FRBSF Economic Letter
2001-36; December 14, 2001
The Economic Return to Health Expenditures
"Runaway" expenditures on health in the United States and what
to do about them have been a feature of congressional debate for years.
In 1998, the United States spent 13.6% of its GDP on goods and services
associated with health care. This represents an enormous increase over
time: the spending share was just 5.1% in 1960. It also represents a large
number relative to other countries. The 1998 spending shares were 10.6%
in Germany, 9.6% in France, 9.5% in Canada, 7.4% in Japan, and 6.7% in
the United Kingdom.
Sometimes forgotten in these debates, however, are the enormous benefits
that are, at least potentially, associated with this spending. This Economic
Letter will review several recent economic studies suggesting that
the benefits of technological change in medicine have been so large as
to overwhelm the costs of health care. While this by no means implies
that there is not substantial waste in the spending of particular dollars,
it does emphasize that reforms should take care not to stifle the technological
progress in medical care.
The overall rise in life expectancy
To begin to measure the return on health care expenditures, many studies
consider estimating the economic value of gains in life expectancy, which
have been striking. In 1929, life expectancy at birth was 57.1 years in
the United States. By 1950, life expectancy had risen to 68.2 years, and
by 1990 it was up to 75.4 years.
Assigning an economic value to these gains is obviously very difficult,
and attached to any answer will surely be a large degree of uncertainty.
Nevertheless, economists have made attempts to estimate the economic value
of an extra year of life by looking at the wage premium demanded by workers
who undertake more hazardous jobs. Kip Viscusi (1993) reviews these studies
and provides some useful numbers. For example, in the early 1980s, the
fatality rate in the mining industry was 35.4 per 100,000 employees, while
the rate in the services sector was only 2.4 per 100,000 employees.
Other things equal, workers in the mining industry presumably earned
a higher wage for taking on this risk, and we can use this information
to calculate the implied economic value that workers place on life. The
twenty-four different studies reviewed by Viscusi (1993) produce economic
values of life in a wide range, from $500,000 to $16 million, with a median
value of about $5 million. Since life expectancy during the periods covered
by this survey was about 72 years, these numbers imply a value of a single
year of life that ranges from about $7,000 to more than $200,000, with
a median value of $70,000. One might argue that these economic values
ignore other important considerations. In this case, one might view this
range as an underestimate of the true value of an additional year of life.
To put an economic value on the gains in life expectancy, notice that
longevity rose by almost 8 years over the 40-year period between 1950
and 1990, or about 1 year every 5 years. Therefore one measure of the
annual economic value of the gains in life expectancy is equal to one-fifth
of the value of a life year. This produces the relatively wide range of
$1,400 to $40,000, with a median value of $14,000 per year.
Using a related and more sophisticated methodology, Kevin Murphy and
Robert Topel (2002) argue that the gains in life expectancy between 1970
and 1990 in the United States were worth about $2.8 trillion per year
in the aggregate, or about $12,000 per person per year, close to the median
value reported above.
Is this a large or a small number? By comparison, per capita GDP in 1980
(roughly the midpoint of our time period) was about $20,000. So, taking
the median estimates, the gains in life expectancy are equal in value
to something like 60% to 70% of per capita GDP each year. Indeed, as William
Nordhaus (2002) concludes in his analysis of the gains in life expectancy,
"[T]o a first approximation, the economic value of increases in longevity
over the twentieth century is about as large as the value of measured
growth in non-health goods and services" (page 17).
But at what cost and by what cause?
The rise in life expectancy in the United States in recent decades appears
to have an economic value of something on the order of $12,000 per person
per year. But at what cost does this increase come, and how much of the
gain is due to medical spending?
One statistic to begin with is that per capita health expenditures in
1980—the midpoint mentioned above—were about $1,800. Thus, the total
value of the gains in life expectancy each year swamp the total expenditures
on health. However, this is probably not the right comparison for several
reasons. First, perhaps not all of the gains in life expectancy should
be attributed to medical care. Second, medical care has additional benefits
beyond the rise in life expectancy, including increases in the quality
Moreover, even the gains in life expectancy that are due to health care
should be matched to spending in a different way. The gains are due either
to an increase in the use of existing medical techniques, in which case
one probably wants to look at the change in health expenditures, or they
are due to advances in medical technology, in which case one probably
wants to focus on the level of expenditures for medical research. Still,
the annual change in health expenditures is much smaller than the level
of spending, and medical research constitutes less than 10% of all health
expenditures, so the comparison to the level of per capita health spending
is likely to be conservative.
David Cutler and Mark McClellan (2001) offer a more careful comparison
of the costs and benefits. Between 1950 and 1990, the present discounted
value of the amount an individual could expect to spend on medical care
over his or her entire lifetime rose by $35,000. During the same period,
life expectancy increased by seven years. Cutler and McClellan calculate
the present value of this increased longevity to equal $130,000. Therefore,
they conclude, if health expenditures explain more than about a quarter
($35,000/$130,000=27%) of the rise in life expectancy, then these benefits
from increased health spending exceeded the costs.
A case study: The treatment of heart attacks
It is useful to consider a specific example in more detail to understand
the changes in medical spending and life expectancy. Cutler and McClellan
(2001) provide a detailed analysis of the treatment of heart attacks.
Between 1984 and 1998, average medical spending to treat a single heart
attack case rose from about $12,100 to $21,700. The additional cost primarily
represented the more extensive use of surgical intervention rather than
the discovery of an entirely new form of treatment. In 1984, only 10%
of heart attack patients were treated surgically, while by 1998 more than
One of the benefits of this more expensive treatment appears in increased
life expectancy. In 1984, life expectancy of a heart attack victim was
4 years and 11 months. By 1998, life expectancy had risen to 6 years.
At a cost of less than $10,000, this additional year of life seems like
an especially good deal, given the values of life reported by Viscusi.
Prospects for future progress
Health expenditures in the United States have risen at an extraordinary
rate over the last 40 years. Much research in economics, as well as much
of the public debate, has focused on the potential waste that could be
associated with this spending, and perhaps for good reason. In the presence
of an insurance system, individuals may have incentives to consume too
many medical services. More recently, however, a number of papers have
highlighted the tremendous gains in welfare associated with the declines
in mortality that have resulted from technical progress in medical care.
It appears that these gains outweigh even the large amount of growth in
health spending, so that, in the words of Cutler and McClellan (2001),
the increased spending has been "worth it."
The potential gains from further medical innovation and the more widespread
application of existing medical techniques remain large. Murphy and Topel
(2002) calculate that eliminating deaths from either cancer or heart disease
would produce gains in life expectancy worth $47 trillion dollars, approximately
five times the GDP of the entire United States. Even a modest reduction
in the mortality rate from cancer by 1% would have an economic value of
$500 billion. By comparison, the United States invests approximately $35
billion each year in medical research. Reforms to medical care should
refrain from stifling medical research and the valuable technological
change that it has produced.
Charles I. Jones
Associate Professor, U.C. Berkeley,
and Visiting Scholar, FRBSF