Economist Alex Tabarrok has recently come out with a short book, “Why are the prices so Damn High”, available in full PDF here.

Since the 1950’s, the inflation-adjusted cost of physical goods has fallen since the 1950’s, and the cost of food has stayed about the same.  But the cost of education, professional services, and healthcare has risen dramatically, despite those sectors not producing much improvement. Why?

The traditional economic explanation for the rising cost of services is the Baumol Effect. Some sectors, like manufacturing, are subject to efficiency improvements over time as technology improves; the more we automate the production of goods, the cheaper they get.  Other sectors are intrinsically harder to automate, so they don’t get cheaper over time. For instance, it takes the same number of musicians the same number of time to play a symphony as it did in 1950.  So, as a proportion of the average person’s paycheck, the cost of intrinsically un-automatable things like live concerts must rise relative to the cost of automatable things like manufactured goods.

Tabarrok doesn’t cover housing in his book, but home prices have also been rising since the 1970’s and I’ve seen the Baumol effect deployed to explain rising housing costs as well. “Land is the one thing they’re not making any more of” — for the most part, technological improvements don’t increase the quantity of livable land, so if technology makes some sectors more efficient and drives costs down, land will become relatively more expensive.

My Beef With Baumol

My preconception coming into the book was that the Baumol effect doesn’t actually answer the question. Why are healthcare, professional services, and education intrinsically hard to make more efficient?  It’s prima facie absurd to say that medicine is just one of those things that technology can’t improve — the biomedical industry is one of the biggest R&D endeavors in the whole economy!  So why is it obvious that none of that innovation can make medicine cheaper?  If it’s not making medicine cheaper, that’s an empirical fact that deserves explanation, and “it’s the Baumol effect” doesn’t actually answer the “why” question.

The same holds true for the other industries, even housing to some degree. While it’s true that the amount of land on Earth is fixed (modulo landfill) and the amount of space in Manhattan is fixed, there’s also the options of building taller buildings, expanding cities, and building new cities.  Why is it in principle impossible for the production of housing to become more efficient over time just as the production of other goods does?

The Baumol Effect doesn’t make sense to me as an explanation, because its answer to “why are these sectors getting more expensive?” is, in effect, “because it’s obvious that they can’t get cheaper.”

It’s Not Administrative Bloat, It’s More Service Providers

A popular explanation for why college and K-12 education have gotten more expensive is “bloat”, the idea that most of the cost is due to increasing numbers of bureaucratic administrators and unnecessary luxury amenities.

Tabarrok points out that this story can’t be true. In reality, the percent of university costs going to administration has stayed relatively constant since 1980, and the percent going to facilities has decreased. In the K-12 world, the number of administrators is tiny compared to the number of teachers, and it’s barely budged; it’s the number of teachers per student that has grown.  Most of the increase in educational costs, says Tabarrok, comes from rising numbers of teachers and college professors, and higher wages for those teachers and professors.

In other words, education is getting more “inefficient”, not necessarily in a pejorative sense but in an economic sense; we are using more people to achieve similar educational results (average test scores are flat.)

This may be fine; maybe people get value out of personal teacher attention that doesn’t show up in test scores, so we’re spending more to get a better outcome, just one that the narrow metric of standardized test performance doesn’t capture.

Likewise, in healthcare, we have an increasing number of doctors and nurses in the US per capita, and (relative to median income) doctors and nurses are making higher salaries over time.  Whatever improvements we’re making in medical technology, we’re not using them to automate away the need for labor.

Again, maybe this is what people want; maybe personal attention is intrinsically valuable to people, so we’re getting more for our money.  (And overall health outcomes like life expectancy have increased modestly since 1950, though I’d argue that they’re underperforming relative to what’s possible.)

But What About Housing?

The argument that the cost of services is rising because we use our increasing prosperity to “buy” more personal attention from teachers and doctors does not apply directly to the rising cost of housing, which is not a service.

However, it may be that the rising cost of housing, especially in cities, is really about buying proximity to increasingly valuable services — good schools, live music, and so on. If the only thing you can’t automate away is human contact, maybe we’re willing to spend more to be around fancier humans.

But What About Immigration?

You might argue “but labor prices don’t come down because immigration restrictions keep foreigners out! Labor-intensive industries are getting more expensive because we allow too little immigration!  The reason why education and medicine are getting expensive is just precisely because those are the sectors where restrictive laws keep the cost of inputs high.”

But, like the Baumol effect, this explanation also begs the question.  Why are healthcare and education, relative to other industries, the sectors where labor costs are the most important?

The immigration explanation is also compatible with the Baumol effect, not a counterargument to it. If we just take as a given that it’s impossible to make healthcare or education more labor-efficient, then it can both be true that “other things getting cheaper” and “immigration restrictions keeping wages high” contribute to the high cost of healthcare & education relative to other things.

Cost Increases Aren’t Driven By Supply-Side Gatekeeping

From Tabarrok’s point of view, rising housing costs, education costs, and healthcare costs are not really mysterious facts in need of explanation by gatekeeping tactics like monopolies, regulation, zoning, or restrictive licensing, nor can they be explained by gatekeeping tactics alone.

Gatekeeping on the supply side increases price and reduces output. For instance, a monopolist’s profit-maximizing output is lower than the equilibrium output in a competitive market, and increases the monopolist’s profit relative to what firms in a competitive market can obtain. Likewise, restrictive licensing laws reduce the supply of doctors and lawyers and raise their wages.

But we don’t see declines in the number of doctors, lawyers, teachers, and professors over time — we see clear and steady increases.  Therefore, the increased cost of medicine can’t be explained by increased restrictions on licensing.

