Monday, February 14, 2011

Baumol's Cost Disease

Matt Yglesias has a post about Baumol's Cost Disease, which he hilariously calls "widely known." Anyways, here's what it is:
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 goes against the theory in classical economics that wages are always closely tied to labor productivity changes.

The rise of wages in jobs without productivity gains is caused by the necessity 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 banking industry pays its bankers 19th century style salaries, the bankers may decide to quit and get a job at an automobile factory where salaries are commensurate to high labor productivity. Hence, bankers' salaries are increased not due to labor productivity increases in the banking industry, 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 are needed to play a Beethoven string quartet today as were needed in the 19th century; that is, the productivity of Classical music performance has not increased. On the other hand, wages of musicians (as well as in all other professions) have increased greatly since the 19th century when not adjusted for inflation.
I was amused that the issue was first seen in the performing arts sector... anyways, the reason that our wages go up when not adjusted for inflation is, well, because of inflation.

They go on to say:
The total factor productivity treatment [increasing productivity] 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.
Note that from the nameless Wikipedia editor's perspective, what we provide is labor.

Anyways, I don't really have a take-away here. I was just amused that Economists have been scratching their beards at us since the 1960s.