Month: August 2012

Ramanan Laxminarayan discusses \”A Matter of Life and Death: The Economics of Antibiotic Resistance,\” in the Third Quarter 2012 issue of the always-interesting Milken Institute Review. (The magazine is freely available, with registration, on-line.) Not only is the topic of considerable importance, but for teachers of introductory economics, it offers a nontraditional example of a shared natural resource–and the risk of a tragedy of the commons.

The problem arises, paradoxically, because antibiotics are such a miraculous medical invention that they are heavily and broadly prescribed, even for relatively minor conditions like bronchitis or ear infections, and even for virus-caused conditions like flu where antibiotics don\’t even work. When antibiotics are so widely used, bacteria mutate in response and build up resistance.

\”In the United States, for example, resistance to the bacterium methicillin-resistant Staphylococcus aureus (MRSA), has reached 60 percent. This means six out of 10 patients with this virulent staph infection can no longer be treated with oxacillin, a relatively low cost drug. But what still amounts to a cost problem in rich countries is becoming a serious threat to public health in the developing world: lower-income countries face a growing toll of death and morbidity from curable infections because the generally available antibiotics no longer work.\”

The problems only start with infections that are resistant. Without antibiotics, almost every form of surgery lead to additional and potentially severe infections.

One obvious answer is to invent new antibiotics, but it has gotten more difficult and costly to do so. \”[O]minously, the pace of development is slowing: 14 of the 16 classes of antibiotics in use
were introduced before 1970. Accordingly, options for treating patients who do not respond to older, less effective antibiotics are shrinking. … Fortunately, there seems to be a glimmer at the end of this tunnel. Two new antibiotic drug classes have been introduced during the past decade, ending a 40-year drought. Moreover, the pharmaceutical industry seems to be returning to antibiotic development, especially for soft-tissue skin infections …\”

Another issue is that the U.S. health care financing system reimburses the costs of antibiotics. However, it does not reimburse–at least not in a direct way–for alternative ways of reducing the spread of infection. One study found that Medicare alone spent $20 billion on addressing costs of hospital-caused infections in 2004. But except for some pilot programs, the health care system is readier to pay for costs of fighting infection than for costs of preventing its spread in the first place. \”The market for antibiotics may fail to produce economically efficient outcomes for other
reasons – notably underinvestment in other means of infection control like vaccinations
and good hospital management practices.\”

Laxminarayan does a nice job of talking through the possible solutions: encouraging development of additional antibiotics, encouraging a range of antibiotics, discouraging overuse of antibiotics when not especially necessary, and encouraging alternative ways of fighting infection. Here, I\’d just emphasize the author\’s point that for teachers of economics, antibiotics resistance offers an example of a shared natural resource. 

Many natural resources–like fisheries or forests or clean air–share the trait that if they are used in moderation, they have an ability to renew themselves and to continue. However, if they are overused, the resource can be depleted in a way that it has great difficulty in recovering. Moreover, as the \”tragedy of the commons\” scenario points out, every individual has an incentive to overuse a common resource, because the gains of using that resource all flow to the individual, while the social costs of overusing the resource are shared across society. This is the economic basis for arguing that natural resources need to be managed in some way: perhaps through private property rights like ownership or marketable quotas, or perhaps through more direct regulation of use, to prevent their overuse and depletion.

The effectiveness of antibiotics fits this scenario. Each doctor and patient has an individual incentive to use a wide spectrum of antibiotics to treat any given condition. The benefits to the patient are immediate, while the potential costs of creating greater resistance to antibiotics are shared across society. The effectiveness of antibiotics is an extraordinarily important social resource, but it is being eroded by overuse. Exactly how to prevent overuse of this resource is debatable, but the need to take steps to do so is clear.

The nature of what the federal government does is shifting over time, away from providing goods and services to the public and toward becoming a conduit for payments to households. Jessica Perez, Gabe Horwitz, and David Kendall summarize some trends in a report for a Democrat-leaning think tank called Third Way. They write: \”Entitlements are squeezing out public investments. In 1962, spending on investments was two and a half times that of entitlements. But today, as a result of this Great Inversion, entitlement spending is three times that of investments. And this trend will only accelerate in time as the Baby Boomers retire and their benefits grow faster than inflation and wages.\” 

What exactly is included in these categories? It takes a quick skip and a hop through federal budget documents to find out.

In the proposed Budget of the United States for FY2013 from the Office of Management and Budget, Table 8.5 in the Historical Tables summarizes \”mandatory spending.\” This category totaled about $2 trillion in 2011. Of that total, about three-quarters was payments from Social Security ($725 billion), Medicare ($480 billion) and Medicaid ($275 billion). Other big categories include payments to federal retirees ($124 billion), unemployment insurance ($117 billion) and food and nutrition assistance ($96 billion).  

