Medical Innovation and the Value of Health Care

Medical innovation or technological change is argued to be a primary source of expansion in many of the world’s growing health care sectors. However, systematic theoretical and empirical analysis of the impact of technological change on the cost and quality of health care is scarce. This paper provides a theoretical analysis which derives the factors that drive changes in quality-adjusted prices for next generation health care innovations. We stress the importance of “health complementarities” in explaining rising quality-adjusted prices in health care, even though quality-adjusted prices fall over time in many other industries. This paper then empirically examines the introductions of over 3,500 new health care innovations and measures the impact such technological change has on the price and quality of care. Our main finding is that next generation medical innovations raise quality-adjusted prices of health care significantly.  Specifically, the median new innovation raises quality by 1 percent and raises price by about 8 percent.  Consistent with the finding that price increases more than quality, we find the median next generation technologies raise quality-adjusted prices by 5 percent, with about 69 percent of new technologies increasing such adjusted prices. We test and find support for changes in quality-adjusted prices to be consistent with the theoretical analysis.