Baumol effect

Baumol's cost disease (also known as the Baumol Effect) 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 seemingly goes against the theory in classical economics that wages are closely tied to labor productivity changes.

The rise of wages in jobs without productivity gains is caused by the requirement 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 retail sector pays its managers 19th century style salaries, the managers may decide to quit and get a job at an automobile factory where salaries are commensurate with high labor productivity. Hence, managers' salaries are increased not due to labor productivity increases in the retail sector, 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 is needed to play a Beethoven string quartet today as was needed in the 19th century; that is, the productivity of classical music performance has not increased. On the other hand, real wages of musicians (as well as in all other professions) have increased greatly since the 19th century.

In a range of businesses, such as the car manufacturing sector and the retail sector, workers are continually becoming 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. This is because those types of activities rely on the movements of the human body, which cannot be engineered to perform more quickly, accurately or efficiently in the same way that a machine, such as a computer, can.

Baumol's cost disease is often used to describe consequences of the lack of growth in productivity in the quaternary sector of the economy and 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.

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 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.

See also

• Paradox of toil

External links

• What Ails Us, James Surowiecki, New Yorker, July 7, 2003
• Baumol's Disease - Is there a Cure? Bill Hackos, Comtech Services, Inc.; Charles Dowdell, The Raymond Corporation
• America's Economic Malady: A Bad Case of 'Baumol's Disease'; Charles Hugh Smith, DailyFinance.com, Dec. 11, 2010