The People Based EconomyKevin M. Murphy

The University of ChicagoOctober 25, 2013

U.S. Real Per Capita GDP 1889-2012

1880 1900 1920 1940 1960 1980 20008.25

8.75

9.25

9.75

10.25

10.75

Log

of R

eal P

er C

apita

GD

P

Where Does Growth Come From?

• There are three primary sources of growth• Investment in physical capital• Investment in human capital• Improvements in technology (knowledge)

• Primary goals of policy should be to• Maintain the incentive for physical investment• Provide an environment that fosters the growth of

human capital• Provide rewards for innovation

How do People Fit into the Economic Picture?

• People are important as both inputs and outputs• Human capital is our most important input

• Accounts for roughly 65 percent of our productive capacity• With increasingly mobile capital and technology, countries

will be increasingly defined by their human capital

• The production and maintenance of human capital is our most important output• Education• Healthcare• On the job training

People as Output

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 200040.0

45.0

50.0

55.0

60.0

65.0

70.0

75.0

80.0

85.0

Cross Sectional Life Expectancy at BirthUnited States, 1900-2000

YEAR

Lif

e E

xp

ec

tan

cy

at

Bir

th

Males at age 50

Females at age 50

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 200040.0

45.0

50.0

55.0

60.0

65.0

70.0

75.0

80.0

20.0

24.0

28.0

32.0

Life Expectancy at Age 50United States, 1900-2000

YEAR

Lif

e E

xp

ec

tan

cy

at

Bir

th

Lif

e E

xp

ec

tan

cy

at

Ag

e 5

0

Males at age 50

Females at age 50

People as InputsThe Demand for Skill

Education Wage Premiums

1.3

1.5

1.7

1.9

2.1

2.3

1965 1975 1985 1995 2005

Rel

ativ

e W

age

College Graduates

Graduate School

Education Premiums by Gender

1.2

1.3

1.4

1.5

1.6

1.7

1.8

1965 1975 1985 1995 2005

Re

lati

ve

Wa

ge

Women

Men

Education Premiums by Race

1.3

1.4

1.5

1.6

1.7

1.8

1965 1975 1985 1995 2005

Re

lati

ve

Wa

ge

Blacks

Whites

Overall Rise in Wage Inequality for Men

80.0

100.0

120.0

140.0

160.0

180.0

1966 1971 1976 1981 1986 1991 1996 2001 2006

Ind

ex

ed

Re

al W

ag

e (

19

67

=1

00

.0)

10th Percentile

50th Percentile

90th Percentile

Wage Growth by Percentile 1968-2004

0.00

0.10

0.20

0.30

0.40

0.50

0.60

5 15 25 35 45 55 65 75 85 95Percentile

Rea

l Wag

e G

row

th

Wage Growth by Percentile 1968-1977

-0.10

-0.05

0.00

0.05

0.10

0.15

0.20

5 15 25 35 45 55 65 75 85 95Percentile

Rea

l Wag

e G

row

th

Wage Growth by Percentile 1977-1986

-0.15

-0.10

-0.05

0.00

0.05

0.10

0.15

5 15 25 35 45 55 65 75 85 95Percentile

Rea

l Wag

e G

row

th

Wage Growth by Percentile 1986-1995

-0.15

-0.10

-0.05

0.00

0.05

0.10

0.15

5 15 25 35 45 55 65 75 85 95Percentile

Rea

l Wag

e G

row

th

Wage Growth by Percentile 1995-2004

0.00

0.05

0.10

0.15

0.20

0.25

0.30

5 15 25 35 45 55 65 75 85 95Percentile

Rea

l Wag

e G

row

th

Explaining Changes In Education Returns Using Supply & Demand

• Growth in the college premium can be explained by a very simple model

• Model based on Katz-Murphy 1992• The model:

• Demand grows steadily over time• Fluctuations in supply cause education premiums to

fluctuate• Supply grows faster than demand premium falls• Demand grows faster than supply premium rises

Supply Growth & Relative Wages

1.20

1.40

1.60

1.80

2.00

2.20

1963 1973 1983 1993 2003

Actual Wage Ratio

Predicted Wage Ratio

The Supply Response

• Growth in the college premium has generated a predictable response – more people have gone on to college

Wage Ratios & College Enrollment

0.35

0.40

0.45

0.50

0.55

1965 1975 1985 1995 2005

Fra

cti

on

of

20

-25

Yr.

