Can Healthcare Spending Cure the Fiscal Deficit?

Overview

Most people, quite rightly and naturally, think of healthcare as solving the covid problem in the form of new tests, treatments, vaccines and public health initiatives.

As it turns out, healthcare may also turn out to play a surprising part in solving another problem caused by covid. This is the risk that loose fiscal and monetary policies meant to address the economic hit from covid could someday rebound and cause an even deeper economic crisis.

Healthcare spending, with its high social payoff, could boost the GDP growth rate and stave off the risk of such a negative economic policy rebound. But, as we will discuss below, this may depend on the healthcare sector first addressing its own productivity problems.

Tail Risk from Covid Economic Policies

A recent paper by economists Joshua Aizenman and Hiro Ito outlines the stark questions that the US and global economies face as they exit covid. Loose fiscal policies and highly accommodative monetary policies, that were already in place prior to covid, were greatly accelerated in response to the pandemic.

The short-term benefits of these loose, accommodative policies include faster economic growth as long as the snowball effect — the difference between the interest rate on public debt and the GDP growth rate — is negative. However, hidden in plain sight within such a strategy is growing tail risk: If and when the snowball effect reverses itself i.e. if the interest rate on public debt shoots above the GDP growth rate, a deeper future crisis could ensue through sudden stop in financial markets and instability across the globe.

The question is how best to ensure that the GDP growth rate stays sustainably above the interest rate on public debt.

Squeezing Higher GDP Growth Rate from Fiscal Spending

The authors of the above paper draw lessons from how developed economies exited high public debt overhang at the end of the second world war e.g. the US saw a rapid decline in public debt/GDP which fell from 106% in 1946 to 23% in 1974. The authors argue that this decline was facilitated by financial repression inducing lower interest rate on public debt, mild inflation, higher taxes, and robust GDP growth.

Drawing from this postwar history, one way of addressing the challenge of exiting high public debt from covid, as Aizenman and Ito propose, is to reallocate fiscal spending away from direct covid spending and towards those expenditures with high social payoffs especially school education and medical infrastructure. Over time and with some lag, these reallocations alongside increased tax collections may reduce deficits and even reach primary surpluses, as happened in the decades following the second world war.

Healthcare and Productivity

As regards healthcare, Aizenman and Ito may definitely be on to something. Intuitively too — with greater life expectancy, societies are aging faster. Improved healthspans — keeping older people healthy will also render them more productive to the economy.

As it happens, simple statistics do show that higher healthcare expenditures are indeed positively associated with GDP and aggregate labor productivity for the economy. For example, one study by Raghupathi and Raghupathi shows that, over 2003 to 2014, physician, hospital as well as total healthcare expenditures are positively related with measures of overall labor productivity in the economy.

Papers including those by David Weil and David Bloom et al have drilled deep below these general statistical relationships to get a better feel of causality and robustness. They have (i) looked at cross-country regressions (ii) made microeconomic estimates of direct health on individual income and (iii) developed macroeconomic production functions where health is an underlying contributor to the aggregate human capital stock. All of these throw up estimates that tend to fall within a range and point in a similar direction. In countries that have already made the demographic transition typically associated with developed economies, a 10% increase in health leads to something like a 6.7% to 9.1% increase in labor productivity. Here health is measured by adult survival rates but using other measures such as life expectancy shows similar results. In short, improving health appears to deliver an economically meaningful and robustly significant boost to labor productivity. So, reallocating fiscal spending towards healthcare does seem to make sense.

However, an important question arises. Isn’t the US already spending disproportionate amounts on healthcare — approaching nearly 20% of GDP? Worse, isn’t the US already spending more per capita on healthcare than other developed countries and perhaps receiving less health benefit from it? By some estimates such as those provided by McKinsey, productivity in the healthcare sector is lower than other US service sectors. Indeed, Nobel economist Angus Deaton and his wife and co-author Anne Case argue that the healthcare sector is dragging down US productivity and the economy as a whole. Much of the debate thus far has revolved around the challenge of curbing health spending because of the burden it places on public debt. In other words, while better healthcare may indeed make labor more productive, delivering that healthcare in inefficient fashion could conceivably drag on or even reverse the overall productivity gains.

If so, couldn’t reallocating fiscal spending towards healthcare even create a risk of dampening rather than speeding up GDP growth and expand rather than eat away public debt?

Healthcare in the Post-Covid Era

Healthcare spending can drive faster GDP growth through its impact on the productivity of labor. However, to achieve this, healthcare spending itself must become more efficient and productive. This brings us to a subject that has been much discussed well before covid and even more since the pandemic brought healthcare into global focus.

Improvements in the delivery of healthcare can come in 3 ways — improving the productivity of the healthcare workforce, better deployment and utilization of capital in healthcare and finally innovations in medical products and technologies.

A study by McKinsey showed that much of the inefficiency of the healthcare workforce comes from surprisingly poor utilization of physicians’ time. What is more, the US healthcare industry has huge administrative overhead given fragmentation and idiosyncratic paperwork across more than 3000 provider systems and 350 odd payor systems, making for high complexity in billing, insurance processing and performance reporting. Capital is equally wastefully deployed — much of it is tied up in or allocated to underutilized fixed assets rather than productivity-enhancing investments. Hospital-centric delivery and compulsions to maintain capacity and equipment to meet public expectations or requirements have worsened the situation. In 2016, for example, several other sectors, including utilities, had capacity utilization of 73% to 86%, whereas hospital bed utilization was 63%.

