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HomeEconomyIncentives to overspend or drive innovation? – Healthcare Economist

Incentives to overspend or drive innovation? – Healthcare Economist

according to a study Frankovich and Kuhn (2022), the answer is both. However, the added value of innovation—measured by increased longevity—could more than offset the inefficiencies created by overspending. Specifically, the authors use a generational overlap model in which individuals can purchase health insurance and medical progress depends on returns on investment in the healthcare sector. The authors calibrated their model using longevity data from the Human Mortality Database from 19650 to 2005, income data from the Current Population Survey (CPS), and health care expenditure data from the National Center for Health Statistics (NCHS). This time frame is relevant because 1965 was the year Medicare was introduced in the United States.

Using this approach, the authors found that:

…Broader health insurance accounts for a large share of the growth in U.S. health spending, but also increases the rate of medical progress. A welfare analysis shows that while subsidizing health care through Medicare creates excess health care spending, it is more than compensated by life expectancy gains from medical advances.

Overall, higher levels of health insurance reduce consumption as more money is spent on health care. At the same time, capital—especially capital invested in R&D—increases as health insurance increases returns on investment because more patients can afford treatments. The author states:

One explanation for why the benefits of medical progress increasingly outweigh the losses of moral hazard lies in the continued growth of income: as long as per capita consumption increases over time, individuals tend to place a higher value on life (Hall and Jones, 2007, Chen et al., 2021). This argument extends to the assessment of moral hazard that individuals are willing to tolerate increasing distortions in health insurance in exchange for increased longevity, so long as this only slows but does not reverse consumption growth.

The authors also note that medical prices increase over time due to Baumol’s cost disease; specifically, the combined effect of productivity growth in the final goods sector and medical progress itself drives up prices.

Polite Journal of Health Economics.

you can read the full text here.

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