For liberals, the problem is not so much the higher costs as the inability of ordinary Americans to pay for them, because so much of the national income is now captured by the rich.
There is some truth to both arguments. But what if the more important explanation for our current predicament is that “goods” such as medical care and education, public safety or social work suffer from the fact that they are so labor intensive. It’s hard, if not impossible, for them to be produced more efficiently.
It was in the early 1960s that a young economist, William Baumol, working with his Princeton colleague William Bowen, hit upon what has become known as “Baumol’s disease.”
No matter how innovative people were in coming up with new technology and new ways of organizing their work, Baumol and Bowen reasoned, it would still take a pianist the same 23 minutes to play a Mozart sonata, a barber 20 minutes to cut the hair of the average customer and a first-grade teacher 12 minutes to read her class “Green Eggs and Ham.” Based on this observation, the duo predicted that the cost of education and health care would inevitably outstrip the price of almost everything else.
Now, 50 years later, Baumol has updated and expanded his observation with a new book, “The Cost Disease,” which sheds some useful light on our current economic debate.
The basic facts are well-known to most Americans: Over the past 30 years, overall prices have risen 110 percent, median income has risen 150 percent, medical costs have risen 250 percent and college tuitions have risen 440 percent.
To hear the politicians talk, you’d think the rise in tuitions and medical costs was an American phenomenon. But as Baumol points out, the growth rates are pretty consistent across all developed countries.
To grasp the impact of Baumol’s disease on the entire economy, imagine a simple economy that has only two broad sectors, one that produces goods and the other that produces services.
In the goods sector, new machinery and production techniques have made it possible to produce each bushel of wheat, car, computer and suit with many fewer hours of labor. Because of these huge gains in productivity, the inflation-adjusted price of goods falls, leading to increases in consumption and production. The number of farmers and blue-collar workers declines, even as their wages go up to reflect some of the productivity gains.
Meanwhile, it still takes as many teachers and nurses and police officers and accountants to provide the economy with services as it always did — that’s Baumol’s disease. Despite no gains in productivity, however, the pay of these service workers rises — after all, if it didn’t, over time all those service workers would be lured to the higher-paying goods sector. Moreover, demand for services rises because all those farmers and factory workers want to use their increased income to buy more services. In response to the increased demand and the higher pay, service companies raise their prices.