In the U.S. as well as in other industrialized countries there has been a large secular increase in life expectancy. At the same time the share of income, measured as gross domestic product, devoted to expenditures on health-related goods has increased substantially, and the relative price of medical goods has been rising. This project develops a novel class of theoretical models to jointly explain these observations, and to study to what extent they are shaped by public policies. In the model individual health investments of households and research and development (R&D) choices of firms in the health sector jointly determine the long-run health distribution and the rate of technological progress in the health services sector. These factors in turn will shape long-run growth of incomes and welfare in society. This theoretical model, and with parameters informed by the data, is then used as artificial laboratory to evaluate the consequences of fundamental reforms in public social insurance programs, specifically the social security and Medicare programs in the U.S. A key novel feature of the model is the explicit endogenous treatment of technological progress in the health sector. According to the hypothesis advanced in this project changes in longevity lead to increased demand for health goods, which channels activity towards the medical sector. The resulting technological progress which is directed towards the medical sector yields new treatments and drugs, therefore stimulating demand for new health goods which in turn improve longevity. This core mechanism is embedded into a complete model of the macro economy in which individuals differ by age, income, health, and wealth, and make medical investment choices over the life cycle. These in turn determine their health and longevity. Household demand of health services induces R&D investments by health sector firms, which in turn determines the speed of technological progress in that sector. Part of the output from this project is the development of software that computes numerically the economic equilibrium emerging from the interaction of households and health production firms in this model with endogenous growth and rich household heterogeneity. To insure that the theoretical model delivers an accurate description of real-world household behavior on the micro household level the crucial parameters governing household earnings and health outcomes are estimated using household survey data containing information on individual labor incomes and health. The so empirically informed theoretical model is then put to use to answer three sets of applied and directly public policy relevant questions. First, it is evaluated whether the model provides a quantitatively accurate explanation for the three joint macroeconomic facts motivating the analysis: longer life expectancy, a rising health expenditure share and a larger relative price of medical goods. Second, it is used for the evaluation of different policy options (e.g. increasing taxes, reducing benefits, or delaying benefits) to keep Medicare and Social Security financially viable in an aging U.S. society. Finally, it is employed to study the impact of health care policies that limit the pricing of pre-existing health conditions by insurance companies and policies that mitigate the impact of changes in household health status on labor earnings.
