The Baumol Effect

After looking at education and health care and doing a statistical analysis covering 139 industries, Helland and I conclude that a big factor in price increases over time in the rising price of skilled labor. Many industries use skilled labor, however, and even so prices decline so that cannot be a full explanation. Moreover, why is the price of skilled labor increasing? The Baumol effect answers both of these questions. In this post, I’ll explain the effect drawing from Why Are the Prices so D*mn High.

The Baumol effect is easy to explain but difficult to grasp. In 1826, when Beethoven’s String Quartet No. 14 was first played, it took four people 40 minutes to produce a performance. In 2010, it still took four people 40 minutes to produce a performance. Stated differently, in the nearly 200 years between 1826 and 2010, there was no growth in string quartet labor productivity. In 1826 it took 2.66 labor hours to produce one unit of output, and it took 2.66 labor hours to produce one unit of output in 2010.

Fortunately, most other sectors of the economy have experienced substantial growth in labor productivity since 1826. We can measure growth in labor productivity in the economy as a whole by looking at the growth in real wages. In 1826 the average hourly wage for a production worker was $1.14. In 2010 the average hourly wage for a production worker was $26.44, approximately 23 times higher in real (inflation-adjusted) terms. Growth in average labor productivity has a surprising implication: it makes the output of slow productivity-growth sectors (relatively) more expensive. In 1826, the average wage of $1.14 meant that the 2.66 hours needed to produce a performance of Beethoven’s String Quartet No. 14 had an opportunity cost of just $3.02. At a wage of $26.44, the 2.66 hours of labor in music production had an opportunity cost of $70.33. Thus, in 2010 it was 23 times (70.33/3.02) more expensive to produce a performance of Beethoven’s String Quartet No. 14 than in 1826. In other words, one had to give up more other goods and services to produce a music performance in 2010 than one did in 1826. Why? Simply because in 2010, society was better at producing other goods and services than in 1826.

The 23 times increase in the relative price of the string quartet is the driving force of Baumol’s cost disease. The focus on relative prices tells us that the cost disease is misnamed. The cost disease is not a disease but a blessing. To be sure, it would be better if productivity increased in all industries, but that is just to say that more is better. There is nothing negative about productivity growth, even if it is unbalanced.

In this post, I will discuss some implications of the fact that productivity is unbalanced. See the book for more discussion and speculation about why productivity growth is systematically unbalanced.

The Baumol effect reminds us that all prices are relative prices. An implication is that over time prices have very little connection to affordability. If the price of the same can of soup is higher at Wegmans than at Walmart we understand that soup is more affordable at Walmart. But if the price of the same can of soup is higher today than in the past it doesn’t imply that soup was more affordable in the past, even if we have done all the right corrections for inflation.

We can see this in the diagram at right. We have a two-good economy, Cars and Education. The production possibilities frontier shows all the combinations of Cars and Education that we can afford given our technology and resources at time 1 (PPF 1). Now suppose society chooses to consume the bundle of goods denoted by point (a). The relative price of Cars and Education is given by the slope of the PPF at that point. That price/slope tells us if we give up some education how many more cars can we get? In a market economy the price has to be given by the slope of the PPF because that is the only price at which people will willing consume the bundle of goods at point (a), i.e. it’s the equilibrium price.

Now at time 2, productivity has increased which means that with the same resources we can now have more of both goods.  Productivity of Car production has increased more than that of Education production, however, so the curve shifts out more towards Cars than towards Education. Suppose society continues to consume Cars and Education in the same proportions, i.e. at point (b). The price of education must increase–and all that means is that if we give up a unit of education at point b we will get more cars than before which is the same as saying that if we want more education at point b we must give up more cars than before, i.e. the price has increased.

Notice, however, that although the price of education has increased, education is not less affordable. Indeed, at point (b) we are consuming more of both goods–broadly speaking this is exactly what has happened–namely, the price of education has increased and we now consume more of it than ever before.

When we recognize that all prices are relative prices the following simple yet deep facts follow:

  • If productivity increases in some industries more than others then, ceteris paribus, some prices must increase.
  • Over time, all real prices cannot fall.

In Figure 22 the economy moves from point (a) to point (b). If we graph the same transition over time it will look something like Figure 23.

Looking at such graphs, our attention naturally is drawn to the rising cost of education. Why are costs rising so quickly? Entranced by such graphs, we may enter into a detailed analysis of the special factors of education—regulation, unionization, government purchases, insurance, international trade, and so forth—to try to explain the dramatic increase in costs. Yet the rising costs in the education sector are simply a reflection of increased productivity in the car sector. Thus, another deep lesson of the Baumol effect is that to understand why costs in the stagnant sector are rising, we must look away from the stagnating sector and toward the progressive sector.

Finally, there is one other addition to the Baumol effect which is not often recognized but worth drawing attention to. In Figure 22, I assumed that preferences were such that people wanted to consume the same ratio of goods over time so we moved from point (a) to point (b). But suppose that as we get wealthier we get tired of more cars and would like relatively more education so we move towards point (d). As we move from point (b) to point (d) we are taking resources away from car production, resources which were probably well-suited to making cars, and instead moving them towards education where they are probably less well suited. As a result as we move from point (b) to point (d) we are driving up the price of education as we try to turn auto workers into teachers. In this case, the Baumol effect gets magnified. We could alternatively move from point (b) to point (c) which would turn teachers into less productive auto workers thus driving down the price of education (i.e. increasing the price of cars). Thus, depending on preferences, the Baumol effect can be magnified or ameliorated.

As a society it appears that with greater wealth we have wanted to consume more of the goods like education and health care that have relatively slow productivity growth. Thus, preferences have magnified the Baumol effect.

Next week, I will wrap up the discussion by explaining some features of the data that the Baumol effect fits much better than do other theories.

Addendum: Other posts in this series.


One of the most reasonable theories. AND it's understandable at a basic level.
Thank you!

Yes! A terrific post. Thank you.

It seems that the "Baumol Effect" is only "valid" in some countries while others are immune.

Not really. Medical spending per country is pretty well explained by how well off the country is and doctors salaries relative to other high earners in each country are pretty constant. Doctors make a top 95-99th% salary in most countries which is consistent with the Baumol Effect

A part of that is government-mandated rent-seeking though. If people didn't require prescriptions to buy substances they know and want, demand for doctors' time would be lower. The medications themselves are often comparatively cheap.

