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Baumol’s Disease: Growing Pains and Hidden Opportunities in the Service Economy

  ”Baumol’s Disease” is a term coined by American economist William Baumol In the mid-1960s, the concept was proposed when studying the costs and prices of artistic performances to describe the following phenomenon: the costs and prices of artistic performances have been rising, while the costs and prices of other commodities have shown a downward trend.
  A large number of subsequent studies by Baumol himself and other economists have shown that this is not a special phenomenon, but a general rule that prevails in the service industry, and is true in both developed and developing countries. In fact, many economists, such as Philippe Agion, have dubbed Baumol’s disease “Baumor’s law,” alongside other well-known laws in economics such as Engel’s law.
  More than half a century after Baumol’s disease was proposed, Baumol published a new book “Growing Trouble: Baumol’s Disease and Its Response”, which comprehensively analyzed the formation mechanism and impact of Baumol’s disease, and then On this basis, possible policy responses are discussed and a number of ambiguities in the public debate are clarified.
Baumol’s disease as a growing pain

  Baumol pointed out that among the various sectors that make up an economy, there must be some sectors (at least one sector) whose labor productivity growth rate is lower than the average level. On the basis of this observation, Baumol proposed a two-sector non-equilibrium growth model to explain the formation mechanism of cost disease.
  Baumol divided the economy into two sectors from the perspective of technological progress: one is the “progressive sector” with rapid technological progress and continuous productivity growth; the other is the “stagnation sector” with slow technological progress and stagnant productivity growth.
  “Progressive sectors” mainly refer to those manufacturing industries that facilitate the application of advanced technology and equipment and can exert economies of scale and economies of scope. In this sector, innovation, capital accumulation, and economies of scale have brought about cumulative growth in per capita output. The “stagnant sector” mainly refers to the service industry, including education, health care, municipal services, performing arts and other industries that rely on “personal services”.
  In this sector, labor is still the main input, and it is not easy to achieve economies of scale, so labor productivity growth is slow. For example, in live art performances, it took four people to play a Mozart quartet 300 years ago, and it still takes four people to play the same piece of music 300 years later. Labor productivity has not changed much.
  At the same time, to attract labor, service sector employers must keep wages growing in line with manufacturing. Over time, rising wages, combined with slow labor productivity growth, have led to rising production costs in services relative to manufacturing.
  When the production costs of the service industry are gradually passed on to prices, the price of services will naturally rise relative to the price of products. Returning to the example above, the real wages of musicians have increased significantly, but their labor productivity has not changed much. Since the rise in labor costs cannot be offset by increases in productivity, and labor is indispensable as an input factor, the result will naturally be an increase in ticket prices for art performances. This is the “Baumol cost disease” in the service industry, or Baumol’s disease for short.
  Baumol pointed out that “cost disease” is prevalent in both developed and developing countries, and will continue to exist in the foreseeable future due to rising costs in the service industry, so Baumol’s disease will also persist.
  However, he sees Baumol’s disease as just a growing pain. The “cost disease” arises from unequal productivity growth across different sectors of the economy. In a competitive society, only when innovation completely stops and productivity growth in all economic sectors reaches zero, will this inequality in productivity growth disappear and Baumol’s disease will not appear. But obviously, that is not really good news: by that time, more serious diseases such as “poverty disease” and “violence disease” will appear.
  However, since Baumol’s disease is a “disease”, it may have some adverse effects. People’s concerns mainly focus on two issues. First, will Baumol’s disease reduce long-term economic growth? Second, will Baumol’s disease result in our society being unable to afford important services such as education and health care?
Producer services and artificial intelligence can alleviate Baumol’s disease

