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Health Care as Main Engine: 
Is That So Bad?


By: David Leonhardt
New York Times, November 11, 2001

Whenever the economy begins growing again — be it early next year, if the recession is an average one, or many months later, if not — the next expansion will probably have a character starkly different from those of the recent past.

For the last few months, the business of keeping people healthy has been one of the only parts of the $10 trillion American economy that has remained healthy, and many economists now say that the sprawling health care industry may be the only driver of growth in the near term. Even when consumer spending and corporate investment pick up, the health care sector is likely to expand faster than most industries in the years ahead.

For the economy over all, that suggests a mixed prognosis. With health care as a growth leader, the next expansion may not be as robust as the boom of the late 1990's. Spending on health care does not ripple through an economy as forcefully as new purchases of technology, housing or factories. It also does relatively little to make an economy more efficient — yet increases in efficiency improve material living standards by allowing more goods or services to be produced with the same amount of human effort.

On the other hand, a health care expansion can bring benefits that new computers, houses and cars rarely do, economists say. By many standards for valuing human life, the medical spending of the last half-century has yielded enormous returns, primarily by cutting the death rate from heart disease, the nation's top killer. Future treatments may well reduce the rate further — or extend the lives of people suffering from diseases like cancer.

"Think of the economy as a system that at the end of the day is supposed to make life nice," said Paul Romer, an economist at Stanford University who studies technological change. Computers, he said, "don't do all that much to make my life happier."

"What makes me happy," Mr. Romer said, "is good food, a nice house and, most of all, good health."

The $1.3 trillion health care industry — including pharmaceutical companies, medical equipment makers, hospitals, nursing homes, assisted-living centers and insurers — has boomed before, as far back as the 19th century. But the current expansion comes after a decade in which health care's share of the economy remained flat, largely because insurance companies and the government restrained spending. Now, widespread demand for more flexible health programs, the aging of the population and a spate of hospital mergers are pushing up both costs and investments in health care.

Research budgets at drug companies and the federal government are also rising, and scientists expect the recent mapping of the human genome and other advances to yield major new treatments in the next decade. As baby boomers near retirement and their golden years, they will further inflate the number of Americans who spend heavily on medical care.

In recent weeks, fears about bioterrorism have led the Bush administration to request $1.5 billion to fight germ attacks, and some members of Congress are arguing for as much as $7 billion in new spending. Policy makers are also considering a law that would require companies to offer more coverage of mental illnesses.

By 2010, health care is expected to account for 16 percent of the nation's economic output, up from 13 percent today and 4 percent 50 years ago, according to the Centers for Medicare and Medicaid Services, a division of the Department of Health and Human Services. In 2040, economists say the sector could exceed 20 percent, and David M. Cutler, a researcher at Harvard, has argued that even 30 percent would not be unlikely.

Whatever the specifics, executives and economists agree that health care will become a more important part of the economy. "We look at various scenarios, and the answer almost always is 8 percent" a year, said Henry A. McKinnell, the chief executive of Pfizer, the drug company, referring to the industry's expected growth rate. "I don't think the economy will grow that rapidly."

As a result, health care is likely to help determine just how rapidly the economy expands. Over the last half- century, a variety of sectors — among them construction, transportation and, most recently, information technology — have fueled economic booms.

Those other sectors have advantages that medical care does not. A new computer, a new highway and a new building not only provide employment, but they can also lift the productivity of the people using them. They are, in other words, investments. Some money spent on health care counts as an investment, but much is pure consumption.

Economists are debating whether the gains in efficiency, and therefore productivity, from the technology boom of the 1990's were large or small. However, most agree that the spending has helped the country emerge from the long productivity slump of the 1970's and 1980's that depressed economic growth. Increases in productivity allow companies to increase their profits without raising prices and setting off inflation.

Health care, by contrast, has little effect on the productivity in a wealthy country like the United States because the population is already healthy enough to perform its work, economists say.

The industry is not ideally suited to stimulating a weak economy because, compared with retail, restaurants, entertainment and many other services, a relatively large part of health care wages go to well-off workers like doctors, scientists and executives. "A dollar to the service sector is almost certainly a bigger stimulus than a dollar to the health care sector because it's more likely to go to a lower-income person who's more likely to consume," said Jonathan Gruber, an economist at M.I.T.

"There is absolutely no credible evidence on the short-run impact of health spending on the economy," Professor Gruber said.

That does not mean that a society that spends more of its money on medical care is worse off. For starters, there are some straightforward economic benefits.

A healthier nation will have a larger work force because many of its citizens can work well into their 60's, 70's and 80's; the more labor a society has, the faster it can grow.

The nature of the industry also requires companies to keep most of their jobs within the United States. Unlike information technology, which is concentrated in a few cities, the health care sector is dispersed across the country and comes in many forms. In many cities, hospitals are the largest employers.

More important, however, are the benefits that simply do not show up in the nation's gross domestic product statistics, economists say.