Yes but people would probably find places to spend the money. Consider how people with buy organic food with very little evidence that it helps their health, it's the same with supplements etc..

Nah. Mexico, for instance had basically unregulated prescriptions until the 80s and still has pretty weak restraints on what prescriptions to buy.

The average Mexican doc makes around $45,000 per annum compared to average wages of $17740. This works out to be about the same proportion as us doc wages to average wage. I would submit that most of the difference has to do with the fact that Mexican docs start training straight out of high school and have many options to finish training in less time than Americans.

What we do not see is a major relative decline in physician wages just because Mexico has and used to have even more loose prescription regulation.

Thing is that medical spending in the US is even higher than in countries where average wages are higher than in the US.

The increase in wages also does not explain why education costs increased so much since 1960 as real salaries of teachers and professors increased by about 20-40% while education costs increased 200%.

A huge number of students get "cheaper" book learning instead of more costly "trade" learning. Schools even when I was young, the 60s, provided vocational training for half the students, even those who attended local colleges of ppractical arts.

I took shop as a boy, girls home ec, with some classes in common. These classes are costly, both in instructors, and in capital. In general, finding instructors is very hard because they did not attend college long enough to get a 4 year degree, much less teaching certification. But the capital costs were high, and would be much higher today: sewing machines, stoves, frigs, etc, and wood working shops,, metal working shops, electronics labs.

Cutting costs required forcing every kid to be headed to college, or they have no future post high school.

But even preppingg kids for college has suffered to cut costs. I mixed real chemicals, cut up real dead animals, etc, in very capital intensive labs on the college track. And my high school chemistry teacher knew many of us paid attention because were wanted to make things go bang. Of course, in a farming community and where construction was big, explosives work was a profession.

Basically, cutting costs ends up lowering quality and increases the costs of remedying the quality problem: not every high school student gets passed onto a college, and those that don't aren't useful to employers straight out off high school.

It seems that the "Baumol Effect" is only "valid" in some countries while others are immune.

Which are most immune?

The output of the string quartet is not Beethoven's 14th, it is utils for consumers. By this measure the productivity of a string quartet is now vastly higher than before as one performance can produce consumer utils for all eternity. Maybe it's long past time to retire Baumol.

My guess based on the post is that the introduction of reproducible recording technologies has made music performance far more productive and driven the cost down. Streaming has driven the cost down further. I used to pay $13 for a single 50-60-minute CD. Now I pay under $10 a month for unlimited streaming of nearly unlimited content (and much is already available without subscription for the cost of internet service). The difference, however, is in the experience of a live concert, which cannot yet quite be reproduced. Yes, I can watch a video, or perhaps even a VR experience. But in neither case will I experience the concert in the same way as experiencing it live. This can be a positive or a negative. It's safer for my ears to stay away from some live performances. On the other hand, I never fully experienced the richness of Beethoven's 9th until I experienced it live in Boston's Symphony Hall.

I disagree. Utils is not the output. If that is the case, then you are saying that cars isn't the output of car manufacturers, but the utility consumers get from them. Car manufacturers produce cars, not utility. Musicians produce music, not utility. Teachers produce education, not utility.

I find this explanation helpful. I saw the Baumol effect mentioned on this blog before without explanation, looked it up, and didn't get it.

Still haven't stated the reason clearly.

If all costs go down, gdp must go down.

You can't get to
gdp' = gdp×2
by going from
gdp = a + b + c
gdp' = .5a + .5b + .5c

Instead you need gdp' = .5a + 1.5b + 25c

How much did Ben Franklin spend on cell service? Wire line phone service? Telegraph?

Circa 1970, my telecomm costs were a party line phone, and the cost of a cb radio, maybe a few dimes for pay phones. TV/radio was all OTA. In real terms, my costs are 3-4 times as much today and I don't have a cell phone, nor cable, but dsl and subscriptions for internet servicess and TV/radio. And a much bigger share of income/consumption. Food is smaller share of income/consumption for products unavailable in Indiana except as luxury imports, eg, coffee other than canned Folgers ground coffee or luxury 8 O'clock coffee beans with in store grinder.

Well, I hate to show up a tenured professor of economics in his own field, but AlexT misunderstands Baumol's cost disease, conflating it with higher labor productivity in non-services vs services. They are not quite the same thing. B.C.D. is used to explain higher wages *within* services, not *between* services and non-services.

I think you are wrong in this. It is not meant to explain differences wages, but to explain differences in production costs. In fact, a key assumption in the model is that wages between sectors are equal. Here is Baumol's original paper: It models an economy in which there are 2 sectors: a sector with constant productivity of labor and a sector with growing productivity of labor. These two sectors compete for labor; thus if the wages in one go up, the wages in the others go up. In the constant-labor productivity sector (which is usually services), cost increase, while in the growing-labor productivity (which is usually described as capital-intensive) cost decrease. Due to differences in labor productivity, the number of workers increases in the constant-productivity of labor sector and decrease in the growing-productivity sector. But the assumption all the way through is that wages are the same between sectors (due to competitive labor markets).

@JFA - thanks, but you're quite wrong as expected when you argue with Ray Lopez. Given that capital-intensive industries are by definition always "growing labor productivity", it remains to show why--and this is Baumol's contribution--a brain surgeon or rocket scientist (highly skilled) and a cello player or secretary's wages start to converge. It's because *between* services (which by definition are not capital intensive), the money that's 'left over' from the growing labor productivity (i.e. capital intensive industries), 'spill over' into the more stagnant, constant productivity fields. That's one reason back in the day a legal secretary working with me made about $100k (probably $150k today).

@JFA - OK I read the original paper and it does seem to be a toy model that assumes wages are initially the same between sectors, as you say, but that productivity in the 'machine' sector rises exponentially, which logically implies eventually it will vanish to zero (water/diamond paradox).

Bonus trivia: Baumol got spectacularly wrong in his original paper: "These observations can be used at once to explain a number of observed phenomena. For example, there is evidence that an ever increasing portion of the nation's labor force has been going into retailing and that a rising portion of the cost of commodities is accounted for by out- lays on marketing. Now there have been several pronounced changes in the technology of marketing in recent decades: self service, the super- market, and prewrapping have all increased the productivity per man hour of the retailing personnel. But ultimately, the activity involved is in the nature of a service and it does not allow for constant and cumulative increases in productivity through capital accumulation, innovation, or economies of large-scale operation."

