Altruism and Innovation in Health Care

The joint presence of technological change and consumption externalities is central to health care industries around the world, because medical innovation drives the expansion of the health care sector and altruism seems to motivate many public subsidies. Although traditional economic analysis has proposed well-known remedies to deal with consumption externalities and inefficient technological change in isolation, it lacks clear principles for addressing them jointly. We argue that standard remedies to each of the two problems are inadequate. Focusing on U.S. health care, we provide illustrative calculations of the dynamic inefficiency in the level of research and development (R&D) spending when innovators are unable to appropriate the altruistic surplus of nonconsumers. We calibrate that altruistic gains amount to about a quarter of consumer surplus in the baseline scenario and that R&D spending may be underprovided by as much as 60 percent.