Drivers of Health Care Expenditure: Does Baumol's Cost Disease Loom Large?

Carsten Colombier

FiFo / Dezember 2012 / Discussion Paper, FiFo

Abstract
According to Baumol (1993) health care epitomises Baumol's cost disease. Sectors
that suffer from Baumol's cost disease are characterised by slow productivity
growth due to a high labour coefficient. As a result, unit costs of these sectors
rise inexorably if the respective wages increase with productivity growth of the
progressive industries such as manufacturing. Thus, according to Baumol (1993)
the secular rise in health-care expenditure has been unavoidable. This present
paper demonstrates that health care is contracted by Baumol's cost disease, but
only to a minor extent. Consequently, policy-makers have more leeway to curb
ever-increasing health-care expenditure than is suggested by Baumol (1993) and
other authors. In addition, we test the implications of Baumol's cost disease for
health care by avoiding the well-known flaws in constructing medical price indices.
Therefore, the adjusted Baumol variable derived in this paper is also extremely
appropriate to test the validity of Baumol's cost diseases of other service
industries such as education or the live performing arts. Additionally, our analysis
suggests that health care is rather a necessity than a luxury at the national
level, which conflicts with macroeconomic evidence provided in the relevant literature.