Five reasons behind rising health care costs

In this post, we digress to touch on the current favorite talking point in American social and political circles - health care.  We will address health care from a purely economic perspective, leaving aside all moral issues for the present.

Health care as an industry is cornering a growing percentage of American GDP. Healthcare costs accounted for 12% of American GDP in 1990, 16% in 2006 and are projected to rise to 20% of GDP by 2016. This means, that the average citizen (per capita) is spending a bigger percentage of his/her income on health care now compared to 20 years ago.

Health care is important (for any society, not just American society) from an economic standpoint because it increases the quality of life and productivity of society as a whole. Economically speaking, any investment that a society makes into health care would be a drain (a cost) if that investment did not cause a rise in productivity and GDP. On the other hand, when citizens feel that the benefits from health care do not outweigh the cost, they begin to resent the investment.

Health care can be demarcated into two kinds - elective and non-elective. Elective health care is chosen by individuals who are otherwise healthy, to correct for physical shortcomings. Non-elective health care is the cure of ailments without which the affected person will have a very poor quality of life.

Discussion in this post will be limited to non-elective health care, whose costs are borne by society rather than by individuals. What is also not part of this discussion, is whether a society has a moral obligation to provide health care to all its citizens (i.e. is health care a basic human right?).

We will focus solely on the factors that have contributed to non-elective health care grabbing a bigger piece of the GDP pie and not on the individual share of each factor (we leave that to other interested parties). From a 'big picture' perspective, the contributing factors boil down to five that we summarize below in no particular order:

1. deteriorating health of society - rise of chronic diseases like diabetes, high blood pressure and heart disease (aka "lifestyle diseases"), greater percentage of population contracting these diseases at a younger age and living to a greater age with them


2. inefficient health care - e.g. multiple ineffective options, unnecessary visits to doctors, treatment of symptoms rather than causes, non-emphasis on preventive health care, defensive procedures for fear of lawsuits


3. disproportionate allocation of profits from health care - e.g. pharmaceutical company executives, insurance company executives, hospital executives, lawyers specializing in medical lawsuits, doctors/surgeons


4. limited success in medical research - medical companies forced to make up for the cost of research by raising the price of health care accessories including medicines and drugs


5. increase in longevity of human life - retired people in need of medical care forming a greater percentage of the population

Moreover, health care costs are not borne equally by everybody in society.  For example, the "healthy insured" subsidize care for the "unhealthy insured", while tax-payers in general subsidize care for  the "unhealthy uninsured" who might use free clinics or emergency rooms (paid for with tax dollars) disproportionately.  This can lead to a vicious cycle - if health care costs become prohibitive, then more people opt out of paying for it (swelling the ranks of the "uninsured"), making costs even higher for the rest of the population - the "insured" and the tax-payers.

It is important to reach a consensus on which of the costs listed above are essential (e.g. care of the elderly) and which can be trimmed (e.g. costs associated with lifestyle choices such as diet and smoking). It is also important to understand which factors contribute more than others to health care costs. Not only will this help to identify measures for lowering costs, but it might also make it easier to decide whether the remaining costs should be borne proportionately by everybody in society.  In addition, an objective measure of the benefits of healthcare (by measuring increases in productivity and GDP) would help keep the burgeoning costs of health care in (economic) perspective.  

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Recession and Stimulus

In the last post (http://layconomics.blogspot.com/2009/09/real-growth-prosperity-and-standard-of.html) we understood that real growth involves an increase in prosperity.


In this post, we will try to understand, without bringing money into the discussion, what recession is and how stimulus spending can rejuvenate an economy into growing again.

Let's go back to our prosperous village. The village has grown in size and prosperity. It now consists of 6 people, Wesley the wise, Henry the hunter, Taylor the tailor, Fannie the farmer, Billy the builder and Debbie the designer. Fannie grows the grain, vegetables and fruits. Henry goes hunting rabbits every week and brings home enough meat. Taylor spins cotton and is responsible for making clothes. Billy is responsible for building houses for the village. Debbie makes designer footwear using rabbit hide. Finally, Wesley is responsible for safekeeping of the village and its wealth. The village economy is humming along via the exchange of goods and services. The employment rate in the village is 100% and everybody in the village has the luxury of enjoying high fashion and leisure. The villagers work 6 months in a year and enjoy 6 months of leisure time.


As time goes by, Henry finds it harder and harder to hunt as he is getting old. Often, he comes back empty handed and soon decides to not go hunting any more. He is unable to get any food or clothes in exchange for meat. Debbie, who depends on Henry's leather for her designer footwear finds herself in the same boat as Henry. They are both soon unemployed. At current consumption rates, the reserves will last only 4 months and Wesley will soon have to start rationing food. The employment rate falls to 66% and the economy goes into recession ...


Wesley "the wise" however, decides to stimulate the economy while he still has some reserves. He digs into the granary and meat stock (bailout, or in this case, handout) and employs Henry to work on advanced hunting tools (an economic stimulus package). As luck would have it, Henry discovers the bow and arrow and is soon hunting down more animals than he was before. He is not only able to hunt rabbits but is also able to hunt bigger animals like deer. Debbie finds employment again and has expanded her line of offerings to leather jackets. The village folk now have to work only for 4 months instead of 6. The employment rate is not only back to 100% but the folks are enjoying more leisure time and higher fashion. Wesley's "stimulus" plan has managed to rejuvenate the economy.


As we can see, stimulus can work by increasing employment and productivity.

