iMFdirect

By Carlo Cottarelli

Health spending in OECD countries increased from 4½ percent of GDP in 1960 to 12½ percent in 2007 (see Figure 1 below). What accounts for this dramatic increase? Income growth, insurance, demographics, and technological change all contributed, but the latter was the key driver. Public spending for health care also increased sharply (by 5½ percentage points of GDP) during this period (see Figure 2).

What about the future? The impact of demographics is reasonably easy to predict, and aging, by itself, will not cause health spending to explode. Other demand-side variables—including such risk factors as obesity, smoking, and high blood pressure—are harder to assess, but should also be manageable.

The real uncertainty is technological change. In principle, technical advances could lower costs. But in practice, as in the past, they could expand the limits—and potentially the cost—of what health care can achieve.

Different countries make different assumptions about the effects of technological change. In the United States, the Congressional Budget Office (CBO) assumes a large impact from technological change: Total health spending is projected to grow at an annual rate that is about 1½ percentage points higher than the GDP growth rate through 2060.

This would cause total health spending in the United States to increase by more than 15 percentage points of GDP over this period, with an increase of 10 percentage points of GDP in public spending (this projection does not take into account possible effects of the health reform proposals currently under discussion).

In contrast, the European Commission (EC) Aging Report baseline projections—used by EU members for their long-run fiscal projections—are much more optimistic. These projections assume that per capita spending at older ages will decline in the future, implicitly assuming that technological change will reduce spending. This leads to a relatively low projected increase in public spending (1½ percentage points of GDP by 2060—less than one-sixth of what is projected for the United States). But this conflicts with the experience of the last decades.

What I would regard as a more realistic scenario is presented in one of the Appendices to the Aging Report: this scenario (see Table 67) involves an increase in public spending of 6½ percentage points by 2060. Even this would assume a moderation of health care spending growth with respect to the past.

So what does this all mean for government budgets? The different assumptions between the two sides of the Atlantic can give the impression that the U.S. budget is much more exposed than European budgets to pressures from health-care costs. While lower public spending growth is likely in Europe—especially since public spending in the United States focuses on the elderly—Europe will also likely face major spending pressures from the health care sector.

So what about the benefits of health spending?

Research has shown that increases in health spending in the 20^th century produced tremendous gains. Technological innovations have reduced the (quality-adjusted) price of medical treatments, including those related to the most important causes of mortality. And new drugs and medical procedures have been developed to treat previously untreatable conditions.

Further advances could improve the length and quality of human life. But we will also need policies that allow us to reap the benefits of technological change without sacrificing fiscal sustainability. This is arguably the key fiscal challenge facing OECD countries in the coming decades.