Health capital accumulation, health insurance, and aggregate outcomes: A neoclassical approach (2023)

Journal of Macroeconomics

Volume 52,

June 2017

, Pages 1-22

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Over the past two decades, medical expenditure growth in the US has outpaced GDP growth by over 1.3% annually. To date, the literature has primarily focused on explaining the rapid rise in medical consumption relative to output, with only limited attention given to understanding the long-run macroeconomic implications of this trend. In this study, I modify the standard Neoclassical growth framework to include health capital accumulation, public and private health insurance, and GHH utility. After calibrating the model to match US data for the period 1996–2013, I systematically investigate the response of output, physical and health capital, medical and non-medical consumption, and household time allocation to one-time exogenous shocks to various potential determinants of medical expenditure growth. I find that a 10% increase in final goods and medical sector productivity shocks each have a positive effect on aggregate welfare. On the other hand, a 10% increase to the endogenous depreciation rate of health capital, or to either the public or the private health insurance share are all found to be welfare reducing.


The elevated growth rate of health care consumption relative to GDP that has occurred throughout the last several decades is one of the most significant and challenging macroeconomic phenomena facing modern industrial nations, and has dramatically altered the structure of the US economy. Between 1963 and 2013, the GDP share of personal health care (PHC)1 expenditures increased by a factor of nearly 3.25, rising from 4.56% to 14.72%. Many have expressed concern over the sustainability of the health care sector’s current growth trend, claiming that the GDP shares of non-medical consumption, investment, and discretionary government expenditures will be diminished as household and government budgets become increasingly constrained by rising medical expenditures (see Auerbach etal., 1992 and Hsiao and Heller, 2007). As a result, there is considerable support for cost containment health care reforms that attempt to curtail the growth of medical expenditures.2

Despite these concerns, there is sufficient evidence in the literature to suggest that the growth in medical consumption relative to output may be the optimal response of households to changes in the economy that have occurred over the past 50 years, potentially contradicting the common assertion that cost containment health care reform is essential. Unfortunately, to date there has not been a systematic attempt in the literature to identify the macroeconomic consequences of the rise in medical expenditures that incorporates the significant aggregate externalities (both positive and negative) that are associated with health investment.

Therefore, in what follows I develop a benchmark neoclassical model that is useful for investigating the aggregate steady-state response to changes in the economy that are related to the growth of the health care sector. More specifically, I adapt the standard Neoclassical growth model with endogenous labor supply to include health capital accumulation following Grossman (1972). Health investment is financed in part by employer-provided private health insurance as well as a government subsidy intended to mimic the public financing of private medical consumption through programs such as Medicare and Medicaid. I assume that the household does not internalize the impact its actions have on the rate of depreciation of health capital and the private health insurance premium, generating a negative externality that may result in a non-optimal level of medical consumption. At the same time, I assume that health capital generates a positive externality on final goods production that may result in under-investment in health capital. Consequently, the response of aggregate welfare to an expansion of health insurance3 is uncertain and will depend on the relative magnitudes of these two competing externalities.

The analytical model is calibrated to match annual data for the US economy from 1996 to 2013. After calibrating the model and solving for the steady-state numerically, I analyze the transition dynamics and steady-state welfare response of the model to various changes in the economy that have been identified by the literature as being related to the growth in medical expenditures. These scenarios include 10% increases to 1) final goods productivity, 2) medical sector productivity (i.e. new medical technologies), 3) the endogenous rate of health capital depreciation, 4) the private insurance share of medical expenditures and 5) the public share of medical expenditures.

The model predicts that a one-time, beneficial productivity shock to either the final goods sector or the health investment sector will have a positive impact on total output, physical capital, and medical and non-medical consumption, leading to an increase in aggregate welfare. In contrast, an increase in the exogenous component of the endogenous depreciation rate of health reduces aggregate output, physical capital, labor supply, and consumption of medical and non-medical goods, leading to a decline in social welfare. Similarly, expanding public or private health insurance motivates the household to investment more in its health, increasing health capital and output. However, since the household is spending more on health care, aggregate non-medical consumption will fall, causing aggregate welfare to decline despite the rise in aggregate output, health capital, and leisure time.

The rest of the paper is laid out as follows; In Section2, I describe the growth of medical expenditures, review the medical expenditure growth literature, and discuss the aggregate role of health investment in the economy. In Section3, I introduce the model. Section4 describes the data sources utilized in the calibration of the model and presents the relevant output ratios and time allocations that the model is calibrated to match. I then discuss the values selected for the parameters in the model and compare the results from the model with the data. In Section5, I analyze the welfare response and transition dynamics that result from one-time permanent shocks to final goods productivity, health investment productivity, the endogenous rate of health capital depreciation, the public share of medical consumption, and the private health insurance share of medical consumption. In Section6, I change certain parameters that influence the size of the externalities mentioned above. Finally, in Section7, I provide my conclusions.

Section snippets

The aggregate role of medical consumption

The majority of the early studies in this literature utilized static, micro models of health investment and health insurance markets. These studies primarily concentrated on identifying and estimating the welfare losses that arise from various market inefficiencies that are present in the health care and health insurance markets.4 These welfare losses were found to be substantial5


I assume that the economy is composed of a representative household, a final goods producer, a medical care provider, a private health insurer, and a government that provides public health insurance and a non-medical government consumption good. The household has a health capital stock h that serves two important functions in the economy; 1) it is employed in the production of the final good and 2) it enters the household’s utility function.7


The data for the calibration is obtained from the national income and product accounts (NIPA), the national health expenditures accounts (NHEA), the penn world tables 8.1 (PWT), the American time use survey (ATUS), and the centers for disease control and prevention (CDC).11 The sample means are presented in Table1. NIPA is the primary data sources for output, its

Long-run effects and transition dynamics

In this section I analyze the transition dynamics for a 10% increase to each of the following; final goods productivity, health investment productivity, the exogenous component of the endogenous depreciation rate of health capital, and the public and private insurance shares of medical expenditures. The transition paths of (a) output, (b) leisure time, (c) health maintenance time, (d) physical capital, (e) private non-medical consumption, (f) medical expenditures, (g) the physical

Sensitivity analysis

The welfare response to the five shocks I consider depends on the relative size of the positive output externality and the loss from moral hazard. In this section, I test the sensitivity of the model to variations in the magnitude of these two respective externalities. This section is broken down into two parts. First, I test my prior assertion that the benchmark model approximates the moral hazard problem. Then, I test the sensitivity of the model to variations in the parameters μ and η.


Over the past several decades the growth of medical expenditures in the US has significantly outpaced the growth of GDP, leading to concern that household and government budgets will become increasingly constrained. In response, health economists have sought to identify the various factors in the economy driving the rapid expansion of the medical sector. This line of research has successfully identified several factors that drive the growth in this sector, including rising income levels, the

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