Why Healthcare Is Unsustainably Expensive ₋ and What We Can Do About It

Why Healthcare Is Unsustainably Expensive ₋ and What We Can Do About It

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02 Jul 24
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In brief

  • To tackle healthcare costs effectively, societies need to ask: why do healthcare costs rise so inexorably?
  • The fundamental problem is that achieving productivity growth in healthcare is hard.
  • At Generation, we tend not to invest in companies which try to limit demand for healthcare.
  • Instead we focus more on the supply side ₋ on technological innovation, with the goal of reducing healthcare costs and cost disease, and in turn improving access and outcomes.


It can seem like a bottomless pit. Last year total healthcare spending across developed markets was probably around $6 trillion, a 20% rise on 2019.1 Even so, healthcare systems today are often in disarray, from France to Canada to the UK, with accident and emergency rooms full and ever-longer waiting lists. There are worries about equity of care for low-income populations, especially in the US. No matter how much governments increase budgets, health systems always seem to need more. Can anything change this? Across our research at Generation Investment Management, we look at companies that we believe can drive the global healthcare system in a more cost-effective, equitable direction.

Over time spending on healthcare has taken up an ever-larger share of government spending and GDP. In 1980 spending on health accounted for 8% of American GDP; by 2022 it accounted for 17%.2 In 1980 10% of Britain’s public spending went to the National Health Service. Now it takes up 20% or more.3 Across the world, the price of pharmaceuticals continues to rise fast.4

The global rise in healthcare spending has had many benefits. Over time, life expectancy has considerably improved, as health services are able to offer a wider variety of high-quality treatments (see figure 1). Developing countries, we believe, should continue to spend more on healthcare ₋ and they are likely to, as they get richer.

Figure 1: Global health spending and global life expectancy. Source: Our World in Data

Yet in the case of rich countries we worry that the trend towards ever-higher health spending is unsustainable. At some point, the higher taxes required to fund costlier healthcare may no longer be politically feasible. If governments at some point struggle to raise the necessary extra funds for healthcare systems, people ₋ especially the poor and the elderly ₋ are likely to go without care. The positive ’spillovers’ from innovation in the most advanced healthcare systems, to less advanced ones, will decline. Alternatively, governments might decide to maintain health spending but cut other public services, such as education, with malign effects. This will be tricky at a time when many governments are also promising higher spending on defence.5 Or, governments may be left with no alternative but to amass huge quantities of debt. Tackling healthcare costs is thus an important sustainability objective.

Three main drivers

To tackle healthcare costs effectively, we need to ask: why do healthcare costs rise so inexorably? A useful paper by the UK’s Office for Budget Responsibility (OBR) identified three main drivers of healthcare spending: demographics, income effects and ’other.’6 We take each in turn.

Demography first. Most people assume that an ageing population is the most important reason behind ever-costlier healthcare. But this is a misconception. The OBR notes that demographic factors “have explained little of the past change” in healthcare costs. A study from the OECD suggests that demographic factors will account for about a tenth of the long-term rise in health and long-term care spending.7 The effects of an ageing population are “merely” measured in the hundreds of billions of dollars, rather than the trillions.8

The real controversy in healthcare economics is over the importance of those two other factors: income effects and other factors (or, alternatively, demand and supply factors). We do not seek to adjudicate on which factor is more important. Both probably play a role.


The theory here is that healthcare is a ’superior’ good. As societies get richer by one dollar, they demand more than a dollar extra in healthcare services ₋ in the same way that in Maslow’s hierarchy you move from basic needs to more sophisticated ones (see figure 2, below). Richer societies may also have more ’lifestyle’ diseases, in particular obesity and those linked to sedentary behaviours, which contribute to higher demand for healthcare.

America’s extremely high level of healthcare spending is, in part, explained by the fact that it is unusually rich.9 Its desire to get access to the “latest and greatest” in healthcare continues to drive extremely high spending per person. As economies grow in the future, we can expect demand for healthcare to continue to grow.

