December 10, 2008

Rising health spending, new medical technology and the Baumol effect

This paper estimates the Baumol effect in health spending, using a panel data set of OECD countries.

Health expenditure as a share of GDP rises in most OECD countries. One of the possible causes is the so-called Baumol effect, which may arise if labour productivity in health care grows more slowly than in the overall economy. If in addition demand for health care is inelastic, then the share of health spending in GDP will rise over time. We do indeed find that one percentage growth in economy-wide labour productivity is associated with about 0.5 percent growth in real health spending. This implies that economy-wide productivity growth leads to higher real health spending.


Marc Pomp
Suncica Vujic

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