Sunday, June 04, 2017

Baumol's cost disease, productivity and the future of growth

William Baumol, one of the most famous economists you've never heard of, died recently. Baumol's fame came out of the observation that there are sectors of the economy in which productivity is rising swiftly, for example, manufacturing, and sectors where it is rising slowly or not at all, for example, string quartet performances.

The conclusion he drew from observing the behavior of wages in these sectors was that wages had to rise in the low-productivity growth sectors even as they do in high-productivity growth sectors. This is because people will over time simply leave the low-productivity growth sectors for the better wages of the other sectors. This theory became known as Baumol's cost disease.

In practice, society still values string quartet performances enough to pay their practitioners sufficiently to keep them playing. Baumol extended his theory to any economic sector in which personal service is essential to that sector. Examples include education, health care, child care, and legal services. As it turns out, nobody (yet) wants a robot lawyer or nanny.

Baumol's theory explains why costs are rising so fast for educational institutions, health care organizations, municipal governments, and performing arts groups. Their productivity increases are limited, but their relative costs for labor continue to rise because of their low-productivity growth compared to other parts of the economy. In more productive sectors, rising wages can be offset by rising productivity which allows costs per hour of labor to remain level or, in some cases, decline.

Baumol realized that even in the mid-1960s when he first formulated his ideas (see here and here), technology was already enabling performing artists to reach larger and larger audiences through television, radio and record players. That certainly increased their productivity by allowing many more people to enjoy a particular performance. But these technologies and their more recent variants do not increase the number of performances that an artist can do.

The broader implication of Baumol is that as societies expand their service sectors, it is inevitable that overall productivity growth will decline. And that can mean that overall economic growth will tend to decline as well. We have certainly seen progressively slower growth in mature world economies over time, particularly since the 2008-2009 recession.

All attempts to reduce overall costs across entire low-productivity sectors (as opposed to small facets of them) have essentially come to naught--unless the sector is simply disappearing. (For example, does anyone remember the typesetting business which was wiped out by the advent of software capable of handling that task on a graphic designer's desktop computer?)

Some attempts have been made to reduce the cost of education. Back in the mid-1990s the University of Michigan proclaimed that it would become a million-person institution with its distance learning program. It took 20 years before the university created what it calls Massive Open Online Courses. They are free (though you can pay a fee to get a nice certificate of completion). Paying customers, however, still want actual live teachers in front of them just as they still crave live performers of music and plays. And, they want the recognized credentials that are included with attendance at the live instruction venue.

Municipalities provide a wide range of services including public safety, fire protection, building code enforcement, and public health. All of these services require people whose productivity is difficult to enhance on par with what is happening in manufacturing, particular high-technology manufacturing.

We have now accepted that maintaining an opera company or a symphony orchestra will cost more than ticket receipts can raise. What Baumol suggests is that we will have to be prepared to pay ever higher prices for those services we want from low-productivity growth sectors such as health care and education so long as productivity continues to grow relatively faster in other sectors.

With exceptionally low overall productivity growth in the United States and the world, it is likely that Baumol's cost disease is catching up with us--even if it isn't the only cause of that low growth.

The fantasy that we can make all services continuously more efficient simply can't get past the human factor in many cases. And, where that factor is being eliminated or reduced--for example, automated bank tellers, self-serve restaurants, and online learning--we are finding increasing bifurcation of the marketplace. The human touch is being reserved more and more for those who can afford it: private banking, high-end sit down restaurants, and ever more expensive college educations (that come with actual personal connections to instructors and with bona fide credentials).

Is our future one in which only the rich are inoculated against Baumol's cost disease? The alternative is increased public subsidies for those services which we deem socially important in order to make them widely available.

Kurt Cobb is an author, speaker, and columnist focusing on energy and the environment. He has been a regular contributor to the Energy Voices section of The Christian Science Monitor and is author of the peak-oil-themed novel Prelude. In addition, he has written columns for the Paris-based science news site Scitizen, and his work has been featured on Energy Bulletin (now, The Oil Drum,, Econ Matters, Peak Oil Review, 321energy, Common Dreams, Le Monde Diplomatique and many other sites. He maintains a blog called Resource Insights and can be contacted at

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