Baumol’s Cost Disease: January 14, 2018 Snippets
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This week’s themes: unpacking an economic paradox, NiYO’s Series A, and Autonomic’s smart city partnership with Ford
In last week’s Snippets, we introduced a question we’re going to discuss for the next little while: why do some things get better and more affordable every year, whereas others seem to get steadily more expensive? Computers have gotten (quite literally) orders of magnitude cheaper and better within a generation, but we pay a whole lot more for a college diploma than we used to. How come?
At first it seems like a non-question; of course there are going to be some industries that experience productivity growth and produce better and cheaper output, more so than others. But that doesn’t explain why the ones that don’t get more expensive in real terms. Today, we’re going to talk about a critical idea called Baumol’s Cost Disease that puts forth an explanation why this is so.
The Cost Disease: why computers get cheaper and health care doesn’t | William Baumol
An Incurable Disease | The Economist
Baumol’s Cost Disease, Explained | Timothy Lee, Vox
The idea is the following: every year, due to advances in technology, better work practices and management, globalization, and competitive forces in the market, the economy becomes more productive than it was the year before, on average. But those productivity gains do not show up evenly across the economy at the same rate. One industry, let’s say natural gas production, might experience a significant step forward in productivity due to some new drilling technology while another, like fruit growing, might not experience the same technological upheaval and remains more or less the same. In those increasingly productive industries, two things happen: firms get more bang for their buck and become more profitable, and their employees become more valuable (since they can now produce 10 units of output per hour worked instead of 5, for instance). As a result, wages in that industry go up, as they should.
But other industries that are not experiencing those same productivity gains face a problem. They must compete in the same labor market as everybody else, and if wages are rising in other industries, they may be forced to raise wages of their own in order to retain their workforce. And in order to support those increased wages, especially in service economies where a large percentage of cost is human labour, they may have no choice other than to raise prices for consumers. Customers now have to pay higher prices for a product that didn’t improve, but that they still want and in all likelihood will continue to pay for. These costs will rise faster than overall inflation (which blends together prices across the entire economy), so in real terms, consumers have to pay more than they used to for something that didn’t get any better.
Now here comes the interesting part. In manufacturing and technology-heavy industries, like consumer electronics (and especially software and internet businesses), we’ve come to expect a certain amount of improvement every year: a 4K TV that cost $5000 three years ago now costs less than a grand, and that’s normal. So what do we do with the savings? Rather than buying additional TVs, or upgrading to a brand new 8K screen (seriously, at this point can you honestly tell the difference?), we’re more likely to spend those savings on something else. We take more Ubers and order more food delivery and put a little aside into the kids’ college fund. So the more productive the 4K TV industry gets, the more we shift our spending away from TVs and towards industries that aren’t getting more productive, because delivering tacos to your door is pretty labor intensive and tech hasn’t really changed that. Moreover, the industries that are likely to experience productivity gains next year are the same ones that became more productive this year. So the more productive the 4K TV industry gets, the more our spending will shift away from the 4K TV industry, which happens to be the most likely to experience future productivity growth.
Take a minute to think about that. That’s a fascinating paradox: the more progress we make, the less of an impact it will have on overall economic growth. That sure sounds familiar to anyone who’s contemplated the weird duality of the American economy today: our economic machine is getting better at a rate never before seen in history, and yet our economy isn’t growing at a rate that reflects this progress. Baumol’s Cost Disease is a pretty plausible, and in some ways worrisome, explanation why.
But there’s a flip side to this that we absolutely need to consider. We as an industry (and us at Snippets) have done a lot of hand-wringing about the future of work, stable jobs, and broad employment in the coming age of better software, AI, and who knows what else. We can rewrite our earlier statement, not in terms of the consumer but instead in terms of jobs: The more productive our automated tech sector becomes, the more of our spending, our employment base, and our wage growth will shift into other areas, and the threat of technological job destruction recedes. So if Baumol’s cost disease is truly the explanatory mechanism for what’s going on, then that may be good news! It suggests a powerful mechanism by which wage-earning employees retain power, importance, and autonomy even as the machines take off. That’s a good thing. The scarier proposition isn’t that Baumol’s Cost Disease is real — it’s that something else might be driving these increase in costs that isn’t employee earning power. Next week, we’ll look at two “classic cost disease” industries — higher education and health care — where this may be the case.
