The MR Podcast: Our Favorite Models, Session 2: The Baumol Effect

On The Marginal Revolution Podcast this week we continue discussing some of our favorite models with a whole episode on the Baumol effect (with a sideline into the Linder effect). I say our favorite models, but the Baumol Effect is not one of Tyler’s favorite models! I thought this was a funny section:

TABARROK: When you look at all of these multiple sectors, the repair sector, repairing of clothing, repairing of shoes, repairing of cars, repairing of people, it’s not an accident that these are all the same thing. Healthcare is the repairing of people. Repair services, in general, have gone up because it’s a very labor-intensive area of the economy. It’s all the same thing. That’s why I like the Baumol effect, because it explains a very wide set of phenomena.

COWEN: A lot of things are easier to repair than they used to be, just to be clear. You just buy a new one.

TABARROK: That’s my point. You just buy a new one.

COWEN: It’s so cheap to buy a new one.

TABARROK: Exactly. The new one is manufactured. That’s the whole point, is the new one takes a lot less labor. The repair is much more labor intensive than the actual production of the good. When you actually produce the good, it’s on a factory floor, and you’ve got robots, and they’re all going through da-da-da-da-da-da-da. Repair services, it’s unique.

COWEN: I think you’re not being subjectivist enough in terms of how you define the service. The service for me, if my CD player breaks, is getting a stream of music again. That is much easier now and cheaper than it used to be. If you define the service as the repair, well, okay, you’re ruling out a lot of technological progress. You can think of just diversity of sources of music as a very close substitute for this narrow vision of repair. Again, from the consumer’s point of view, productivity on “repair” has been phenomenal.

TABARROK: That is a consequence of the Baumol effect, not a denial of the Baumol effect. Because of the Baumol effect, repair becomes much more expensive over time, so people look for substitutes. Yes, we have substituted into producing new goods. It works both ways. The new goods are becoming cheaper to manufacture. We are less interested in repair. Repair is becoming more expensive. We’re more interested in the new goods. That’s a consequence of the Baumol effect.

You can’t just say, “Oh, look, we solved the repair problem by throwing things out. Now we don’t have to worry about repairs.” Yes, that’s because repair became so much more expensive. A shift in relative prices caused people to innovate. I’m not saying that innovation doesn’t happen. One of the reasons that innovation happens is because the relative price of repair services is going up.

COWEN: That’s a minor effect. It’s not the case that, oh, I started listening to YouTube because it became too expensive to repair my CD player. It might be a very modest effect. Mostly, there’s technological progress. YouTube, Spotify, and other services come along, Amazon one-day delivery, whatever else. For the thing consumers care about, which is never what Baumol wanted to talk about. He always wanted to fixate on the physical properties of the goods, like the anti-Austrian he was.

It’s just like, oh, there’s been a lot of progress. It takes the form of networks with very complex capital and labor interactions. It’s very hard to even tease out what is truly capital intensive, truly labor intensive. You see this with the AI companies, all very mixed together. That just is another way of looking at why the predictions are so hard. You can only get the prediction simple by focusing very simply on these nonsubjectivist, noneconomic, physical notions of what the good has to be.

TABARROK: I think there’s too much mood affiliation there, Tyler.

COWEN: There’s not enough Kelvin Lancaster in Baumol.

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