Abstract
We study medical progress within a two-sector economy of overlapping generations subject to endogenous mortality. Individuals demand health care with a view to lowering mortality over their life-cycle. We characterise the individual optimum and the general equilibrium, and study the impact of a major medical innovation leading to an improvement in the effectiveness of health care. We find that general equilibrium effects dampen strongly the increase in health care usage following medical innovation. Moreover, an increase in savings offsets the negative impact on GDP per capita of a decline in the support ratio. Finally, we show that the reallocation of resources between the final goods and health care sector, following the innovation, plays a crucial role in shaping the general equilibrium impact.
Highlights
A consensus has emerged that medical progress is driving both the increase in health care spending and the increase in longevity (e.g. Cutler 2004; Chandra and Skinner 2012; Chernew and Newhouse 2012).1 Recent analysis by Fonseca et al (2013) shows that about 30% of health care spending growth in the US over the period 1965–2005 can be explained by medical progress, with improved health insurance coverage explaining 6% and income growth explaining 4%.2,3 At the same time, medical progress explains most of the increase in life expectancy over the period of observation, which in welfare terms more than offsets the greater spending
The modelling in Frankovic and Kuhn (2018, 2019) shows that a full general equilibrium analysis is warranted in particular to capture (1) an increase in the price of health care, as driven by Baumol (1967)-style effects that arise from productivity growth in the production sector and by medical progress, which in turn much dampens the demand increase for health care; (2) the macroeconomic impacts of the increase in the economy-wide capital intensity that is driven by a savings response to greater longevity and enhanced medical treatment options in old age; and (3) the offsetting impact of an increase in old-age dependency if medical progress allows for lives to be saved predominantly after retirement
We construct the effective supply of labourl(a), as depicted in Fig. 1b, from agespecific earnings data for the year 2003 that is provided by the Bureau of Labor Statistics (BLS) in their Current Population Survey (CPS)
Summary
A consensus has emerged that medical progress is driving both the increase in health care spending and the increase in longevity (e.g. Cutler 2004; Chandra and Skinner 2012; Chernew and Newhouse 2012). Recent analysis by Fonseca et al (2013) shows that about 30% of health care spending growth in the US over the period 1965–2005 can be explained by medical progress, with improved health insurance coverage explaining 6% and income growth explaining 4%.2,3 At the same time, medical progress explains most of the increase in life expectancy over the period of observation, which in welfare terms more than offsets the greater spending. The modelling in Frankovic and Kuhn (2018, 2019) shows that a full general equilibrium analysis is warranted in particular to capture (1) an increase in the price of health care, as driven by Baumol (1967)-style effects that arise from productivity growth in the production sector and by medical progress, which in turn much dampens the demand increase for health care; (2) the macroeconomic impacts of the increase in the economy-wide capital intensity that is driven by a savings response to greater longevity and enhanced medical treatment options in old age; and (3) the offsetting impact of an increase in old-age dependency if medical progress allows for lives to be saved predominantly after retirement. Some of the proofs have been relegated to an “Appendix”
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