According to Baumol (1993, Public Choice, 77, 17 - 28) 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. This along with a rather price-inelastic demand causes wages in such sectors as health care to rise proportionally to productivity growth of the overall economy so that relative prices in these sectors increase. Whereas recent empirical evidence seems to confirm the view held by Baumol (1993) for health-care services some health-care economists point to the fact that quality improvements through medical progress is not properly measured by current health-care price indices. As a result, relative price increases would be dampened if the prices were quality-adjusted. This paper contributes to this debate by estimating the impact of Baumol's cost disease and medical progress on health care expenditure for 20 OECD countries. In deviation to the literature we do not only focus on the effects on total current health care expenditure but also on current health care expenditure excluding long-term care. This is done because it is commonly not contested that long-term care epitomises Baumol's cost disease. In order to avoid omitted variable bias other important cost drivers such as national income are taken into account. To deal with measurement problems surrounding health-care prices we use the so-called Baumol-variable, which has been recently proposed in the relevant literature.
(3) Data and methods
The data stem from the OECD Health Data Base 2009. We take data of 20 OECD countries into account. We choose a panel-data approach by applying a fixed-effects model. The regressions are instrumented to deal with the endogeneity of regressors.
(4) Expected Results
We expect to show that contrasting with Baumol's hypothesis (1992) health care is not a prime example of Baumol's cost disease. Rather, other cost drivers, in particular medical progress, play a major role. This is due to the fact that health care excluding long-term care does not suffer from Baumol's cost disease to a large extent.
(5) Conclusion
As Baumol's cost disease seems to be overrated for health care the secular rise in health care expenditure would not appear to be inevitable. Moreover, the relevance of medical progress as a cost driver seems to suggest adjusting health-care prices for quality. However, as new technologies induces new demand, the increases in health care expenditure would appear to reflect this additional demand. Furthermore, we show that the empirical evidence provided by the relevant literature in favour of the cost disease refers to a special case. This leads to an overrating of the cost disease. To sum up, this paper demonstrates that policy-makers have more room for manoeuvre as commonly thought because Baumol's cost disease is less important.