Also, though not in Baumol's original paper, I've seen people use Baumol's cost disease to explain close similarities in wages within services despite big differences in productivity in services, which was my original point.

This is all very interesting and, as you say, it will take time to digest.

I do have questions though. I recognize that your analogy may not be perfect, but is it not true that productivity of the string quartet has increased immensely because the performance can now be broadcast live on television and radio, and recorded for sales and infinite playback? To be sure, the in-house performance has not produced much more revenue unless the venues are larger. But we now have more ways to generate revenue. Additionally, concessions and souvenirs are another form of revenue.

If what I'm saying is correct, then it is important to account for productivity growth in the high skilled sector that might not be immediately apparent.

In that same vein, does it matter that a quartet performance is a public good while alternatives are private goods? Is the substitution analysis the same?

I think that you are confusing one common and impressive example with the general notion.

All that is needed for Alex's argument to hold is for the productivity of the string quartet to grow less rapidly than that of other workers.

In the case of the quartet specifically, except for a few quite famous musicians the gain in productivity from recording and videos may be (I'm guessing) small. There are lots of quartets making lots of recordings - a quick google shows ten versions of this quartet on YouTube alone. So maybe what technology does here is increase productivity in a situation in which the musicians do not capture much of the surplus.

And, come to think of it, that phenomenon - the inability of the worker in some areas to capture much of the surplus - may contribute to the Baumol problem as well.

Baumol’s theory and supporting data have been around for a long time. Why does it receive so little attention in the health policy field? You want to talk about costs - think of the vast amounts of human and financial capital that have gone towards trying to solve the cost problem in healthcare. Baumol tells us this is a losing battle and a battle that’s not even worth fighting. Yet even after several decades, academia and industry continue to charge forward with supposed “innovations” in healthcare delivery and incentivization, to largely no avail.

To the contrary there have been tons of cost saving innovation. The problem is that the public debate over health care revolves around cost to the end-user (price), not production costs.

"Health care" is also an amorphous aggregation of billions of different goods and services. If you look at any one of these, prices and costs have dropped precipitously, e.g. laser eye surgery. One problem is the constant conflation of expenditures with costs. Expenditures are price times quantity with a quality component. Expenditures can rise because of rising costs, rising prices, rising quality, or rising quantity. That is, there are both supply and demand elements involved. This tells us nothing about whether innovation has lowered costs.

Part of the problem is that most health care is highly subsidized by government and insurance pools. Consumers have almost no incentives to keep quantity demanded low. Cost innovations by providers flow into profits and wages because there is limited competition. Price obscurity is a problem.

The real problem is that "healthcare" is kindof like "housing".

In 1960 the average house was about 1,200 square feet. It had one bathroom. It did not have air conditioning. Its heating was most likely wood, coal, or heating oil that required significant effort to maintain. And it housed a lot more people.

Similarly 1960s healthcare is the stuff where they had just barely figured out that aspirin is useful in a heart attack. Women routinely endured anal trauma with births. Imaging was non-existent so cancer often killed you before your doctor even knew you had it. If you had circulation problems we mostly amputated. If you had immune disorders we had the choice of letting you suffer, or jacking you up on steroids and letting you die from infection. If a vital organ began failing, you died.

Today healthcare does so much more. In 1960 heart failure was basically untreatable. Today we can decrease your symptoms and use drugs to let you live longer. We can transplant a heart. We can piggyback transplant a heart so you can manage with pulmonary hypertension. We can give you an LVAD so that after your heart craps out we can keep you alive in decent condition until a heart is available. Tentative data suggest we may be able to keep you alive with decent function on a LVAD for decades.In 1960 if you were diabetic you had to run chemical reagent reactions on your urine in the hope of controlling your blood sugar. You suffered all manner of horrors even if you were perfectly compliant because these tests were utterly unreliable below 180 mg/dl. Today we can fit you with an indwelling pump that is about two steps away from being completely autonomous. In 1960 you had basically metformin (which is still first line) and then you went on the insulin train. Now you have a half-dozen options that allow you to treat through other comorbidities. In 1960 if you had a stroke, you either died or didn't die; your doctor often was unable to even tell for sure if you even had a stroke. Your only hope for prophylaxis was a very dangerous carotid surgery. These days? We can diagnose your stroke within minutes, have treatments that are pharmacological or interventional, and have many ways of preventing recurrence ranging for pacemakers to anti-platelet therapy.

In both cases we pay massively more, but we also get massively more. Are there some tweaks around the edges jacking up prices? Absolutely. Is bad government policy making prices higher? Sure. But in the main, "healthcare" is going to be more expensive because we prevent more mortality and morbidity every year.

And as always. Lest we forget, "healthcare" is about differential outcomes. The less healthy you are to start with, the harder it is to achieve outcomes like functional status or life expectancy. Pretty much all the determinants of health outside of healthcare have been trending down for decades with only a very few bright spots (e.g. net smoking exposure actually started downtrending in the US a decade or so ago, though marijuana might reverse the overall impact). Healthcare today is not yesterdays efforts to keep people with good health habits from catastrophe, it is allowing people to consume health reducing things (e.g. promiscuity, gluttony, sedentary lives, drugs, alcohol, divorce, irreligion) without paying the full consequences of their consumption.

Well, since you mentioned the changing price of soup over time....

More to the main point, what you've described may help explain something we've observed in data for the changing costs of college over time, where before 1980, we see it responding to recessionary pressures, but not after - you could argue that we really were trying to turn auto workers into teachers, to borrow a phrase, which amplified the effect at these times.

Incentives have changed. College costs are largely financed with student loans that can be deferred as long as you are still in school. This provides an incentive to seek more school during recessions. If students were retraining into different fields to respond to structural unemployment, that would be great. But we indiscriminately allow students to augment their BA in Sociology with an MA in Medieval English Literature. They are just as useless to the economy before and after accruing massive amounts of debt.

Yes, but is it the same soup? Or the same college education?

Controlling for quality is difficult for technological problems, presumably easier for services. Yet the quality of today's classical music performance is almost certainly better than was available to Beethoven (although I'm not so sure about the soup or the education).

