Insight of the day: Cost Disease

Thanks to the economist William Baumol, who died this month

The Economist has an insightful article on William Baumol this week.

Begin with this chart (from twitter). It demonstrates the striking difference between price rise in the non-traded service oriented sectors such as education and healthcare, compared to traded goods such as cars, clothing, and TV.

How do we explain this? William Baumol’s “cost disease” is an elegant explanation of this phenomenon. Here is from The Economist:

Workers in the arts compete in the same national labour market as those in factories. As rising productivity in manufacturing lifts the wages of factory workers, arts organisations must pay their staff more to keep them from quitting to make widgets. But rising wages in the arts are not matched, as in manufacturing, by corresponding productivity growth: performing a piece by Schubert took the same time and the same number of musicians in the 20th century as it did in the 19th. Thus rising costs and stagnant productivity create increasing pressure over time to raise ticket prices, or take in more donations, or produce less art. The analysis bore relevance outside the arts, he quickly realised. Technological progress in some industries implies that in services with relatively low rates of productivity growth — like health care, education and government — swelling costs will outstrip growth in productivity. Costlier public services are a necessary side-effect of long-run growth

An extrapolation of this insight is to envision the future of the world in light of automation.

Cost disease also provides a vision of a world of large-scale automation. As machines become better at doing things, the human role in generating faster productivity growth will converge towards zero. At that point, so long as society expects everyone to work, all spending in the economy will go towards services for which it is crucial that productivity not grow, in order to provide jobs for everyone. Society could seemingly be both characterised by technological abundance and paralysed by cost disease

I also note the tension between different ideals when you have huge price rise in areas such as education and healthcare, that helps workers, but not consumers.