a new theory of life

Health as Human Capital : an investment for life

This is a non-technical reader-friendly analysis on Human Capital, Health Capital, Longevity and Aging.
It is part 2 of 7 in my work summary:
  1. Who’s who in interdisciplinary research
  2. Human Capital and the Value of Statistical Life
  3. Health economics & outcomes research: “a new kid on the block”
  4. International standard for Health Outcome Measurements
  5. Basic types of health systems and Country readiness for “value-based” health care
  6. Scientific methods used in developing evidence of value
  7. A case study of real world research – based on U.S. Medicare Health Outcomes Survey

Introduction 

“China has made great progress in human development, yet must continue deepening its reforms and encouraging social innovation to ensure that human development is inclusive and equal and benefits all members in society”, says the United Nations Development Program in its 2016 Human Development Report, launched this August in Beijing.

Human development has been attracting increasing attention around the globe since its first appearance on the Human Development Report of the United Nations Development Program in 1990. In these publications, human development was measured by a composite statistics known as human development index (HDI) which is composed of life expectancy, education, and per capita income indicators. It was devised by a Pakistan economist named Mahbub ul Haq with the purpose of shifting the focus of development economics from national income accounting to “people-centered policies”.

Decades before Mr. Haq had his vision, researchers had already begun exploring the concept of human capital in the 1950s. Human capital consists of all the knowledge, health, talents, skills, intelligence, and experience possessed by an individual or collectively by individuals in a society. Pioneers in this field include Schultz (1961), Becker (1964), Mincer (1974) among several others.

Before health capital was fully accepted by mainstream economists, the important attributes of human development were treated as given and not augmentable in economic studies. For example, it was once believed a student’s ability to learn and make good grades in school was determined by the amount of “talents” they have received, and a person’s ability to survive certain age or illnesses was assumed to follow strictly the probability distribution in a life table for a given population at a given age. As shown in Table A, for instance, the life expectancy at birth for the ones born in the year of 2011 represents the average number of years that a group of infants would live if they were to experience throughout life the age-specific death rates prevailing in 2011.

These overly simplistic assumptions render many economic models unfit for the studies of human development. An alternative approach which takes into consideration the effects of individual drive and efforts should be devised for scientific investigations that aim to deepen our understanding on human development, productivity, health, and longevity.

One major challenge for scientific investigation on human development stems from the lack of transparency on individual’s drive and efforts made towards achieving their goals. However, this barrier has been largely solved by the human capital theory.

Human Capital

“Human capital analysis starts with the assumption that individuals decide on their education, training, medical care, and other additions to knowledge and health by weighing the benefits and costs. Benefits include cultural and other non-monetary gains along with improvement in earnings and occupations, while costs usually depend mainly on the foregone value of the time spent on these investments”, says Gary Becker in his Nobel Lecture “The Economic Way of Looking at Life” in 1992.

Over the past century, remarkable growth in technologies, wealth, and life expectancy has proved the message that humans are capable of driving positive growth that they hope to see in life. If individuals are making rational decisions on their education, training, and medical care, it is worth studying what drives these behaviors and how to design a system that maximizes individual efforts while minimizes unintended consequences. Applied research in this field can provide valuable insights to tackling some of the most challenging issues we face in our society today, such as overall economy, healthcare, education, unemployment, environment, inequality, poverty and so forth.

Redefining human behavior and interactions in non-market or “pre-market” activities by steering away from the “black box” approach that assumes all the key attributes in life are given and not augmentable has opened countless possibilities for economists to study how people make long-term decisions in life in non-market sectors in particular, and to explore the design of an optimal system that maximizes human potential for the common good.

 

Health as Human Capital

Becker continued to point out in his 2007 Oxford lecture, “While literally thousands of articles and books followed on human capital dimensions of education and training, there have been fewer discussions on health as human capital.”

This is partly because the concepts of knowledge and skills which are acquired through education and training is somewhat different from the concept of health which are determined by a host of endogenous and exogenous factors. Factors such as where we live, the state of our environment, genetics, our income and education level, and our relationships with friends and family all have considerable impacts on health. Besides, the access to health care services also play a role in determining health, however, it often has less of an impact than commonly considered, according to World Health Organization Health Impact Assessment Program. In fact, statistics show that more than 43 million people are injured worldwide each year due to unsafe medical care, according to a study from Harvard School of Public Health in 2013.

To understand the concept of health as human capital, it is important to learn about Grossman’s model and its alternatives. There has been debates on the formulation of health capital models in recent years, and it remains to be seen whether there exists a unified approach on this matter.

Grossman’s Model

Early exploration on health capital by Grossman (JPE, 1972) simulated a large literature in health economics. However, there are issues under this approach that weaken its ability in providing meaningful understanding on behavior relating to aging, longevity, and optimal demand for health and health care.

In Grossman’s model, health was defined as a capital stock ‘H’ that was given to every individual as an initial endowment at birth. Health capital stock produces “healthy time” which enters the household production function as an input for both market and non-market activities. For example, healthy time can be used for employment to generates periodic income, or for consumption of market goods which generates utility, or for investment in their health capital by having regular health check-ups, vaccination, and other health services which in turn reduces the time of falling sick or being hospitalized.

Based on the initial level of health capital ‘H’ and a depreciation rate which was given, consumers decide on the optimal allocation of time and resources among work, consumptions, and health production, in order to maximize their overall utility in life.

Grossman’s model has made significant contributions to health economics and human capital research, however, there were quite a few issues that limit its usefulness and applicability in the analyses of demand for health and in its ability to provide insights in solving health and aging related issues. (See Case and Deaton (2005), McFadden (2008) and Strulik (2015)) For example, some of the issues include a general prediction of immortality over an infinite time horizon, and a near zero probability of surviving the next period is required for an optimal solution to actually involve death.

