Recently I asked about cost disease at the Austin, TX meetup and someone responded "Isn't it just increasing labor costs via the Baumol effect?" and I said "huh?" The next day a friend on facebook linked to Marginal Revolution (MR) discussing the Baumol effect. Next thing I know I'm nerd-sniped.

Turns out Alex Tabarrok at MR just published a free book with the thesis, "Cost disease is mostly just the Baumol effect, which btw isn't a disease and is actually good in a way."

How does this fit in with Scott Alexander's original posts on cost disease? Well here's an imaginary dialogue to demonstrate how I think things went (MR sometimes means Alex Tabarrok and sometimes Tyler Cowen):



MR: Education and healthcare are experiencing cost disease!

Scott: Wow you're right! Let's look at a bunch of possible reasons but see that none of them quite work. For example, it can't be the Baumol effect because that implies increasing wages (for i.e. teachers, professors, and doctors), but we see all those wages increasing at rates equal to or less than the average.

MR: Great post Scott!

Scott: ... And despite lots of good comments, I still can't tell what the cause is. It's certainly not just the Baumol effect though.


MR: So we did some research and actually, looks like it's mostly just the Baumol effect.

Scott: ???


(Scott's last line is a stand-in for both "Is Scott going to respond?" and "what the eff?")

This back-and-forth of course made me extra confused. What did Scott and Alex see differently? Have the relevant salaries been greatly increasing or not?

Seems they disagree on the basic facts here. Focusing just on public K-12 education for simplicity, in 2017 Scott posted this (section III) graph:

from SSC, source at link above

which seems to show unimpressive changes in teacher salaries, ruling out Baumol. In contrast, Alex's new 2019 book gives this (page 19) graph:

from Alex Tabarrok's new book

which shows huge increases in "expenditures per instructor." And he insists that trend is mostly driven by increases in teacher salary and benefits. So either those are some serious benefits, or Scott and Alex are living in different USA's. I'm not sure what's going on here. It's very exciting that Alex says he's solved "cost disease," but it seems like a piece of the story is either missing or confused. (Or I just need to read his whole book.) Comments welcome!

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I looked through Tabarrok's book, and my general impression is:

  • He does a decent job going through the education data. (At least, he finds the same stuff I did when I went through the data a few years ago.)
  • He totally whiffs on healthcare data. In particular, I saw no mention of demographic shifts, which are far and away the biggest driver of growth in US healthcare spending.
  • He then takes a hard left turn and goes off talking about the Baumol effect, without grounding it very well in the data. He gives a bunch of qualitative arguments that things look consistent with Baumol, but never makes the quantitative arguments that Baumol explains all the growth, and never properly rules out alternative hypotheses.

A good example is on page 50: "it is evident that despite higher costs Americans have chosen to buy more healthcare output over time. Once again, this is consistent with the Baumol effect but inconsistent with a purely cost-driven explanation for rising prices." It's also consistent with the demand curve shifting up over time, and Baumol having nothing to do with it. Which is exactly what we'd expect in an aging population.

He does do a decent job ruling out "purely cost-driven explanations" as an alternative hypothesis, but that does not imply Baumol.

It also fails to account for the fact that health care is, in a sense, an ultimate superior good - there is no level of income at which people don't want more health, and their demand scales with more income. This combines with the fact that we don't have good ways to exchange money for being healthier. (The same applies for intelligence / education.) I discussed this in an essay on Scott's original post:

If we measure the Baumol effect in healthcare using "salary and benefits" where there's no increase in salary and the increase in benefits all goes to increased healthcare costs, that seems like a form of circular reasoning or begging the question. We've only concluded that healthcare costs increased because healthcare benefits increased.

Good point about benefits = healthcare = rising, but I'm not sure about your circular reasoning claim. Seems more like you could argue that K-12 cost increases are the result of healthcare price increases, but now you still have to explain why healthcare prices have increased so much.

They have a good argument that the Baumol effect explains a significant fraction of cost disease.

Much of their point is that it's not surprising that some industries have better productivity growth than others.

But they don't have a full explanation of the extent to which productivity growth varies by industry. Why do medical productivity trends appear much worse than auto repair productivity trends? What caused the pharmaceutical industry to become less productive?

Their partial answer seems to be Hansonian:

A key distinction is when labor is an input into the good or service and when labor, in essence, is the service. Consumers do not care how much labor is used as an input into the production of a car, but they do care how much labor input is used in a massage, artistic performance, or doctor’s visit.

That's pointing in the right general direction, but I expect a full explanation would also involve consumers being unwilling or unable to switch to companies that offer cheaper services.

Your images don’t work because you’re not actually linking to images—you’re linking to pages on Imgur.

Your first link should be:

And your second link should be:

Thanks! I originally tried using those links but didn't know to add ".png" to the end.

Salary and expenditures are related, but not apples-to-apples. The first thing that popped to mind is healthcare. Here's a reference link which mostly overlaps the above graph's timeline:

Next would be administrative costs...we'd have to see if district salaries are counted and averaged into teacher expenditures...since it's all about the children, and what it costs the public (taxes) to pay the teachers (and everyone who supports them within the educational system).

Is part of the discrepancy the inclusion of more people (administrators, support personnel, etc., who are not necessarily paid more, but who are more numerous) in the "expenditure per educator" but not the "salary of educators" measurements?

We have to separate colleges from public K-12 education. Colleges are the place where you hear about increasing numbers of non-teaching staff. K-12 actually has fewer administrators per student than 20 years ago (in most places).

On page 17 of his book, Alex shows that administrators in K-12 education are a vanishingly small fraction of the employees. He thoroughly addresses and dismisses bloat theory in the book (which would notably be a different effect than Baumol).