Auto workers and police officers will see their wages rise at roughly the same rate in the long run, but if productivity on the assembly line advances while productivity in the patrol car does not, then the cost of police protection will increase – relative to manufacturing. Over several decades, the two sectors’ differing costs growth rates ad up, making personal services enormously more expensive than manufactured goods (Baumol 2012).
It is worthwhile to periodically revisit Baumol’s cost disease because an appreciation of its underlying logic is – despite its elegant simplicity - extremely powerful analytically. And this understanding, I believe, has the potential of staying recurring and ongoing internecine conflicts and finger-pointing in academia and finger-pointing and scapegoating in municipal administration (and many other sectors, as you will see).
My hometown of Hamden just increased its mill-rate, again! And I suspect many other municipalities are not far behind. This has ignited a massive epidemic in Hamden of finger-pointing, accusations, and blame-mongering. There are daily calls for one or all of the following: throw the bums out, condemnations of the Democrats (which control both the town-council and the mayor’s office in the town of Hamden), excoriating the out-of-control unions, special favorite being the teacher’s union, and calls to expunge corrupt politicians, administrators and union hacks that ruin it for the rest of us. At least half of the families in my neighborhood are quietly packing their bags and heading to Texas or Colorado.
In academia, my day job – there is a massive comparable hand-wringing afoot – but at the national level and here at ol’ U of NH. The faculty gripe about the incessant rise of our tuition– and blame the administration, pointing, inter alia, at the narrow, pedestrian focus on cost-margins as the key indicator for shutting programs, and to cost-augmenting rise in the number of vice-presidencies – which are in the faculty’s opinion, clearly unnecessary.
The administration in turn snaps right back: alleging that the faculty’s sole focus is their perks, and compensation and some ethereal, noble-minded concept of education-at-any-cost entirely untethered from practical economic reality, which in this day and age demands that all students be training in welding skills – or, even better, computerized, welding skills.
Nationally, the hand-wringing is about the affordability of tuition costs – which increase relentlessly year to year surpassing by far, the increases in the cost of living. The blame-game and cause-ascribing has led to various federal proposals including the ranking of schools and other attempts by politicians to impose “accountability” on academia.
Clearly, we cannot avoid the natural impulse to explain the cumulative cost increases: the continuous ramp-up in tuition, municipal services, health care costs and other service sectors. But there is no guilty party – only the compelling tenacity of Baumol’s cost disease.
In certain labor-intensive industries, the “personal services” industry there is less opportunity for productivity gains to reduce labor costs. Labor productivity refers to output produced by each worker or laborer. Accordingly, labor productivity in health care or education refers to the number of students or patients treated, or educated, in a given amount of time. The example in William Baumol and William Bowen’s original paper still applies with equal force – and therein a lesson: the number of musicians needed to perform Beethoven’s quartets is the same today as it was decades ago. And from my own experience: I am presently teaching a class of 18 students; the same amount I taught when I first started at UNH in 2001; put differently, my productivity has hardly budged. Yet, my salary is considerably higher than it was then – and same goes for the increases in tuition.
By contrast, the number of workers needed to produce a single car has fallen considerably. Car manufacturing has over the years benefited from abundant opportunities for labor-saving changes and improvements – which naturally results in the growth rate of costs being lower than the average growth rate and massively lower than the growth rate of costs in the personal-services sectors.
Note that an increase in labor productivity in education, or health care, or in Beethoven Symphonies is difficult to attain without an accompanying decline in quality. These sectors generally have a human element nor readily replaceable by machines in their production process, which makes it difficult to reduce their labor content.
Formally, my productivity plateau can be understood with the following example (based on an example from Baumol 2012). Suppose that wages in manufacturing increase by 2 percent. The cost of manufactured products need not rise because increased output per worker offsets the higher wages. But the “high-touch” nature of education, or health or any other personal services makes it very difficult to introduce labor-saving devices. A 2 percent wage increase for teachers, or college professors, or police officers is not offset by higher productivity and therefore must lead to equivalent increase in municipal and educational budgets. A 2 percent wage increase for nail salons must lead nail salons to raise their prices. Thus, as you can see from the attached graph, both hospital services and education significantly outpace inflation.
And here is the key feature joining the two sectors: wages for all workers tend to remain comparable across all industries over the long-run; they tend to go up and down together. Otherwise, if wages lag in a particular sector, it will lose laborers.
So – the moral of the story has two parts. The first one is that there is no single culprit behind the cost ramp-up in the services sector. Paradoxically, the affliction is a result of the relentless advances in sectors more amenable to productivity gains. And therein the second part: as long as productivity continues apace into the future, then we will be able to afford the more costly services.