  The first concern seems reasonable. Generally speaking, productivity increases more slowly in services than in manufacturing. In fact, academic circles now often use “Baumor’s disease” to describe the decline in overall labor productivity in the economy that occurs as the proportion of the service industry increases.
  Economist Jiang Xiaojuan once summarized that the traditional service industry has the following characteristics: first, “intangible results”, that is, the service process does not produce tangible results; second, “synchronization of production and consumption”, that is, service production and service consumption occur at the same time and in the same place. When completed, the service has been provided to the consumer; third, it is “unstorable”. When the service process is completed, the service is over, and the results cannot be stored.
  These characteristics make it difficult for traditional service industries to adopt new technologies, and it is difficult to achieve economies of scale, so labor productivity increases relatively slowly. As a result, as the economic structure increasingly transforms towards the service industry, the proportion of “stagnant sectors” in the entire economy will become higher and higher, and the productivity growth rate of the entire economy will continue to decrease. In various developed countries, the economic growth rate after the industrial revolution obviously increased first and then declined.
  However, we should also see that technological progress and innovation and changes in business models and organizational systems can weaken the above-mentioned characteristics of the traditional service industry and expand the space for the service industry to improve efficiency, thereby alleviating Baumol’s disease.
  In the broadest sense, the service industry itself is “productive” to a certain extent. The most obvious ones are the education and health care industries, because education and health care are not only a kind of consumption, but also an investment in human capital, which is beneficial to future economic development. But the “productivity” of the service industry is not limited to this. Even many services that purely create “instant gratification” are also productive, because spiritual pleasure and psychological satisfaction are not only effective needs, but can also directly improve people’s working time. s efficiency.
  What is more worth mentioning are the changes brought about by various “directly productive” service industry innovations. In fact, Jack Triplett and Barry Bosworth even claimed that the service industry that has deepened IT capital has cured the “Baumer cost disease.” Their research results show that from the late 1990s to the early 21st century, the average annual growth rate of U.S. service industry productivity was 2.3%, which was higher than the 1.8% growth rate of the manufacturing industry during the same period. There is still controversy in the academic community about this research, but with the deepening of the application of digital technology and the acceleration of innovation in the service industry, the shortcomings of the traditional service industry have indeed been significantly weakened in many aspects, thus alleviating Baumol’s disease to a certain extent.
  Perhaps, this innovative service industry can be called “producer service industry”. One of the models is to improve the matching accuracy and transaction efficiency of promotion services through digital platforms. As mentioned before, a large part of the service industry is completed at the same time as production and consumption, so it is very critical to improve matching efficiency and transaction efficiency. Today’s food delivery platforms and travel platforms all improve the efficiency of the service industry in this sense.
  Another model is to use digital technology to aggregate demand and improve the efficiency of service product delivery, for example, through online communication to increase the audience for teachers’ lectures. In addition, for every link in the original service industry, the production and delivery methods of service products can be reshaped through digital and intelligent transformation to improve efficiency.
  Regarding this “producer service industry”, Baumol also gives a series of wonderful case studies in the book, which are worth savoring.
  Of course, the most important thing may be the widespread application of artificial intelligence technology, which may fundamentally change the way products in the service industry are produced and provided.
  ChatGPT, the artificial intelligence product previously launched by OpenAI, already has many “production service” capabilities. It can search and automatically integrate information, write emails, video scripts, copywriting, code, complete translations in multiple languages, draw paintings, and even write papers.
  If artificial intelligence can feel, think, reason and judge like humans in the future, and then generate content with practical value, then many tasks that can traditionally only be completed through “personal services” can be completed easily and efficiently by artificial intelligence. One day, Baumol’s disease should be in great relief.
Falling costs for certain products are another side of Baumol’s disease

  Baumol is optimistic about whether Baumol’s disease will make our society unable to afford important services such as education and health care.
  In his book, he estimates based on current trends in the United States that the proportion of U.S. health care expenditures in GDP (gross domestic product) will increase from 15% in 2005. In 2022, U.S. health care spending will be $4.3 trillion, accounting for 18% of GDP. Many people believe that such a heavy burden must be unbearable for us. But Baumol believes that rising productivity alone will ensure that in the future we will have access to abundant products and services that meet our needs, as long as the system can guarantee innovation, even if health care and education become more and more expensive, our incomes will remain the same. It will grow, so there is nothing to worry about.
  He emphasized that it is precisely the illusion that “services such as medical care and education are unaffordable for us” that hinders the improvement of medical care and education, because this illusion will lead to various “political infantilizations” and thereby deprive us and future generations of better enjoyment. opportunities for poor service, thereby hindering innovation and technological progress.
  Baumol also believes that many of the most serious threats to humanity’s future stem from falling costs of products in “progressive sectors” rather than rising costs in “stagnant sectors” such as services such as health care and education. On the surface, this may seem like a paradoxical conclusion, but it is actually a very profound insight.
  And this means that there is another side to Baumol’s disease, which although people tend to ignore it, is also worthy of our attention.
  Baumol noted that the rapid growth of certain “progressive sectors” fueled the most threatening problems, such as terrorism and climate change. It is their falling costs, rather than rising costs in service sectors such as education and health care, that pose a greater threat to public welfare. For example, the rapid development of military weapons production technology has led to the emergence of a large number of powerful and cheap weapons. As industrial products, their costs have dropped very quickly.
  It is clear that the continued decline in the cost of products in such “progressive sectors” is likely to have adverse consequences for humanity.

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