In brief: when wages are pushed up in ‘essential’ sectors, the cost of those sectors goes up as a share of people’s income. This can be difficult. Baumol identified one ‘cost disease’ which can drive this effect. Could increasing prevalence and share of income from investments (often alongside labour) have a similar cost-inflating effect?

Disclaimer: I am not an economist.

Cross-posted from my blog.

Baumol’s original cost disease

Baumol’s ‘cost disease’ is a tricky phenomenon in advanced economies. As we improve the efficiency of formerly labour-intensive processes (like agriculture), they diminish as a share of overall activity (no need to employ all those peasants any more)… but they push up wages in other sectors which have not been so automated (like healthcare), making those other sectors more expensive as a share of incomes.

Why does the wage push up happen? The efficient industries, where workers’ activities are highly productive, must pay far more than previously (consider a modern farmer vs a downtrodden serf), and this new level represents a higher ‘best alternative’ for workers in the less productive sectors (why be a poorly-paid doctor when you could be a well-paid farmer?). Thus the less productive sectors can find workers only at higher wage costs than previously — even if the work and output are essentially identical.

This would be mostly fine (after all, everyone is getting paid more, so they can afford more) except when the less productive sectors are closer to the ‘necessity’ end of the commodity-necessity spectrum, and difficult to substitute with other goods. (If I can’t afford healthcare, it’s little consolation that I could buy mountains of bread.) ^[1] This tension is a driver of much policy challenge in developed economies.

A ‘cost of capitalists’ disease?

One way of looking at Baumol is to note that it arises because it’s harder (more expensive) to incentivise people to do the important scarce work. Are there (or could there be) other forces in this direction?

In the early days of capitalism and the later industrial revolution, there was a fairly clean role distinction between capitalists, those whose main income came from return on investment (or rent), and workers, those whose main income came from wages paid for work.

Today, gradually, many who work for wages also have passive income from interest and investments as well as the expected lifetime income from (state and private) pensions. For most workers in developed economies, these are an appreciable, though not yet remotely dominant, source of lifetime income. Looking forward, barring radical upsets or increased concentration of income ^[2] , we might expect a trend where eventually most or all people are capitalists in this sense, deriving income from ownership of (shares in) automated production (or perhaps in some cases from de-facto shares via political rights to a universal minimal income of some kind).

It’s widely known that with a higher baseline income, we’re marginally less incentivised by further offers of income: $1000 extra looks a lot when your current income is $500, and less when it’s $500k. ^[3] Could an increasing prevalence and share of income from investments similarly make it difficult to animate labour across tasks where it’s important?

I haven’t thought through where the overall equilibrium might land here: perhaps this effect is matched or beaten by rising incomes or by increased productivity from automation. (Another reason to not care might be that the trajectory toward the ‘fully automated luxury communism’ of widespread investment income seems too far fetched — a valid rebuttal, even if empirically we’ve moved some small part of the way in that direction.)

I’d love economically-minded people to weigh in here.

1. For better or worse, some things which are more substitutable, but which haven’t seen labour productivity increases, such as live classical music, are simply consumed less (at much greater expense): we often choose more scaled alternatives like TV, streaming, or cinema instead. ↩︎

2. I don’t consider these at all out of the question, but for this discussion I bracket them out. ↩︎

3. I’m unclear how strong this effect is: some evidence shows that windfalls decrease propensity for work (a short term, localised effect), but clearly over the decades as societies get enormously richer we still mostly work many hours weekly for many decades of life (demonstrating a relatively weak longer term or generalised effect). This might be explained by relative wealth and positional goods. ↩︎