On the other hand, if Henry had not discovered new tools, the stimulus would not have worked. Employment would have briefly risen to 84% with no corresponding real growth. If Wesley's earmark choice for the stimulus package had been poor (i.e. Wesley had asked Henry to work on a project with little chance of success) the stimulus would not have worked. The reserves would have been exhausted sooner than planned and the economy would have been in dire straits.

The example we gave here is a gross simplification. There are a number of ways a recession can strike. With the advent of money this number can only grow bigger. In the next post, we will understand the role of money and why it is indispensable to the modern economy. So, stay tuned!

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Real growth, prosperity and the standard of living

The first post (http://layconomics.blogspot.com/2009/09/why-layconomics.html) necessitated the definition of "real" growth. As we saw, increases in asset values in terms of monetary units do not automatically translate to the prosperity of a society. However, since all transactions are defined by money changing hands, prosperity has become synonymous with the amount of money circulating in a society.

However, money is useful only if there are tangible goods available to be purchased with it. Imagine a scenario where a natural disaster suddenly wipes out food supplies in a region. The amount of money circulating in the region remains the same, yet people still starve because they no longer have any food to buy with that money. So, we can conclude that it is not money but, goods circulating in a society that are an indication of its prosperity.

To drive home the point further and also to understand "real" growth, let's travel back in time to when societies were primitive, the concept of money did not exist and people relied on simple barter to obtain goods and services.

Let's consider two villages A and B, consisting of three people each. Let's assume both villages have equal access to natural resources, and let's further assume that environment is not a factor in determining the standard of living in both villages.


In Village A, each resident is only capable of hunting food for him/herself everyday. Each person's entire day is spent searching for prey, tracking it and finally killing it. This provides him with one meal for the day.


In contrast, in Village B consisting of members B1, B2 and B3, B1 has discovered agriculture and farming and therefore s/he is able to provide food for the entire village. B1 agrees to share the food with B2 and B3 provided they give him/her something in exchange for it. B2 and B3 end up doing the following:

1. B2 discovers a way to spin cotton and make clothes for all three people in the village


2. B3 discovers a way to put branches together and build shelters for all three people in the village

Now,

1. B1 trades food for clothes with B2 and food for shelter with B3
2. B2 trades clothes for food with B1 and clothes for shelter with B3
3. B3 trades shelter for food with B1 and shelter for clothes with B2
4. All three residents of village B enjoy food, clothes and shelter

So, by being able to produce not just for themselves but also for others and engaging in the exchange of goods, people in village B have experienced "real" growth and now enjoy a much higher standard of living than the people in village A. One might even say that people in village B are more "prosperous" than those in Village A, since, not only do they have enough food to eat but also clothes, shelter and some leisure time. Also, since every member in village B produces goods for 3 times as many people, one can also say that the gross domestic product (GDP) of village B is three times that of village A.

Therefore, the main ingredients of prosperity are (it's not money!):

1. Availability of natural resources
2. Productivity and specialization
3. Exchange of goods and services

In this post, we hope that we were able to explain growth and prosperity in simple layman terms. In the next post, using similar examples, we will try to get our hands around other economic terms like "recession" and "stimulus". So, stay tuned!

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Why Layconomics?

Layconomics started when we received the following - idiot's guide to economic boom and bust - in an email one day (partially reproduced and edited below) that attempted to explain the recent financial meltdown triggered by the real estate bust without using any technical jargon.

Once there was a little island country. The land of this country was the tiny island itself. The total money in circulation was 2 dollars (two pieces of 1 dollar coins)

1. There were 3 citizens living on this island country. A owned the land. B and C each owned 1 dollar.
   Net asset of the country = 1 island and 2 dollars.
2. B decided to purchase the land from A for 1 dollar. So, now A and C own 1 dollar each while B owned a piece of land that is worth 1 dollar.
   The net asset of the country now = 3 dollars.
3. C now thought that since there was only one piece of land in the country and land is a limited asset, its value would definitely increase. So, he borrowed 1 dollar from A, and together with his own 1 dollar, he bought the land from B for 2 dollars.
* A has a loan to C of 1 dollar, so his net asset is 1 dollar.
* B sold his land and got 2 dollars, so his net asset is 2 dollars.
* C owned the piece of land worth 2 dollars but with his 1 dollar debt to A, his net residual asset is 1 dollar.
Thus, the net asset of the country = 4 dollars.
4. A saw that the land he once owned had risen in value. He regretted having sold it. Luckily, he had a 1 dollar loan to C. He then borrowed 2 dollars from B and acquired the land back from C for 3 dollars. The payment is by 2 dollars cash (which he borrowed) and cancellation of the 1 dollar loan to C.
   * A now owned a piece of land that is worth 3 dollars. But since he owed B 2 dollars, his net asset is 1 dollar.
   * B loaned 2 dollars to A. So his net asset is 2 dollars.
   * C now has the 2 coins. His net asset is also 2 dollars.
   The net asset of the country = 5 dollars.
5. One day nobody wanted to buy the land anymore and A could not pay the two dollars he owed B. So, B grabbed the island from A. Therefore, in the end:
   * A owned nothing.
   * B owned the island.
   * C owned the 2 dollars.
   The net asset of the country = 1 island and 2 dollars again.

Even though this simple example did not exactly explain the recent financial crisis precipitated by the real estate crash, it still showed how people might feel like they are getting richer with no concomitant real growth. But, what does one mean by "real" growth?

We will attempt to address this question and more using simple examples as above in subsequent posts. So, stay tuned!

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