Baumol Cost Disease and Relative Prices – Part 2
Baumol Cost Disease and Relative Prices – Part 2
Many thanks to the Angrybear for reposting this as well as some excellent comments (save that absurd contention I’m a Luddite). If you check the comments over at Mark Perry’s place you will see that Paul Wynn made the same point I made and even linked to Timothy Lee:
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. Decade after decade, health care and education have gotten more expensive while the price of clothing, cars, furniture, toys, and other manufactured goods has gone down relative to the overall inflation rate — exactly the pattern Baumol predicted a half-century ago… this has an important implication for government policy. Most of federal and state budgets are spent on services — law enforcement, education, health care, the courts, and so forth — that are subject to Baumol’s cost disease. Government spending on these categories has grown inexorably in recent decades, and many conservatives see this as a sign that there’s something badly wrong with how the government provides these services. But Baumol’s work suggests another explanation: It was simply inevitable that these services would get more expensive over time, at least relative to private sector manufactured goods like televisions and cars. The rising cost of services is an unavoidable side effect of rising affluence generally. There’s probably no way to maintain our current standard of living while cutting the cost of these services back to the levels of the 1950s.
Lee wrote this back on May 4 and included the same graph that Mark Perry presented.
Lee links to a Steven Perlstein discussion that is behind that pesky Washington Post firewall – alas. If someone has access to this discussion and could make it available, I would love to read it as well.
I do wonder if the GMU crowd reads outside its little comfort level given how these discussions of the Baumol Cost Disease have been out there for months but Mark Perry fails to mention them.
https://www.washingtonpost.com/business/steven-pearlstein-why-cheaper-computers-lead-to-higher-tuition/2012/10/05/5dced2a0-0fd6-11e2-acc1-e927767f41cd_story.html?utm_term=.57aad4519c65 See if this works
Run75441 – thanks but WaPo shuts me out as I’m too cheap to pay for their articles. I have the same attitude towards that NYTimes fire wall. Too bad they put Krugman’s blog behind it.
pgl:
Read your email. I can usually get into both.
Everybody recognizes that as manufacturing gets cheaper, labor by definition, becomes relatively more expensive.
* * * * * *
Why doesn’t everyone just as consciously recognize that if labor cannot in-directly bargain with the ultimate consumer — not able to withhold it’s input into the product or service — that labor is …
… well that’s the problem; there doesn’t seem to be an accepted language for that. Economists talk widely of rational actors — and are fascinated when actors act irrationally; they have a whole new branch study that (fascinating) — seems all same whether rational actor is acting on mutual satisfaction or being squeezed by market power.
Any time two rational actors cannot agree to exchange value based on mutual gratification, e.g., labor’s price and consumer willingness to pay (nobody has any trouble automatically thinking this way when the min wage is raised) …
… anytime labor’s price set instead according to the least labor can be paid in a race-to-the-bottom labor/business market …
… I consider that an irrational labor/consumer market — because two rational actor cannot interact on the same rational. If that definition is true, then, the US labor/consumer market is 94% irrational.
Coming up with just the right words for that — that will really stick — is my current focus (probably wont).
I see two reasons why services cost rise relative to goods.
Productivity via automation methods in goods is far less costly than in services not to mention the fact that automating technology in services is barely started (Bank teller machines, & retail checkout Kiosks are a narrow and small segment of use in services).
With goods employment dropping employment available for services necessarily has to increase. This increases the supply relative to demand (which is why the minimum wage wasn’t exceeded long ago by labor demand forces.
This keeps service labor costs low. Low services labor costs means investments in services automation can’t return as high an ROI as when labor cost are higher. — in other words its not profitable enough to invest in services automation in a big way as it was & remains in goods production
Some service are importable where those services cost less in other nations
— software code is a universal language so the U.S. outsources some coding, especially to English speaking India. I’ve been amazed at the winners and 1st 10 places in global coding contests — one or two in ten is a U.S. citizen. — most winners are from Asian nations and Eastern Europe’s’ former Soviet nations.
— Communications have become far faster and cheaper globally so verbal “help” services can be exported to any place where there’s an English speaker at far lower costs than the same service provided in the higher standard of living U.S.
However for services which are limited to domestic locations, the supply of low cost services labor outweighs demand and since automation is more costly even when it’s feasible at al, the productivity gains are far lower than for goods.
That means services cost relatively more in general as goods prices fall by increasing productivity. .
For example, higher education costs have increased with increasing proportions of the population seeking advanced education. In the early 1970’s ~10% – 12% of the workforce had a 4 year or better degree. It’s presently pushing on 34%.. a nearly 3-fold increase in demand with a concurrent reduction in public funding put a far greater economic burden on each student. More students means more buildings, more real-estate, more overhead, more student housing, more professors, assistants, & maintenance, and thus also more administration. etc.
Healthcare, Education, and Housing are all captured domestic labor markets. & since there’s no foreign competition for these services (or construction) there’s less competition driving prices down or keeping them lower as well. This means its also where investment can get a greater bang for the buck.
Real example of higher profits in university education.
My daughter-in-law received her masters degree in a difficult field from a major private University on the East coast while she worked full time on the West Coast. Her company paid for several of their employees to obtain their Masters in tis field if study — about 15 participated in each term which was for three years.
Their instruction by the profs was from real classes on the East Coast by tele-conferences. They used no other University services, only the books (which the company paid for).. The company paid full tuition costs per student however, while the University’s costs were near ‘nil… and thus almost 100% pure profit. Oh, they attended graduation ceremonies in June at the University — but they had to purchase or rent their gowns, caps and buy their own tassels, pay own transportation and costs of stay..
