The rise and rise of health costs

It is highly likely a big chunk of the increased resources will be soaked up in pay increases

If you’ve been following the latest news in astronomical physics, you will have probably seen first photos of the black hole at the centre of the Milky Way.

The images produced by the Event Horizon Telescope collaboration depict the stars on the periphery of the black hole that are just about to disappear into it.

For those involved in the Budget process, particularly the Treasury and every minister and ministry beyond health, it must be tempting to see spending on health services as the black hole at the centre of the galaxy of government expenditure.

The extra $11 billion or so that has been added to Vote Health in Budget 2022 are the stars on the event horizon.

No one within the health sector will be arguing against an increase of this magnitude. From the perspective of those outside the health sector, however, the gravitational force of health spending inevitably means other important Government priorities are squeezed. But would they be justified in looking at Vote Health with a leery eye?

To understand the strength of this gravitational pull, look back at the early 1980s’ expenditure on health services (by governments, insurers and patients via out-of-pocket expenses). The total averaged around 6 per cent of GDP in OECD countries; now the average is 10 per cent.

This applies regardless of how the health system is funded – whether it be via government, private insurers, or social insurance schemes. In the US, it is closer to 17 per cent. In Aotearoa, the health system accounts for one in every five dollars spent by government; 40 years ago, it was one in seven dollars.

Why does health chew up an ever-increasing share of the economic pie? The biggest reason is that health care is labour intensive. The Ministry of Health recently estimated that 66 per cent of DHB expenditure goes on salaries. This is probably an underestimate as it doesn’t include non-clinical employees working for non-government health providers that contract with DHBs.

The rise in health costs is driven by “the Baumol effect” (after the late William Baumol, an American economist). This simply means the salaries of those in people-dependent professions such as health, education and the arts, increase in line with other salaries – even though these activities can’t, for very good reasons, achieve the same productivity growth as other jobs.

In health, the gravitational effect is amplified further. One strong gravitational field is specialisation. The medical profession’s evolution continues to track in the direction of ever-increasing specialisation. More specialisation entails more training costs, ever greater remuneration of specialists and higher costs of specialised medicines. More treatments become possible, and patient expectations increase over time.

Demographic change, particularly as a larger proportion of the population falls into the 65-plus age group, also increases health spending.

Part of the rationale for this Government’s health reforms and its Budget increases is that they are necessary to pay for large swathes of health need that has never been met, even in times of clover.

To underline that point, there are decades worth of data on inequities of access to the vast majority of health services. But, until now, the imperative to reduce health inequities has not exerted much gravitational pull.

Health’s gravitational field is occasionally resisted temporarily. Canada saw a marked reduction in expenditure on health as a proportion of GDP in the 1990s. The UK seemed to defy the trend for longer, bobbling along below 6 per cent of GDP throughout the 1980s and 1990s.

In New Zealand, health spending as a percentage of GDP declined from 9.6 per cent in 2010 to 9.0 per cent in 2018, according to OECD figures.

Government contributes about 80 per cent of all health spending, so this decline was a clear consequence of then finance minister Bill English’s belt-tightening in the aftermath of the 2008 Global Financial Crisis and beyond.

Interestingly, countries that defied gravity, share an important attribute. All have health systems that are predominantly financed through taxation. This enables more centralised control over health spending, making austerity measures possible. Dips and plateaus are less apparent in health systems funded through insurance.

But in every case where gravity is defied, the resistance is only temporary. Canada and the UK spent the 2000s in catch-up mode. In the UK, Tony Blair’s New Labour Government pledged to lift health spending to the OECD average, and did so quickly. Such bounce-backs are equally as striking a characteristic of tax-funded systems as the feats of defying gravity. And that’s exactly what is now playing out in Aotearoa.

We know that you can’t see what happens to whatever has been sucked inside a black hole. Does this analogy also apply to the health sector? Under current health sector labour market and economic conditions, it is highly likely a big chunk of the increased resources will be soaked up in pay increases. These are certainly long overdue for both the regulated and unregulated health workforces.

Perhaps it’s possible to defy gravity by getting rid of wasteful expenditure in health. Certainly, everyone in the health sector I know, myself included, has their pet theory of how and where significant amounts of money could be saved. But, in looking at health reforms internationally over 25 years, I don’t know of a single country that has ever managed to isolate the source of such waste on a large scale and eliminate it, or replace it with more productive spending.

Governments that go big on health tend to use the language of investment – invest now and we’ll reap the benefit of a healthier population in the future.

Here, the UK of the 2000s is instructive. Between 2004 and 2014, the UK experienced a 37 per cent decrease in mortality amenable to healthcare – the largest dip of all 11 countries monitored by the Commonwealth Fund.

In most other countries, the reduction was 25 to 30 per cent. This may well be attributable to the large Budget increases of the early 2000s. However, this faint burst of starlight only became apparent in the late 2010s, long after Tony Blair and his chancellor of the exchequer Gordon Brown had left the political stage.

That means that, even if we manage to detect any light escaping from the black hole of Vote Health, it will be the light of the long distant past. In the meantime, let’s watch gravity go to work.

Tim Tenbensel is associate professor, health policy, in the School of Population Health at the University of Auckland