For an overview of \”Federal Investment,\” the useful starting point is Chapter 21 with that title in the
Analytical Perspectives volume of the federal budget. It defines federal investment broadly:

\”Federal investment is the portion of Federal spending intended to yield long-term benefits for the economy and the country. It promotes improved efficiency within Federal agencies, as well as growth in the national economy by increasing the overall stock of capital. Investment spending can take the form of direct Federal spending or of grants to State and local governments. It can be designated for physical capital, which creates a tangible asset that yields a stream of services over a period of years. It also can be for research and development, education, or training, all of which are intangible but still increase income in the future or provide other long-term benefits.\”

Along with annual spending numbers, the chapter makes an interesting attempt to estimate the total value of the accumulated stock of federal investment in several areas. For example, it estimates the total stock of federally financed physical capital in 2011 was worth $3,054 billion, of which a bit under  one-third ($925 billion) is national defense, almost exactly one-third is transportation $1,017 billion), and the rest is for water and power, natural resources, community and regional resources, and \”other.\”

The chapter estimates the value of the total stock of federally financed research and development at $1.5 trillion in 2011. This total can be divided more-or-less 50:50 into the value of the stock of basic and applied research, or it can be divided about 60:40 into the value of the stock of non-defense and defense-related research and development.

Finally, the stock of federally financed education capital is given as a shade over $2 trillion in 2011, of which three-quarters is the total value of federally-financed elementary and secondary education, and the rest is fedearally-financed higher education.

I\’m sure the exact assumptions behind these numbers are debateable, but the broad theme seems well-established. Back in the 1960s, about one-third of all federal spending was devoted to building up these various types of capital. Now only half that share of federal spending goes to these purposes, and the Third Way report projects that public investment spending may be headed for just 5% of all federal spending in a few decades.  Conversely, entitlement spending was only about 15% of all federal spending back in the 1960s. Now it\’s more than half of all federal spending, and the share is rising. The main functions of what the U.S. government actually does are shifting before our eyes.

A half-century ago, white men dominated the high-skilled occupations in the U.S. economy, while women and minority groups were often barely seen. Unless one holds the antediluvian belief that, say, 95% of all the people who are well-suited to become doctors or lawyers are white men, this situation was an obvious misallocation of social talents. Thus, one might predict that as other groups had more equal opportunities to participate, it would provide a boost to economic growth. Pete Klenow reports the results of some calculations about these connections in \”The Allocation of Talent and U.S. Economic Growth,\” a Policy Brief for the Stanford Institute for Economic Policy Research.

Here\’s a table that illustrates some of the movement to greater equality of opportunity in the U.S. economy. White men are no longer 85% and more of the managers, doctors, and lawyers, as they were back in 1960. High skill occupation is defined in the table as \”lawyers, doctors, engineers, scientists, architects, mathematicians and executives/managers.\” The share of white men working in these fields is up by about one-fourth. But the share of white women working in these occupations has more than tripled; of black men, more than quadrupled; of black women, more than octupled.

Moreover, wage gaps for those working in the same occupations have diminished as well. \”Over the same time frame, wage gaps within occupations narrowed. Whereas working white women earned 58% less on average than white men in the same occupations in 1960, by 2008 they earned 26% less. Black men earned 38% less than white men in the typical occupation in 1960, but had closed the gap to 15% by 2008. For black women the gap fell from 88% in 1960 to 31% in 2008.\”

Much can be said about the causes behind these changes, but here, I want to focus on the effect on economic growth. For the purposes of developing a back-of-the-envelope estimate, Klenow builds up a model with some of these assumptions: \”Each person possesses general ability (common to
all occupations) and ability specific to each occupation (and independent across occupations). All groups (men, women, blacks, whites) have the same distribution of abilities. Each young person knows how much discrimination they would face in any occupation, and the resulting wage they would get in each occupation. When young, people choose an occupation and decide how
much to augment their natural ability by investing in human capital specific to their chosen
occupation.\”

With this framework, Klenow can then estimate how much of U.S. growth over the last 50 years or so can be traced to greater equality of opportunity, which encouraged many in women and minority groups who had the underlying ability to view it as worthwhile to make a greater investment in human capital.

\”How much of overall growth in income per worker between 1960 and 2008 in the U.S. can be explained by women and African Americans investing more in human capital and working more in high-skill occupations? Our answer is 15% to 20% … White men arguably lost around 5% of their earnings, as a result, because they moved into lower skilled occupations than they otherwise would have. But their losses were swamped by the income gains reaped by women and blacks.\”

At least to me, it is remarkable to consider that 1/6 or 1/5 of total U.S. growth in income per worker may be due to greater economic opportunity. In short, reducing discriminatory barriers isn\’t just about justice and fairness to individuals; it\’s also about a stronger U.S. economy that makes better use of the underlying talents of all its members.