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It is well known that the “US” spends more on health care than any other country on earth. This is true in per capita terms and it is true as an overall share of GDP.

According to the OECD, the U.S. spends 5% of GDP more on health than France, the nation with the second highest level of health spending among the 30 wealthy countries in the organization. The average for all OECD countries is 8.9% of GDP.

We spend $7,290 per person on average versus $2,964 among all OECD countries. Norway, the nation with the second most expensive health system on a per capita basis, spends $4,763. (Currency conversions based on purchasing power parity.)

In other words, we spend about $2.25 trillion as a nation of 308 million out of an economy of $14 trillion. Let’s just look at France versus the US. The per capita income in France is roughly $33,800. Per capita income in the US is roughly $46,400.  The “average” Frenchmen spends about $3,700 on health care each year while the “average” American spends roughly $7,300.

It is really hard to make comparisons about spending decisions across countries with very different levels of wealth. As our wealth increases, so too does the composition of our consumption baskets. When we are really poor, virtually 100% of our income is dedicated to securing the necessities. As we get wealthier, our spending on necessities does not change much, but we are able to dramatically increase our consumption of things that are less necessary – and hence the share of our income dedicated to other things increases as we get wealthier. So, being as wealthy as we are, it ought not be surprising that Americans choose to spend a good deal of their “extra” income in health care services.

Note, I am not trying to argue that this is sensible or efficient, or anything like that. I am merely trying to think about our spending decisions as they relate to our overall living standards. So, back to France. If you take the typical Frenchmen and allow him to earn an additional $12,600, how much of that would he dedicate to health care services? Remember, that with his existing $33,800 of income, he already enjoys a pretty snazzy standard of living – could he possibly want to buy more crusty bread, wine and vacation time? Perhaps. But for the French to be spending like Americans, then all that would be needed would be for them to choose to spend an additional $3,600 of their newly found $12,600 of income on health care. Is it unconscionable to think that you would spend 29% of your extra income on something as important as health care?

In terms of income elasticities, here is how the calculation would break down. For the French to get to American income levels, that would represent a 37% increase in income. Moving from their existing health spending to American levels of health spending would represent a 97% increase in spending. Thus, a raw and rough estimate of the income elasticity of demand for health services is 2.6. This is extremely large. Elasticities greater than one are indicate that goods are viewed as luxuries. Income elasticities for some other goods, such as environmental quality, are around 2. So health care seems to be treated like environmental quality.

However, the back of the envelope calculation above grossly overstates the true income elasticity of demand for health care. The income elasticity is supposed to capture the idea of how much the quantity of a good consumed will change when your income changes by some percentage.The estimate above is only showing you how much spending changes when income changes by some amount.

Americans have the highest life expectancy in the world when we adjust for things that kill us that have nothing to do with the health care system. Americans have by far the highest cancer survival rates in the world. Americans pay prices for CT scans, MRI’s, drugs and all manner of sophisticated technologies that are much higher than the rest of the world (the US subsidizes the world’s medical R&D) and that rationing by wait time is virtually unheard of in the US. It is therefore hard to argue that the differences in health care spending across two countries like the US and France represent something sinister.

French spending for the same quality and quantity of medicine they are getting now would have to be higher were it not for US R&D spending. The extra spending in the US does seem to be on a much higher quantity of medical services – it is not simply that we are paying more for the same services. It is not clear then, that if much of the world were as rich as the US, that some of those countries would be spending as much as, if not more than, Americans do. Of course, some countries would not (such as the Scandinavians), but how is that an indictment of anything Americans choose to do? No one condemns me for choosing to spend $1,000 of my annual income on attending various sporting events. That does nothing to make me healthier. On many dimensions that is viewed as extremely wasteful. Even if people just as wealthy as I am are only spending $500 on attending sporting events, can we draw any interesting conclusion from that idea whatsoever?

One Response to “Income Elasticity of Demand for Health Spending”

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