US healthcare leaders such as Rakowski see covid as having unmasked these major deficiencies and inflexibility in the hospital-centric healthcare system. They visualize a transformation catalyzed and begun by covid. In this view, the tailwinds of increased costs, consumerism, and technology will accelerate a new, more decentralized paradigm of healthcare delivery that is supported by technology and advanced logistics. As patients bear more co-pays and deductibles, they will demand value, convenience and customer service from their healthcare, as with any other item from their consumer basket. Healthcare services will accordingly be decoupled from healthcare assets and delivered in a decentralized way through telemedicine, AI-based treatment, point of care diagnostics and wearable biometric monitoring. Homes, worship / community centers and outpatient surgery venues will become sites of delivering care while current hospitals themselves will eventually transform into health and wellness campuses. Next generation paramedics and care quarterbacks will enable care to be coordinated and delivered where needed, allowing physicians to concentrate on the most complex parts of their license.

If covid indeed catalyzes some or all of these above changes, we should be well on our way to improving the productivity of the healthcare workforce as well as that of capital deployed within the sector. However, another important route to more productive delivery of healthcare is innovation, specifically better medical products and technologies. Here again, discussions about how to deliver better innovation have actually preceded covid. Within the private sector, there have been longstanding efforts at value-based pricing i.e. aligning price signals and formulary access of new products to the differential clinical benefits they offer, as Kaltenboeck and Ohn explain. And, going beyond the private sector’s discussions of value-based pricing, economists Mazzucato and Roy ask how value can be re-framed in terms of public health value, where innovation is directed at societal health needs. First of all, such health innovation would be mission-oriented, informed by open debates about where public health threats are the greatest. Second, they suggest that financing for such innovation would combine grants, milestone prizes, and contracts with rewards focusing on health benefits rather than patentability. Third, they call for innovation driven not solely by shareholder value but instead through companies that are accountable to multiple stakeholders including patients and health systems.

The upshot is that covid seems likely to accelerate a number of already-simmering changes to healthcare. If executed well, these changes will likely improve the productivity of both labor and capital in healthcare. They will also likely drive private and public innovation in the direction of greater value, whether in the sense of greater clinical benefit from new medical products or mission-oriented efforts towards addressing the greatest societal health needs.

Concluding Summary

As we limp back from the worst of the covid health crisis, economists have started working on ways to exit the dramatic fiscal and monetary expansions applied to counter the economic fallout from the pandemic. While attention has thus far focused on its tests, treatments and vaccines for covid, healthcare may turn out to have an additional and surprising role in solving this attendant economic crisis.

To counter the risk that expansionary policies may someday result in a snowball i.e. an interest rate on public debt that shoots above the GDP growth rate, it is imperative to find ways to boost the latter. Healthcare spending, with its high social payoffs, is emerging as an important candidate for such efforts to boost the GDP growth rate. Over time, reallocating fiscal spending towards healthcare alongside increased tax collections may reduce deficits and ward off the snowball risk, similar to how other growth-boosting efforts reduced public debt in the decades following the second world war.

Healthcare is a good candidate for this because there has been enough research to show that healthcare has a beneficial effect on national economic productivity. Triangulating cross-country regressions, microeconomic estimates of health effect on individual income and macroeconomic production functions, a 10% health improvement appears to lead to 6.7–9.1% improvement in labor productivity in developed economies.

The challenge, though, is that the delivery of healthcare itself suffers from productivity issues. Covid has certainly brought these deficiencies front and center of national and global discussions. We may therefore see capital and labor productivity as well as value-focused innovation in the healthcare sector improve as long overdue steps are accelerated by the pandemic.

The discussion in this paper has of course been preliminary, speculative and partial equilibrium in nature. Much more analysis needs to be done to definitively conclude that reallocating fiscal spending towards rather than away from healthcare can help stave off the negative rebound risk from loose fiscal and monetary policies to counter covid. And, in any case, it seems clear that improving healthcare’s own productivity through widely desired changes would be a necessary first step.

If -and of course it is still a big if — such changes take hold, we could see healthcare spending become central to discussions of fiscal and monetary policies. The discourse on healthcare may then shift from bending the cost curve to lifting the growth curve.

References

Aizenman and Ito (2020) “Post-Covid 19 Exit Strategies and Emerging Markets Economic Challenges”, NBER Working Paper 27966, October http://www.nber.org/papers/w27966

Bloom, Canning, Kotschy, Prettner and Schunemann (2019) “Health and Economic Growth: Reconciling the Micro and Macro Evidence”, NBER Working Paper 26003, June http://www.nber.org/papers/w26003

Case and Deaton (2020) “Deaths of Despair and the Future of Capitalism”, Princeton University Press, Princeton NJ, March 17

Committee for a Responsible Federal Budget (2018) “American Healthcare: Health Spending and the Federal Budget”, May 16

Kaltenboeck and Ohn (2018) “Value-Based Pricing as a Signal for Drug Innovation”, Health Management Policy and Innovation, Volume 3, Issue 2.

Mazzucato and Roy (2018) “Rethinking Value in Health Innovation: From Mystifications Towards Prescriptions”, Journal of Economic Policy Reform, 22:2, DOI: 10.1080/17487870.2018.1509712

McKinsey & Company (2019) “The productivity imperative for healthcare delivery in the United States”, The McKinsey Center for US Health System Reform, February

Raghupathi and Raghupathi (2020) “Healthcare Expenditure and Economic Performance: Insights From the United States Data” Frontiers in Public Health, 8:156. DOI: 10.3389/fpubh.2020.00156

Rakowski (2020) “A Vision of Healthcare In a Post-COVID-19 World”, Scientific American Medically Home, June 22

Weil (2007) “Accounting for the effect of health on economic growth”, Quarterly Journal of Economics, 122(3)