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.