Diagnosing the Causes of Rising Health-Care Expenditure in Canada: Does Baumol's Cost Disease Loom Large?

William Baumol (1967) identified an excess of wage over labor productivity growth in health care (the cost disease or rent) to be the main reason for rapid long-term growth in health-care expenditure in rich countries. In contrast, mainstream studies running national time series have generally decomposed the growth of health-care spending into observables and nonobservables (a mixture of technological progress and the cost disease), thus ignoring the separate contribution of the cost disease. But progress is something good, while rent may be viewed as being wasted in the system and is to be avoided. It is important to separate the two. This paper uses a new (Hartwig-Colombier) method to decompose the growth rate of provincial per capita health-care spending in Canada over the period 1982–2011 into the contributions of the cost disease, traditional observable variables, and technological progress. Based on extensive robustness analysis across a variety of specifications, estimation methods, and two separate data sets, we find that the cost disease (rent extracting) is a relatively minor contributor, while technical progress in health care and growth in per capita incomes are by far the biggest contributors to the secular growth in health-care spending in Canada.