GDP Shocker: a Drop of 2.9%!
The New Normal of Healthcare Spending
Why Healthcare Spending Went Down
Muddle Through Economy Redux
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A rather interesting shockwave came across the newsfeeds this week. I was actually doing a TV interview when the host announced that GDP was down 2.9% for the first quarter. There was not much else I could do but note that that was a really bad, ugly, terrible, not very good number. But I had no real basis, without any facts in front of me, by which to understand why the revision was so extreme. Sure, we were all expecting a pretty large revision, but what we got was the worst decline in five years and the largest downward revision since recordkeeping began. Later, a quick perusal of the data on the BLS website revealed the culprits: exports and healthcare spending.
Last year I was one of the very few who suggested that the implementation of Obamacare could cause a recession (see more below). Such a suggestion was universally dismissed by all right-thinking economists, and for very good reasons based in sound economic theory, I might add. But sometimes the real world neglects to adhere to our models and theories, and that was my concern.
While I doubt we’ll see a recession – classically understood as two quarters in a row of negative GDP – this rather large bump in the road offers a number of teaching opportunities. This week’s letter will look at the actual numbers; and then, rather than try to spin the numbers to fit some preconceived political agenda, we will examine what actually happened in the spending data and why. And while it may surprise some of you, I actually think a few good things did happen, things I find encouraging.
Baupost's investment process involves "never-ending" gleaning of facts to help support investment ideas Seth Klarman writes in his end-of-year letter to investors. In the letter, a copy of which ValueWalk has been able to review, the value investor describes the Baupost Group's process to identify ideas and answer the most critical questions about its potential Read More
Anytime I write about healthcare it’s controversial, and I expect this letter will be received that way as well. However, as I (and many others) have clearly established, the healthcare system in the United States is massively dysfunctional. We are simply spending too much money on healthcare and are on a path to spending an unsustainable amount of money by the end of the decade. Things are going to change no matter what. The Affordable Care Act (ACA or Obamacare) was one way to try to address the problem. The majority of the country now feels this might not have been the best way, but that really doesn’t make any difference. It is going to be the basic law for another three to four years. My job, at least in this letter, is not to discuss policy but rather the economic effects of the policies we have chosen to implement, and what those effects may mean for our investment portfolios.
First, let’s look just at the facts as given to us by the BLS. US Q1 GDP Q/Q was revised much lower, to -2.9% on an annualized basis, down from the -1.0% previously reported (which itself was revised lower from the +0.1% initially reported) and well below the expected decline of -1.8%. How did we go from barely positive to down 2.9%?
When the BLS gives us its first estimate of previous-quarter GDP, it is forced to use models based on previous trends until the actual data comes in. This is why we get two monthly revisions and in future years will get even further revisions. (Sidebar: don’t you wish the US Bureau of Labor Statistics could be as good as their Chinese counterparts? The Chinese never have to revise their numbers. Obviously they are very good at this type of thing.)
And we all know that assumptions will sometimes bite you in the derrière. Look at this chart of projected healthcare spending from the original release of first-quarter GDP data in April. Notice that the projected spending was almost double what it had been just the previous quarter and over four times the previous year’s average. I’m not quite certain how trend models got to that number, but then I’m not a mathematician. In any event, here’s the chart, courtesy of Zero Hedge:
Now fast-forward to last week’s revision and notice that the healthcare spending number has dropped from the previous quarter, not doubled. In fact, it dropped an enormous 6.4%. Rather than contributing 0.62% to GDP is it did in the fourth quarter of 2013, in Q1 2014 it subtracted 0.16% from GDP growth.
Just for the record, here are the actual numbers from the BLS data. Roughly 2/3 of the negative revision in Q1 GDP was from healthcare spending, and the rest was from falling exports and rising imports (from an accounting standpoint, imports are a negative in figuring GDP).
I want us to look quickly at two charts to get some historical perspective on growth in the US. The first is GDP quarter by quarter for the last seven years. Notice that only two quarters ago we had a 4.1% positive quarter. During the 19 quarters since the current expansion began in June 2009, the economy has grown at an annual rate of 2.1%, compared to the 4.1% average in every other expansion since 1960.
In fact, rather than the comfortable +3% from 1950 through 2000, growth fell to +1.9% for the entire decade of the aughts and has not risen appreciably above that in the last four years. Here is a chart showing the rolling four-quarter average for GDP growth since 1980. With last quarter’s negative revision included, we’ve only grown 1.6% for the last 12 months. Dude, who stole my productivity?
