1. The People Based Economy Kevin M. Murphy The University of Chicago October 25, 2013

2. U.S. Real Per Capita GDP 1889-2012

3. 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

4. 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

5. People as Output

8. People as Inputs The Demand for Skill

9. Education Wage Premiums

10. Education Premiums by Gender

11. Education Premiums by Race

12. Overall Rise in Wage Inequality for Men

13. Wage Growth by Percentile 1968-2004

14. Wage Growth by Percentile 1968-1977

15. Wage Growth by Percentile 1977-1986

16. Wage Growth by Percentile 1986-1995

17. Wage Growth by Percentile 1995-2004

18. 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

19. Supply Growth & Relative Wages

20. The Supply Response Growth in the college premium has generated a predictable response – more people have gone on to college

21. Wage Ratios & College Enrollment

22. College Graduation by Gender (Age 30)

23. Mean GPA of High School Graduates, High School Transcript Studies

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

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

26. 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

27. 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

31. 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

32. Aggregate Gains 1970-2000

33. Aggregate Gains from Increased Longevity 1970-2000 Aggregate Gains (Billions of $2004) 1970-19801980-19901990-201970-2000 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

35. 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

36. 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

37. 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?

38. 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

39. 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!

40. 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”

41. 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

42. 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

43. 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

44. 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