Speaking for Campbell's condensed tomato soup, every single aspect of it has changed over its 120+ year history. The tomatoes, the recipe, the can, the labeling, how it's made, where it's made, who makes it, everything. And yet, today's can of tomato soup would be almost immediately recognizable and familiar to any American consumer from almost anytime in the last 120 years - at least, since the iconic red-and-white labels were introduced very early in its history. As human endeavors go, that's some pretty outstanding quality control.

Is this just a different perspective on the jobs-skills mismatch? What I mean is that some people can't code (or can't code very well) no matter how much training/education they get in coding. Some people are born to engage in manual labor and some are born to play a musical instrument in the symphony. The mismatch in output (or change in relative prices) results when the demand for the symphony increases or the demand for manual labor decreases; manual laborers do not the symphony make. The demand for health care has increased significantly, caused in large part by an aging population, but those born to be doctors has not increased to the same extent. The price of health care must increase because the number of born to be doctors has not kept pace and, consequently, the level of output per doctor (productivity) has decreased and thus the price must increase. Since the world is changing at an escalating rate the mismatch will escalate too. Of course, if the world is doomed (because of climate change, nuclear war, etc.) then we would face the same dilemma but in reverse: too many coders and not enough manual laborers.

I don't agree with the last sentence. everyone has the capacity to do manual labor, same as the capacity to code, however the productivity difference output between the top 20% and bottom 20% of manual laborers is going to be much smaller than that for coders.

Really bad coders will not only produce less, but produce negative productivity in that they will produce code that will force other coders to devote additional resources to fix their bad code.

Bad manual labors will produce less, but still produce something positive.

It was commonly understood years ago that for most large software efforts, the best thing to do for productivity was fire the worst 10 or 15% of the coders.

Three blind mice. The health professional of today asks about symptoms, orders tests, compares the test results to established diagnoses and on that basis orders treatment. There's nothing magical about it. Even brain and heart surgeons are basically technicians. The reason they're highly paid is that they're members of a very effective guild whose enrollment is limited. In fact, medical professionals tend to run in families just like cops, farmers and well drillers.

Not everyone has the capacity to do manual labor. Hundreds of lazy, ignorant, wanna-be construction workers are made redundant every day. But it's typical of the educated elite to denigrate those whose interests and abilities aren't indicated by a suit and tie. That's why greasy, unshaven neanderthals show up at the back door to repair Mr. College Professor's air conditioning. Because he doesn't understand how it works and couldn't fix it if he did.

you say
"The health professional of today asks about symptoms, orders tests, compares the test results to established diagnoses"
you sorta left out the physical exam & and all the cognitive stuff
medicine is not supposed to be magic
but its not just being a technician either
also thanks to yale
you gotta learn how to code drgs

In practice there are complications. Companies that implemented so-called "stack ranking" mostly ended up abandoning it, including Microsoft and Amazon.

I disagree with several premises in this post.
1- The labor productivity of a quartet playing "Beethoven’s String Quartet No. 14" has indeed gone up. While its true it still takes 4 people 40 minutes, they can record it and upload it to a Spotify, and deliver it to billions of people, possibly simultaneously. If they also happen to be named Billy Joel or Taylor Swift, they can earn some monopoly rents from their reputation. In 1826, those 4 people would have had to play 1 hundreds of millions of times to deliver their music to a billion people. Now, they can play once.
2- education: When I was in grad school I gained massive back and mid section muscle strength from my tomes, and svelte legs from biking around campus. Not even 10 years later I decided to supplement my degree with lots of accounting credits, enough to earn a CPA. I did almost all of it online at a mostly famous school from the privacy of my home while my kids were napping. While also still working. I actually had to show up in person for some higher level tests.

In other words, we need to be careful about how we define labor productivity before we blame cost rises on Baumol's disease. A lot of the "cost" of a Harvard education is the monopoly rent Harvard gets on its reputation, same as Taylor Swift or Billy Joel. Harvard has not seen the future where it can expand its capacity to educate and accept all applicants, but deliver education online. Or, maybe they have and have realized there is nothing to gain (True fact: A lot of Econ 101 classes use the same text from a famous Harvard economist). I am not really convinced that the content of the first 60 credits of a Bachelors degree differ greatly from school to school. But maybe I am biased since I started at a middle tier school, worked hard, and spend most my time telling those Harvard grads what they are doing wrong (also true fact: Many Harvard and Yale grads make horrible employees because they are entitled divas).

The trouble with education prices is that they are absurdly distorted by federal, state, and local subsidies. Unions push to stop "for profit" and charter schools. Many top-tier schools resist the online wave, probably because it dilutes their monopoly rents. So yeah, it could be Baumols disease, but probably not.

P.S. Re:healthcare I can now see a doctor over facetime and get bloodwork at the grocery store. A lot of health care pricing is monopoly rents too. Look up how many hospitals in Baltimore Johns Hopkins owns. See also unions and federal, state, and local subsidies.


Good comment. I would also like to add that there are well documented cost additive factors which are exogenous of productivity in higher education(e.g. sports stadiums, huge "book stores").

I agree with the premise of Baumol's disease, but I also agree that we should be careful in assigning varying degrees of productivity growth. The implication from Tabarrok's reading of Baumol is that productivity in education has grown at a proportionately slower rate than other sectors, making it relatively more expensive. To challenge that I would ask the following:

1. Are we able to educate more students than we were 50 years ago when university was cheaper?
2. Are students able to learn more material faster?
3. Are students better prepared for the workforce after graduation?
4. Are students able to learn more with less materials?

These are the questions which, if answered, would point to whether higher education has shown growth in productivity.

Keep in mind that a bunch of online course material came down due to an ADA lawsuit about access for the deaf/blind. Totally awesome.

It's the marginal cost of healthcare and schooling that has gone up and yes Government subsidies have made it worse. What I think he is saying is that we are buying more healthcare beyond the growth in productivity, meaning that we spend more.

It merges nicely with Robin Hanson's idea that we buy more healthcare in part to show how much we care, so we are now even buying healthcare beyond the point where it even improves health just because we want to spend more to show how much we care.

Let me add so that a live teacher helps even a tiny bit over an online lecture we are willing to pay for it.
Like Kruger's research showed no benefit of Ivy league schools over state schools but parents are willing to pay big bucks to get there child in and through, so they can brag.
In healthcare we pay a lot to get the MD we want and if a live MD is perceived as giving any benefit at all we will pay for it. They will screen 85 year olds for breast cancer etc.