In recent years, a handful of researchers have tried to quantify those benefits. Usually, they begin by examining the amount of money the country has spent on medical care. The researchers next study the extent to which medical treatment — as opposed to diet or other factors — has reduced death rates. Finally, they try to put a value on a year of human life by analyzing, for example, how much more people are paid to work in jobs with a higher risk of death.

In one finding, William D. Nordhaus, a professor at Yale University, calculated a value of the last century's improvements in health. That value, he said, slightly exceeded the enormous gain in monetary wealth that the United States has experienced since 1900.

Professor Romer said, "The naοve perspective is, `Spending on health care has gone up; that's a bad thing.' " But, he added, "If the question is have we gotten big benefits from spending on health care, the answer is unambiguously yes."

Increased medical spending is not a new development. In the late 19th century, a typical family used almost all of its income for food, shelter and clothing and an extremely small amount for health care, said Robert William Fogel, a Nobel laureate in economics at the University of Chicago. In the 125 years since, spending on food, clothing and shelter has fallen to less than half of the family budget, and medical spending has risen rapidly.

As the nation has grown richer, more people have been able to afford not only basic necessities but also as many televisions and cars as they wanted. After that, they tend to choose to spend additional income on their physical well-being.

"A lot of people would rather have a new knee than a new Mercedes," Professor Fogel said.

That attitude becomes even more common in a downturn, because much medical spending is not discretionary, and health care is now one of the few areas cushioning the effects of recession for corporate America. General Electric , Marriott International , Tyco International  and other big companies with health care divisions are suffering less than many rivals.

The Minnesota Mining and Manufacturing Company , based in St. Paul, is another example. Since the start of the year, it has laid off 5,000 of its 75,000 employees. In the third quarter, sales dropped 7 percent, compared with a year earlier, and operating profit fell 24 percent.

But in a recent call with analysts, Robert J. Burgstahler, 3M's chief financial officer — who had been describing the environment with words like "challenging," "difficult" and "weak" — turned almost ebullient about the company's health care division. Sales at the unit, which makes stethoscopes, medical tape and other equipment and supplies, rose 9 percent in the third quarter and operating profits jumped 16 percent.

"Health care continues to be a great business," Mr. Burgstahler said. "We see solid and steady growth well into the future."

Wall Street has also caught health care fever. Since early 2000, when dot-coms began looking shaky, health care companies have accounted for 20 percent of all initial offerings, up from 5 percent in 1998 and 1999, according to Thomson Financial, a New York company that analyzes market data. The market for initial offerings was virtually closed from mid-August until early October, when some companies began to test the waters — many in health care. The Amerigroup Corporation, a managed care company, was the latest to go public, and its shares closed at $18.95 on Friday, up from their $17 offering price on Wednesday.

Of course, a word of caution may be necessary. Recessions have often bred heady predictions for health care because it is a not particularly cyclical industry, and some of those predictions have not exactly come true.

In 1993, as the country was slowly emerging from recession, the government projected that health care would account for 20 percent of the nation's economic output by 2000. Instead, starting in the middle of the decade, health insurance companies were able to increase their profits by restraining medical spending, and Congress took a similar step in an effort to balance the federal budget. By the end of the 1990's, health care made up 13 percent of the nation's economy — just as it did at the start of the decade.

Investors have become overly excited about the sector in the past. Many biotechnology companies first offered stock, with great fanfare, during the last recession. "If you go back to the early 90's, there were a whole slew of biotech deals that are trading at pennies on the dollar" now, Richard J. Peterson, the chief market strategist at Thomson Financial, said.

But analysts say that even if the most optimistic projections again prove unfounded this time, the forces propelling the sector's growth seem too strong to be fleeting. For example, most of the possible cost reductions imposed by managed care companies and the government have already happened, and any similar efforts are unlikely to succeed in the near future, analysts say. The earlier restraints lowered health care spending once but will not reduce future growth rates.

And while some predictions about the effect of mapping the human genome may also be grandiose, researchers agree that many new treatments will be possible in the decades ahead. "There's a whole new industrial revolution afoot," said Uwe E. Reinhardt, a Princeton economist who studies health care. "It will just take a little longer than people thought."

Unfortunately, many analysts say, the benefits of the health care boom will not flow evenly. In fact, some say, the very causes of the sector's growth — the expensive new treatments science is discovering and the proven demand for them — are also likely to widen the gap between Americans who can afford the world's best health care and the 40 million others who have no insurance to help them pay their bills.

Already, with profits falling and premiums rising, companies are discussing shifting a greater share of health care costs to employees. And new medical clinics are popping up, promising to bypass the headaches of managed care in exchange for an annual fee of a few thousand dollars — for starters.

"The health care sector will expand," said Drew Altman, president of the Kaiser Family Foundation, a research group in Menlo Park, Calif. "The irony of that is that it will only make it harder to solve our long- term health problems."
Of course, the extent of those problems depends largely on the health of the economy, which itself is likely to depend even more on health care.