Why have prices for services like health care and education risen so much over the past fifty years? When I looked into this in 2017, I couldn’t find a conclusive answer. Economists Alex Tabarrok and Eric Helland have written a new book on the topic, Why Are The Prices So D*mn High? (link goes to free pdf copy, or you can read Tabarrok’s summary on Marginal Revolution). They do find a conclusive answer: the Baumol effect.
T&H explain it like this:
In 1826, when Beethoven’s String Quartet No. 14 was first played, it took four people 40 minutes to produce a performance. In 2010, it still took four people 40 minutes to produce a performance. Stated differently, in the nearly 200 years between 1826 and 2010, there was no growth in string quartet labor productivity. In 1826 it took 2.66 labor hours to produce one unit of output, and it took 2.66 labor hours to produce one unit of output in 2010.
Fortunately, most other sectors of the economy have experienced substantial growth in labor productivity since 1826. We can measure growth in labor productivity in the economy as a whole by looking at the growth in real wages. In 1826 the average hourly wage for a production worker was $1.14. In 2010 the average hourly wage for a production worker was $26.44, approximately 23 times higher in real (inflation-adjusted) terms. Growth in average labor productivity has a surprising implication: it makes the output of slow productivity-growth sectors (relatively) more expensive. In 1826, the average wage of $1.14 meant that the 2.66 hours needed to produce a performance of Beethoven’s String Quartet No. 14 had an opportunity cost of just $3.02. At a wage of $26.44, the 2.66 hours of labor in music production had an opportunity cost of $70.33. Thus, in 2010 it was 23 times (70.33/3.02) more expensive to produce a performance of Beethoven’s String Quartet No. 14 than in 1826. In other words, one had to give up more other goods and services to produce a music performance in 2010 than one did in 1826. Why? Simply because in 2010, society was better at producing other goods and services than in 1826.
Put another way, a violinist can always choose to stop playing violin, retrain for a while, and work in a factory instead. Maybe in 1826, when factory owners were earning $1.14/hour and violinists were earning $5/hour, so no violinists would quit and retrain. But by 2010, factory workers were earning $26.44/hour, so if violinists were still only earning $5 they might all quit and retrain. So in 2010, there would be a strong pressure to increase violinists’ wage to at least $26.44 (probably more, since few people have the skills to be violinists). So violinists must be paid 5x more for the same work, which will look like concerts becoming more expensive.