Austro-Hungarian Emperor Franz Joseph I thought so much of his heir Prince Rudolph that he hired Viennese economist Carl Menger to be his personal tutor, providing an education that couldn't be gotten in any university. Today, there are any number of business titans that could afford to hire, for instance, Paul Krugman or Ben Bernanke to provide the same service for their children, an exclusive education from a recognized authority. But they don't. Why?

" In healthcare we pay a lot to get the MD we want "

Not true. A significant fraction of healthcare, including primary care, is delivered through Emergency Rooms or Urgu-Care type facilities. You dont get to pick your doctor at an ER.

In fact many people are going to the ER precisely because they have a hard time getting an appt with a primary care Dr. Last time I made a Dr appt for a check up, I could only get one 2 months away.

Another (potential) problem I see here is the calculation of the average wage of a production worker. Does this include foreign labor from imports?

If not, then the average wage is grossly inflated.

Another criticism is that the next most valuable use of a quartet member's time is NOT as a production worker. While in the microcosm of a two vocation world there will be direct substitution effects, that is not the case in the real world. If we had a two vocation world, most of the consumers of concerts would be production workers. Thus wages and productivity are interrelated in ways that I think the model ignores.

It all makes sense, but I don't feel satisfied. I still don't think it's an accident that the two sectors that have experienced runaway inflation are heavily influenced by regulation and rent-seeking. First, I would say that education and medicine aren't naturally like string quartets, there ARE great productivity enhancement possibilities, but that many are blocked by regulation and rent-seeking.

Imagine if musicians had the political power to ban the use of recording and amplification and then, ignoring that, we observed that, naturally -- due to Baumol and the demand from increasingly wealthy consumers -- the cost of string quartet performances had climbed dramatically.

Another problem with the Baumol story is that, in education, costs are increasing dramatically even when salaries of workers providing education are low and stagnant. At this point nearly three quarters of faculty are non-tenure track. These positions are generally neither secure nor well paid. This is possible because supply of PhDs wanting teaching positions far outstrips demand. How does the Baumol explanation dovetail with a great oversupply of high-skilled workers relative to demand?

I agree with most of what you say, until you describe nontenured faculty as not secure and not well paid. Lack of job security is the rule, not the exception in employment. Tenure is the market distortion. Also, they are indeed well paid. They are just not as well paid as the cartel wages of tenured professors. Adjunct wages are actually much closer to market wages. Many of them are unionized which tells us immediately that they are, in fact, paid MORE than their marginal revenue product.

The value of tenured professors is their reputation and research. They bring prestige to the university. It is a fundamental mistake to think they are paid for teaching. Teaching is and always has been a side gig. It is a grudging chore and a distraction from their real work. Adjuncts allow for specialization and trade.

Grrr--where's my edit function

Private sector employees typically are not “permanent”, they are at will. I remember in fact when the employee handbook at the Fortune 500 where I works changed the description of the standard situation from “permanent employee” to “regular employee” to make this point explicit and unambiguous.

Private sector employees typically are not “permanent”, they are at will.

Yes, but in the private sector, there is still a difference between a regular/permanent employee and a contract employee, with the contract employee's position tending to be less secure and shorter-term. Non-tenured faculty are typically contract employees. This differs not only from tenured/tenure-track faculty but also from other university staff who never gain tenure but nevertheless are 'regular' employees.

Slocum, I think you are more or less correct. The structure of these markets has resulted in a lack of productivity growth which has led to Baumol's cost disease. But I don't think it's all that easy to fix the situation in education or medicine. It's not just about poor government policy-making, in other words.

Okay but the educational sector is not a pure string quartet. E.g the professor’s time is a not a fixed input consumed 1:1. Lecture time could decrease per-pupil with better instruction methods. Staff can decline overtime through administrative efficiency. Building costs can decline by optimizing use of space, and the declining in person lecture hours. Etc.

"* If productivity increases in some industries more than others then, ceteris paribus, some prices must increase.
* Over time, all prices cannot fall."

This isn't true in any meaningful sense. Suppose an island has an economy of just apples and oranges. A new technology comes along which doubles apple production and trebles orange production. The money in circulation stays constant. The following are all true:
* The price of apples goes down.
* The price of oranges goes down.
* The relative price of apples to oranges increases (well demonstrated in your post).

Now, if we were to define prices as adjusted for inflation, then of course all prices cannot fall, but that's only because you built that into your definition of price. Once we correct for the "deflation" on the island, apples got more expensive! But this is a very unhelpful way of looking at what happened. Are apples really more expensive in "real terms"? No, I can pick twice as many in an hour's work.

Indexing prices to inflation is useful from a macroeconomic perspective. But for this kind of analysis of sectoral prices over time - or what we really care about, sectoral affordability - it's not useful.

He said, Over time, all *real* prices cannot fall. And that is a true, if kinda trivial, statement. In your example, since apple and orange real prices can only be expressed in terms of one another, they cannot both decrease (or increase, for that matter). Your example shows that nominal prices (absolute money prices) can fall over time. And that is true. But it isn't what the author wrote. ("Real" prices are prices of a good expressed in terms of the prices of other goods. They are just relative prices, over time.)

Prof Tabarrok actually edited the post (whether in response to my comment or not, I don't know) - when I wrote my comment, it read as I quoted.

Too bad you ignored the government subsidy for education and the increased allocation of resources to education (and health care etc). Not to mention the increased regulation and rules that prevent some of the increases in productivity that might occur absent such regulations.

Not to mention that areas where the government forces cross-subsidization which also works against price signals that would otherwise encourage greater efficiency and productivity.

But that's exactly the point: one might think that the reason behind the cost increases is something that has changed in the stagnant good. And then those people do studies showing price increases in education do not correlate with any of the increased regulation or subsidies, and so assert that these things do not cause education price inflation. The lesson of Baumol is to focus on relative productivity, not absolute productivity. Costs in education can be exploding not because something has changed in education, but because something has changed in other sectors (to improve their productivity) while education has stayed (inefficiently) the same. It doesn't mean that the lack of productivity growth in the stagnant sector is just, only that the rising cost in that sector need not be coming from growing absolute inefficiency in that sector, only relative inefficiency.

The ability to monetize the work of a string quartet has changed substantially, especially through technology. The "star" culture means that elites can generate incomes that would have been unthinkable once upon a time. In turn, the ability to expose more people can increase the demand for such concerts. The markets are dynamic and technology allows you to reach and possibly expand into new markets.

