On Employer Health Costs and Crowding Out

Don Boudreaux has a nice post at Café Hayek, responding to Malcolm Gladwell’s claim that the cost of providing healthcare to workers puts American companies at a competitive disadvantage relative to their foreign competitors (in countries with government-run healthcare systems). I don’t want to repeat Don’s arguments, but I have an addendum.

As Don implies in passing, the U.S. healthcare system is very far from a free market. The phenomenon of employer-provided health insurance is largely attributable to a distortion in the tax code, and the results are undesirable in a variety of ways. But are higher employer costs among those bad results? Yes, employers make substantial expenditures on healthcare. But the question is whether costs are higher on net. There is a good deal of evidence that health insurance benefits crowd out other forms of compensation, particularly wages. Here’s an illustrative graph, based on Bureau of Labor Statistics data:


(Note: since the time I downloaded the data, the BLS has changed it to reflect a different base year.) The blue line shows how employer costs in the form of wages have changed over time. The pink line shows the same for employer costs in the form of benefits – mostly health insurance. Note how the pink line has risen faster than the blue line; moreover, notice how the blue line tends to stay flat or fall when the pink line is rising most steeply.

Now, this is probably a bad thing for workers, because the rising cost of healthcare is eating into their compensation. But is it really a bad thing for employers? What they care about most is the total expenditure on labor. This rises with worker productivity (which explains the growth in overall compensation, shown by the yellow line), but it does not necessarily rise with the cost of healthcare. In the short run, rising health costs will hurt employers who cannot quickly adjust wages. But in the long run, they can change the composition of the compensation package by, among other things, resisting wage increases they would otherwise have granted.

I don’t wish to imply that rising health costs have no ill effects on employers. Among other things, they have to deal with workers disgruntled by the paucity of wage increases. But it’s certainly an error to say the employers’ burden is equal to their entire expenditure on health insurance, because that conclusion fails to account for any amount of crowding out.