Rational Health Investment?

Several years ago I had a student whose day job was running a large clinic. He was enrolled in a Masters of Public Health program, taking my course on ethics and economics at a business school as an elective. He once told me that one of the most important things he learned from studying economics and public health was that the health production process begins before people walk through his clinic doors (often his emergency department door). (By health production, he meant the process, the combination and amounts of inputs such as medical care provided by his clinic and individual's own choices about what and how much to eat, how much to exercise, that ultimately produce a given level of health for an individual.) Why was that such an important revelation for him?

Let’s start at what could be regarded as “the beginning," at least in economics.

In 1972, Michael Grossman published “On the Concept of Health Capital and the Demand for Health” in the Journal of Political Economy. If there were a Nobel Memorial Prize in Health Economics, he would have won it. Using Gary Becker's household production framework, Grossman revolutionized and formalized how economists think about health.

A key feature of the new framework was the conceptualization of health as something that is produced by individuals and households by combining market inputs, such as nutrition, tobacco, alcohol, and medical care, and non-market inputs, such as own time spent in exercise, information gathering/education, child care, and leisure/relaxation. Another feature of the model is a stock of health capital that depreciates over the life cycle, but that individuals and households can invest in through preventive inputs (again market goods, such as healthy foods, preventive medical care, and non-market own-time spent in, say, exercise). Such investment can add to the stock of health in future states of the world thereby slowing the rate of depreciation, at least over some range of the life cycle. (After all, in the long run, we are all dead.)  Inputs such as tobacco (and alcohol at higher consumption levels) have negative marginal product thereby increasing the rate of depreciation and lowering the stock of health capital in future states of the world.

Grossman's model sees humans as demanding health, not medical care per se. Medical care is demanded as input to health production. Health is demanded and produced for the utility it provides as a consumption good in the current time period (because it translates into more healthy days, presumably higher wage income from the productivity gains, and feeling better). However (and this is what was innovative about the Grossman model), health is also demanded as an investment good, that is, a good that if invested in would yield more healthy days over the life cycle. More future healthy days yield utility through the extra earnings that are realized from them. As number of healthy days rises and as the wage rate rises, returns to investment also rise, leading to more investment in health (holding all else constant).

The Grossman model wasn't just theoretically elegant. It also explained a lot of observed human health-related behavior. It could account for why individuals with higher rates of time preference were less likely to demand preventive care as a hedge against future (unhealthy) states. It predicted that such individuals would be more responsive to changes in current prices, such as can be achieved by a "sin tax" on tobacco or alcohol, than to new information about future health consequences of consumption of such goods. It predicted that individuals with lower rates of time preference would be more responsive to information about the (future) bad effects of current consumption of goods such as tobacco and alcohol. These effects have been confirmed empirically (see for example here.) The model also predicted that more efficient producers of health (usually the more highly educated) face a lower "shadow price" for health, therefore demanding more of it. (The shadow price can be thought of as the money and time that individuals have to spend in producing an increment in health.) The model also predicted a wide range of wage rate effects on both investment decisions and on the substitution of market goods for own time in the production of own and child health.

What can we learn from this? Well, one thing is that medical care is one input among many to improving our own health now and in the future. Moreover, it may not be the most important input. However, when needed, if delivered too late or not in the right amount, it is likely to have severe negative consequences for the individual. It is necessary, if not sufficient.

It also means that rational economic actors may differ in the amount of health they choose to produce or to invest in. But the reasons for this do not translate readily into "personal accountability." The Grossman model suggests that economic actors who are less efficient at producing health face a higher shadow price. All else equal, they will rationally demand less health. The model suggests that individuals with lower wage rates and life expectancies will face a lower return on investment in own health and will rationally reduce investment in that health. The model suggests that individuals with higher rates of time preference, i.e., they discount future health states at a higher rate, will invest less in achieving those states.

Is it a "free choice" when the (shadow) price of health, the subjective discount rate, and the ROI that condition the choice are determined in large part by a circumstance of birth, early home environment, and even the culture and context into which they live?  What does it mean to hold individuals personally accountable for making the rational choice not to invest as much in current or future health as someone judges they should, given the price they face, the discount rate they have inherited, and the ROI they're likely to realize? If they are rationally not purchasing health insurance should we force them to?  Are we, in effect, requiring them to be irrationally exuberant? To produce more health and to invest more in future health than their price, time preference, or the ROI would warrant?

