A failure to understand why ‘handicraft’ industries such as healthcare become more expensive over time means we repeatedly make misguided moves to curb increases in health spending

According to NHS England, the health system is currently facing a funding shortfall that by 2020 will amount to about £30bn. The health budget is only increasing in line with inflation, but there does appear to be political commitment to increase spending, and possibly for this to be ringfenced.

Paul McCrone

‘It is inevitable that healthcare will become relatively more expensive compared to other products because it is labour intensive’

However, most would agree that this is far from being sufficient to address the long term “crisis”. Increases in demand are well recognised – the population is growing and becoming older, and technological advances increase the number of treatments that can be provided.

While the NHS has been spared some of the austerity measures imposed elsewhere, there have long been concerns about rising healthcare costs. Some, including government ministers, argue that the system is “unsustainable”.

This is seen as even more of a problem in the US, with a far greater proportion of GDP going on healthcare than in other countries.

But concerns regarding high and rising costs reflect a misunderstanding about the composition of healthcare.

Cost disease

In 2012 the American economist William Baumol published The Cost Disease, in which he argued that it is inevitable that healthcare will become relatively more expensive compared to other products and activities because it is a disproportionately labour -intensive industry.

‘Healthcare is not composed entirely of labour – technological advances will mean that we can do more with limited resources’

The argument is simple: industries such as car manufacturing are exposed to technological advances that lead to output per employee increasing over time. This in turn means wage increases in those industries are easily affordable.

Those working in industries that are not so capital intensive – such as healthcare, education and the performing arts – will quite naturally desire wage levels that increase to the same extent. But productivity increases in any traditional sense in those sectors are far less viable.

As such, “handicraft” industries will produce outputs that become increasingly expensive over time.

Baumol suggests that this in itself should not be a huge concern – it is a result of technological advancement – but it does mean that labour intensive sectors will account for disproportionately more of GDP.

Misguided budgeting

This argument is not new; Baumol articulated it nearly half a century ago. But with some exceptions it has been strangely ignored. Not recognising this phenomenon has led to misguided moves to curb increases in health spending or even reduce it, to the detriment of patient care.

‘Efforts to achieve improved efficiency are fine as long as that does not translate into a striving for reduced costs’

Does this mean that all attempts to reduce costs have to be resisted? No. Cost increases driven by the high labour composition of healthcare are only one part of the story.

High costs may result from the delivery of non-optimal treatments and excessively expensive medications, and approaches to address these inefficiencies should be welcomed.

The work of many in my profession – health economics – has identified interventions that are cost effective. Sometimes these will be cost saving but they can equally result in higher costs that are justified by enhanced outcomes.

Similarly, it would be wrong to assume that productivity cannot increase. Healthcare is not composed entirely of labour and there will always be technological advances that mean that we can do more from our limited resources.

Human industry

The fact remains, though, that whereas a car plant that is absent of human labour is imaginable, the same cannot be said of hospitals. That is not something that should worry us – healthcare for now is an industry, thankfully, characterised by human interaction.

Efforts to achieve improved efficiency are fine as long as that does not translate into a striving for reduced costs. The two are not synonymous and referring to “efficiency savings” does not help with this confusion. Why not just refer to “efficiency”? If it also saves money, then all is well and good.

So, costs are likely to increase as an economy develops. High costs do not of themselves infer a healthy situation, as a high cost healthcare system may not be of the highest quality (a recent report from the Commonwealth Fund shows that this is not the case).

But the fact remains that healthcare should – and will – become more expensive as the economy grows and the positive aspects of this have to be embraced. GDP has to go on something, and why should this not increasingly be healthcare?

Paul McCrone is professor of health economics at King’s College London