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The Economy Tamed Health Costs; That's Ending

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Paul Krugman tweeted the following about health care last week:

Paul Krugman @paulkrugman Why this is important: claims of an entitlements crisis rest largely on the assumption of rapid growth in health sp… Twitter: Paul Krugman on Twitter

The point is significant. For decades, public and private health care spending have grown significantly faster than the economy as a whole, a phenomenon known as excess-cost growth. Krugman’s tweet and a chart he attached from the Kaiser Family Foundation both suggest that excess-cost growth has ended. If this is the case, then fear of a looming Medicare crisis is overblown, and Republican enthusiasm for cuts in Social Security, Medicaid and Medicare is misplaced on two counts.

First, there’s no reason to panic even if entitlement spending contributes to federal deficit growth; concerns about the deficit are not only exaggerated, but at least in the short term, actively harmful. Chronic slow economic growth implies that the U.S. needs bigger deficits, not smaller ones.

Second, the biggest long-term driver of economic costs, health care spending, has been subdued recently and so there is no looming crisis to avoid.

The Congressional Budget Office, unsurprisingly, is less sanguine. Its charts show exploding government spending driven primarily by health care costs all the way to 2047. The CBO doesn’t agree with Krugman’s assertion that excess-cost growth is under control even in an aging population.

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Yet the CBO is often way too conservative in the way it uses economic data. It wouldn’t be shocking if its analysts were reluctant to incorporate good news on health costs into their forecast models until they had well over a decade’s worth of evidence to back up those conclusions. In many ways, this level of caution is a benefit. It means that the scare stories we hear are always a little bit scarier than reality. At the same time, however, if scare stories lead to unnecessary benefit cuts, people could be exposed to hardship for no good reason.

This discrepancy sent me digging. The issue is complex, but from what I can find I am reluctantly siding with the CBO. The underlying projections on health care costs come from the Centers for Medicare and Medicaid Services, which condenses them into a 32-page methodological summary. Most of it concerns how to determine total spending on private health care. The relevant bits for our investigation are in these excerpts:

Our measure of input price inflation is based on the expenses of health providers as estimated in input price indexes by type of medical providers. … Due to data limitations, this input price index has historically omitted compensation for self-employed workers (a substantial fraction of whom are physicians). … For this reason, in our model we include growth in physician income as a proxy for supervisory and self-employed provider compensation not covered by our input price indexes a strategy that substantially improves the fit of the model. …

Physician income is projected based on the assumption that rates of increase in such income will tend to follow a similar trajectory as rates of compensation for alternative occupations over long periods of time.

What the analysts are telling us is this: First, they need a way to estimate the pace of increases in expenses paid by hospitals and other health care providers— to determine whether they outpace ordinary inflation. Those expenses are dominated by salaries, in particular physician salaries. To estimate how fast physician salaries are growing, the study looks at the growth in salaries for professionals in general.

It turns out that the wages for professionals have grown exceptionally slowly over the past few years.

Before the 2009 recession, wage growth for professionals grew at nearly 4% a year. That growth collapsed to nearly zero and has not yet recovered to its pre-recession norms.

This is almost certainly a result of the slow U.S. economic recovery. As Krugman was adept at elucidating, businesses are usually wary of laying off or cutting salaries of highly skilled workers during a recession. Instead, wage growth falls. Wage growth stays subdued until the economy has recovered to full employment, the point where nearly everyone looking for a job can find one. The U.S. economy at best has reached full employment only in the last year or so, and by some measures is still short of it.

As the economy recovers, expect salary growth for professionals to pick up and for excess-cost growth to resume. So long as the system depends on highly skilled professionals to deliver health care services, health care costs can be expected to grow faster than the rest of the economy.

— For more columns from Bloomberg Opinion, visit

Pen (Image: iStock)

Karl W. Smith is a former assistant professor of economics at the University of North Carolina’s school of government and founder of the blog Modeled Behavior.

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