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Baumol’s Cost Disease: A critique

By Amartya Menon

In his paper, “Children of Performing Arts, The Economic Dilemma: The Climbing Costs of Health Care and Education,” William Baumol asserts that sluggish sectors such as the performing arts, healthcare and education are plagued by cost disease, or the rise in wage rates despite little or no increase in labour productivity. The rise in wage rates without commensurate rise in productivity occurs because these industries must compete for employees with industries that have seen productivity levels rise, allowing them to pay higher wages.

The definition of productivity is key to the cost disease argument. Take for example the performing arts sector. If productivity is defined as the total number of performances within a certain period of time, data indicates that the past few decades have certainly experienced a productivity lag. On the other hand, if productivity was to be measured as ticket prices multiplied by the number of performances, output will depend on how elastic demand is for these performances, allowing room for altering productivity rates. In short, Baumol’s definition of productivity – output per man work hour – is crucial to his cost disease argument.

Following this line of thought, calling the performing arts sector a stagnant one is incorrect for several reasons. Firstly the performing arts today reach a far wider audience than it has in the past. This can be attributed to the onset of internet and advances in sound recording and reproduction technology. Furthermore, developments in this field have not been a one-time benefit but frequent and noteworthy, progressively improving efficiency and quality. Baumol argues that as the cost of recording sound falls, the cost of labour involved in producing these performances as a percentage of total cost rises, therefore constituting a higher percentage of the total industry costs. This in turn results in the cost disease phenomenon.  Yet, if the quantity of performance output were to be measured by consumption units, output numbers could be said to have gone through the roof, establishing that cost disease as a phenomenon does not necessarily exist.

Secondly, the cost disease argument does not incorporate creativity of the human mind and contributions to productivity in the form of new ideas. Instead, it assumes quantity of input and output to be constant while real wage rates continue to increase, thereby establishing that the performing arts sector is a victim of cost disease. On the contrary, today, the Berlin Philharmonic Orchestra performs Scorpions’ Rock You Like a Hurricane while the late Pandit Ravi Shankar pioneered what is popularly referred to as fusion music, incorporating elements of jazz, pop and rock into Hindustani classical music. This exponential growth that the performing arts have undergone is indicative of an increase in productivity.  Most interestingly, productivity improvements in manufacturing and agricultural sectors can be largely attributed to the very creative labour that Baumol leaves out in his definition of productivity.

It is becoming evident that the cost disease argument gives undue importance to cost (in money terms) which is easily measurable, rather than focusing on value added through the productive process. When considering long-term growth, productivity improvements most often present themselves in the form of innovative new products. If the cost disease argument restricts itself to products of a constant type and nature, it will not apply to long-term growth. That said, there are instances where cost disease does find relevance, all factors considered. An appropriate example is that of the barber business; the past century has seen little change in terms of final output, revolutionary technology and an exploitation of the economies of scale. It is only when products are changing that measuring productivity through cost comparisons is an absurd notion.

Therefore, I propose instead that the cost disease argument applies solely to industries whose functioning depends on the execution of repetitive tasks, stagnant technology and has little scope for improvement. These attributes are not reflective of the performance arts industry.

Amartya Menon is an intern at the Takshashila Institution.

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