Skip to main content

Life is good

Considering benefits—and accurately measuring costs—is critical when evaluating health care spending.

May 1, 2002


Douglas Clement Senior Writer

Often lost in the uproar over "skyrocketing" health care spending is a full appreciation of what we purchase with all that money and a consideration of whether, in fact, the benefits might outweigh the costs. Indeed, a growing consensus among economists is that when costs are accurately measured and dollar figures are attached to increases in quality and quantity of life due to health care expenditure, the benefits may well dwarf the costs. This doesn't negate the need to minimize waste, but it does caution against the pursuit of false efficiencies.

Quality (and quantity) of life

In the last few years, economists have begun paying closer attention to the economic value of medical outcomes. By calculating increases in longevity associated with medical treatments and then attributing an approximate value to those added years, they arrive at rough estimates of the value added to society by medical care. This analysis gets beyond the debate over why health care expenditure is rising and asks the bottom line question: Is it worth it? The apparent answer: Yes, without a doubt.

In a 2001 article, David Cutler, a Harvard health economist, and Mark McClellan, a member of the President's Council of Economic Advisers and an economist and physician at Stanford University, reviewed data on a number of conditions (heart attacks, low-birthweight infants, depression and cataracts) and found that the benefits of medical technology far exceeded the costs. The net economic benefit for heart attack treatment, for example, was calculated at $60,000.

Chart-Life Expectancy at Birth, 1960-1997

In a related result, Cutler and McClellan calculated that if the value of such outcomes were incorporated into calculations of price indexes (essentially an adjustment for product quality improvement), the actual price of heart attack treatment has fallen by 1 percent annually, rather than rising at 4 percent per year as reflected in official numbers.

In another recent paper, two economists at the University of Chicago, Kevin Murphy and Robert Topel, estimated that a 20 percent reduction in U.S. deaths from heart disease or cancer "would be worth about $10 trillion, or more than one year's national product." Such rates of return to medical care provide a solid reason to be less frantic to trim health care expenditure that currently amounts to just over a tenth that sum; indeed, it presents a strong justification for increased funding for medical research. "Even modest progress against mortality-causing diseases such as cancer, heart disease and AIDS would have values that are many times the current level of medical research spending," wrote Murphy and Topel. "These estimates ignore corresponding improvements in the quality of life, and for this reason they are likely to be conservative."

Similarly, in a paper published earlier this year, Columbia University economist Frank Lichtenberg measured relationships between increases in life expectancy at birth from 1960 to 1997 and increases in health expenditure and medical innovation. He found that both medical innovation (particularly new drug approvals) and medical care spending (especially by public entities) contributed to greater life expectancy. The returns to expenditure on health care were substantial, according to Lichtenberg: The medical expenditure needed to gain one life-year is about $11,000 and the pharmaceutical research and development expenditure needed is $1,345. Compared to an economic value of $150,000 for a year of life, he said, the returns to health spending are enormous.

Indeed, economist William Nordhaus of Yale University calculated in another 2002 paper that the economic value of longevity increases in the last 100 years is about as large as the value of growth in all other goods and services during this time. "If this is anywhere near the case," Nordhaus wrote, "it would suggest that the image of a stupendously wasteful health-care system is far off the mark."

Overstating inflation

In addition to looking more carefully at benefits, economists are also beginning to recognize that increases in the actual costs of health care have been overestimated. For example, when government statisticians report on the health care consumer price index (CPI), they record the current prices of a certain "basket" of medical products and services, weight them appropriately and calculate the index. But the statistics are misleading for several reasons: Some health care CPI measures use list prices rather than actual costs; the services used to treat patients change rapidly, but the basket used by statisticians doesn't; hospitals are usually paid an aggregated fee for a specific diagnosis, which is cheaper than an item-by-item total.

When Cutler and McClellan looked closely at the actual cost of treating heart attack patients between 1983 and 1994, they took these pricing factors into account and calculated that the actual inflation figure was about 0.5 percent to 1 percent per year, compared to an "official" government CPI hike of 3 percent to 4 percent annually. A similar study of the costs of treatment for depression by Ernst Berndt of Massachusetts Institute of Technology and his colleagues found that official government figures overstate inflation significantly; in fact, relative to overall inflation, prices for treating the acute phase of major depression fell from 1991 to 1995.

These flaws apply to price indexes for many parts of the economy but tend to be especially severe in the health care industry. While government price index calculations are being improved, experts say they still significantly overstate the rate of inflation of health care prices.

The value of health

Whether costs are overestimated or benefits underestimated, the root of our high and increasing health care spending is not dollars-and-cents calculation, but rather a simple matter of preference. Americans spend a lot on health care because we choose to; we value health highly.

"We're a wealthy country and we spend more as a percentage of GDP on health care than other countries," said Jon Christianson, an economist at the University of Minnesota. "But at some level you have to say, 'Well, do we care about that? How important is that?' And I would guess France doesn't care a lot that it spends a higher proportion of its GDP on wine than most other countries. That's a part of their culture, that's important to them. Spending on health care is important to us."

Douglas Clement
Senior Writer

Douglas Clement was a managing editor at the Minneapolis Fed, where he wrote about research conducted by economists and other scholars associated with the Minneapolis Fed and interviewed prominent economists.