Understanding Baumol’s Cost Disease And Its Impact On Healthcare

Varun Ganapathi, Ph.D. is co-founder & CTO at AKASA. Varun's two previous AI companies were acquired by Google and Udacity.

Female nurse working on computer in hospital


For anyone who isn’t an economist, it can be challenging to make sense of the dramatic increases in healthcare costs that have occurred since the mid-20th century and why the price of consumer goods has plummeted over the same period. The fact is, some industries don’t follow the expected trajectory of declining costs with greater efficiency, even as technology improves.

Economist William J. Baumol first described this phenomenon in his 1966 book, Performing Arts: The Economic Dilemma. It can help explain one reason why the U.S. healthcare system is so expensive and provide insight into how technology (like artificial intelligence) can reduce costs.





What Is Baumol’s Cost Disease?

Economics theory states that wages rise when there’s greater productivity. However, a rise in wages without an increase in productivity is referred to as “Baumol’s cost disease.”

Baumol was examining the economics of the performing arts in his original study when he arrived at the concept, using the illustration of a string quartet. The output of a quartet playing Beethoven has not increased since the 19th century, yet their salary has increased dramatically. The same could be said for barbers, personal fitness trainers, lawyers, teachers and other skilled workers. Wages increase in those jobs simply because wages are rising in other jobs that have achieved productivity growth. In order to attract the best musicians, wages in the music industry needed to increase as well—even if the musicians are playing the same melody.

The implication is that we should anticipate decreasing costs in areas like manufacturing or agriculture due to improving technology. But at the same time, the cost of labor-intensive services will rise.

Spiraling Costs In Healthcare

Healthcare provides yet another clear example of Baumol’s cost disease. This industry relies heavily on labor- and time-intensive interactions between healthcare providers and patients. However, the overall cost of these services is rising faster than wages are growing. Therefore, rising wages are far from the only factor contributing to the unsustainable growth in healthcare spending.

Data reveals how medical billing and reimbursement are significant drivers in the rise of healthcare costs:

• $0.25 out of every dollar: That’s how much hospitals spend on administrative tasks to collect revenue. Most of that pays for staff to perform time-consuming, repetitive tasks. It’s also several multiples higher than other industries’ payment processing fees.

• One to 16: That’s roughly the ratio in healthcare of doctors to non-doctor workers. It’s shockingly disproportionate. Of those 16 workers for every doctor, only six are clinical roles caring for patients (like nurses). The remaining 10 are administrative and management (like receptionists).

While alarming, these numbers make it clear there’s a tremendous opportunity to reduce spiraling healthcare costs, despite the extent to which Baumol’s cost disease is infecting the U.S. healthcare system today. Modernizing the broken back office of healthcare to reduce administrative costs often passed onto the patient is a logical place to start.

New AI Technology Puts Efficiency Within Reach

There’s a lack of purpose-built tools specifically for the financial function of healthcare operations (including revenue cycle management, or RCM). Financial leaders have had to cobble together a patchwork of solutions that often don’t integrate with one another and only automate a portion of processes.

But when you combine artificial intelligence with human judgment and revenue cycle expertise (with an expert-in-the-loop), healthcare leaders can achieve robust and resilient automation.

With AI, it’s possible to harness deep learning to automate bill processing and payment within the healthcare revenue cycle. Hospitals and healthcare systems need to focus on making the process more efficient. This will allow them to shift investment into patient care, elevate staff to tackle more rewarding and patient-facing work and reduce spending. Productivity will increase, the value of administrative staff efforts will increase and the impact of Baumol’s cost disease on their organization will decrease.

They will be better able to focus on the “care” part of healthcare.

Fewer Mistakes Equals Greater Efficiency

Automation can also help hospitals and health systems prevent errors and even curb the unpopular practice of surprise medical billing. About 75% of medical bills have errors, according to Medical Billing Advocates of America. Even further, 57% of Americans have been surprised by a medical bill, according to a study by NORC at the University of Chicago.

With automation, healthcare organizations can reduce coding errors and delays. Removing the dependency on human-entered information has the added benefit of freeing up staff time, allowing them to focus on more challenging and rewarding work.

Much of healthcare operations’ complexity lies in the coding system: This could include as much as 72,000 different lines of code assigned to specific health conditions and diagnoses and used by insurers and payers for billing.

Hundreds of these lines are added, altered or deleted each year. AI capabilities can create automatically coded charts by connecting clinicians’ notes from patient charts with multiple code subsets in the system. New technology can drastically improve the efficiency and accuracy of this automatic coding from clinical notes.

How To Address Baumol’s Cost Disease In Healthcare

What can healthcare organizations do to balance the impact of Baumol’s cost disease? They can start by prioritizing the main issue healthcare organizations face right now, staffing:

1. Look for ways to better compete with other industries for the same talent. For example, many people are looking for flexible opportunities to work from home beyond the pandemic. Restructuring your operations to offer benefits like this will attract a larger talent pool.

2. Offer clear growth opportunities for entry-level staff. For more senior staff, provide ways to expand their skills and assume more responsibility—without them feeling like you want them to do the work of five people because you’re short-staffed.

3. Leverage automation to elevate your staff. By automating mundane and time-consuming tasks, you can focus teams on the more complex issues or patient-facing roles. Your staff will feel more empowered, and you’ll drive more revenue.

While the impact of Baumol’s cost disease is inevitable in healthcare, technologies like automation offer exciting possibilities for mitigating rising costs—now and in the future.

Previous post
Back to list
Next post