Health-Care Costs: The Sky Isn't the Limit

New York has never been known for its fragrance, but few periods were as pungent as the late 1800s. Prior to the automobile, over 100,000 horses provided transportation on the city's streets. That meant a lot of manure -- 2.5 million pounds of it a day.

As Stephen Davies of the Institute of Economic Affairs wrote:

In 1898 the first international urban-planning conference convened in New York. It was abandoned after three days, instead of the scheduled ten, because none of the delegates could see any solution to the growing crisis posed by urban horses and their output.

The problem did indeed seem intractable ... Writing in the Times of London in 1894, one writer estimated that in 50 years every street in London would be buried under nine feet of manure.

That never happened, thank heavens. More importantly, it stood no chance of ever happening in the first place. Forecasting that something unsustainable will go on forever, at current growth rates, unchecked, isn't forecasting at all; it's merely drawing a straight line. The writer's warning was a load of crap, if you will.

Yet, we still fall for the same blind extrapolations that lead to silly conclusions. Consider this prediction from a recent report by the Annals of Family Medicine:

If health insurance premiums and national wages continue to grow at recent rates and the US health system makes no major structural changes, the average cost of a family health insurance premium will equal 50% of the household income by the year 2021, and surpass the average household income by the year 2033.

There are no certainties in the economy, but it can get awfully close. So let me state clearly: It's nearly certain that this won't happen.

The most important word in AFM's warning is "if." True, if insurance premiums rise at previous rates, and if income growth stagnates, and if there are no changes to the health-care system, the average family will eventually face spending every penny they make and more on health insurance.  

Far more likely, though, is something like this: Medical care will eventually get so expensive that people use less of it. Prices will then fall, or at least growth will slow. And that's bound to occur well before most Americans face spending more than 100% of their income on medical care.

Or maybe it goes like this: Medical care eventually gets so expensive and there's so much money to be made in the industry that hospitals and clinics suddenly outnumber Starbucks on street corners. A surge of supply will cause prices to fall, or at least growth to slow.

Or maybe it's some combination in between. Or perhaps it's something else we can't even think of, akin to automobiles replacing horses. AFM briefly cites this possibility -- "the health care system is complex and adaptive," it writes -- but doesn't seem to appreciate the strong likelihood of those forces rendering its forecast meaningless.

What's important is that markets change when things get out of whack. When gas prices were unbearable in 2008, calls came in that oil would soon spike to $250 a barrel. Instead, it collapsed. Why? Because prices were already unbearable. The global economy could not afford $250 oil, and thus wouldn't support prices anywhere close to that level. Same with medical care.

AFM's concern over rising medical costs shouldn't be belittled, of course. According to the Kaiser Family Foundation, health care costs have grown an average of 2.4 percentage points faster than gross domestic product since the 1970s. In 1980, 9.1% of GDP went to health care. Today it's more than 17%. That growth has been painful, and it has fundamentally changed how Americans access health care.

But one thing is mathematically certain: It won't go on forever. Nothing can grow faster than the overall economy indefinitely. Rapid growth in any industry must obey Stein's Law: If something can't go on forever, it won't.

And there are already signs of spiking growth in medical prices reaching a limit. "The rates of health spending growth in 2009 and 2010 marked the two slowest rates in the 51-year history of the National Health Expenditure Accounts," the health policy journal Health Affairswrote recently. Among the explanations cited: "[T]he burden of increased cost sharing led people to forgo care or seek less expensive treatment options."

That's exactly the kind of behavior you see when rapid price increases are about to ebb. And it's exactly the kind of behavioral change that makes extrapolating trends over several decades (small-f) foolish. Indeed, in recent months the "medical care" component of the Consumer Price Index has grown at a nearly identical rate as overall inflation -- one of only a few times that's occurred in the last four decades.

The sky, it turns out, isn't the limit for health care costs.

For more on the recession's impact on the economy, check out my latest ebook, 50 Years in the Making: The Great Recession and Its Aftermath, for your iPad or Kindle, on Amazon or Barnes & Noble. It's short, packed with information, and costs less than a buck.

Check back every Tuesday and Friday for Morgan Housel's columns on finance and economics.

At the time this article was published Fool contributorMorgan Houseldoesn't own shares in any of the companies mentioned in this article. Follow him on Twitter @TMFHousel.Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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