Baumol Cost Disease? I’m Not Convinced…

Yes, another old link that someone pointed me at weeks ago and I’ve lost the back-pointer to whom. If it was you, pipe up.

The article is about Baumol dying. He postulated an economic theory that is, basically, as costs of other stuff goes down, and labor intensive services don’t, we’ll have to pay MORE for those services and this limits economic growth as we pay up for non-growth services.

William Baumol, whose famous economic theory explains the modern world, has died
Updated by Timothy B. May 4, 2017, 5:00pm EDT

William Baumol — an economist who just died at the age of 95 — had a famous idea, commonly known as Baumol’s cost disease, that explains a lot about our modern world.

It explains why barbers make more in San Francisco than in Cleveland and why services such as health care and education keep getting more expensive. And it provides a possible explanation for why rich countries like America are devoting more and more of their workforces to low-productivity services, dragging down the economy-wide rate of productivity growth.

In the 1960s, Baumol was trying to understand the economics of the arts, and he noticed something surprising: Musicians weren’t getting any more productive — playing a piece written for a string quartet took four musicians the same amount of time in 1965 as it did in 1865 — yet musicians in 1965 made a lot more money than musicians in 1865.

The explanation wasn’t too hard to figure out. Rising worker productivity in other sectors of the economy, like manufacturing, was pushing up wages. An arts institution that insisted on paying musicians 1860s wages in a 1960s economy would find their musicians were constantly quitting to take other jobs. So arts institutions — at least those that could afford it — had to raise their wages in order to attract and retain the best musicians.

The consequence is that rising productivity in the manufacturing sector of the economy inevitably pushes up the cost of labor-intensive services like live musical performances. Rising productivity allows factories to cut prices and raise wages at the same time. But when wages rise, music venues have no alternative but to raise ticket prices to cover the higher costs.

This became known as Baumol’s cost disease, and Baumol realized that it had implications far beyond the arts. It implies that in a world of rapid technological progress, we should expect the cost of manufactured goods — cars, smartphones, T-shirts, bananas, and so forth — to fall, while the cost of labor-intensive services — schooling, health care, child care, haircuts, fitness coaching, legal services, and so forth — to rise. And this is exactly what the data shows:

Now IMHO there is some “there there”. Just not much. “Why” is in the graph in the article. (Sidebar: “Why? Don’t ask why. Down that path lies insanity and ruin. -E.M.Smith”… so now: Exploring why…)

Prices of goods vs services over time

Prices of goods vs services over time

Now they concentrate in the article on the top two lines. Education and health care. I can’t think of any other two areas more dominated by Government Mandates, Intrusion, and Darling Of The Left promotion than them. Government pretty much owns Education from the Federal Department of Education down to local School Boards. It’s nearly all government all the way. Only a few (very few, nearly token) private schools for the Very Rich survive. Similarly, now that the USA has effectively nationalized Health Care with the unaffordable Health Care Act, I can see no reason at all not to call it what it is: A “3rd Way Socialist enterprise”.

Now look at the center lines. Food at home and food away from home. Basically flat lines. I know something about food away from home. I grew up in a Family Restaurant. It is 100% a labor and service industry. You try to take in the most basic materials possible in the stock room, add the most value added labor possible in the middle, and serve it with a smile in the front. Not a lot of capital stock involved. Stove, fryers, fridge and freezers, dishwasher (that was me… not a machine then), hot table, and dishes. Oh, and a coffee maker too. Yeah, that simple.

(I’ve spent years cleaning every part of it, and helped build it too… you could consider the tables, chairs, booths, and counter / stools part of the capital, but it took all of about 3 weeks to build and install them. I also put in the plumbing to the coffee island… yeah, doing plumbing at 8 years old… but Dad didn’t fit in the crawl space…)

So just WHY is such a labor intensive thing flat lined if labor is the issue, hmmm?