In recent years, new and alternative approach to health capital models has been developed, see Becker (2007), Strulik (2014), Galama & Kippersluis (2016). In his 2007 Oxford lecture “Health as Human Capital: synthesis and extensions”, Becker suggested there are three interrelated development areas in this emerging field:

  1. The analysis of optimal investment in health by individuals, drug companies, and to an extent by governments that follows on Grossman’s analysis, and also on the discussions in the insurance literature of self-protection and investments by pharmaceuticals;
  2. The value of life literature that analyses low much people are willing to pay for improvements in their probabilities of surviving different age;
  3. The importance of complementarities in linking health to education and other types of human capital investment, and in linking investment in health to discount rates, to progress in fighting different diseases and to other sources of overall changes in survival.

Clearly there are lots to be done in this multidisciplinary emerging field. As Becker has argued there is a strong motivation for an interest in the economic value of improved life expectancy. In my opinion, it is one of the most fundamental questions to be answered before value of health can be clearly defined and measured in practice. One reason is that achieving the goal of living longer and staying healthy comes with both benefits and costs. And it is not entirely straightforward to define and measure these benefits and costs for the purposes of decision-making in policy, health care management, and economic evaluation, especially when patient personal preference and risk aversion are involved. As a result, we do not always agree on what metrics for cost-effectiveness should be used nationally or internationally, or which treatment should be accepted, prioritized and financed by public health programs, or whether a “one-size-fits-all” approach would benefit nations in achieving their own health care goals.

 

Benefits and Costs of Living Longer

To understand the complexity of health investment, it helps to break down the benefits and costs of living longer.

Benefits

The benefits of improved life expectancy from an individual’s perspective may involve longer time to enjoy leisure and retirement, longer career life, higher earnings, and greater overall life satisfaction.

From an intergenerational/societal perspective, longer life expectancy implies extended overlapping period between generations, which results in better knowledge transfer and human capital development among the younger persons which can be translated into higher earning potential and an overall increase of productivity in a society.

Costs

While the benefits of increased life expectancy are plenty, living long is inevitably associated with aging as well, which is a major risk factor for many chronic diseases such as dementia, chronic obstructive pulmonary diseases, diabetes, and cancers. If improved life expectancy results in an increased prevalence of chronic diseases or long-term disabilities, the benefits of living longer would then be significantly offset by the downside of an aging population, slowing down economic growth, adding to the financial burden on the economy, and pushing for health care system reform and new ways of health care delivery and management.

To measure the costs that are associated with living longer, one may start with the following aspects:

Costs on the financing side of health care likely to include:

It is likely that an increased proportion of household income will be spent on health care, either directly paid to private care providers or indirectly through public health care programs or private health insurance.

Costs on the delivering side of health care include:

Higher utilization of health care resources can lead to shortage in health care supply which puts upward pressure on health care price and creates a longer wait for care. This shortage leaves patients two options – either to pay an extra fee to get pass the waiting line for a doctor visit, or to delay the treatment they need at the risk of paying more for their health when their conditions worsen. Whoever can and willing to afford the extra fee will likely to get the access to care and experience better outcome, while the less affluent will likely to end up worse off both in their physical health and financial situations later on. This is known as health inequality, in this case, inequality between high and low income classes.

Furthermore, increased care-giver burdens such as family members could hurt productivity in a range of markets and have a negative impact on the economy in the long-run. The immediate impact may include higher risk of falling ill or being stressed themselves for taking care of a sick family member.

To estimate and account for all of the costs shown above under the current fragmented legacy health care systems in many parts of the world is extremely challenging, main reason being that these legacy health systems weren’t designed in the way that market failure can be corrected for efficient resource allocation. In part 5 of this article, we will discuss more about major health systems around the world.

One result of running a legacy system such as a disease-centered, volume-based health system would contribute to an increasingly large budget deficit on public spending. According to a recent article from FT.com  on the scale of pension funds deficit, by September 2016, the US public pension deficit is 3.4 trillion USD, which is 6 times the size of Apple. In a report from PwC, the combined deficit of the UK’s 6,000 defined benefit pension funds is £710 billion that is 868 billion USD.

According to the U.S. Congressional Budget Office 2016 Long term Projections, the overall federal budget deficit is expected to go up from 2.9% of GDP to 8.8% of GDP in 30 years with more than 60% increase in spending on Major Health Care Programs.

Health Investment as a Strategy

Despite of the rising public awareness of disease burden and an increasingly tight budget on public spending, there is little one can do to fix a nation’s health system or to accelerate the pace of health innovation which will lower the cost of health care services in a significant way. But there is still a lot one can do to take care of their own health by acting responsibly and wisely, by understanding their own health and choosing a healthy lifestyle that minimizes the risk of becoming unhealthy in the future.

There is a large number of barriers and disincentives in the legacy health systems that hinder health investments from the general public. These barriers include but not limit to:

Conclusion

To strategically avoid the downside of aging and living longer, a society can do at least two things to ease the direct impact of aging on patients and payers:

  1. To effectively prevent costly diseases above certain cost-effectiveness threshold;
  2. To effectively treat these diseases at a reduced cost without compromising quality standard of care and patient outcomes

If we can manage to tackle these health care challenges and make necessary system adjustment before it is too late, the benefit of living longer and healthier collectively should outweigh the added costs in an aging society.

PS. In the next section, we will be focusing on health economics and outcome research – the workhorse for health investment – in my opinion. 🙂

 

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