Old

s w

ith

So

me

C

olle

ge

1.3

1.4

1.5

1.6

1.7

1.8

Wa

ge

Ra

tio

Attendance

Wage Ratio

College Graduation by Gender (Age 30)

Mean GPA of High School Graduates, High School Transcript Studies

DISTRIBUTION OF FIRST-YEAR UNDERGRADUATE GPA, BEGINNING POSTSECONDARY STUDENTS LONGITUDINAL STUDY

Improvements in Health & Longevity(Based on Murphy & Topel 2007)

Basic Results• Historical improvements in life expectancy

have been very significant – improvements in longevity from 1970 to 2000 were worth roughly $95 trillion (or about $3.2 trillion per year) to U.S. citizens

• Improvements in life expectancy have contributed about as much to overall welfare as have improvements in material wealth

Methodology

• Groundhog Day model• Model based on willingness to pay• Willingness to pay based on market

experience• Cigarettes• Safer cars• Risky jobs

• Value is measured by the value to people not contribution to GDP

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 200040.0

45.0

50.0

55.0

60.0

65.0

70.0

75.0

80.0

85.0

20.0

24.0

28.0

32.0

Life Expectancy at BirthUnited States, 1900-2000

YEAR

Lif

e E

xp

ec

tan

cy

at

Bir

th

Lif

e E

xp

ec

tan

cy

at

Ag

e 5

0

Males at age 50

Females at age 50

Figure 5: Cumulative Value of Longevity Gains Since 1900: Men and

Women in 2000

-$200,000

$0

$200,000

$400,000

$600,000

$800,000

$1,000,000

$1,200,000

$1,400,000

1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000

Year

Gai

n (

1996

Bas

e Y

ear)

Males

Females

Figure 6a. Gains from Increased Longevity for Males 1970-2000

-$100,000

$0

$100,000

$200,000

$300,000

$400,000

$500,000

0 10 20 30 40 50 60 70 80 90 100

Males1990-2000

Males1980-1990

Males1970-1980

Recent & Longer Term Changes

• Recent improvements are reflective of longer term gains in longevity

• Gains were actually somewhat greater in earlier decades using a fixed valuation profile (like fixed basis GNP accounting)

• Gains have become increasingly concentrated at older ages in recent decades

Aggregate Gains 1970-2000

Aggregate Gains from Increased Longevity 1970-2000

Aggregate Gains (Billions of $2004)

1970-1980 1980-1990 1990-20 1970-2000

Males $26,699 $15,471 $19,153 $61,323

Females $20,515 $9,067 $4,440 $34,022

Total $47,214 $24,538 $23,593 $95,345

Estimated Gains Net of the Increase in Health Expenditures 1970-1980 1980-1990 1990-2000 1970-2000

Gross Gains (from Table 5) $47,214 $24,538 $23,593 $95,345 Increase in Expenditures $8,206 $14,928 $11,591 $34,725 Gains Net of Expenditure Growth $39,008 $9,611 $12,001 $60,620 Expenditure Increase as a % of Gains 17.4% 60.8% 49.1% 36.4%

The Good News & the Bad News:

• The Good: People value gains in health and longevity a lot

• The Bad: Medical care is not cheap• While life extension added 3 trillion per year

in value, medical expenditures grew by roughly 1 trillion per year

• For the oldest groups expenditures grew by more than the value of life extension

Balancing the Costs & Benefits

• In thinking about medical advances we must consider both sides of the equation

• Progress is important• Controlling costs is important• Controlling costs raises the value of medical

advances• Cost containment and medical progress

complement one another

A Simple Example

• 200 billion dollar “war on cancer”• 50% probability of success – 50% probability

of total failure• Success = 10% reduction in cancer death rates• Based on Murphy & Topel – value of success ≈

$5 trillion• What about costs of care?

Costs of care• Two scenarios:

• “good” outcome = treatment adds 2.5 trillion (50% of value) to costs of care

• “bad” outcome = treatment adds 10 trillion (200% of value) to costs of care

• Assume each scenario is equally likely

• Three potential outcomes:• 50% chance of “Failure” = -$200 billion• 25% chance of “Good Success” = +$2.3 trillion• 25% chance of “Bad Success” = -$5.2 trillion

• Expected gain = -$825 billion

What matters in this calculation?

• Costs of research are small by comparison to costs and benefits (making them $100 billion or $300 billion has little effect)

• Probability of success matters some but not much

• Expected costs of care matter a lot• Question: What can we do to improve the

situation?• Answer: Make good care decisions!

Example Continued• Improve care system = don’t implement if

costs of care are high• Chance of “failure” now 75%• But expected gain now +$425 billion• Bottom line: appropriate cost containment

RAISES the value of research by eliminating the major downside

• The potential downside to research is not failure but unaffordable “success”

How do we get there?

• Best solution: improve incentives and decisions in the delivery system – research will follow

• Second best: change the direction of research to look only for lower cost solutions

• Both enhance the case for more research

What does it take?

• Improve incentives for doctors and patients to control costs

• Use technologies appropriately – not all or nothing – many treatments will be cost effective for some patients not for others

• Focus on treatments with low incremental costs – reduces problem of over use

Potential Pitfalls• Behavioral change is not free – people value behavior

as well as health – people value eating and even smoking

• Behavioral change that mitigates gains in longevity does not diminish the value of progress and maybe increases it

• Behavioral factors increase in importance as care moves out of the hospital and into the household

• Patient inputs make education more important and inequality a bigger issue

Important Policy Questions• How do we take advantage of growing

demand for education and skills?• Increasing investment in higher education• Improving education at lower levels• This is a long term project

• How do we take advantage of potential gains from medical advance?

• Balancing the costs and benefits• Improving delivery system/ treatment choices• Talking advantage of scalable technologies and the

world-wide growth in incomes