Is there a cure for Baumol’s disease?
How can we afford to pay nurses more?
One of the features of modern history is that of rising standards of living. We are incomparably better off than our grandparents, who were in turn incomparably better off than their grandparents before them. The engine of this rising prosperity is economic growth, and underpinning that is the role of productivity. We are richer today — measured by our material standards of living — because we are more productive in material terms than our forebears. There is a link between productivity and pay. If we are more productive, then our employer receives more output from our efforts, and in turn is better able to compensate us for that greater output through higher pay.
It can be objected that there is a tension between the employer and the employee over pay. Given the financial relationship between the two, the employer has an incentive to pay as little as possible, whilst the employee has an incentive to be paid as much as possible. Normally, a bargain is struck between the two. Part of that bargain is determined by demand factors, such as the derived demand for the goods and services sold by the employer. Part of that bargain is is determined by supply factors, such as the degree of skill required to do that job and the relative availability of suitably skilled workers.
In an industrial setting the implementation of a new technology can be used to increase the output of staff, raising the prospect of increased revenue for the employer by selling more goods. That increased revenue can then be shared between the staff in terms of higher salaries and the employer in terms of greater profits. This is all well and good for and industrial setting where inputs and outputs can easily be measured. Problems start to arise in the case of services, where there may not be a clear link between inputs and outputs, especially if those services are public goods.
If we consider an economy that has a sector where productivity can increase rapidly and one where productivity gains are much slower to accrue, how would that end up in the longer term? The sector with higher productivity would be able to increase salaries higher than the sector with lesser productivity. We would expect to see a wage gap emerging between the employees in the two sectors. There would be an incentive for the staff in the lesser productive sector to relocate into the more productive sector. Employers in the less productive sector would be forced to raise the salaries in that sector in order to attract staff to that sector, but it would always remain lower paid and catching up with the more productive sector. This is especially the case if the lesser productive sector were to provide an essential public good, such as healthcare. This is known as Baumol’s Disease, after the economist who highlighted this feature— it is a process where salaries rise without an attendant increase in underlying productivity, thus lowering the total productivity of the economy as a whole.
Perhaps it might help to leave the abstractions behind and talk cases? Why is it that bankers are paid more than doctors? On one level, the answer is that bankers are more productive than doctors, meaning that the monetary value of the output of bankers is greater than the monetary output of doctors. This leads us in two directions. The first is that productivity has nothing to do with usefulness. The pandemic showed us that the social usefulness of nurses was very high, and the social usefulness of media influencers was very low. We could live without social media influencers, but not without nurses. And yet that difference is not reflected in the pay levels of the two occupations.
The second direction, which is closely allied to the first, is that productivity is often reflected in monetary values. And yet, money is not the only measure of value. This is particularly acute for those occupations that provide a public good. Public goods tend to be essential goods — healthcare, security, education, and so on — where they are the result of a collective effort and cannot be funded easily through a market mechanism. For example, a lesson learned from the pandemic was that the virus didn’t discriminate between the wealthy and the poor. It would strike both equally if the person was infected. This is a key reason why doctors are paid less than bankers. Their output — healthcare — is not easily rendered to monetary valuation and their efforts are usually part of a much larger team that achieves this result.
Does it means that nurses are always doomed to be lowly paid? That has certainly been the case in recent times. Productivity in the healthcare sector has been relatively static. As the population gradually ages, the demand upon the healthcare sector increases, with the greater volume of demand leading to greater pressure on budgets and the increase in the percentage of GDP spent on healthcare. This is as much as we could expect from the various models. In that sense, nurses are always doomed to be lowly paid.
And then came the pandemic. Part of the response to the pandemic was to put a bit of physical distance between patients and healthcare professionals. And yet, people didn’t stop being sick and in need of attention. This problem was solved through the use of proximity technology. Doctor appointments moved to Zoom or Teams. Online repeat prescription cycles from patient, to doctor’s surgery, to pharmacist, back to the patient again took away the need to visit a GP (the family doctor in the UK) to be provided with a prescription. Much of the routine healthcare was conducted remotely or through the delegation of tasks to more junior, but suitably qualified, staff, such as prescribing nurses.
This quiet change, born out of necessity, has started something of a revolution in healthcare provision. GP appointments, much to the dismay of many who are uncomfortable with change, are still quite difficult to arrange. The technology that was used during the pandemic has been enhanced and developed further, allowing healthcare staff to deal with greater volumes of patients. And guess what? This is making the healthcare sector as a whole far more productive.
That is starting to show in the figures. Since 2010, the spending on healthcare in the OECD countries has levelled out at about 9% of GDP. Part of this reduction is the result of various forms of austerity as a response to the global financial crisis. However, that was over a decade ago and still spending hasn’t resumed the pre-crisis growth trajectory. A study in the British NHS found that staff productivity between 2004 and 2016 rose by about 17% on a like for like basis, compared with productivity growth of 7% in the economy as a whole. There is more going on here than simple cost restraint.
During this period, greater reliance was placed upon the digital integration of healthcare systems. Within the various units of the NHS, much activity was moved away from paper systems and towards digital ones, affecting a range of processes from patient records to medicine inventories. We have started to see the rise of virtual wards in hospitals, where the patients remain in their homes and undergo a form of digital monitoring of their underlying health complaints. There is much scope for even greater productivity gains in the event of the various parts of the NHS integrating their various operational digital systems. For example, at present, very few GPs can integrate with their patient’s hospital records. If these were to be integrated, yet more productivity savings could be reaped, both by GPs and hospitals.
To be sure, this all comes at a cost. The cost is one of placing technology between the patient and the healthcare professional. Not all patients would be comfortable with this. We can speculate that some older patients would have problems adapting to digitally based systems. This is not necessarily resistance to change, but possibly more a need to have the new systems explained to them. Those NHS units that have prioritised this outreach have witnessed greater adoption of the new technology. From a staff perspective, it allows greater throughput within the healthcare systems.
This greater throughput is a cause for hope. It is a means to raise the productivity of healthcare staff, which creates the space to raise the salaries of those staff. Over the past decade, much of the productivity gains in healthcare have accrued back to the Treasury in the form of the opportunity cost of spending foregone. This may not be entirely viable in the near future. Staff shortages are increasing the salaries of healthcare staff through the use of agency staff and locums to fill the gaps in the scheduled staff rosters. There has to come a point where it becomes more cost effective to simply pay higher salaries. We haven’t reached that point just yet, but we are heading in that direction.
Greater productivity levels on the part of healthcare staff provides the cure for Baumol’s disease. That trend is already under way, even if the productivity gains have tended to accrue to the funding agencies. As we go forward from now, there is likely to be greater pressure to share those productivity gains with healthcare staff. In other words, we can afford to pay nurses more because they are working more productively than before.
© Stephen Aguilar-Millan 2023
