Medical Progress, Health Expenditure and Population Ageing

The nexus of population ageing, health expenditure and medical progress attracts great political and academic interest. While empirical work reveals the mutual dependence of the three phenomena, little is yet known about (i) the nature of the dynamic interrelationship; (ii) the incentives for individuals, medical providers and innovators, whose decisions drive the process; and (iii) the way in which these incentives and the resulting outcomes are affected by policy-making. This project develops, solves and numerically implements an intertemporal general equilibrium model with overlapping generations subject to endogenous mortality, the latter depending on individual health care and medical technology. In so doing, we explicitly study a three sector model, where a medical sector (e.g. hospitals) and an R&D sector developing medical technology operate beside a production sector. We derive from individual choice an age-specific demand for health care as well as its underlying value. Aggregating across cohorts, we show how the total demand for health care translates, via the medical sector, into a demand for medical innovation. We assess the efficiency of the allocation and how it depends on the competitive and institutional environment. Specifically, we contrast the decentral allocation against a first-best solution, which we derive using age-structured optimal control techniques. Calibrating the model to US and European data, we examine numerically how the dynamics are shaped by the nature of medical technology, by population change (e.g. exogenous ageing, baby-boom/bust) and by policy (e.g. health insurance, provider regulation, patent policy). Our numerical model allows us to trace the out-of-steady-state dynamics. We study the sustainability of current health care policies under population ageing and derive optimal policies. The project advances the literature by expanding and integrating different strands of theoretical and empirical insights into a coherent general equilibrium framework with a realistic demography and endogenous mortality; and by applying this model in numerical exercises to understand health policy options in the face of the triple dynamics of ageing, health expenditure, and medical progress.

How do population ageing, medical progress and the increase in health expenditure interact with each other and what are the consequences for economic performance and welfare? In order to gain insights into these issues we have developed mathematical-economic models of the choice of health care and consumption at the individual level and of the markets for health care, other goods as well as capital and labour at the macroeconomic level. Calibrating these models to US data, we have simulated a range of policy scenarios. Our key results can be summarised as follows:While life-saving medical progress induces an increase in health care spending, it does not induce a drag on economic performance within a US-style social security system,. This is because of an increase in old-age savings for the purpose of financing consumption and now more effective health care over an expanding lifetime. The resulting increase in capital investment more than compensates the increase in old-age dependency.The expansion of health insurance in the US over the period 1965-2005 has induced an inefficient boost to health expenditure but, in so doing, has also increased the incentives to invest into the development of medical innovations. The resulting increase in life expectancy has generated an increase in welfare that exceeds by a large margin the efficiency cost of an overgrown health care system. The growing education gap in life expectancy can be explained by a double disadvantage of the lesser skilled: On the one hand, they are lacking the income to purchase state-of-the art health care that would allow them to participate in medical progress; on the other hand, they suffer from a direct disadvantage in the use of innovative therapies.Climate change is likely to have an ambiguous impact on health care expenditure: while the cure and prevention of heat-related illness and climate related injuries is prone to boost health care spending, this is offset, however, to the extent that productivity loss under climate change and a reduction in the willingness to spend on an increase in life expectancy under deteriorating environmental conditions lead to a dampening of spending. Generally, our modelling framework allows us to study a variety of health policy scenarios by way of (counterfactual) simulation. The insights from such studies about the transmission channels and side effects of policy measures are essential for the design of effective and sustainable health policies.