Innovation is frequently underemphasized in the economics literature because it is qualitative by nature, and qualitative changes are hard to measure. A new NBER paper by three economists, Lakdawalla, Reif, and Malani, makes some progress toward a better measure of innovation, specifically innovation in health care. They show that by ignoring the way medical innovations help reduce risk, previous studies have tended to underestimate the true value of medical innovations—by as much as 30-80%.
To arrive at their estimates the authors use a new way of valuing risk. Our health is inherently risky, which is why we have health insurance for smoothing expenses out over time and between people. Innovation is also risky, which is why investors in startups often expect high returns and we often look to the government to fund basic research. But Lakdawalla, Reif, and Malani show that risks don’t always add up—sometimes they cancel out. Risks taken to innovate and create new health products and treatments can reduce health risks for people, because new innovations help keep us safer and healthier.
When risks taken in health innovation pay off, the reward they bring isn’t just the money value of new treatments: new medical treatments also help people by decreasing the health risk they face in their daily lives. For example, new treatments and other improvements have resulted in nearly a 40% reduction in deaths from heart disease. Valuing the lives that are saved by these treatments isn’t so difficult, but up to now it hasn’t been directly connected to the spending on medical innovation.
When we think of innovation in our economy, the health sector is not typically the first thing that comes to mind. Yet, the federal government spends more than half its non-defence R&D budget on the funding of the National Institutes of Health and related organizations. These public programs along with private and academic research improve the lives of Americans and people around the world immensely, often in straightforward ways. Work that reminds us of that importance, and that improves our ability to value it, is immensely useful.
(photo courtesy of U.S. Army Materiel Command)