I’d also point out a hair cut costs me about $15 (last time I paid for one… the spouse does it at home now with our own clippers… but 2 years ago I bought one). Deflated by my own personal deflation metric, that’s about 75 ¢ in 1960 dollars and IIRC that’s about what I paid for one then. I’m just not seeing the rapid and extreme real cost rise. I suspect his thesis rests on poor inflation adjustment.

The article goes on to assert others are involved, too, but without evidence:

While some argue that prices keep rising because the government subsidizes health care through programs like Medicare and college educations through student loans and grants, you see the same basic pattern with services like summer camps, veterinary services, and Broadway shows that aren’t hamstrung by government regulations and subsidies.

Summer camps? Vet Services? Broadway Shows? Are you effing kidding me? I’ve NEVER EVER been to a Broadway Show. The Vet Services rise with medical as they draw from the same talent pool and frankly, only rich folks can pay to have Fluffy get a Cat Scan. Folks out in poor country take the rifle and put Fluffy out of his misery. ( I know. I’ve “participated” in it…) Then there is “summer camp”. I went to Church Camp, exactly once. My kids went to church camp too, and one went to Girl Scout Horse Camp once. These were not high cost operations. Whatever “summer camp” they costed out is not what “folks like me” use. An old pickup and a week in the wilderness with Dad was what I called “summer camp” most years.

So gee, their “proof” rests on “what rich folks buy”. What a surprise…

Then they show 35 years of China stealing manufacturing and driving prices down on the other side? WT?

No, I’m not at all convinced that this is anything other than a Plausible Story (“There is ALWAYS a story. -E.M.Smith) masquerading as Economic Theory.

IMHO, an equally plausible economic theory would be based on Survivor Bias. We’ve automated those services where costs got high AND we could apply automation. That only leaves those services where automation was not possible (yet). Grape Pickers have been largely replaced by machines. That ought to drive the cost of grape picking services down fairly nicely. But that isn’t in the graph, is it?

So we’ve made all sorts of “services” cost less, often to the point of obliterating them. How about Cobblers. When was the last time you had your shoes rebuilt? For me, it was about the 1970s. For the spouse (who takes custom shoes) about 1990. It is just too cheap to buy new shoes. So Cobbler leaves the metric of “service” costs. Only those services where their is no alternative, and especially those with a Government Mandate, enter the Baumol calculations…

Then there is the question of just what “price deflator” is applied. This is a huge issue in historical economics. Not much can be done to “correct” out changes from inflation and product changes. Just how do you compare a Big Band of the 30s with a Disco DJ of the 70s and a Rave Concert of the 00s? Is U2 comparable to Glenn Miller? Really? Including CD and DVD sales? Oh, wait…

So IMHO it is an interesting THEORY that is worth the ponder. Might even have some truth in it to be discovered. But believe that it “explains the modern economy”? No way. Far too many moving parts have moved and changed for it to do that.

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About E.M.Smith

A technical managerial sort interested in things from Stonehenge to computer science. My present "hot buttons' are the mythology of Climate Change and ancient metrology; but things change...
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9 Responses to Baumol Cost Disease? I’m Not Convinced…

  1. EMS,
    I’m not convinced either.
    Seems that the cost of service jobs must go up for those working in it survive. There is not a lot of fat in most of them.
    The other factor on the service surviving is whether people really need it. One has to eat and not much option if you get sick. The cost of college is forecast to collapse. I saw a Princeton study that said the majority of colleges would be bankrupt in 15 years. It is easy to take most courses on-line now and the value of the piece of paper has declined and the job market is declining.

  2. pearce m. schaudies says:

    @Chief- i confess, i posted this to tips, mabe last month; the part about the string quartet having to have their wages go up was the main thing I thought might be interesting. Now that I’ve read your analysis I went back and reread parts of it. I agree with your current analysis it doesn’t fit very well. However in other branches of analysis that are not as rigorous as physics say a correlation of .35 is considered very very good, heh.

    Hi Chief. I saw this today and found it interesting. About ‘cost disease’.

    They say-
    And it provides a possible explanation for why rich countries like America are devoting more and more of their workforces to low-productivity services, dragging down the economy-wide rate of productivity growth.

