Fifteen years after the Global Financial Crisis: Recessions and Business Cycles in the History of Economic Thought

Baumol’s Cost Disease - Then and Today. Structural Change, Intermediate Services and Income Inequality

Krämer Hagen M., Karlsruhe University of Applied Sciences

2023 marks the one hundredth anniversary of William J. Baumol’s birth. Among Baumol’s most important contributions to economics is the theorem of ever-increasing costs in the provision of (personal) services, which he published in an article in the American Economic Review more than 50 years ago. Baumol observed that prices of services in health, education, art and culture in particular increase faster than prices of almost all material goods. A key factor in his model is the difference in labor productivity growth rates between a stagnant and a progressive sector. This development has consequences for structural change, resulting in “unbalanced growth” that ultimately leads to stagnation. Baumol was not the first author to address a sectoral bias in productivity growth rates and analyze its economic consequences. Authors like for instance Jean Fourastié have also recognized the importance of the different growth rates of labor productivity in the manufacturing and service sectors for long-term structural change. But it is only through Baumol’s work on this issue that we better understand why in almost all advanced economies services are becoming increasingly costly and why this process tends to reduce the overall economic productivity growth rate. This paper pays tribute to Baumol’s pioneering idea and places it in the context of other historically important theories of structural change in the 20th century: The explanations and predictions of Colin Clark, Allan G. B. Fisher, and Jean Fourastie, which led to the development of the three-sector hypothesis. Additionally, this paper shows that Baumol’s model still has a high theoretical and practical relevance despite all attempts to refute it and to relativize its statements over the past decades. From the decade-long debates over the validity of Baumol’s theorem of the cost disease of services, some unanswered questions remain, however. Theoretical issues relate to the difficulties in measuring the productivity of services and the relevance of the productivity effects of business and intermediary services (Oulton’s theorem), in particular. The practical relevance concerns the question of how cultural, social and health services should be financed in the future if they are subject to the cost disease of services. This question is all the more urgent to answer as a trend takes place that Baumol did not take into account, the increasing inequality of income distribution.

Area: Eshet Conference

Keywords: Structural change, productivity growth, personal, business and intermediate services, income inequality.

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