Baumol's Cost Disease, explained.
Baumol's cost disease describes relative cost pressure in activities with slower productivity growth when wages rise with more productive activities.
Why it happens
Wages and manufacturing productivity rise 5% annually, keeping manufacturing unit labour cost at 10. A service initially needs four labour hours per unit; its productivity growth is adjustable. Unit service cost equals four times wage divided by its productivity index. Compare indexed cost paths and a fixed budget's purchasing power.
Baumol's cost disease describes relative cost pressure in activities with slower productivity growth when wages rise with more productive activities.
Read the result
Read relative unit cost, not a claim that one worker became less productive. The same wage growth has different implications when output per hour grows differently.
A worked example
A constant-duration service in a growing economy
Keep service productivity growth at zero and inspect the four-hour service as wages rise five percent each year.
Compare manufacturing, where productivity also rises five percent and offsets wage growth in unit labour cost.
Set service productivity growth to five percent; its unit-cost index now stays flat under the same wage assumption.
OPTIONAL DEEPER DETAILGo deeper: inside the model
Inside this model
Wages and manufacturing productivity rise 5% annually, keeping manufacturing unit labour cost at 10. A service initially needs four labour hours per unit; its productivity growth is adjustable. Unit service cost equals four times wage divided by its productivity index. Compare indexed cost paths and a fixed budget's purchasing power.
Where this idea is useful
A practical use
A labour-intensive performance can become relatively more costly without its workers becoming less diligent.
A common misconception
“Rising service prices prove workers are doing less work.”
Relative cost pressure can arise from uneven productivity growth even with unchanged diligence. Demand, quality, pricing and institutions can also affect actual prices.
What this explanation leaves out
- The rates are invented and the model omits quality, demand, innovation channels and wage differences. It cannot explain every rise in service prices or forecast education, healthcare or arts budgets.
Does this explain every increase in tuition or healthcare costs?
No. The board isolates one mechanism with invented rates and omits many determinants of actual sector spending and prices.
Which part of an activity's output can expand with technology, and which part still requires a person's time?
Associated thinkers
Associations marked provisional are awaiting source review.
Further reading
Explore the original research or the teaching reference behind this experiment.