Investment, Human Capital and Growth Kevin Murphy, PhD 86 January 17, 2013
U.S. Real Per Capita GDP 1889-2012 10.75 10.25 Log of Real Per Capita GDP 9.75 9.25 8.75 8.25 1880 1900 1920 1940 1960 1980 2000
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
Education Wage Premiums 2.3 Relative Wage 2.1 1.9 1.7 College Graduates Graduate School 1.5 1.3 1965 1975 1985 1995 2005
Education Premiums by Gender 1.8 1.7 Relative Wage 1.6 1.5 1.4 1.3 Women Men 1.2 1965 1975 1985 1995 2005
Education Premiums by Race 1.8 1.7 Relative Wage 1.6 1.5 1.4 Blacks Whites 1.3 1965 1975 1985 1995 2005
Overall Rise in Wage Inequality for Men 180.0 Indexed Real Wage (1967=100.0) 160.0 140.0 120.0 100.0 10th Percentile 50th Percentile 90th Percentile 80.0 1966 1971 1976 1981 1986 1991 1996 2001 2006
Wage Growth by Percentile 1968-2004 0.60 0.50 Real Wage Growth 0.40 0.30 0.20 0.10 0.00 5 15 25 35 45 55 65 75 85 95 Percentile
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 2.20 2.00 1.80 Actual Wage Ratio Predicted Wage Ratio 1.60 1.40 1.20 1963 1973 1983 1993 2003
The Supply Response Growth in the college premium has generated a predictable response more people have gone on to college
Wage Ratios & College Enrollment 0.55 1.8 Fraction of 20-25 Yr. Olds with Some College 0.50 0.45 0.40 Attendance Wage Ratio 1.7 1.6 1.5 1.4 Wage Ratio 0.35 1965 1975 1985 1995 2005 1.3
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
The Fiscal Threat to Growth 4,000 3,500 U.S. government surplus/deficit to GDP (in %) signficantly worsened 4% 2% receipts/outlays (bln. US$) 3,000 2,500 2,000 1,500 Outlays escalated Revenue growth stayed behind 0% -2% -4% -6% -8% -10% surplus/gdp or deficit/gdp (%) 1,000-12% Receipts, bln. US$, left Outlays, bln. US$, left Government surplus/deficit to GDP, right Sources: OECD, BEA, The Conference Board
How do we get out of this?
receipts/outlays (bln. Can$) The Canadian Experience 1990-2010 700 650 600 550 500 450 400 350 300 250 A 2-year pause in spending growth (1996-97) Canadian government "gets its house in order" Revenues grow at or below nominal GDP Outlays grow at or below population plus inflation 80% 70% 60% 50% 40% 30% 20% 10% government debt/gdp (%) 200 0% Receipts, bln. Can$, left Outlays, bln. Can$, left Debt-to-GDP, right Sources: Bank of Canada, IMF, The Conference Board
6% Canada Debt Reduction 1995-2008 The Sources of Canada's GDP Growth and Debt Reduction, 1995-2008 5% 4% P g r e 5.2% =NOMINAL GDP growth = N + I + P 4.6% =revenue growth 3.6% =expense growth 3% 2% 1% 0% g I N e e r r λ 0.86 = ratio government growth to N + I = λ β 0.88 = ratio revenue growth to GDP (N + I +P) N 1.9% = employment growth I 2.3% = inflation (GDP deflator) P 1.0% = productivity (GDP - N - I) nominal GDP employment growth (N+I+P) (N) + Inflation (I) + productivity (P) growth government expenditure growth(e) government revenue growth(r) Sources: IMF, The Conference Board Total Economy Database
U.S. Recent Historical Picture The Sources of U.S. GDP Growth and Debt Reduction, 1995-2008 6% 5% 4% P g r e 5.5% =NOMINAL GDP growth = N + I + P 4.8% =revenue growth 5.2% =expense growth 3% 2% g I e r λ β 1.58 = ratio government growth to N + I = λ 0.87 = ratio revenue growth to GDP (N + I +P) 1% 0% N e r N 1.1% = employment growth I 2.2% = inflation (GDP deflator) P 1.8% = productivity (GDP - N - I) nominal GDP employment growth (N+I+P) (N) + Inflation (I) + productivity (P) growth government expenditure growth(e) government revenue growth(r) Sources: BEA, Federal Reserve, The Conference Board Total Economy Database
Applying the Canadian Model to the U.S. Sources of Projected U.S. GDP growth and Debt Reduction P g I e r N Note: Assuming a cyclically adjusted 19% revenue-to-gdp ratio Sources: Federal Reserve, The Conference Board.
Improvements in Health (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
Figure 6a. Gains from Increased Longevity for Males 1970-2000 $500,000 $400,000 Males1990-2000 Males1980-1990 Males1970-1980 $300,000 $200,000 $100,000 $0 0 10 20 30 40 50 60 70 80 90 100 -$100,000
Aggregate Gains
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%
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
$1,400,000 Figure 5: Cumulative Value of Longevity Gains Since 1900: Men and Women in 2000 $1,200,000 $1,000,000 Males Females Gain (1996 Base Year) $800,000 $600,000 $400,000 $200,000 $0 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 -$200,000 Year
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 insurance delivery system Talking advantage of scalable technologies and the world-wide growth in incomes