and early 1990s

• Most dramatic change is for nurses and therapists—those occupations also had the fastest employment growth

Health Service Cost Growth

• Slowdown in employment growth and reversal of relative earnings growth clearly consistent with spending slowdown

• Unless both employment shares and relative earnings expected to resume growing at pre-1992 rates, no basis for projecting health costs using data from 1970 to 1992 period

Other Health Spending

• Health insurance and drugs/durables have not slowed as much; no factor payments data available to break down trends

• Factor payment logic still holds looking ahead: how many people will be employed by drug companies, and how fast will their relative earnings grow?

Conclusions

• Extrapolating past trends is suspect; should project costs based on employment and relative earnings

• Employment could be projected based on real quantities of services; number of doctor visits, various procedures—have those stabilized?

• Relative earnings probably reached a new equilibrium after boom period of 1970s and 1980s