Figure 2: Relationship between income per capita and health spending per capita. Income is an extremely strong predictor of health spend (R^2 of 0.9). PPP = purchasing power parity. Source: Generation analysis of OECD data


Other researchers, however, argue that rising healthcare spending is to do with other factors ₋ in particular, rising costs (supply). The fundamental problem is that achieving productivity growth in healthcare is hard. In most sectors of the economy a new technology ₋ say, better computers ₋ lowers costs and raises productivity. In healthcare, however, new technologies tend to have the opposite effect, raising costs and lowering productivity. This is because they tend to make new treatments possible ₋ for example, new drugs for cancer or new surgical techniques.10

Healthcare also suffers from what economists call ’cost disease.’ Other sectors of the economy (for instance, manufacturing) can cut labour inputs into production, resulting in higher productivity and higher average wages. These gains are harder to come by in healthcare, however, because the ratio of human carers to patients is often fixed (ie, there should always be three or four nurses to every bed). To continue to attract staff, healthcare providers must continue to offer wages close to market levels, raising costs relative to output. As such, healthcare costs rise ₋ and by a large amount, given that in some health systems salaries account for as much as half of total costs.11 Healthcare inflation tends to exceed headline inflation, which is testament to the power of cost disease.12

Figure 3: Overall inflation and healthcare inflation, US, 1960-2024. Source: Federal Reserve Bank of St. Louis.

In sum, we believe that demand- and supply-side factors are important in explaining rising healthcare spending.

Beyond economics

Stop for a moment. There is some fatalism in this analysis. It is not necessarily true that technology must cause healthcare costs to rise; rather, that is what has happened so far. A recent paper published by America’s National Bureau of Economic Research notes that some innovations can reduce costs too. “Managed care, changes in provider payment methods, and increasing patient cost-sharing have all been shown to have some effect on lowering the level of spending as they are phased in.”13

Other improvements can be made to limit growth in healthcare costs.14 These include moving people (who are fit to be discharged) out of hospital and into more appropriate settings.15 It could also include efforts to drive automation and digitisation in healthcare administration.16 New research has also explored the potentially high cost savings linked to adoption of artificial intelligence.17 AI could help with the automation in the provider/insurance/payor ecosystem. The proliferation of glucagon-like peptide-1 drugs may also help to cut obesity rates, which could feed into reduced demand.

The lesson is that the world does not have to sit back and watch as healthcare becomes unaffordable.18 Indeed figure 3, above, shows that in recent years medical inflation in America has been no higher than overall inflation.19

How we at Generation aim to move the needle

We believe companies with sustainable business models, which offer solutions to creating a more equitable, efficient and effective society, are more likely to thrive in the long term. We first explored these two dimensions within a healthcare context in a 2004 research roadmap, early in our firm’s history. While we continue to iterate our thinking and stay close to developments, this fundamental ’Healthcare Roadmap’ is largely unchanged, continuing to shape where we focus our time.

We tend not to invest in companies which try to limit demand for healthcare. Indeed we recognise that there remains huge unmet demand for healthcare services across the world. Our focus has not been on hospitals, healthcare-services organisations and insurance companies: their interests may be misaligned with a healthcare system that offers high-quality, cost-effective healthcare that is accessible to all.

Instead we focus more on the supply side ₋ on technological innovation, with the goal of reducing healthcare costs and cost disease, and in turn improving access and outcomes. Our interest is in sectors that often are growing faster in part because they lead to savings elsewhere in the system ₋ and hence are self-funding to some extent. The areas we invest in include medical devices, diagnostics and tools that go into research and development (R&D). This can include everyday supplies such as tubes and vials, as well as driving efficiencies in the development of drugs and diagnostics. The goal is to reduce costs downstream as a result of earlier diagnosis or better therapy selection, ultimately feeding into lower healthcare cost growth.

One company we have looked at, Edwards Lifesciences, focuses on structural heart disease and critical-care monitoring. Another, BD, produces everyday supplies such as needles and syringes. In many cases these companies’ products can substantially reduce hospitals’ costs. 10x Genomics and Illumina, two other companies, both contribute to driving efficiency in the development of drugs and diagnostics. In our view, this should reduce costs downstream as a result of earlier diagnosis or better therapy selection.