At the same time, government and charitable contributions have reshaped how musicians make money. It sustains markets that might have died, or that might have evolved into something else. Your local symphony might die out but a traveling symphony of "star" performers could be created.

My question is whether the subsidy stands in the way of technological changes.

Look at education. You have star professors earning incomes that are, excuse the pun, astronomical. You have many people enter the market hoping to achieve these high returns and you have society subsidizing the purchase of these lottery tickets.

You have tremendous subsidies and cross-subsidies in education. Who knows what form a more competitive system would have. Vocational education, on the job training, etc could all play a more prominent role. I would imagine many of the Woke classes on college campuses might disappear. Bottom line, you might see a much more efficient system evolve if you didn't see such large subsidies of the current system. Cost increases to maintain the current system might look like Baumol effects but allow greater innovation and remove the subsidies to the current system and the costs issues start to solve themselves.

Look at sports. Would you argue that players salaries are because of Baumol effects? You could argue that the basic skills needed to play baseball, basketball, or any sport have not had great technological breakthroughs. Clearly, the ability to monetize sports has increased dramatically but the basic skills are the same. Sports are to a large degree subsidized by the government either through the tax code or direct subsidy of stadiums. However, supply and demand determine the salaries. Over time the demand for star players, people of exceptional skills, has outstripped the supply. If you had the same level of demand for star violinists, would you be explaining it by Baumol effects?

Look at health care. Health care is far more complicated today. Perhaps the supply of workers who can deal with this increased complexity is limited. The rise in wages could be Baomol effects or it could be that we require more skilled workers than our education system can supply. Technological advances, at this point, require a workforce with skills that can use the technology. Perhaps in time, the technology will only require a low skill worker to operate but we are not at that point. Once upon a time, a doctor could do little to aide a patient but today the interventions are potentially far more complex and the people with the skills are in relatively short supply.

Baumol effects may explain haircuts, grill operators, and many occupations but I don't think it works as well explaining health care or education

The string quartet performance technology HAS gotten more productive, with better acoustics and bigger concert halls holding more people. Is it really 23x more expensive today in real terms to hear the string quarter than in 1826? This doesn’t sound plausible. My guess is only aristocracy attended back then

He didn't say it was more expensive to hear them. He said the labor was more expensive to put on the performance.

This was probably the most useful post at MR in three years. Please don't let the point of it go whooshing over your head.

We'll be back to passive-aggressive support of statism in no time, I assure you.

"He didn't say it was more expensive to hear them. He said the labor was more expensive to put on the performance."

No. The string quartet does not play to an empty hall. Or in the words of the Zen master: "If a string quartet plays in a forest, and no one is there to hear them, have they delivered a product?" Heck no!

See my post above: "putting on a performance" can mean recording the music and delivering it over Spotify (or iTunes). Labor productivity of the actual product has gone up massively because the same quartet can deliver the product to billions simultaneously.

Cars: Tradeable goods (ie import competition)

Doctors and College Education: Non-tradeable goods, ie, services dependent on location

What has been the change in the price of washing machines v. plumbers.

By the way, there are some very interesting datasets for various services being developed so that you can measure changes over time.

For example, plumbing job rates by zip code are available at HomeAdvisor. If you are empirically oriented, you might compare washing machine prices (ex tariffs) v . plumber rates over time v. doctors v non-tenured faculty

Tradeable goods v. non-traceable goods and services.

the Baumol Effect is antique academic nonsense in this year 2019,

... efficient application of capital resources greatly improves labor productivity -- and will do so for health care labor efficiency at lower prices.

However, such efficiency is impossible under a command-economy system in America... with government politicians & bureaucrats controlling two-thirds of the health sector -- and aiming for full control.

Then how come in Britain, with a healthcare sector dominated by the state-run NHS, healthcare spending is half of what it is in the US, with better life expectancy too? The problem in the US is too much market forces, not too little: however much regulation there is, the US barely regulates prices. Healthcare makes absurdly high profits that play no useful social role, and should be restricted by government.

a. The UK is crap, even compared to the rest of the EU healthcare systems

b. Life expectancy is only tangentially related o how good healthcare system is. Nobody who has a clue about healthcare uses this for an argument.

The key point is, the NHS is more state-controlled than the US system, yet cheaper and more efficient, and has better outcomes. For the purposes of your argument that state intervention is the problem, isn't that a counter-example?

It is more efficient at allocating resources without using prices. It allocates by waiting time, denying care, etc. I.e. it is much better at hiding the true price. If you assume that health care is as good as it will ever be, or you can freeride off the innovations of others, then the system works well for basic services.

If you concentrate on the low hanging fruit of health care, basic public health, you can get a high return on your investment. Just accept that people die from stuff and it's too expensive to try to cure some stuff.

The post needs to ignore cause and effect for a moment and simply ask what does the first chart say.
I have the answer. In 1980, we lost a bunch of subsiitutability., otherwise known as the commutative property, gone.

I cannot exchange less Medicare for a car, that flexibility went away . There was a time when we could choose, get this medical condition checked now or later. We no longer have that flexibility in medicine, and we lost it in education. There was a time when we could choose between nice house and nice schools. That cummutative property is gone, we pay the same tax rate state wide for schools.

Call it the Baumol effect if you want, but the increasing spread in prices is not natural, it is a result of government causing the Baumol effect. Alex makes the common mistake that Sumners keep mentioning, you cannot reason from a price change.

You etill have plenty of control over your consumption of healthcare. No one will tie you up and cart you off to the doctors if you choose to ignore a potential health problem

But why is education so labor intensive in the face of rising skilled labor costs?

Most economic agents respond to a price increase by making substitutions unless there are barriers to substitution. Given the dramatic cost increases and the availability of low cost IT-enabled education products it seems that the education producers either a) are not, in fact, approximating rational economic agents (price insensitive) or b) that there exist very large barriers to substitution.

Both of which, as others have noted in other ways, are predicted by the government production + regulation hypothesis.

Yes. It was not productivity, it was segmentation of education and health care by government. Alex, I suspect knows this but needs to keep his audience happy and was perfectly willing to exchange cause and effect.

Great post.
One numerical mistake, repeated: Because 70.33/3.02 = 23, the right answer is 22 times more expensive, not 23. It's 23 times AS expensive.

While I’m at it, the statement that all prices cannot fall is not true.

