Cost Disease?

Many Americans feel that the country is headed in the wrong direction. They feel they spend more and get less. Many factors feed this sense but here I want to focus on a nearly 60-year-old idea from late economist William Baumol called “Cost Disease.”

There was rage in this recent election about inflation. But inflation does not affect everything equally. When I was growing up, we could not afford a stereo or a color TV. Now, even a minimum wage worker can easily afford such things.

Where does most of our money really go? Housing. Education. Young people are saddled with lifelong debt if they go to college. And healthcare is still the leading cause of bankruptcy in the U.S.

Baumol explained this in the 1960s: Manufactured goods get ever cheaper due to productivity increases. But services like home building, teaching, and nursing never get more productive. We still build houses as individual works of art. Baumol called these industries economically “stagnant” because innovation has not replaced this human labor.

People also get upset that government spending keeps rising and there is little to show for it. But where does most government spending go? To “stagnant” industries: Military, policing, healthcare, and education. Government is not “wasting” money. The problem is the rising cost of human services.

Unfortunately, self-promoting demagogues like Trump and Musk distract people from this fact. They are on a rampage of smashing vital government institutions that cost very little. The entire USAID program was about 1% of the Federal budget. Investment in science and technology is being demolished. This aids our enemies and darkens our future, but saves little money.

One consequence of Cost Disease is that as productivity increases in some sectors, more money is available to spend on stagnant industries. This is true for the economy as a whole. But not for individuals who may be at the bottom of the economic pyramid.

I just lost my latest doctor because he is switching to “concierge medicine.” Instead of having 2,000 patients, a doctor can reduce to 200 patients and charge them an annual fee of about $3,000. Every time a doctor switches to concierge medicine, 90% of patients are forced to find a new doctor. Soon there will be no doctors left.

The problem hits lower class people hardest. One solution is for government to subsidize stagnant industries. But this leads to “Cost Disease Socialism.” The more government subsidizes student loans, for example, the more tuition rises.

Many countries surprisingly solve this “socialism” problem in healthcare with socialized medicine! Instead of subsidizing out of control private costs, the government directly employs the healthcare workers. Salaries and incentives are set to maintain good quality.

These countries also tend to redistribute income. Redistributed income allows market forces to control prices that might soar with targeted subsidies.

There is no magic solution to Cost Disease, but some improvement is possible. In the case of housing, much more mass production technology could be used. Experimental houses have already been constructed with huge 3-D printers.

In the case of healthcare, wearable measurement devices and artificial intelligence may be able to diagnose health problems. Improved vaccines and medicines can reduce disease and maybe even aging. In Japan, there is growing acceptance of robot nurses. But, for now, skilled surgeons and nurses are still essential here.

Last year I wrote about how the Khan Academy can replace some teaching with videos and software. But human teachers are still essential for mastering understanding.

If you want to see a live performance, the musicians and actors cannot increase their productivity. This will be an ever more expensive luxury.

We need to understand Cost Disease so that we understand the real causes of rising prices for essential services. We must avoid being lured by Trump/Musk non-solutions like cutting funding for international disease control, which will come back and bite us.

If we really want to cut our expenses, we actually may need government to spend more: We need government to invest in the best technology of the future. A Taylor Swift performance won’t get cheaper. But we can lower the cost of some essential services.