Or do we have an obligation as a society and a community, to counter these "market forces" that are so obviously harmful to less educated, less advantaged individuals and to society?  Do we "nudge" them to be irrationally exuberant about their own life and health prospects? Do we demand that they over consume and over invest in their own health and penalize them when they rationally opt not to?  Or do we offer them more education, greater future opportunity, the potential for a higher wage and a longer life to increase the ROI and reduce their discount rate? Do we subsidize health insurance and provide lower co-pays and deductibles to reduce their shadow price of health? These are the ways to create the proper incentives for disadvantaged and less educated individuals to invest in their own and their children's health.

If health reform is repealed, if the electorate continues to hear simplistic, but emotionally engaging rhetoric, about personal accountability, free choice, and so-called "rational behavior," one day we will have created an even more unequal society.

The obvious "market solution" is to improve the long run return on investments in health among the disadvantaged through meaningful and effective publicly funded education. The obvious short run "market solution" is to reduce the costs of investment and the shadow price of health for the disadvantaged by providing health insurance cover and reduced out-of-pocket costs.

That these policies are likely to produce a less unequal society and a more educated electorate is pure benefit to a democracy that favors, benefits from, and rewards commercial and individual endeavor.

Comments

[K Ackermann]

These are dangerous waters you are wading in, and that alone speaks volumes about the political paralysis gripping the US.

The political debate is impossible in the current climate. We have people screaming that a railing against the ideal of national health insurance while advocating Medicare. It's not rational.

Rational plays very little roll in health.

I, like president Obama, smoke cigarettes. We know it's bad for our health, but we irrationally choose to remain addicted.

Should you pay for any costs that we might inflict on society?

I can argue that my pack of cigarettes weighs 2 ounces, yet a tank of gas weighs a few hundred pounds. Both burn up and produce harmful toxins, but I filter mine through my lungs first. This does not justify my smoking, but it does point out that the scope of what affects our health is often not looked at in the proper scope.

The free market is a terrible model for dealing with health, but its so entrenched, that it is here to stay.

"What's the treatment worth to you?"
"I don't know, Doc; what do I have?"
"You might die."

48% of drug R&D is paid for using public money, yet companies are allowed to patent the drugs.

If the government were to create a wall between drug manufacturing and drug R&D, then think how that could work:

First, labs that only invented new drugs would want to invent as many drugs as they can. They would not use potential sales as the main motivation for choosing which drugs to develop, and hence, some of the less profitable diseases might stand a better chance of being developed.

Labs could propose new drugs and petition the government for funds - not just the 48% it pays now, but the full 100%. The government would own the drug, placed in public escrow.

Manufacturers who only build pills could then liscense the recipe from the government, and the fees would be used to fund new drugs.

Manufacturers would compete in the free market, increasing margins through innovation and effiency just like any other product. The cost of branding a drug would be eliminated (which runs 2-3 times the cost of R&D), and we wouldn't have to watch so many commercials for words that have an excessive amount of x's, y's, and z's in them.

More drugs treating more illnesses delivered to the market for less cost. In my opinion, that's the type of economics that have to be applied to health care.

[Devin]

I agree with the previous commenter that "rational" simply doesn't apply to the way people approach health...for more reasons than I can list. It's also true that health care is the rare industry in which un-satisfied customers are more likely to become repeat customers than satisfied customers. This is another reason market economics simply can't be applied to health care...at least not to any of the more meaningful parts of health care. Purely elective, non-life-threatening procedures that apply only to the moderately affluent (think Lasik or plastic surgery) are often trotted out among people who think markets can apply to health care. But the decision-making process around activities like that is completely different from the decision-making process when your spouse just passed out unconscious.

As somebody who loves economics and believes in free markets in many situations, I'd love to believe there's some elegant way to apply basic principles of economics to health care. But all of the basic ingredients of efficient markets are lacking, so we can either keep trying to jam a square peg into a round hole, or we can try to tackle the problem for what it actually is. Of course, the second approach would require rational thinking, which is why I think the future of health care in this country is filled with square pegs.