It’s still possible that licensing is artificially restricting the supply of skilled professionals relative to an even higher counterfactual growth rate, but this doesn’t by itself explain the growth in spending we see. Demand for professional services is rising.

Prescription-only drugs are another good example of regulatory gatekeeping not being enough to explain rising costs. The total cost of getting a prescription drug is higher when there’s a legal requirement of a doctor visit than when you can just buy the drug over the counter; in that sense it’s true that regulation increases costs.  However, prescription-only requirements have been pretty much fixed for decades, not getting more severe, while consumption of prescription drugs per capita is rising; we’re spending more on drugs because there’s growing demand for drugs.

This means that deregulation alone won’t change the fact that a growing portion of each person’s paycheck is getting spent on medicine.  If the law reclassifies a drug as over-the-counter, we’d expect a one-time downward shift in the price of that drug, but the slope of the curve of total spending on that drug over time won’t get flatter unless demand declines.

Now, increased demand isn’t only possible to get from consumer preferences; governments can also increase demand for a service by providing it to the public, in effect (through taxes) requiring society to buy more of it.

You can still in principle make a case that government is to blame for increasing healthcare and education prices; you just can’t claim it’s only about gatekeeping, you have to include demand in the picture.

A “Dismal” Conclusion

Ever-increasing healthcare, education, and housing costs are a big problem. It would be “good news” if we could solve the problem by passing or repealing a law.  It would also be “good news” if the high costs were driven by foolish waste — then a competitor could just remove the waste and offer consumers lower prices.

Tabarrok’s analysis suggests this isn’t the case.

The cost increases are coming from lots of skilled professional labor — something that isn’t obviously a thing you can get rid of without making people unhappy!  In order to reduce costs, it wouldn’t be enough to cut gatekeeping regulations, you’d also have to cut subsidies — which does, unfortunately, entail taking a thing away from people (albeit potentially giving them lower taxes in exchange.) This “minimalism” can be the kind of free-market minimalism that Bryan Caplan talks about, or it can be part of a state-run but price-conscious system like the UK’s (where doctors go to school for fewer years than in the US). But either way, it involves less man-hours spent on education and healthcare.

One way or another, for costs to come down, people would have to spend less time going to school, and get less personal attention from less-educated experts.

Deeper Issues

Tabarrok’s attitude, and the implicit attitude of the Baumol effect, is that the increasing relative costs of education and healthcare are not a problem. They are just a side effect of a society getting richer. Goods whose production is easy to automate get cheap faster than goods whose production is hard to automate. Fundamentally, we’re spending more on healthcare and education, as a society, because we want to.  (If not as consumers, then as voters.)

This isn’t how most people feel about it. Most people feel like it’s getting harder to get the same level of stuff their parents’ generation got.  That the rising prices actually mean something bad.

If the real driver of cost is that we’re getting more man-hours of time with professionals who, themselves, have spent more man-hours of time getting educated by other professionals, then in one sense we’re “paying more to get more”, and in another sense we’re not. It’s nice to get more one-on-one time with professors; but part of the reason we get higher education is to be considered for jobs that require a diploma, and the rise in education costs means that a diploma costs more.

We’re “paying more for more”, but the “more” we’re getting is primarily social and emotional — more personal time with more prestigious people — while we’re not getting much more of the more concretely observable stuff, like “square feet of housing”, “years of life”, “number of children we can afford to have”, etc.

At this point, I tend to agree with Robin Hanson.  We have more doctors, nurses, lawyers, professors, teachers, and financial managers, without corresponding improvements in the closest available metrics for the results those professionals are supposed to provide (health outcomes, access to efficient dispute resolution, knowledge and skills, and financial returns.)

Ultimately you have to conclude that this is a matter of divided will. (Hanson would call it hypocrisy, but unexamined confusion, or conflict between interest groups, might explain the same phenomenon.)  People are unhappy because they are “spending more for the same stuff”; at the same time, we are spending more for “more” in terms of prestige, and at least some of us, some of the time, must want that.

All You Need Is Love?

It’s directly valuable, as in, emotionally rewarding and probably even physically health-promoting, to get personal care and undivided attention from someone you think highly of.

Hanson may think that getting personal attention from prestigious people is merely “showing off”, but something that brings joy and enhances health is at least as much of a valid human benefit as food or housing space.

The feelings that come from good human connection, the feeling of being loved and cared for, are real.  They are “objective” in a way that I think people don’t always appreciate — in a way that I did not appreciate until very recently. What I mean is, just because you do something in search of a good feeling, does not mean that you will get that good feeling. The feeling is “subjective” in the sense that it occurs inside your mind, but it is “objective” in the sense that you cannot get it arbitrarily by wishing; some things produce it and some do not. For instance, it is a hell of a lot easier to feel loved by getting eye contact and a hug, than it is by typing words into a computer screen.  “Facts vs. feelings” is a false dichotomy that stops us from learning the facts about what creates good feelings.

Prestige addiction may come from spending a lot of resources trying to obtain a (social, emotional) thing by proxy, when in principle it would be possible to get it more directly.  If what you want is to be cared for by a high-integrity, kind, skilled person, but instead you insist on being cared for by someone with an M.D., you may miss out on the fact that nurses or even hospital techs can be just as good, but cheaper, on the dimensions you really care about.  To the extent that credentialism results from this sort of misunderstanding, it may be possible to roll it back through advocacy.  That’s hard, because changing minds always is, but it’s doable in principle.

To the extent that people want fancy things because they are expensive, in a zero-sum sense, there is no “efficiency-improving” solution.  No attempt to make healthcare or education cheaper will help if people only care about having more than their neighbors.

But: to the extent that some people are doing mostly zero-sum things while other people are doing mostly positive-sum things, the positive-sum people can notice that the zero-sum people are ruining things for everyone and act accordingly.