Tuesday, February 28, 2012

Why do Americans spend more on healthcare? Because they can

By Christopher J. Conover - February 25, 2012

Americans have the highest health spending on the planet. Why? Because they can afford to do so. What few people realize is that the United States has increased its standard of living vis-à-vis its biggest competitors despite rising health expenditures (figure 1.6c).

It may seem trivial to observe that Americans spend more on healthcare because they can afford it. But it gets to the heart of an important question: Why are we so preoccupied with rising health costs in the first place? From the standpoint of the average American’s welfare—measured in terms of their standard of living—what really matters is how much they have to spend on everything else once healthcare has been purchased. We can approximate this standard of living by simply subtracting national health expenditures from the rest of GDP and then dividing by population. To make these comparisons, I have relied on Penn World Table estimates of GDP per capita, which have been carefully constructed to produce a standardized metric of living standards that allows for meaningful comparisons across countries and over time. That is, in these comparisons, a 2005 dollar has equivalent general purchasing power across each of the years and countries shown.

In the United States, real (inflation-adjusted) healthcare spending per capita has been rising faster than real GDP per capita for as long as we can measure it (back to 1929). Consequently, healthcare absorbs a growing share of GDP. But the same has been true for all our major competitors for as long as we can measure it (back to 1960). For purposes of discussion, I’m defining the nation’s major competitors as the rest of the countries in the G7 (Japan, Germany, UK, France, Italy, and Canada) since these represent our major industrialized trading partners. Countries such as China and India surely will grow in importance in the decade ahead, but right now their standard of living is far behind that of the United States.

The United States for many decades has enjoyed a far higher standard of living than in the rest of the G7. In 1960, non-health GDP per capita in Japan was 62 percent lower than in the United States. The rest of the G7 also lagged behind the United States, though by not quite as much (ranging from 43 percent lower in Italy to 19 percent lower in Canada, the country whose standard of living came closest to that of the United States). This should come as no surprise: the United States emerged as the world’s strongest industrial power after World War II, an advantage that could easily have been predicted to persist only 15 years later.

But here’s what may surprise many readers: in real dollar terms, the U.S. margin of advantage in non-health spending increased between 1960 and 2007 for every single G7 country except Japan. Moreover, even since 1980, this U.S. margin of advantage increased for every country except the UK (which saw a minuscule decline in this metric). This means that even countries which experienced a lower growth rate than the United States in real health spending per capita lost ground to the United States in their real non-health standard of living. How could that be? The absolute increase in real U.S. GDP per capita was more than enough to absorb the absolute increase in its real health spending per capita during the same period.

A concrete illustration will make this clearer. From 1980-2007, U.S. health spending per capita grew by 4.3 percent a year. In Germany, this increase was only 2.5 percent a year. One might suppose that this large difference in health spending growth rates would have allowed Germany to catch up with the United States in terms of its non-health GDP per capita. That is, if Americans were spending more on healthcare, they must be spending less on everything else. But that’s not what happened. Between 1980 and 2007, the difference between U.S. and German health spending per capita grew by more than $3,000 (i.e., Americans spent $528 apiece more than Germans in 1980, but by 2007, this difference had grown to $3,078). Had non-health GDP per capita grown by identical amounts in each country, this would have reduced the U.S. non-health standard of living by more than $3,000 vis-a-vis Germany. But the rise in U.S. GDP per capita instead was so large that it not only covered the $3,000 in added health spending, but increased the U.S. margin of advantage over Germany in non-health spending by nearly $4,000! This illustrates the enormous power of a growing economy: Americans literally were able to have their cake and eat it too.

This is a critically important truth: the United States spends more on healthcare in large part because it can afford to do so. And unless the United States suffers a sharp decline in its GDP growth compared to its competitors, this pattern can persist for many decades. Even today, the margin of advantage I have been describing remains so large that even for Canada (where the U.S. margin of advantage is smallest within the G7), the United States could afford to increase its health spending by 50 percent without entirely eradicating Americans’ higher non-health standard of living relative to Canadians.

A rich country has to spend its income in some fashion. Would critics of the U.S. health system feel better if all the extra income that found its way into the healthcare system had instead been devoted to buying pet food, lottery tickets, or fancier cars? Put another way: which would you rather be? The country that spent more on healthcare because its booming economy gave it the means to do so? Or the country whose growth in healthcare was constrained by lower economic growth? This is not to argue that we cannot and should not find ways to get rid of avoidable health spending where feasible. But it puts into perspective where the United States really sits relative to its competitors. The United States is not doing nearly as badly as some critics have alleged. Moreover, these figures raise serious questions about whether we really wish to go down the same path as other European social welfare states.

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