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Is Health Care Infected by Baumol’s Cost Disease? Test of a New Model Using an OECD Dataset

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Abstract

Rising health care costs are a policy concern across the OECD and relatively little consensus exists concerning their causes. One explanation that has received revived attention is Baumol’s Cost Disease (BCD). However, developing a theoretically-appropriate test of BCD has been a challenge. In this paper, we construct a two-sector model firmly based on Baumol’s axioms. We then theoretically derive two propositions that can be tested using observable variables. In particular, we predict that: 1) the relative price index of the health care sector, and 2) the share of total labor employed in the health care sector should both be positively related to economy-wide productivity. Using annual data from 27 OECD countries over the years 1995-2013, we show that empirical evidence for the existence of BCD in health care is sensitive to model specification and disappears once we address spurious correlation due to contemporaneous trending and other econometric issues.

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  • Akinwande A. Atanda & Andrea K. Menclova & W. Robert Reed, 2016. "Is Health Care Infected by Baumol’s Cost Disease? Test of a New Model Using an OECD Dataset," Working Papers in Economics 16/04, University of Canterbury, Department of Economics and Finance.
  • Handle: RePEc:cbt:econwp:16/04
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    Keywords

    Baumol’s Cost Disease; OECD; health care industry; panel data;

    JEL classification:

    • I11 - Health, Education, and Welfare - - Health - - - Analysis of Health Care Markets
    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General
    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity

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