Many countries’ concern over their level of health care expenditure raises the question of what the optimal level of national expenditure devoted to health care ought to be. It is, unfortunately, extremely difficult to define such a universal level of health care expenditure. A basic problem is that the objectives of the health care sector are not normally defined in an explicit manner. Efficiency is often stated as an objective, but is seldom quantified. Common wisdom holds equity as a major consideration in the resource allocation process, but equity, too, is hardly ever explicitly defined. Yet until the objectives are clearly outlined, it is impossible to state whether health care is under- or over-funded. Many arguments on both sides are misleading, generally supporting long-held biases or confusing the relevant issues. An economic perspective can, however, illuminate some points of this discussion.

The past 30 years have experienced a slight but steady increase in the share of national resources devoted to health care in a number of developed countries. This trend indicates that the income elasticity of health care expenditures, defined as the proportionate change in expenditure given a proportionate change in national income, is greater than one—a one percent increase in gross domestic product (GDP) is associated with a greater than one percent increase in health care spending.

Real Health Care Gains

That a number of countries are indeed devoting more national income to health care each year is shown in Figure 1 of “Health Care Headaches,” which reports data on a few major Organization for Economic Cooperation and Development (OECD) countries. Even during periods in which gross domestic product (GDP) growth rates are relatively low, growth in health care expenditure remains high. There are, of course, some periods of exception to this rule, but the general trend holds. Indeed, since 2000, growth rates in health care expenditure have far outstripped growth in GDP for most of these countries. Although the period is smaller and the choice of a base year therefore probably matters more, these relatively high growths in health expenditure occurred when GDP growth rates were relatively modest.

It could be suggested that these recent growth rates are restoring the relatively high rates of expenditure of the 1960s and early 1970s. But given that health care expenditure is at a much higher level now than it was in those earlier periods, these higher growths in expenditure do in fact appear exceptional. Reliance on the restoration of historical rates of growth as the sole justification for increased expenditure has little real defense as an argument for retaining high health care expenditure.

Another equally simple, supposed justification for the increased levels of health care expenditure compares relative expenditure across different countries by regressing health care expenditure per capita on GDP per capita. Such a regression is typically used to show that GDP per capita “explains” a remarkable 90 percent of the variation in health care expenditure per head across the majority of developed countries, as shown in Figure 2 of “Health Care Headaches.” This explanation of the pattern of health care expenditure fails, however, when the United States and Luxemburg, two outliers, are taken into consideration. Therefore, such regression does not necessarily reflect any causal relationship between health and wealth at an aggregate level; high levels of GDP do not necessarily lead to high levels of health care expenditure. Nor can such relationships be used to determine whether some countries are under- or over-spending on health care.

Regression operates on the basis of random variation. In other words, some observations will lie below and some above the regression line. The interpretation that because an observation lies below or above the regression line, it is evidence of under-spending or over-spending, involves a value judgment that observations that lie on the regression line are somehow “appropriate.” Other than defending some form of average expenditure, it is unclear what argument is thereby being presented. Moreover, when health care expenditure per head is regressed against indicators of health, the statistical relationship is clearly weakened. Health care and aggregate health outcome have a much weaker relationship, but this does not imply that increasing health care expenditure is per se a “bad thing.”

Expenditure is simply price times quantity, or volume of consumption. Rising growth in health care expenditure relative to GDP means that two basic factors may be at work. Either prices are rising faster in the health care sector than in other sectors of the economy, or the volume of health care produced is rising more rapidly than is output in other sectors of the economy.

The extant evidence supports the argument that both relative prices and the relative quantity of health care have been rising in most countries over most time periods. Though the relative quantity of health care produced appears to be the driving force in generating higher relative expenditure, some evidence suggests that, in a number of countries, higher relative prices have also contributed to the most recent trends in health care expenditure. Given that prices are dominated by labor costs in this sector, higher relative prices probably reflect some degree of wage inflation in the sector. While some labor is relatively well-rewarded, physician income is at least four times the average wage in most OECD countries, and the vast majority of health care labor is paid at a comparable rate to average wages in most countries. The largest component of labor, nursing staff, tends to be paid around 1.5 times more than the average wage in most countries. Moreover, in most cases, these multiples have not changed markedly for some time. Therefore, given that prices in the sector are dominated by labor costs and given that labor costs in this sector move in line with wages, there is generally limited scope for relative prices to generate higher growth rates in health care expenditure than in the economy as a whole.

The contribution of relative prices to the growth in health care expenditure therefore tends to be much lower than the contribution through a relative increase in output. During the ten-year period from 1990 to 2000, relative price growth in the health care sector was approximately 1.5 percent or less in most countries, while the relative volume of health care delivered grew at approximately 3 percent per year. In other words, with relative output growing at twice the average rate of increase in prices, most of the increase in the growth of health care expenditure is related to the volume of health care delivered rather than to price increases.

Explaining The Shift

Two basic explanations have been proffered to account for this relative increase in the volume of health care delivery. One is that countries have experienced aging in their populations, and therefore, it is not surprising that health care output is rising. The second, and somewhat related, argument is that health care technology keeps health care output rising.

