Baumol's Cost Disease in Acute vs. Long-term Care - Do the Differences Loom Large?

Baumol's (1967) model of ‘unbalanced growth’ yields a supply-side explanation for the ‘cost explosion’ in health care. Applying a testing strategy suggested by Hartwig (2008), a sprawling literature affirms that the ‘Baumol effect’ has both a statistically and economically significant impact on health care expenditure growth. Skeptics maintain, however, that the proliferation of hi-tech medicine in acute care is clearly at odds with the assumption underlying Baumol's model that productivity-enhancing machinery and equipment is only installed in the ‘progressive’ (i.e. manufacturing) sector of the economy. They argue that Baumol's cost disease may affect long-term care, but not acute care. Our aim in this paper is to test whether Baumol's cost disease affects long-term care and acute care differently. Our testing strategy consists in combining Extreme Bounds Analysis (EBA) with an outlier-robust MM estimator. Using panel data for 23 OECD countries, our results provide robust and statistically significant evidence that expenditures on both acute care and long-term care are driven by Baumol's cost disease, even though the effect on long-term care expenditures is more pronounced.