Baumol's Cost Disease isn't quite what everyone thinks it is

William Baumol has just died and we must insist that the part of his economics we like the best is his investigation of entrepreneurship and technological advance. For his result gives us the background and theory as to why the empirical observation that it is freedom and markets Wot Does It is true.

But then we all know that.. It's the part of his work that all too many don't quite get which is our concern, the Cost Disease argument. The result is that services will become more expensive relative to manufactures as a society gets richer. The cause is that a richer society means higher labour wages - this is obvious, higher wages is the same thing as saying a richer society. Manufactures have some amount of labour embedded in them as do services.

But one of the ways that a society becomes richer is that we automate more of that manufacturing, thus having less labour embedded in our manufactures, while services don't undergo quite the same transformation. Thus, as labour becomes more expensive, the manufactures with ever less labour in them become cheaper relative to the services which retain about that same labour contribution. Agreed that's not quite the way it is usually presented but it's an explanation we find easy to understand ourselves.

The classic example of this, from Baumol himself, is that it still takes a string quartet exactly the same amount of time to play a piece as it did when Mozart wrote it. We can't make them more efficient by speeding it up. But we've automated much of farming so food is cheaper relative to string quartets than it used to be.

This is then used to go on to show why government will take an ever larger part of the economy, akin to Wagner's Law. Because we get a lot of our services, like health care and education, through government, services become relatively more expensive as we get generally richer et voila, cough up more tax you peasants!

Except there's a piece of Baumol missing from that latter idea. Which is that the true statement of Baumol's Cost Disease is that services will become more expensive relative to manufactures unless we automate services and so turn them into manufactures.

With the string quartet the obvious example is recording them once and then replaying the recording. This does hugely increase the productivity of producing music, even if not of live music. Similarly with health care. Time was when the treatment for a headache was a darkened room and a comely virgin to cool the brow with a damp cloth. This was an extremely low productivity activity for the young maid. We are now very much more efficient in our treatment of headaches for we have invented aspirin. Which is really a mechanisation of the darkened room etc and as a mechanisation something we can increase the productivity of.

Wagner's Law is not thus an inevitability, it's rather a measure of how good, or bad, we are at automating services. It isn't true therefore that government must become an ever larger part of our or any other economy. It could even be that we want it to be, but it isn't inevitable. It depends upon the technological advance of, for medicine say, pill making, for education of video and distance learning. And isn't that just where we think we are? On the cusp of new technologies making those things vastly more efficient and productive?