    *we are devoting Workforce to low productivity services because that is all the elite have left for us to do. They exported all the high-paying technical jobs to India and China. we may have to take them back by Force of Arms haha.
    They say-
    manufactured goods — cars, smartphones, T-shirts, bananas, and so forth — to fall,

    *this article is way out of date. The banana Factory in Texas move to Guatemala in 1919.
    Pearce M. Schaudies.
    Minister of Future
    Falling Skys &
    Wolves at Door

  3. philjourdan says:

    It does not explain the new economy. It is an attempt to justify government intrusion. But the facts do not back it up. Broadway increases because of government subsidies for the arts! Where they got that government was not in there is beyond me.

    Technology makes labor more productive, and thus worth more. But in the end, it still comes down to a cost benefit analysis.

  4. Richard Ilfeld says:

    The market will provide as much of anything as people want to buy, absent government intrusion which defile what people “should” and “should not” have.
    The arts makers will not care whether they are supported by the Medici or the rabble (or the government)….they will produce as much “art” as the market will consume. And of the type the consumer wishes. Starving painters in garrets and Slavador Dali’s soaking patrons coexist; as do Ford Fiestas and Ferraris. The true service job has always been a luxury — slaves or servants only being affordable at the very narrow top of the pyramid…..
    If we measure outcomes we see diffferent picture.
    A sends B a message in 1800 — A servant runs there and back.
    Mail does it cheaper.
    Phone does it cheaper.
    Modern Audio Plus Video Plus document transmission does more cheaper.
    Technical workers may make a lot, but the net labor cost to get that one high quality message between A and B is pretty low.
    This argument only works if you maintain the 1800 standard of person – on person interaction, rather than generally mesauring labor cost for outcome.
    & we tend to be short sited. Even cleaning a bedpan is not a forever one-on-one human task, except perhaps to an economist wiuth his head up his numbers.

  5. pouncer says:

    “it is an interesting THEORY that is worth the ponder.”

    HYPOTHESIS, I think. Less than a theory until its predictive value has been repeatedly demonstrated.

    And I also think the predictive value has not been so demonstrated. Were wages rising for “labor intensive” professions relative to times past, then more would-be professionals would be entering the market. (Or else we can abandon “supply and demand” and maybe just after that, “conservation of energy” ) Are there in fact more — either absolutely or as a percentage of the workforce — violinists, cellists, etc performing live classical music in quartets than in times past? Are there more tailors and plumbers and wood carvers and skilled laborers, generally?

    Not evident to me, at least.

  6. Terry Jay says:

    At some point there comes an irreducible minimum in many activities. A plumber can make a joint and do it without too much outside interference from government, and on-site work is not a good candidate for automation. But material substitution and tool improvement can also combine to increase productivity significantly. Threaded connections gave way to solder, and then to glued plastic, and then to PEX and various crimps. The sum result is improved product and a bit of a gain in productivity.
    In Medical, there have been a lot of improvements in testing, imaging, and procedures leading to better outcomes and lengthening life spans, but they come at a cost for acquisition and training. And yes, Government has also acted to increase costs significantly.

    I suspect the theory is valid, but it can be mis-applied.

  7. cdquarles says:

    I agree here. These people need to read more outside of the ‘mainstream’ of economics these days, namely, the Austrian School. People who keep trying to put numbers on things that can’t be measured are doomed to keep their delusions.

  8. E.M.Smith says:


    If you had links in that comment, wordpress stole them. (Anything inside angle brackets, it takes; then if it doesn’t like it tosses it. Any error in HTML, that is, anything wordpress sees as something it doesn’t understand, gets dropped silently.)

