#baumol

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:

It takes me 10-seconds to order a car to take me wherever I want to go.

It takes me the same amount of time as Jimi Hendrix to play "Hey Joe" (3 minutes, 30 seconds).

The rising cost of healthcare is a global phenomenon. Why? Because the relative productivity of labour intensive industries inevitably – and inexorably – declines. Computers get cheaper; healthcare doesn’t. It’s a simple idea, now proven by historic data and in need of appreciation. The cost disease allows – encourages, even – affordable increases in spending on health. Though incisive, Baumol’s…

I really hope Thomson Reuters (HT Michael Thomas) is correct in their prediction that Baumol and Kirzner will win the Nobel Prize. 

I have Baumol's Economic Dynamics (textbook) and Kirzner's Competition & Entrepreneurship and Market Theory & The Price System.

So if they win . . . that's two more books by Nobel Laureates I have.

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Matt Yglesias writes:

The so-called “Baumol Effect” is something that’s pretty widely known even as its implications are rarely confronted squarely. For example, suppose you’re thinking about spending on teacher compensation. The following options are available:

Class size can steadily increase over time.

Teacher pay relative to average pay can steadily decline over time.

Taxes can steadily rise over time

This is really hard to understand. The "Baumol Effect" — also known, more colorfully, as "Baumol's cost disease" — captures a supposedly anomalous economic phenomenon: wages can increase for a particular line of work even when labor productivity hasn't, if the pool of employees capable of performing that work is also capable of performing jobs where labor productivity has increased, and wages have gone up. I guess Yglesias thinks this is happening with teachers. They are not becoming more productive; but because they could also be, say, accountants, their employers have to pay them something like what an accountant would expect or perhaps somewhat less. And this is supposedly unfortunate — a "cost disease" — since it means we have to pay more and more for something that is not worth any more to us year after year.

This analysis of teacher pay is problematic for at least three reasons. First, most teachers are represented by unions. They have the power to earn good wages through collective bargaining. We should look for Baumol's cost disease in non-unionized schools, then — where, typically, teachers are paid significantly less than in public schools. Even here, though, the union power of public-school teachers probably has an effect on salaries; and it's not clear to what extent it is cost disease and to what extent it's the red menace.

Second, it's not clear mere productivity is the issue here. Teacher productivity can, in theory, increase even if class sizes don't. For example, a teacher might provide more and more aggregate "education" to the same number of students each year by introducing them to more and more educational Web sites or by adding more and more questions to her multiple choice exams. In that case, we'd still face the same three policy choices Yglesias mentioned: increase her class size steadily, cut her salary steadily, or raise taxes steadily to pay her what she deserves. Baumol's cost disease is just not relevant here. Or, if it were relevant, it would be as part of an argument against raising taxes to pay teachers more, because their labor is no more productive than that  of teachers 30 years ago. (Also: make it illegal for them to strike. And they should have to say the Pledge of Allegiance every morning.)

Finally it's far from clear that the concept of productivity is relevant to what teachers do at all. A moment ago I mentioned the "aggregate 'education'" a teacher provides, but in truth I  have no idea what that is. Is education like a kind of particle, that can be transmitted from brain to brain? That doesn't seem right to me. Is it whatever net effect on overall labor productivity each teacher is responsible for? My sense is that at this point we've gone pretty far from what teachers conceive of themselves as doing: which is, I take it, to instill a broad but systematic conception of one or more academic disciplines, a certain amount of factual knowledge, a sense of the interest and the importance of this knowledge, and — hopefully — an ethic of civil responsibility. Also gym. Do we really want to think of these things in the same way we think of, say, annual soy bean yields?

(A more productive teacher.)