The New Normal of Healthcare Spending
On October 6, 2013, I penned a rather lengthy discussion of the economic impact of the Affordable Care Act. I still think it was one of the better pieces I have written. You can read it here. I offered an analysis of what healthcare will look like within a few years. Essentially, we are moving to a three-tiered system. Somewhere between 3 to 5% of people will have what is coming to be known as concierge care, another 20% or so will have what we think of as traditional insurance, and the remaining 75% will get by with some form of government-mandated and -controlled healthcare (with high deductibles and increasing costs).
I titled the letter I wrote back in October “The Road to a New Medical Order.” Business Insider, which posts my letter each week (a surprising number of people think I actually write for them, which is fine by me, I guess) generally tries to come up with impactful and somewhat controversial headlines to attract readers. Their headline over my piece was “Obama Care Will Change Everything – And I Think It Might Cause a Recession.” And yes, buried deep in the article I did write:
When I am asked what keeps me up at night about our economy, my ready answer for the past few months has been the unknown transition costs associated with the ACA. I hope Jack Rivkin is right and that the transition to Obamacare proves to be just another Y2K. I truly believe that healthcare will be significantly better in 10 years, largely due to advances in technology, but also as we streamline our healthcare delivery. So I’m a long-term optimist, though I have to confess that, in the short term, which would be through the last half of 2014, I am quite concerned that dislocating 1 to 2% of the economy could be enough to push us into recession. I have nothing factual to base that on – no inverted yield curve, no evident bubble getting ready to burst – so I will stop far short of a prediction. Let’s just say that these issues need to be right up front on our radar screens. And it wouldn’t hurt to keep our fingers crossed.
Let’s run through a quick summary of my analysis then – which is the same as how I see things today. We are going to reduce the amount of money we spend on healthcare by around 1% of GDP a year for the next four years, or about 5% per year in actual reductions. While right-thinking economists will point out that that money will be spent elsewhere, and they are correct, my concern was – and it is evidently turning out to be pretty correct – that the transition will be messy. I simply do not believe that you can change the “plumbing” of how healthcare dollars are spent, totally change the incentive structure, and demand more service for 20% fewer dollars while reducing the number of workers at hospitals, without serious short-term dislocations. Like we saw last quarter.
Will all this wash out over the next few years? Absolutely. We are not on some permanent healthcare spending death march where quarter by quarter healthcare spending will keep dropping. It is just, to borrow a phrase from my friend Mohamed El-Erian, that we are entering into a New Normal of Healthcare Spending. And eventually that money that we are not spending on healthcare will get spent on something else, and those people that are not employed in the healthcare industry will find other jobs or end up taking less pay for doing the same job. But it is the turmoil created in the midst of that process that is going to create some ups and downs in the economy (more on that later).
I have regular conversations with numerous friends about what’s happening in the healthcare world, as I think that is where the real action is. For an economist, this is a wonderful experiment in incentive structures. And if you are an economist worth your salt, you know that economics is all about incentives. Individuals have an incentive to maximize their healthcare services and reduce their actual out-of-pocket expenses. Healthcare businesses have an incentive to make sure that expenses don’t exceed revenues. And the ACA is nothing if it is not an enormous incentive-changing machine.
Jack Rivkin sent me a note yesterday detailing a conversation he had recently with a healthcare provider. (I’ll remove names, just in case.)
Had a great 3 hour dinner discussion in Chicago three weeks ago with the head of the … Hospital. He realizes he’s at the bottom of the food chain but is very excited about what is happening. First dinner with him was three years ago when he was just beginning. He’s substantially changing the mix of his work force. That includes doctors who are now employees, not independent business folks. He has made the switch to outcomes-oriented medicine and is looking to become his own insurance company where he believes the big ripoff has been taking place. You should hear what he has to say about Blue Cross/Blue Shield and the people running it. He is tired of getting paid for procedures as opposed to outcomes, e.g., [he’s] down from using 7 different types of hip replacements to 3, based on those with the best long-term success. The doctors were told you either switch to what we have chosen or find another hospital. Actually “fired” some do ctors when the data showed what a high rate of repetition [their] patients had.
That complaint about insurance companies is showing up a lot. Here’s a section from agreat little article by Jake Novak at CNBC called “An Obamacare bailout? Insurers already got one!”
Whether the ACA has actually helped more citizens than it’s hurt has turned into a partisan war of statistics. That war will be waged for years to come. While I believe the new law will ultimately hurt more people than it helps, I realize those on the other side of the political spectrum will never agree with that assessment.
So let’s not have that fruitless argument.