Baumol's Cost Disease

What is Baumol's cost disease?

Salaries rise in jobs that have experienced no or low increase of labor productivity, in response to rising salaries in other jobs that have experienced higher labor productivity growth.

— Wikipedia: Baumol's cost disease

We can describe this with an example. Imagine a world dominated by farm workers and doctors.

Let's say the farm worker works Fh hours per year, and thus yields a certain amount of grain, worth $Fd

Technological advances means that the farm worker's Fh hours per year of labor now yields a much larger amount, say 10 times as much.

Meanwhile, let's say a Doctor would initially exert Dh hours per year, and would treat a certain number of patients, and can still only treat that same number of patients. Let's say the revenue for this labor was Dd dollars per year.

The Baumol effect says that:

  1. Farm workers will now be paid something like 10 times as much, in line with their increased productivity.
  2. Now that farm workers are paid so much, it will be hard to retain doctors, as they will all want to rush off and become farm workers. Doctors will now need to be paid 10 times as much as they were before, despite their field undergoing no gain in productivity.
  3. And thus, 'Baumol's cost disease' is seen to strike everywhere -- in this case the cost of seeing a doctor will go up, because farm workers are more productive.

This whole notion strikes me as pretty far fetched. It could only be true if you ignored every possible consequence of the productivity gains... refused to engage in any systems-thinking... and yet it's a generally well regarded theory, and people claim to see a lot of evidence for it.

Is it a dumb theory or a clever one?

Regarding Baumol's Cost disease. Is it generally spoken about by:

  1. people who are dumb and think Baumol's Cost Disease is a dumb theory?
  2. people who are clever and think Baumol's Cost Disease is a dumb theory?
  3. people who are dumb and think Baumol's Cost Disease is a clever theory?
  4. people who are clever and think Baumol's Cost Disease is a clever theory?

I'd argue that I've seen a lot more of "4" than any other group.

i.e. People who are smarter than me, and people who understand economics better than me, think BCD is a real thing that really happens and it really has some "explanatory power".

Yet it seems completely upside down to me.

We have seen productivity increases and cost increases everywhere: have wages risen?

The first great big hole I see in applying BCD to the current "real" world -- is that "real" wages have not risen in the face of productivity increases. Since real wages haven't risen, BCD cannot apply, and cannot be the cause of increase costs.

If we're working from first principles, here would be an equally compelling guess at what happens with an uneven growth in productivity:

  1. Farm workers are now 10 times as productive. The need for grain did not increase. So 9 out of 10 farm workers are laid off.
  2. The laid off farm workers are now desperate for a job, and will lower the price at which they are willing to do farm work.
  3. Wages for farm work will be much much lower. And since there aren't enough jobs for all the laid off farm workers, they will flood into every other occupation. Many farm workers will become doctors, and due to supply and demand, all doctors will thus be paid less.

This line of reasoning is just as fallacious (to me) as BCD, and it is exactly the line of reasoning used by every journalist in the world, in 2014 during The First Great AI Panic when they all wrote tear-soaked articles about how the rise of automation would mean that no one had to work anymore and would thus all be forced to starve to death unless the owners of the robots would flip us a penny now and then.

Neither BCD or the reasoning above is what we actually see happening.

Here's what I see happening:

  1. Farm workers are now 10 times as productive. 5 out of 10 farm workers are laid off.
  2. The remaining farm workers do not see any increase or decrease in wages. They do not physically work as hard as they used to, but the decrease in physical labor is eaten up by an increase in paperwork, qualifications, certifications, meetings, reports, administration, stress, and stress-leave.
  3. The increased yields mean that the cost of grain is momentarily lower -- and people can now afford to consume far more than they used to. Their "revealed preference" then shows that the demand for grain was higher than previously seen. So the amount of grain being produced also increases -- a feat that is easily achieved due to the highly productive new methods. This leads to a further drop in the cost of grain (which soon disappears as we see in step 6)
  4. The farm workers who were laid off do not become doctors. Everyone is now eating more grain than ever before. Their health deteriorates, there are not enough doctors to treat all the sick people. The number of doctors does not increase, the cost of healthcare goes up in line with the general rule of supply and demand. The doctors themselves work harder than ever before, the wage they receive barely moves up at all.
  5. The surplus money paid for that extra grain and the increase of medical care is funnelled to the capitalists who own the farm and the health care service. None of them have ever worked in agriculture or medicine. Their field of study was economics. They are now making so much extra money that they write wise little articles about how Baumol's cost disease has increased their wages.
  6. Since the capitalists "know" that wages have increased, they raise the cost of grain. There are no non-capitalist competitors to undercut the high prices. People are now hooked on grain and despite the increase they will sacrifice anything they can to maintain their current consumption level. We end up with the ridiculous notion that more grain is produced, by less people, for a higher unit price, by workers whose wages are stagnant, bought by consumers whose wages are also stagneant. (Substitute grain for 'oil' or 'anti-biotics' if you don't believe me.)

bonus The Truth

The Population Reference Bureau predicts that the world's total population will double to 7,000,000,000 before the year 2000. I suppose they will all want dignity, I said.

—Kurt Vonnegut, Jr, "Slaughterhouse Five".

What I really truly see happening is that -- for example -- people in 2021 treat their pets far better than people in 1936 treated their children.

I edited my father's memoirs, which were focused on his life as a child during World War II. The most striking difference to me was the casual cruelty afforded animals, and it's indicative of a broader change. Life itself -- individual lives -- were considered far less valuable than they are now.

I think this very large and very long-term shift in values is why we are willing -- and thus required 1 -- to spend so much more on services now than services then. And it's a change that has continued steadily -- year in year out. Unless you look at day to day accounts of life from (for example) 50 years ago you can't begin to see how gigantic this shift has been.

When "old people" complain about "Political Correctness Gone Mad" -- they're buckling at a shift in language that attempts to affords basic dignity to everyone... a very recent invention. When, as Stewart Lee says, people confuse the concept of "Political Correctness" with "Occupational Health and Safety" -- they are confusing two new ideas both of which stem from The Rise of -- the Invention of -- Dignity.

And in consequence of this shift in values, we not only pay more for services, but we have invented many (many, MANY) new services. How much did people pay for "Mobile dog grooming" in 1942? I decided to put this question to my Dad, and the answer was "Fucking what?". The rise in price, expressed as a percentage, is infinite. And that's a more real and significant economic change than the phantom of "Baumol's Cost Disease".


Footnote 1

...we are willing -- and thus required -- to spend...

-- the implication here is that there is so much market manipulation occuring that service providers do not charge at their minimum price (the cost of the inputs) but at their maximum (the most we are willing to pay). This is a big allegation that I'm not going defend as this webpage is not long enough to contain the full reasons for this occurrence. It's true tho.