Second the existence of general inflation as a monetary phenomenon (increasing monetary supply for a fixed basket of goods/services) implies the possibility of general deflation as a monetary phenomenon (decreasing monetary supply for a fixed basket or a monetary supply that is increasing at a rate slower than the rate of basket growth).

So all you need is decreasing monetary supply or a rapidly increasing production of stuff.

We generally do not have general inflation. The double entry accounting system tracks and eliminates general price changes.

But once a generation, at MMT time we do indeed executive real life losses, known as defaults, a true general prices rise. We have done the general prices hikes and defaults about 10 times since the founding, according to history. between MMT moments we engage in double entry accounting money, which cannot have general price rises.

"Over time, all real prices cannot fall." Real prices as opposed to "money" prices. The Baumol effect, and Alex's statement, are simply the result of applying basic price theory to a situation where productivity changes differently across goods.

Look at Alex's production possibilities frontier. The price of education is the other goods/services that must be forgone, in this case simplified to only cars. If car manufacturing productivity increases we can get more cars for a given level of input and the economy is wealthier. But if we want more education we must now give up more cars precisely because of the productivity increase in car manufacturing. The real price of cars falls and the real price of education increases.

This is the same logic as comparative advantage.

The graph on this post brings into question whether Baumol disease is responsible for cost increases in healthcare and education, as wage of other non-tradeables, barbers and bus drivers, have not increased.

So now we are talking of 'selective Baumol disease' which affects only professionals, it appears. But is this even true? The control group would be legal services, in which prices and quantities are not materially determined by government intervention. Have wages grown as fast in legal services as for government-meddled sectors like education and healthcare? This is the basic analysis I would like to see from Alex.

If they have, then the Baumol hypothesis may have legs. If they haven't, the Baumol hypothesis can be discarded.

I tried to talk about this, the natural barriers in IQ/training for some fields .. and boy the trolls didn't like it.

Sure, there might be other factors, but anything where you must train a select group of smart people for a long time is going to cost more money.

"As a society it appears that with greater wealth we have wanted to consume more of the goods like education and health care that have relatively slow productivity growth. Thus, preferences have magnified the Baumol effect."

This sounds reasonable, and reminds me of the old advice to "zig when they zag."

We can choose our personal inflation experience to a large degree, and reduce it by preferring "deflationary goods."

As an aside, my first computer memory purchase was $79 for 16K.

I just happened to see that 16Gb has fallen to $69.

A neat one million fold decrease in nominal cost. And now I don't even turn on most computers in my house. But yes, I pay a bit more in monthly health insurance.

Does the Baumol Effect account properly for US public education's being a pedagogical scam? How does the pedagogical scam that is US public education affect costs and prices in those few locales where something like a proper education is expensive enough to warrant parental meddling and risks of criminality?

Or: where are the computations and metrics that show irrefutably that "education" is a pedagogical good yielding outcomes of uniform quality of intelligence and performance that merit or permit comparison with automobile manufacture?

("Education" by what we read from Alex might as well be "just another good for consumption". Privately, I don't see that the processes of public education in the US yield outcomes at all comparable with contemporary automobile production, but I'm sure our economists know exactly how valuable American public education is and has become.)

Education as in actual learning has had massive productivity gains to the point it is largely free (e.g. youtube videos, etc.)
Education as in signalling, that has had much smaller productivity gains and that is what is putting kids into massive debt

Agree about signaling.

Consulting firms, instead of relying upon the school of graduation, are placing more emphasis on problem solving tests as part of the interview. So, you get a series of problems prior to the interview and are asked to solve them.

I am waiting for testing or occupational testing results or academic qualification testing (other than GRE, MCAT,or LSAT) to become the new standard. By the way, you are already seeing low cost signaling on Linkdin pages where people post their online class completion certificates.

Signalling, however, doesn't replace connections. Ask Jared.

The Baumol Effect, however it happens, is a number theory effect, true for all systems of finite things aggregating with local knowledge, and derives from prime number theory. There is a reason that primes get increasingly less dense as they get bigger, it allows us to round off with accuracy, the essence of creating a valid field in algebra. The Riemann hypothesis was about how much accuracy is implied as we extend the primes.

The yield curve does the same, term points become increasingly less dense along the X axis, for the same reason: We can pay for stuff out of petty cash and round up to the nearest ten year rate we would otherwise pay with debt.
The longer we stretch our debts, the more accuracy we need to support the debt expansion.. And we will expand debt until we reach our accuracy limit, then execute an MMT to reset prices. Wash, rinse and repeat, standard behavior of finite thing aggregating with local knowledge, right out of Riemann, once we prove it.

Then we have economists who thing they compute with a different number theory, they don't.

The wages are too damn high!

You know how Puritanism is said to be the fear that someone, somewhere is having a good time? I think libertarianism is the fear that someone, somewhere is making a decent living.

I think this is way more multi-factoral, starting with the fact that medical care and education have huge third-party payor issues. Professional services are government guilds with rent-seeking incentives. What was the last big ticket-item--automotive repairs? Looking at the guys who work on my car, I don't think they're living off the fat of the land so something else is probably going on.

Yes, just needed to confirm: medical care, education, professional services, and car repair (markedly less than the other three).

"There is nothing negative about productivity growth, even if it is unbalanced."

Only if we ignore externalities. I'd rather have the tech level of 1826 and remove all negative externalities from tech invented after 1826. AI research, torture enhancements and forced artificial longevity combined have more disvalue imo than all innovations since 1826 combined are worth.

Well, the Marquess of Queensberry rules weren't invented till the 1860s, so you'd have to do without those. In your world, boxers would be able to grapple and kick!

I myself don't see many negative externalities of AI. Maybe in the future, if/when our robot overlords arrive. But not yet.

Torture has been enhanced? Waterboarding is from the14th century (or so the Internet tells me).

Artificial longevity? You mean, like, sanitation and antibiotics? Those kinds of technologies that force us to live artificially longer? I agree, those really suck. I guess I can live with boxers kicking and rolling around on the ground if it means we also get rid of those awful antibiotics. Forcing all that artificial longevity on us...and our children.

Because we had about 30%+ child mortality rates (death before reaching age 5) back in the glorious days of the early 1800s.

Plus cars are awful. Wish we could go back to horse and buggy:

The Strand of those days...was the throbbing heart
of the people's essential London...But the mud! [a
euphemism] And the noise! And the smell! All these
blemishes were [the] mark of [the] horse....