I have no idea how many other companies do the same thing for their employees who qualify, but I’m sure it’s a lucrative and hugely profitable business for the “not for profit” universities.
Actually only ~ 10% of the classes were real-time teleconferenced.. the bulk were taped so students working times weren’t upset.
“The rising cost of services is an unavoidable side effect of rising affluence generally. There’s probably no way to maintain our current standard of living while cutting the cost of these services back to the levels of the 1950s.”
probably more complicated than that.
but if you are talking about government services, there are two factors worth considering.
First, political pressure can be brought to bear to cut the wages (including especially “benefits”) of civil servants. This will lead ultimately to civil servants working for starvation wages and have to supplement their wages by taking bribes. Story of civil service in other countries, other times.
Second, it is not only the cost of government workers that annoys the rich (who determine policy, including by convincing the voters that civil servants are lazy and overpaid), but they desire to reduce the quality of government services to the point where “government IS the problem”. (you know, long lines at the DMV). This keeps government from being able effectively to balance the power of the rich,
And, I suppose, it is the case that this (Baumol’s disease) is the reason wages of working people have not risen in 30 years… not competition from abroad, not automation, not that worker’s marginal value has not increased… but that employers don’t have to pay workers more, so why should they?
It’s not that a lawyers maid is worth less than he is (to the GDP of course) but that he won’t pay her more.
Lee: “Of course, as the Atlantic’s Derek Thompson pointed out a few years ago, the cost of many of these services is actually rising faster than wages are growing, suggesting that Baumol’s disease isn’t the whole story. ”
If Perry could show that prices in some categories had undergone an increase in regulatory capture, I would expect the prices to increase because of it. But there are other obvious reasons for tuition and healthcare.
Note that decreased public funding causes tuition to increase even if education costs are only wage driven. On top of that education is a Veblen good for people who can afford to brag about it. A small private college would rather have a high tuition that no student actually pays than a tuition that represents the actual cost. Every student who can meet the entrance requirements at Pacific University as qualifies for scholarships that cover 60 percent of the tuition. Mix that “data” in with public schools and you start to have meaningless analyses.
I wrote: “If Perry could show that prices in some categories had undergone an increase in regulatory capture, I would expect the prices to increase because of it. ”
I meant: “If Perry could show some categories had undergone an increase in regulatory capture, …”
hmmm:
What do you get when you cross naproxen and esomeprazole, which are two relatively inexpensive over the counter drugs? According to the manufacturer Horizon Pharma, the result is Vimovo, a special formulation pain killer that will not disrupt your stomach. The price like Humalog and EpiPens went up dramatically from $138 to $2900.
The cost of manufacturing did not change, which I can tell you from my own experience is minimal on an established drug. The manufacturer sells at a list price and then rebates money to the buyer. The end customer is given a discount.
There is no reason for this type of shell game. Vimovo
Run,
Don[t you mean “There is no reason for this type of shell game. [unless middle man can take a larger profit cut in pricing to the consumer]?
Pharmacy to consumer: “I’m giving you a huge discount. Look. Here’s the list.”
Consumer to pharmacy: “Gee, thanks a bunch.”
Consumer to friend: “Go to xyz Pharmacy. They give huge discounts.”
I had to take a drug (daily) that cost $120k per year.
My hospital system’s cost was $80k/year. With the cost to get through donut hole my total annual cost was $~ $3k
I checked several major pharmacy chains in the U.S. They charged the list price or a 5% lower price.
Then I checked the prices in Germany, France, and England. They purchased the drug at a $50k/year annual rate. After their healt care systems kicked in the consumer paid $20 / month.
When I looked deeper into the history of why those European Countries paid so much less for this particular drug I found by much searching it was because France’s health care system uses a cost benefit formula that priced the drug at $50k and thus they refused to include it when it was originally offered on the market. Germany and England followed suit based on France’s cost/benefit formula, and I suspect most other European health care systems did the same.
That locked out this drug’s sales in Europe. Result: Six months after the drug’s introduction the price to European nations was $50k/year.
My hospital system then was able to negotiate their $80k/year price and include it in their formulary. Before the European’s forced the $50k/year price my hospital system didn’t include it in their formulary..
Granted the drug has low volume sales since it’s for a very rare cancer, and for a couple more years there was no effective alternative at all… die within a 6-12 months max or pay the price. Very wealthy people in Europe and U.S. paid the list price to live longer. Nobody else could afford it.
The lesson is that a national health care system can and does force pharmaceuticals to cost/benefit pricing. Frances formula is the most stringent, weighting benefit by also including “quality of life” for the added average life benefit of a drug higher than some of the other European Nations. “Quality of Life” means side-effects of the drug are weighted more negatively.
BTW, I lucked out.. I took the drug for 2.5 years with almost none of the debilitating side affects.. none that had any real impact on anything I did, far, far longer than any actual statistical probability data showed. In that 2.5 years two more drugs came on the U.S. market so when the 1st drug stopped working for me, I was able to switch and get more time. When the last drug stopped working a new even better newer drug (4th) had been approved for my cancer 2 weeks earlier.. luck again. I’m still kicking ass 6.5 years after diagnosis, though not as much kick as I used to have..
I have France’s cost/benefit formula to thank and the US donut hole deal, which is to say the general federal income taxpayer. If you want to cut pharmaceutical prices there’s only one way.