Baumol's cost disease
Encyclopedia
Baumol's cost disease is a phenomenon described by William J. Baumol and William G. Bowen
in the 1960s. It involves a rise of salaries in jobs that have experienced no increase of labor productivity in response to rising salaries in other jobs which did experience such labor productivity growth. This goes against the theory in classical economics that wages are always closely tied to labor productivity changes.
The rise of wages in jobs without productivity gains is caused by the necessity to compete for employees with jobs that did experience gains and hence can naturally pay higher salaries, just as classical economics predicts. For instance, if the banking industry pays its bankers 19th century style salaries, the bankers may decide to quit and get a job at an automobile factory where salaries are commensurate to high labor productivity. Hence, bankers' salaries are increased not due to labor productivity increases in the banking industry, but rather due to productivity and wage increases in other industries.
The original study was conducted for the performing arts
sector. Baumol and Bowen pointed out that the same number of musicians are needed to play a Beethoven
string quartet
today as were needed in the 19th century; that is, the productivity of Classical music performance has not increased. On the other hand, wages of musicians (as well as in all other professions) have increased greatly since the 19th century when not adjusted for inflation.
In a range of businesses, such as the car manufacturing sector and the retail sector, workers are continually getting more productive due to technological innovations to their tools and equipment. In contrast, in some labor-intensive sectors that rely heavily on human interaction or activities, such as nursing
, education
, or the performing arts there is little or no growth in productivity over time. As with the string quartet example, it takes nurses the same amount of time to change a bandage, or college professors the same amount of time to mark an essay
, in 2006 as it did in 1966.
Baumol's cost disease is often used to describe the lack of growth in productivity in public services such as public hospitals and state colleges. Since many public administration
activities are heavily labor-intensive there is little growth in productivity over time because productivity gains come essentially from a better capital technology. As a result growth in the GDP will generate little more resources to be spent in the public sector. Thus public sector production is more dependent on taxation level than growth in the GDP.
In the case of education, the Baumol Effect has been used as at least partial justification for the fact that, in recent decades, college tuition has risen faster than the general rate of inflation.
The reported productivity gains of the service industry in the late 1990s can be mostly attributed to total factor productivity. Providers decreased the cost of ancillary labor through outsourcing or technology. Examples include offshoring data entry and bookkeeping for health care providers, and replacing manually-marked essays in educational assessment with multiple choice
tests that can be automatically marked (see Scantron
).
The total factor productivity treatment is not available to the performing arts sector, because the consumable good is the labor itself. Instead, it has been observed that increases in price of the performing arts has been offset by increases in standard of living and entertainment spending by consumers. The extent to which the other treatments have been employed is subjective.
William G. Bowen
William G. Bowen is President Emeritus of The Andrew W. Mellon Foundation where he served as President from 1988 to 2006. He was the president of Princeton University from 1972 to 1988....
in the 1960s. It involves a rise of salaries in jobs that have experienced no increase of labor productivity in response to rising salaries in other jobs which did experience such labor productivity growth. This goes against the theory in classical economics that wages are always closely tied to labor productivity changes.
The rise of wages in jobs without productivity gains is caused by the necessity to compete for employees with jobs that did experience gains and hence can naturally pay higher salaries, just as classical economics predicts. For instance, if the banking industry pays its bankers 19th century style salaries, the bankers may decide to quit and get a job at an automobile factory where salaries are commensurate to high labor productivity. Hence, bankers' salaries are increased not due to labor productivity increases in the banking industry, but rather due to productivity and wage increases in other industries.
The original study was conducted for the performing arts
Performing arts
The performing arts are those forms art which differ from the plastic arts insofar as the former uses the artist's own body, face, and presence as a medium, and the latter uses materials such as clay, metal or paint which can be molded or transformed to create some physical art object...
sector. Baumol and Bowen pointed out that the same number of musicians are needed to play a Beethoven
Ludwig van Beethoven
Ludwig van Beethoven was a German composer and pianist. A crucial figure in the transition between the Classical and Romantic eras in Western art music, he remains one of the most famous and influential composers of all time.Born in Bonn, then the capital of the Electorate of Cologne and part of...
string quartet
String quartet
A string quartet is a musical ensemble of four string players – usually two violin players, a violist and a cellist – or a piece written to be performed by such a group...
today as were needed in the 19th century; that is, the productivity of Classical music performance has not increased. On the other hand, wages of musicians (as well as in all other professions) have increased greatly since the 19th century when not adjusted for inflation.
In a range of businesses, such as the car manufacturing sector and the retail sector, workers are continually getting more productive due to technological innovations to their tools and equipment. In contrast, in some labor-intensive sectors that rely heavily on human interaction or activities, such as nursing
Nursing
Nursing is a healthcare profession focused on the care of individuals, families, and communities so they may attain, maintain, or recover optimal health and quality of life from conception to death....
, education
Education
Education in its broadest, general sense is the means through which the aims and habits of a group of people lives on from one generation to the next. Generally, it occurs through any experience that has a formative effect on the way one thinks, feels, or acts...
, or the performing arts there is little or no growth in productivity over time. As with the string quartet example, it takes nurses the same amount of time to change a bandage, or college professors the same amount of time to mark an essay
Essay
An essay is a piece of writing which is often written from an author's personal point of view. Essays can consist of a number of elements, including: literary criticism, political manifestos, learned arguments, observations of daily life, recollections, and reflections of the author. The definition...
, in 2006 as it did in 1966.
Baumol's cost disease is often used to describe the lack of growth in productivity in public services such as public hospitals and state colleges. Since many public administration
Public administration
Public Administration houses the implementation of government policy and an academic discipline that studies this implementation and that prepares civil servants for this work. As a "field of inquiry with a diverse scope" its "fundamental goal.....
activities are heavily labor-intensive there is little growth in productivity over time because productivity gains come essentially from a better capital technology. As a result growth in the GDP will generate little more resources to be spent in the public sector. Thus public sector production is more dependent on taxation level than growth in the GDP.
Effects, symptoms, and therapy
Producers can react to wage inflation in a number of ways:- Decrease quantity/supply
- Decrease quality
- Increase price
- Increase non-monetary compensation or employ volunteers
- Increase total factor productivity
In the case of education, the Baumol Effect has been used as at least partial justification for the fact that, in recent decades, college tuition has risen faster than the general rate of inflation.
The reported productivity gains of the service industry in the late 1990s can be mostly attributed to total factor productivity. Providers decreased the cost of ancillary labor through outsourcing or technology. Examples include offshoring data entry and bookkeeping for health care providers, and replacing manually-marked essays in educational assessment with multiple choice
Multiple choice
Multiple choice is a form of assessment in which respondents are asked to select the best possible answer out of the choices from a list. The multiple choice format is most frequently used in educational testing, in market research, and in elections-- when a person chooses between multiple...
tests that can be automatically marked (see Scantron
Scantron
Scantron is an American company based in Eagan, Minnesota, that manufactures and sells machine-readable papers on which students mark answers to academic multiple-choice test questions. To analyze those answers, the machines use image-based data collection software and scanners...
).
The total factor productivity treatment is not available to the performing arts sector, because the consumable good is the labor itself. Instead, it has been observed that increases in price of the performing arts has been offset by increases in standard of living and entertainment spending by consumers. The extent to which the other treatments have been employed is subjective.