Baumol's cost disease, or 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 that have experienced the labor productivity growth. This pattern seemingly goes against the theory in classical economics for which real wage growth is closely tied to labor productivity changes.
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. For instance, if the retail sector pays its managers 19th-century-style salaries, the managers may decide to quit to get a job at an automobile factory, where salaries are higher because of high labor productivity. Thus, managers' salaries are increased not by labor productivity increases in the retail sector but by productivity and corresponding 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; the productivity of classical music performance has not increased. On the other hand, the real wages of musicians (like 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 by 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, as 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
Employers may react to cost increases in any number of ways including:
In the case of education, the Baumol effect has been used as at least partial justification for the fact that in recent decades, the price of 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 attributed most by 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, as 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 other treatments have been employed is subjective.