It seems straightforward to argue that health care expenditure may be rising in response to aging populations. While it is true that the growth rates for populations over age 65 have been rising in most countries throughout the period, these growth rates have been relatively modest so far, at under three percent growth per year in most countries. The population of very elderly has, of course, been growing more rapidly, but even here growth rates of the population over 80 years of age, for example, are generally under four percent. It is difficult to imagine how such growth rates in a population can do more than support some modest percentage of the OECD countries’ growth rates in health care expenditures. Indeed it has been argued that these growth rates in the elderly population account for less than 0.5 percent of the increase in health care expenditure. There is increasing evidence that the demography of the population per se does not radically alter the demand for health care. What matters is not the aging of the population itself, but rather the increasing tendency to use health care resources as individuals grow old. This intensity appears to have been rising over time.

Increases in the intensity of health care service delivery to the elderly population is in part related to increases in the availability of health care technology. In the health sector, new technology tends not to replace older technology rapidly or completely. It is true that new technology partly acts as a substitute for older technology, but more generally, newer technology expands the treatment possibilities available to the population. Such treatment expansion allows more people to be treated. The uptake of new technology in the health care sector, unlike in other sectors of the economy, is therefore liable to be cost-increasing rather than cost-saving. New drugs do not completely substitute for older drugs, but allow more people to be treated. Newer surgical techniques do not completely replace older techniques, but simply allow more individuals to be treated. The increase in the elderly population is not in itself an issue, but coupled with the availability of newer technology this allows health care providers to service the elderly more intensively. This is what increases cost.

What then can we say generally about health care expenditure? Prices, which are dominated by the cost of labor in the health care sector, play a limited role in determining the sector’s growth in expenditure. At the same time, health care expenditure has generally been rising faster than GDP. An increased growth in the volume of services delivered would appear to account for the majority of this growth in health care expenditure. This increased growth in the volume of output cannot all be accounted for by increasing demands from demographic and technological changes, being placed on the system. Yet in aggregate terms, growth in expenditure has certainly outstripped growth in income in most countries over most time periods.

If, in any society, there is a desire to spend a greater amount of resources on health care, there is nothing wrong in doing so. It merely means that the opportunity cost of health care resources will rise, although the rate is unknown. But that is no reason to withhold funding; different countries spend resources in different ways and distribute resources to different groups, reflecting the difference in the tastes and preferences of their societies. It is, after all, these differences in tastes and preferences that dictate the differences in cultures. In other words, based on tastes and preferences, it may be that spending on health should be increased in most countries. The level and growth of health care expenditure is ultimately a normative issue reflecting the value judgments expressed by any given country.

However, it may also be that society has optimistic expectations about the capability of health care to deliver results. The assumption that we are constantly in pursuit of an optimal level of health care funding presumes that we would not knowingly use our resources in a wasteful way. Certainly some health care may do little good for the patient; tonsillectomy, haemorrhoidectomy, and hysterectomy have all been shown to be of little benefit for specific groups of patients. Other health care procedures may be of questionable incremental benefit; there is little evidence, for example, that some laparoscopic surgical procedures yield additional benefit beyond those gained by undergoing open surgery. In some areas, including prostatectomy, the additional benefit is highly questionable.

Value Judgments

Identifying the value that is obtained from specific interventions remains a complex task. The additional benefit arising from additional expenditure on individual therapies is an underdeveloped but growing area of evaluation. The growth in the identification of the cost-effectiveness of health care interventions relies on defining the benefit from individual treatments. Defining benefit, despite all the optimism generated by such outcome measures as quality adjusted life years (QALYs) gained, remains in an early stage of development. Attaching value to that additional benefit, such that a society’s tastes and preferences are represented, is even less developed.

An ideal system of funding would consider the additional benefit to be gained from additional expenditure. The incremental benefit of expenditure, the health gained for each dollar spent on health care, would be constant across different interventions, no matter the health outcome. Unfortunately it is currently unknown what the precise relationship is between expenditure and benefit across most medical interventions, not least because of the difficulty in defining benefit.

In most cases we simply do not know whether further expenditure represents good value for the money. We cannot, therefore, rely on information about allocations to individual interventions to dictate the optimal level of funding. As more information becomes available, this may be an option. The experiments in calculating costs per QALY within the health care sector, or indeed costs per any unit of measure of outcome, can only help in this respect.

Ultimately, the optimal level of health funding is a normative question dictated partly by the aggregate tastes and preferences of society. Even accepting this general statement, however, some information can be gained about the general trend in expenditure levels. It can be shown, for example, that expenditure on health care in most OECD countries has increased over time, often at levels greater than the rate of increase in GDP and arguably keeping slightly ahead of the demands placed on the sector.

But given that there still remains little knowledge about the effectiveness and cost-effectiveness of individual treatments, and given also that the question of what represents the optimal level of health care expenditure is a normative one, it is not possible to state whether such growth has represented a movement towards “acceptable” funding of health care or not. The question of whether any given country is under- or over-spending on health care remains, at this aggregate level, open to discussion.