09 October 2012

Diagnosis: Baumol

Washington Post | Steven Pearlstein | Why cheaper computers lead to higher tuition

No matter how innovative people were in coming up with new technology and new ways of organizing their work, Baumol and Bowen reasoned, it still would take a pianist the same 23 minutes to play a Mozart sonata, a barber 20 minutes to cut the hair of the average customer and a first-grade teacher 12 minutes to read her class "Green Eggs and Ham." Based on this observation, the duo predicted that the cost of education and health care inevitably would outstrip the price of almost everything else.
Baumol & Bowen are right, of course, that it still takes a barber 20 minutes to cut a head of hair. But I think they look at innovation too narrowly. We don't just need technology which will let the barber give faster haircuts. Such technology is unlikely.

But what about innovations that will allow him to take payments more efficiently, or lower the cost of cleaning or heating his establishment? Or technologies which manage the arrival of customers, allowing him to spend fewer minutes each day not producing haircuts and also allow customers to spend fewer minutes waiting for their cut? Holding the 20 minutes/head constant there is still much innovation to be had, even in an apparently innovation-averse field.

Innovation is not just new gadgets. Hair cut technology may be trivial, but looking at the broader environment for many of these apparently-immune-to-innovation fields changes the picture a lot.
The basic facts are well-known to most Americans: Over the past 30 years, overall prices have risen 110 percent, median income has risen 150 percent, medical costs have risen 250 percent and college tuitions have risen 440 percent.
Presumably a doctor can do the same number of nose jobs or face lifts per hour as thirty years ago, and yet the costs of voluntary cosmetic surgery has not risen 250%.
From a political perspective, Baumol’s most important insight is that government spending must grow as a percentage of the economy. Most of the services that are provided by, or financed by government — health care, education, criminal justice, national security, diplomacy, industry regulation, scientific research — are those that suffer most acutely from Baumol’s disease. That’s not because of incompetence or self-interest on the part of public servants or even the socialist instincts of Democratic politicians — it’s in the nature of those activities.
If this is true and the government sector is destined to grow no matter what, then it becomes even more important to fight against incompetence, self-interested employees, socialism, etc.

Character quiz: your doctor prescribes you some necessary medicines which will have a side effect of causing you to gain some weight. Do you:

(a) pay extra attention to your diet and increase your exercise, so as to minimize the weight gain, or

(b) conclude that the weight gain is happening regardless, so you might as well have those extra donuts and slices of pizza?

I think a depressing number of people will choose (b) because an excuse to be less responsible is more appealing than a reason to be more responsible.

As an example, a depressing number of the — high-acheiving, high SES, highly motivated — parents of Mrs SB7's students see their children's diagnosis of dyslexia, etc. as an excuse for their children to do less work, rather than a reason to double down and work harder.

Baumol's cost disease will make many government activities relatively more expensive. So when you find some part of government activity to which Baumol doesn't apply — I'm looking at you, USPS — what are we doing? Taking advantage of the situation to increase productivity? Or spending billions on new capital equipment to allegedly improve productivity while still retaining the same workforce which is accomplishing a decreasing amount of work?
To demand, as Republicans do, that government be held to some historical average as a percentage of the economy stubbornly ignores this reality. It would condemn the country, as John Kenneth Galbraith once put it, to a future of “private affluence and public squalor.”
Again, let's take Pearlstein's analysis as a given. Even in this case of inevitably growing government sector spending, I think it becomes more important to demand spending growth be constrained.

Perhaps this is the Catholic lurking in me, but you don't often get acceptable behavior by demanding acceptable behavior. You have to demand perfection, knowing that people will fall short and hoping that in doing so they will land in an acceptable position.

Even if the fight against state growth is a fight we are destined to lose it is still an important fight to have, if only to try and put the breaks on things.

It's all good and well to consider Baumol's disease as applied to the government sector in some theoretical world. It's good stuff to know, really. But we're not in that world. I don't see any indication that that's the primary cause of increasing spending now, or even a significant one. Baumol hasn't caused my local school district's budget to double in a decade. Baumol hasn't caused the number of secondary or tertiary school administrators to explode. Baumol hasn't lost the USPS billions. Baumol hasn't underfunded government unions by trillions. Until we get the Public Choice factors underlying those phenomena under control, the State's Baumol diagnosis is a triviality.

Via Matt Yglesias, who comments:
This is a key reason why I think people need to start paying much more attention to questions of tax efficiency. It's overwhelmingly likely that we're going to want the public sector to be a larger share of the economy in 10, 20, 30, 40 years than it is today and we need to find relatively growth-friendly ways to make that happen.
It seems like the more a person wants the government to do, the less concerned with government efficiency they seem to be. It should be the other way around.

PS Tyler Cowen:
If government outputs increasingly cost more to produce, should not a substitution effect kick in and lead us to prefer, at the margin, a higher proportion of productivity enhancement-enjoying private sector outputs? [...] This implication often receives less stress from cost-disease advocates and you will note that it militates in favor of substituting away from government outputs.

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