Cost divergence

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Source: Marginal Revolution
This lovely picture is from Why are the prices so D*mn High? by Eric Helland and Alex Tabarrok. (It’s covered in Marginal Revolution: The Initial post,  Bloat does not explain the rising cost of education, and an upcoming summary on health care.)

Bottom line: objects got cheap, people got expensive. Technology, automation, globalization (thank you China), and quality improvement made goods cheaper. People, especially skilled people, got more expensive. All of which should make you feel good if you’re a person and especially a skilled person.

The source of the relative rise in the cost of education and health care is less clear. Looking around at  a typical university,  school system, or hospital suggests massive bloat and inefficiency. Alex suggests  not:
I assumed that regulation, bloat and bureaucracy, monopoly power and the Baumol effect would each explain some of what is going on. After looking at this in depth, however, my conclusion is that it’s almost all Baumol effect. 

In case you need to look it up (Wikipedia),
Baumol’s cost disease (or the Baumol effect) is the rise of salaries in jobs that have experienced no or low increase of labor productivity, in response to rising salaries in other jobs that have experienced higher labor productivity growth…. 
The rise of wages in jobs without productivity gains is from the requirement to compete for employees with jobs that have experienced gains and so can naturally pay higher salaries, just as classical economics predicts…. 
The classic example:
the same number of musicians is needed to play a Beethoven string quartet today as was needed in the 19th century; the productivity of classical music performance has not increased. On the other hand, the real wages of musicians (as in all other professions) have increased greatly since the 19th century.
The basic idea, if productivity of skilled people rises in one place, then you have to pay more to the skilled people who stay behind even in an industry like education that has had no change in technology. In education, where it’s pretty clear that technology has not improved, they find that we use fewer teachers per student, and teachers are paid more. Most of the rise in the cost of health care, they claim, is greater doctor salaries. My personal observation of the massive growth of school bureaucracies, and astonishing and growing waste in our health system is denied by their data.

I think the question is still open, but theirs is a challenging view which is why I point to it in the blog. They close with a suggestion that education and medicine are ripe for a big technological disruption.

As they point out,  “The cost disease is not a disease but a blessing.” It is the result of the tremendous increase in productivity of skilled people over the last few decades. Compared to stagnant periods of human history, a chance to fight about divvying up a bountiful pie is not the worst thing that could happen to us.

Two minor quibbles: We should not state the “cost disease” proposition wages have increased while productivity has not increased. In the Baumol proposition, and to a good approximation in the huge change in musician wages from 1826 to now, musicians are paid their marginal products.  The physical marginal product of string-quartet playing is the same, as (apparently) is the physical marginal product of teaching, but the value marginal product has risen, which is why wages rise.

When skilled people leave music playing for other fields, music playing contracts, and people are willing to pay more to hear music played. (All of this may or may not be true about music. I’m just using it to illustrate the theorem.) You can charge more for a string quartet performance, so the amount of (real) dollars produced by playing a string quartet rises in parallel with the productivity of potential musicians in other fields.

The pure “cost disease” phenomenon, then, should accompany a dramatic reduction in the physically unchanged technology. And indeed, a few horse shoers and craft blacksmiths still exist, and charge modern prices to wealthy horse owners.

But health care and education have rapidly expanded, not contracted. We need a different source for the fact that the value marginal product has risen while the physical marginal product has not done so.   Evidently, demand for health care and education has risen as well. We need both observations to account for the rising relative cost.