• The Cost Disease: Chapter 3

    From Chapter 3 of The Cost Disease:

    As we have already seen, productivity growth ensures that both wages and per capita income will continue to increase, making most products and services cheaper relative to consumers’ buying power. This means that we can afford not merely the current quantities of these items and services but also ever greater quantities and ever rising quality in the future, despite their rising costs. Thus, there is no need to contemplate reductions in the provision of health care, education, or the performing arts.

    Just in case it isn’t crystal clear what Baumol is saying, let me break this down. There are a few hidden assumptions.

    The overall wage level rises because overall productivity rises. If the average worker can produce more per unit time (higher productivity), her employer can afford to pay her more per unit time (higher wage). This doesn’t itself mean that workers wages rise, because another thing employers could do is cut the price of the goods produced.

    However, any way you slice it (wages go up or price of goods goes down, or some of each), productivity increases consumers’ buying power. In terms of real goods and services, you can afford more per unit of your labor when productivity goes up.

    Just because you can afford more stuff, you don’t want or need more of all kinds of stuff. You can only eat so much. You can only listen to so much music. In general, how your demand for products and services changes with your purchasing power is different for different products and services. In economics jargon, price elasticity of demand varies by product. Consequently, some stuff both becomes cheaper and you don’t want that much more of it (inelastic demand). You’re spending less of your paycheck for such stuff over time. This has happened in the area of food, for example. Americans’ food budgets have gone down over the past century. Calories got cheaper. Sure, we have bought and consumed more calories, but not enough to offset the fall in price per calorie.

    That fact opens up the possibility that some stuff can become more expensive and you can still afford it. If you’re spending less on food, you can afford to spend more on health care (ignoring all other types of spending), even if health care productivity is not growing as fast as that for food — that is, even if health care prices are not falling like those of food are.

    Whether there is really no need to contemplate reductions in health care, education, or the performing arts (Baumol’s last sentence in the quote) depends on productivity rates and income elasticities across goods and services. Or, in less jargon-laden terms, it depends on how prices are changing across products and how much you need or want them. It is possible that we can continue to afford health care at the rates its prices have been growing. But that depends on how fast other stuff is becoming cheaper, all relative to our incomes.

    All posts about the book are under the Cost Disease tag.


    • “However, any way you slice it (wages go up or price of goods goes down, or some of each), productivity increases consumers’ buying power.”

      I thought the lesson of the last 30 years, or at least the last 15, is that profits and capital gains can take a higher proportion of the pie, so that average (mean) income does indeed go up, but the average (median) consumers’ buying power does not increase. It is possible for neither prices to go down nor median wages to go up, but instead profits to go up as productivity increases. This is not a small point. The middle class has a standard of living that is not improving at a rate that matches the overall growth in productivity.

    • Let me say this simpler: Since humans can produce more stuff with less effort we are wealthier and when we are wealthier we spend more on healthcare.

    • “However, any way you slice it (wages go up or price of goods goes down, or some of each), productivity increases consumers’ buying power.”

      theory defies the reality of income trends in the united states

    • Wages depend as much on bargaining power as on productivity.

      Wages also depend on the amount of profits in an industry.

      I believe that if you did a longitudinal study of those Americans whose wages have increased the most in the last 30 years, you would find categories such as:


      unionized faculty

      oil and energy workers

      psychiatric counselors

      investment analysts

      What any of these groups have to do with traditional industrial productivity is beyond me, at least at first glance.

      Wage growth in health care has, on the whole, vastly outpaced wage growth of average workers. It sounds simplistic to say this, but there is no easy way for a $12 per hour barista to pay for a $150 per hour doctor and his $60 per hour assistant.

    • Given this why do we* often say health care as a proportion of national spending is many times higher now than in 1960 = this is a problem because “soon” it will be unaffordable. The implicit and unacknowledged assumption here is that the distribution of national spending in 1960 was optimal forever and any change is a bad thing.

      When you state it like that of course it doesn’t make sense. So how do we figure out what the optimal spending distribution is at any point in time?

      I suspect that one reason people focus on this shifting distribution when it comes to health care (rather than say cell phones and Internet browsing) is that so much of health care spending goes through the government and a higher proportion of total spending going to health care necessarily implies an higher proportion of income taken in taxes to fund that health care spending. Given American attitudes to taxes this is a heavy lift. The historical stability of federal taxes at about 18% of GDP makes it even more challenging as a government distribution problem because that implies that the federal government must pay increasing health care costs without collecting increasing revenues.

      Which sounds about like where we are right now.

      *meaning the generic national we, not this blog specifically which frequently does a better job of breaking it down than the national debates.

      Taxes: http://www.theatlantic.com/business/archive/2012/04/how-we-pay-taxes-11-charts/255954/