Baumol's cost disease
Baumol's cost disease is an economic phenomenon that describes how wages in labor-intensive, low-productivity sectors, such as the arts, education, and healthcare, tend to rise in tandem with wages in high-productivity sectors like manufacturing. Coined by economists William Baumol and William Bowen in 1965, the theory highlights that while productivity in manufacturing can increase—leading to lower costs and higher wages—sectors reliant on human labor often cannot achieve similar productivity gains. As a result, they must raise prices to keep pace with rising wages, even though their productivity remains relatively constant.
For example, a musician performing a piece today is no more productive than a musician performing the same piece a century ago; yet, due to wage increases driven by broader economic trends, the cost of attending performances has risen. This dynamic creates financial pressures for non-profit organizations within these sectors, often forcing them to struggle with compensation for artists and personnel while trying to maintain accessibility for diverse audiences. Consequently, Baumol's cost disease can contribute to broader economic implications, such as rising costs for essential services and slowing economic growth, as consumers may find themselves allocating more of their budgets to these labor-intensive services.
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Baumol's cost disease
Baumol’s cost disease refers to salary increases in jobs that have failed to achieve higher productivity over time simply because salaries have increased in jobs that have increased in productivity. The phenomenon suggests that paying more for labor-intensive, low-productivity services has a negative impact on productivity growth across the economy.
Economist and professor William Baumol and his colleagues examined performance in the arts. Baumol argued that musicians were not more productive in performing a piece in the twentieth century than they were performing the same piece in the nineteenth century—the piece was neither shorter nor more easily learned—yet their wages increased. Wages in manufacturing rose as workers became more productive. This boosted wages in unrelated labor-intensive areas, such as the arts, because arts institutions could not find and retain the best performers if they did not increase wages.
Background
Economists William Baumol and William Bowen developed the cost disease theory in 1965. They explained the idea in an essay on cost increases in the performing arts. The essay “On the Performing Arts: The Anatomy of Their Economic Problems” examines the seemingly constant state of panic of organizations supporting artists, such as dance and opera companies, orchestras, and resident theater companies. Such organizations are overwhelmingly non-profit. This economic pressure forces pay to decrease for performers, which may prevent some from continuing to work in the arts and keeps many in poverty and often juggling multiple jobs unrelated to the arts, such as waiting tables.
Baumol and Bowen recognized that non-profit status itself prevents many of these organizations from achieving firm financial footing. They are providing a product—the arts—to a community with varying economic means. These organizations often have a mission of including those who do not have the means to pay for expensive events, as well as children and others who might not be exposed to the arts without the efforts of such organizations. Establishing a just price for tickets often runs counter to these missions, yet at the same time, prevents the organizations from paying performers a just wage. The organizations, in short, want to provide a product of the highest quality possible and distribute it in a way that does not provide the most revenue. A high demand for these products could hinder such organizations and weaken their financial footing.
The cost disease idea has been applied to the overall economy. Sectors of the economy may be categorized as rising productivity and stable productivity. Rising productivity refers to industries that can improve efficiency, which lowers cost and increases productivity. Live performing arts fall into the stable productivity sector. The output per work-hour of a performer—a musician performing a specific piece, for example—remains the same across the centuries. A production of a particular play requires actors and a crew and has little room for reducing the number of either while staging a full production. Any technological advances that bring small improvements in productivity provide one-time savings. As Baumol’s cost disease effect notes, wage increases in rising productivity sectors consistently boost wages in stable productivity sectors. This is true of the performing arts as well as many sectors that consumers rely on every day, such as education and healthcare.
Overview
Factories and other sectors of the economy can raise wages when productivity increases because they can cut prices. In stable productivity sectors, such as the arts and health care, costs rise, but productivity remains constant. Therefore, these organizations must raise the prices they charge.
Baumol recognized that technological advances would increase productivity and reduce the cost of manufactured goods. Examples of such goods include shoes, clothing, and computers. Costs for labor-intensive services, such as childcare, education, haircuts, healthcare, and legal services, would continue to rise, however. This has proven to be true, as college costs and healthcare, for example, have become steadily more expensive while the cost of most manufactured goods has fallen.
However, experts have noted that the cost of many labor-intensive services is increasing much faster than wages. Some of this increase can be attributed to the rise of affluence. Wealthy Americans have discretionary spending and will continue to send their children to pricey summer camps and universities regardless of how expensive they are. In some cases, the organizations themselves are driving up costs. Universities often increase in size by constructing additional buildings and stadiums to satisfy donors and add perceived value to the product they offer, which in this case is education.
Government spending, too, is subject to Baumol’s cost disease. While many conservatives decry the increasing cost of the government, the services it provides are labor-intensive. They include the courts, education, healthcare, and law enforcement. As with universities and healthcare organizations, these costs continue to grow steadily and at a rate faster than wages. Yet, these are areas in which governments cannot afford to reduce spending if they are to continue to provide services at the same level.
Baumol’s cost disease also provides insight into slowing economic growth. When the cost of manufactured goods falls, consumers freely stock up on T-shirts, shoes, and other goods. Eventually, however, they have no further need of them—the closets are full, and the goods in stores are cheaper but not significantly different or better. Instead, consumers find that they are paying more for labor-intensive services, such as childcare, education, healthcare, and restaurant meals. When these services are in demand, a larger share of the economy is focused on providing them. When more people are working in these labor-intensive fields, the impact is not offset by greater productivity in manufacturing, and the economy slows.
Bibliography
Baumol, William J., et al. The Cost Disease: Why Consumers Get Cheaper and Health Care Doesn't. Yale University Press, 2013.
Baumol, W. J., and W. G. Bowen. "On the Performing Arts: The Anatomy of Their Economic Problems." The American Economic Review, vol. 55, no. 1/2, 1965, pp. 495-502.
Cooper, Preston. "The Exaggerated Role of 'Cost Disease' in Soaring College Tuition." Forbes, 10 May 2017, www.forbes.com/sites/prestoncooper2/2017/05/10/the-exaggerated-role-of-cost-disease-in-soaring-college-tuition. Accessed 24 Dec. 2024.
Ganapathi, Varun. “Understanding Baumol's Cost Disease And Its Impact On Healthcare.” Forbes, 8 Apr. 2022, www.forbes.com/councils/forbestechcouncil/2022/04/08/understanding-baumols-cost-disease-and-its-impact-on-healthcare. Accessed 24 Dec. 2024.
Helland, Eric, and Alexander Tabarrok. "Why Are the Prices So Damn High?" Mercatus Center at George Mason University, 22 May 2019, www.mercatus.org/publications/healthcare/why-are-prices-so-damn-high. Accessed 24 Dec. 2024.
"An Incurable Disease." The Economist, 29 Sept. 2012, www.economist.com/finance-and-economics/2012/09/29/an-incurable-disease. Accessed 24 Dec. 2024.
Lee, Timothy B. "William Baumol, Whose Famous Economic Theory Explains the Modern World, Has Died." Vox, 4 May 2017, www.vox.com/new-money/2017/5/4/15547364/baumol-cost-disease-explained. Accessed 24 Dec. 2024.
Maiello, Michael. "Diagnosing William Baumol's Cost Disease." Chicago Booth Review, 18 May 2017, review.chicagobooth.edu/economics/2017/article/diagnosing-william-baumol-s-cost-disease. Accessed 24 Dec. 2024.
Smith, Noah. "America Can't Shake the Cost Disease." Bloomberg, 19 July 2019, www.bloomberg.com/opinion/articles/2019-07-19/america-can-t-shake-baumol-s-cost-disease. Accessed 24 Dec. 2024.