In the real world, of course, there are many other factors that impact prices and wages and production volumes. But Baumol’s point is that because of the cost disease, it is inevitable that the cost of things such as health care or a college education will rise faster than everything else.
Not only should we not be surprised, argues Baumol, but we shouldn’t be that concerned. Given the large productivity gains in the goods producing sector, he says, we cannot only afford the higher prices for things such as health care and education, but still have plenty of money left over to pay for more food, more cars, bigger houses, more clothes and more home appliances. The idea that we can’t afford medical care or higher education, he argues, is just an “illusion” reflecting some fixed notion of what percent of our income should be devoted to such activities.
This doesn’t mean that there aren’t things we can and should do to bring down the price of medical care or of a college education.
The Institute of Medicine recently estimated that as much as one-third of our spending for medical care is wasted or harmful. Major efforts are underway in government and the private sector to restructure the health-care system so that providers and patients have the information and incentives to wring out that excess cost.
And as the melodrama at the University of Virginia revealed, the higher-education establishment is finally beginning to address the challenge of using technology and new teaching strategies to lower costs, increase the number of students and improve learning outcomes.
Such reforms can result in significant reductions in the cost of health care and education, but they are only one-time reductions in the level of spending. As Baumol reminds, the rate of growth from those new, lower levels will largely be determined by the rate of productivity growth in the rest of the economy.
One conclusion I draw from Baumol’s new book is that productivity growth — and with it economic growth — is likely to decline in the future as more workers are shifted to “stagnant” sectors of the U.S. economy. My George Mason colleague Tyler Cowen, along with Northwestern’s University’s Robert Gordon, have recently predicted such a slowdown. Baumol’s insights would tend to support that hypothesis.
From a political perspective, Baumol’s most important insight is that government spending must grow as a percentage of the economy. Most of the services that are provided by, or financed by government — health care, education, criminal justice, national security, diplomacy, industry regulation, scientific research — are those that suffer most acutely from Baumol’s disease. That’s not because of incompetence or self-interest on the part of public servants or even the socialist instincts of Democratic politicians — it’s in the nature of those activities.
To demand, as Republicans do, that government be held to some historical average as a percentage of the economy stubbornly ignores this reality. It would condemn the country, as John Kenneth Galbraith once put it, to a future of “private affluence and public squalor.”
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