The whole of London's crowded wheeled traffic -
which in parts of the City was at times dense
beyond movement - was dependent on the horse
lorry: wagon, bus, hansom and `growler', and
coaches and carriages and private vehicles of all
kinds, were appendages to horses...the characteristic
aroma - for the nose recognized London with gay
excitement - was of stables, which were commonly
of three or four storeys with inclined ways
zigzagging up the faces of them; [their] middens
kept the cast-iron filigree chandeliers that
glorified the reception rooms of upper- and lower-
middle-class homes throughout London encrusted
with dead flies, and, in late summer, veiled with
living clouds of them.

A more assertive mark of the horse was the mud
that, despite the activities of a numberous corps
of red- jacketed boys who dodged among wheels and
hooves with pan and brush in service to iron bins
at the pavement-edge, either flooded the streets
with churnings of `pea soup' that at times
collected in pools over-brimming the kerbs, and at
others covered the road-surface as with axle grease
or bran-laden dust to the distraction of the wayfarer.
In the first case, the swift-moving hansom or gig would
fling sheets of such soup - where not intercepted by
trousers or skirts - completely across the pavement, so
that the frontages of the Strand throughout its length
had an eighteen-inch plinth of mud-parge thus
imposed upon it. The pea-soup condition was met by
wheeled `mud-carts' each attended by two ladlers
clothed as for Icelandic seas in thigh boots,
oilskins collared to the chin, and sou'westers
sealing in the back of the neck. Splash Ho! The
foot passenger now gets the mud in his eye! The axle-
grease condition was met by horse-mechanized brushes
and travellers in the small hours found fire-hoses
washing away residues....

To clarify, the externalities I mentioned mostly aren't in existence yet. I guess some Orwellian surveillance risks have already materialized, but I'm mostly referring to the risk of upcoming technology. If AGI solves aging and enhances agony induction, we can look forward to scenarios where people are kept alive against their will for hundreds if not thousands to millions of years of subjective lifetime while forms of suffering not yet even neurally possible can be forced on them.

The probability of this conjunction is lower than 0.05%, but the disutility of it happening is so much greater than all the benefits from tech combined that the EV of innovation is negative. I'd personally prefer the 1820s over my current situation and hope to be dead before AGI fully materializes.

We were outside picnicking before a summer classical concert and a woman strode up, asked what was on the program, and emphatically told us "I don't listen to anything from after 1810." I guess she left before the Shostakovich

This might be a stupid question: Why isn't inflation just calculated using those sectors where labour productivity is stable? Then it wouldn't be that "education is getting more expensive", but that everything else is getting cheaper (faster than we already thought).

Where does Tyler Cowen stand on this these days? Previously, he’s been skeptical, publishing as much.

What I think is interesting about this post is that it attempts to identify a Baumol effect through, a hospital pays a doctor and you look at hospital rates, when the intermediary is the hospital. These arguments rest on the assumption that intermediaries have no market power, or don't develop it over time, and simply pass on certain labor costs, ignoring that there may be other factor input costs which are changing at the same time.

All of this seems to support the idea that the UK system is a good way to go. Have the government provide the healthcare that shows significant margin of net benefit above costs and let people but more if they want it.Very difficult to get there with Medicare and AARP out there though.


Yes, Baumol effect, but I see you have conveniently ignored my comment on your earlier post about ed. You are just dead wrong about higher ed. It is bloat combined with rising salaries especially for those bloating administrators. Multiple sources show that. I cannot find any that support your argument. What is this dateless placeless "NCES" that is the supposed source for your clearly incorrect figure supposedly showing that it is not administrative bloat? I am hearing from lots of knowledgeable people on this. None of them agree with you. You need to deal with this. This is so badly wrong, it is seriously embarrassing. You should not publish this.

In order to get a significant productivity increase you have to change the way something is done. In both education and health care we have decades of laws and regulations that prevent that from happening.

Bah, unless Alex is using "Baumol effect" in some special way to distinguish it from "Baumol's cost disease" or "Baumol-Bowen cost disease", he and Tyler have been arguing against the Baumol-Bowen cost disease model for years.

For example this post from Alex in 2016:

Indeed the very same day that Alex made that post, Tyler made a post about how revenue was up but quantity down in New York's market for dance, and I pointed how that looks like a classic case of the Baumol-Bowen cost effect.

This is good old-fashioned price theory. It seems that Alex has finally seen the light, maybe Tyler will follow. They've made some good arguments about the over-application of the Baumol-Bowen model in particular the increased availability (thanks to technology) of close substitutes for skilled services. But they have consistently over-estimated how close a substitute say online education is for face-to-face education.

One of the econ principles that I hammer to the intro students is this one: "there are more substitutes than you expect". But in the case of online education Alex and Tyler have continued to go too far in thinking how well the one good or service can successfully substitute for the other.

There is a bit of a statistical budget problem in chart one, the basis of the argument. The top lines broke off, together suddenly in 1980 and remained bundled together until 1995. Then we started to get a split.

Your data that explains the top lines of interest starts in 1995 when the effect of some exogenous event petered out. And from 1995 on it is hard to really separate car repair and health care worker.

I doubt more than 40% of the spread is Baumol's cost disease. Most of the rest will be correlated with the event in 1980.

BCD doesn't exist anymore. Spotify has all the Beethoven I could ever listen to for the price of a couple cups of coffee per month. If I want to be even cheaper I could fire up Youtube for free.

This is excellent and explains a lot, but not all of it.

I'm no economist, but my understanding is that productivity is what we can do for a given cost. My friend's dad recently switched to EPIC, an electronic medical record system. Overnight, his RVUs (a measure of physician activity) doubled, but obviously he was seeing the same number of patients and doing the same things. Thus, his productivity was cut in half overnight by the adoption of new technology.

What is the difference between the "Baumol effect" and the "Balassa-Samuelson" effect? (Just substitute cars and education for traded and non-traded goods).

Maybe I'm just daft, and I'm certainly no economist, but, the quoted bit does not seem to actually be adjusting for inflation. $1.14 in 1826, adjusted for inflation according the the US Bureau of labor and statistics to 2010, is $25ish. This would seem to indicate that the opportunity cost of producing the performance is all but identical, in real purchasing power, to the opportunity cost in 1826.

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