AlayaCare, a portfolio company of our Growth Equity strategy, is a software provider which allows home-based care to be more efficient ₋ potentially taking some care out of costly hospitals. Our research has shown the potentially huge benefits of better care in the home. This can be achieved when large parts of the process are automated, as well as by making the experience for care workers better (including via optimised schedules). BenchSci, another Growth Equity portfolio company, provides AI solutions for preclinical R&D. The company’s technology recently allowed top customers to reduce unnecessary experimentation by 40%, contributing to a new era of more efficient, AI-driven drug discovery.20

Investments such as these, in theory, can have a huge impact ₋ not just on health outcomes but also on fiscal sustainability and therefore public services overall. We urge other investors to see the system-positive potential of a more sustainable healthcare system.

  1. Generation estimates and calculations using OECD and World Bank data
  5. For example, see:
  7. Chart 6.7
  8. One caveat: past performance is not a predictor of future performance. We note that, in many developed markets, population ageing is likely to accelerate in the coming years relative to previous ones. As such the demographic effect on healthcare costs is likely to rise over time. Nonetheless, it is highly likely to remain small relative to other factors.
  9. Note that this chart analyses household income, rather than GDP. Household income better reflects the resources available for consumer spending, broadly defined. GDP has components, such as foreign profits, which complicate analysis of this sort. For more on this, see:
  10. Historical studies suggest that up to two-thirds of real increases in health spending is due to technological change.
  11. In 2019/20 the total cost of NHS staff was £56.1 billion, which amounted to 47% of the NHS budget.,NHS%20England%20and%20NHS%20Improvement.
  12. Though, as we discuss in more detail below, this does not have to be the case. In recent years medical inflation has been lower than overall inflation.
  13. Lucarelli, Claudio, Molly Frean, Aliza S. Gordon, Lynn M. Hua, and Mark Pauly. How Does Cost-Sharing Impact Spending Growth and Cost-Effective Treatments? Evidence from Deductibles. No. w28155. National Bureau of Economic Research, 2020.
  14. We have chosen not to focus on policy in this paper.
  18. In addition, some countries have been able to bend the healthcare-cost curve. Ireland has a relatively high income per person but pretty high healthcare costs. Italians have a similar income, but their average spending on healthcare is about 30% lower. We also do not find much evidence, if any, that Italians get much less healthcare than Irish people: the annual number of doctor consultations in Italy, for instance, is higher. Italy tends to do well in global rankings of healthcare systems. The Italy-Ireland comparison suggests that healthcare investments, deployed sensibly, can make a difference.
  19. We feel fairly confident that US healthcare is experiencing a genuine “cost slowdown.” The chart above uses the personal-consumption-expenditures index of inflation (the Fed's preferred inflation metric), but using the consumer-price index you find similar results. The question is why this might be happening ₋ and a detailed answer is beyond the scope of this paper. Looking at data for the other OECD countries, however, it is quite hard to spot a similar trend. This suggests that US-specific factors, rather than global ones, are behind the drop-off in US healthcare inflation. That could be in part the impact of the Affordable Care Act (though the slowdown in medical inflation precedes that legislation). So it could well be technological change/adoption at the frontier that is behind the slowdown.

Important Information

The ‘Insights 19: Why Healthcare Is Unsustainably Expensive ₋ and What We Can Do About It’ is a report prepared by Generation Investment Management LLP (“Generation”) for discussion purposes only. It reflects the views of Generation as at July 2024. It is not to be reproduced or copied or made available to others without the consent of Generation. The information presented herein is intended to reflect Generation’s present thoughts on sustainable investment and related topics and should not be construed as investment research, advice or the making of any recommendation in respect of any particular company. It is not marketing material or a financial promotion. Certain companies may be referenced as illustrative of a particular field of economic endeavour and will not have been subject to Generation’s investment process. References to any companies must not be construed as a recommendation to buy or sell securities of such companies. To the extent such companies are investments undertaken by Generation, they will form part of a broader portfolio of companies and are discussed solely to be illustrative of Generation’s broader investment thesis. There is no warranty investment in these companies have been profitable or will be profitable. While the data is from sources Generation believes to be reliable, Generation makes no representation as to the completeness or accuracy of the data. We shall not be responsible for amending, correcting, or updating any information or opinions contained herein, and we accept no liability for loss arising from the use of the material.