    Per high value jobs being shipped out:

    One need not go beyond basic economics to understand what happens. Labor intensive work goes to low wage low skill places first, then as that economy develops more skills, more jobs move. This continues until wages become “equal enough”. The USA took low wage labor from the UK, eventually moving into manufactures (and we fought a few wars over that… as the UK didn’t want us competing…) and eventually we did just about everything the UK did. Eventually surpassing it in things like space travel…

    Similarly, the US textile industry (having come here from expensive Europe) ran off to Asia once it was stable enough and shipping costs were low enough. At the time, mostly outside of China as they were full on Communist and you couldn’t make any money. China became a “Lange Type Socialism” (or “3rd Way aka Fascist Socialism) and textiles and sewing moved there. Now, with China having rising wage and skill levels, they are no longer the low cost producer and textiles are moving elsewhere, slowly at first… But now China and India are in the big manufactures businesses, even aerospace. Eventually they will catch up to the USA and once wages equal, the movement will stop.

    In fact, that is the big complaint about China. The artificially prevent that equalizing of wages (in real terms) via mercantilist policies (like low exchange rates and a dollar peg).

    So it isn’t really some grand conspiracy of Elites. Just normal economic forces. Much like the 1600s and 1700s Europe hit a bump when the Americas came on line as manufacturing and agricultural centers. (France is still trying to prevent the effects what with agricultural supports and all). The only real difference this time is that the advanced economies are trying to absorb a 2 Billion worker bolus of Chinese and Indian workers into the global workforce in all of about 20 years. That’s causing a lot of disruption and dislocation. ( I’m one of them, BTW. H1B visas killed my market so I’m going onto government payments with my signing up for S.Security. I’d rather work another 4 years, but “oh well”, let some H1B Indian guy pay taxes to support me instead… )

    So in the process of merging two vastly different wage rate areas into one functioning market area, the low wage rate area has wages rise, but the high wage rate area has jobs leave and that causes wages to fall. This continues until a new balance is reached; then normal 2% to 3% technological rate of advance starts raising both areas together again.

    Doesn’t matter if it was 1700s USA vs Europe textiles, or 1900s Japan vs USA & Europe (think cameras and radios and TVs and…) or 2000s China vs The Globe. All it takes is reasonably low tariff and similar trade barriers, modest shipping costs, and time. No grand plan or conspiracy required.

    So you can choose: Do you want shoes that cost $9 at Walmart, but a job that pays $9 too? Or do you want the same shoes that cost $50 at Bob’s Shoes and a job paying $50? Hmmm? France has chosen (in many cases) the high cost high wages route. The USA has chosen open markets and the lower real wages much lower cost route. Personally I don’t see much difference in the outcomes between the two.

  9. John P Miller says:

    William Baumol was a smart guy and I hate to argue with smart experts, but his theory does not make sense to me. Why? I agree that the more efficient producing things becomes, the more wealth people have to spend on services. Ah, but will that increased wealth from more efficient goods production accrue to capital or labor? And, if to capital, how widely will capital be owned? If the wealth accrues to capital and capital is concentrated in the hands of a few, then the cost of services should be comparatively low (think Asia…having drivers, cooks, nannies, etc. is exceedingly cheap, although few can afford it). It would be unlikely that increased wealth from more efficient goods production would accrue to labor as labor would be less demanded. But, what if the ownership of capital is widely dispersed? Then, the increased wealth would be spread among many and that may — or may not — provide enough imbalance to drive up the cost of services….

    ….because on the other side of the equation, the lower the percentage of people needed to produce things, the higher the percentage of people available to produce services. Thus, greater labor supply could lead to falling wages.

    Why should the cost of the people to produce services necessarily go up or down? I should think it would depend on the relative demand of various different services versus the relative supply of people capable of providing those services. And, that depends on the dynamic evolution of a socio-economic system with the distortions caused by government taxes and regulations (see EM Smith’s comments with which I concur) and the greater global environment in which those rules compete.

    Besides, economic “goods” (I mean any good or service someone will pay for) are rarely “pure services” or “pure goods.” For example, is transportation a good or a service? Is Baumol referring only to what might be considered personal or professional services or to a broader class of economic good that is not embodied in a physical object possessed by the owner? In either case, I’d love to hear his fully work-out argument because to my simple-minded economic thinking it makes no sense….

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