Elsewhere in the world (and in the solar system):
Amazing bamboo structures from Assam, as a part of Indian Magh Bihu celebration | Raju Das, OpIndia
Online shopping in Africa doesn’t work because of this web form | David Okwii
Discovery and characterization of the first known interstellar object | Meech et al., Nature Letters
The continuing evolution of ride-sharing:
Cities have to get creative when Uber & Lyft won’t release trip data | Laura Bliss, The Atlantic
Interviews with interesting people:
Fred Turner on utopias, frontiers and brogrammers | Logic Magazine
Full transcript: former Twitter CEO Dick Costolo on talks comedy with Kara Swisher | Recode Decode
Creative investing, with CoVenture’s Ali Hamed | Investor’s Field Guide Podcast
Jeff Bussgang on early internet commerce | The Internet History Podcast with Brian McCullough
Don’t steal things, kids:
Other reading from around the Internet:
The wonders of the future | Morgan Housel, Collaborative Fund
New measurement confirms: the ozone is coming back | John Timmer, Ars Technica
The case for Ethereum maximalism | Eli Dourado
The encyclopedia of the missing | Jeremy Lybarger, Longreads
Beware the lessons of growing up Galapagos: outdated playbooks from the age of scarcity | Eugene Wei
Big news from Social Capital this week, as we welcome two new members to the family: Cryptomove and NiYO. We’re going to feature Cryptomove next week, so sit tight on that front; in the meantime, here’s why we think NiYO is a special company:
Social Capital; others invest in fin-tech startup NiYO | Anand J, VC Circle
You may have already heard about Ezetap, our first major investment into an Indian company in the Social Capital portfolio; NiYO is the second, and we’re very excited about it. What happens as a billion people rise into the middle class and become 21st century consumers? What kind of banking, payments, identity, accounting, savings, and other spending infrastructure will emerge out of this upswell? We certainly believe one thing: the ultimate solution will be uniquely Indian, home grown, and built by a team that understands the power of ubiquitous mobile Internet combined with rapidly expanding consumer expectations. Although major initiatives like the Aadhaar Universal ID platform are already making a huge impact, many Indian individuals are still underserved when it comes to their own money: managing their salaries, their daily expenses, and their benefits. As CEO Vinay Bagri explains, “We deeply believe that the rapidly growing number of salaried employees in India have not seen much innovation when it comes to their own payroll and benefits. They are mobile and app-savvy and very demanding.”
Social Capital is very excited to partner with NiYO to help build out a 21st century payroll and benefits solution for India that captures all of the complexity, nuances and character of Indian citizens today. Our own Arjun Sethi had this to say: “NiYO is digitizing the entire employee payroll and benefits value chain, making the process easier and more transparent for employers and employees alike. This is an area that hasn’t seen much innovation in the Indian technology ecosystem, despite the massive addressable market. We believe that India is on the brink of unprecedented consumer consumption, and that movement begins with infrastructure that manages people’s earnings in a reliable and modern way.”
CES was this week, and one of the brightest spots (while the lights were on, anyway) was Ford’s keynote presentation on the future of cities and transportation, which highlighted the automaker’s blossoming partnership with Autonomic.
Ford and Autonomic are building a smart city cloud platform | Darrell Etherington, TechCrunch
Ford plans to develop a connected car open-source platform | Zac Estrada, The Verge
Cities and transportation are inextricably intertwined: the way we move from place to place within, and in and out of a city may be the single most important factor that goes into the character and makeup of the places where we live. We may talk about AI, cryptocurrency, 3D printing, or bioengineering as the biggest “sweeping wave” platform technology shifts of the next twenty years, but in all likelihood, the imminent technological revolution that will reshape our lives the most will probably be transportation. The stakes are high, and the amount of potential good we can accomplish is great: as Ford VP Rich Strader and Autonomic CEO Sunny Madra wrote in a recent post, “As we adapt our cities for the next 100 years, it’s important and thrilling to remind ourselves that this is a rare moment in technology where an innovation can be designed to build community.”
To that end, Ford and Autonomic have collaborated to build what they call the Transportation Mobility Cloud: a cloud platform, set of rules and standards, and collaborative environment for car makers, developers, city planners and staff, and especially citizens to collaborate together and build the urban fabric of the 21st century. Sunny describes it this way: “Think of it as similar to a box of Legos with configurable pieces that we can quickly rebuild to create different assets, products and services, much more quickly. Users get access to a new mobility experience, app developers can easily leverage connected vehicle capabilities such as GPS and sensors, partners can access users and the platform’s capabilities, and connected vehicles can pull the service together. As every city has its own requirements, transportation systems, traditions and needs, this box of assets enables flexibility for each one.” It can help combat negative externalities like congestion and emissions too: “Think of something as simple as pollution. We want a city to define a geofence that would make so any hybrid vehicle operates in an electric mode there if the city needs to cut down on pollution. Cities can impact their constituents by creating rules around different types of scenarios.”
One day, we’ll look back at the cities of today and hardly recognize them. We don’t quite know yet how to get from here to there; but the best way to predict the future is to go build it. Ford and Autonomic are doing exactly that.
Have a great week,
Alex & the team from Social Capital
