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Why Some Consumer Costs Just Grow and Grow

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Wednesday, 15 Feb 2017 07:09 AM Current | Bio | Archive

Why does everything cost so darn much? More to the point, why does it cost so much more than it used to?

Well, not everything costs more than it used to. Food is cheap. Electronics are absurdly cheap: I can get a clock radio on Amazon today for not much more than I would have paid in 1965 (before adjusting for inflation). The cost of air travel has fallen dramatically.

But these things seem to pale in comparison to the items that have gone up, up, up: health care, education, housing.  Those things make up a lot more of our budget than televisions and bread. And they make up more of our budgets than they used to, thanks to rampant cost inflation.

This helps explain why people feel so pinched, even though they haven’t objectively gotten poorer. Things we have to have -- a roof over our head, schooling for our children, treatment when we’re sick -- seem to have spun out of control. Even when people can afford these things, they worry that they won’t be able to in the future, and this contributes to a pervasive feeling of unease about our economic futures.

But describing what has happened doesn’t necessarily get us closer to understanding why it has occurred. Scott Alexander has a long post exploring the matter, and I recommend that you read the whole thing. He’s asking whether the traditional explanation, an economic phenomenon called Baumol’s cost disease, can really explain what’s going on in these sectors. And the answer he comes up with is, basically, “I’m skeptical.” I’m skeptical too.

Baumol’s cost disease is the idea that as productivity increases throughout society, sectors that aren’t particularly productive will suffer from a problem. They need to compete with other sectors for labor, but those sectors are producing more with less, and can afford to use some of that surplus to pay workers higher wages. The sectors where productivity is stagnant will therefore have to raise the wages they offer in order to keep good workers. So the labor cost per widget will fall rapidly, while the labor-cost-per-expensive-service shoots rapidly in the other direction.

To make that more concrete, it now takes dramatically fewer autoworkers to produce a car than it did in Henry Ford’s day. But it still takes exactly one masseuse to deliver a one-hour massage, and four musicians to play a movement in a string quartet. If everyone used to get $2 an hour, and the autoworkers are now getting $20, you’re going to have a very hard time retaining your cellists and masseuses unless we all pay a lot more for those things.

There are some problems with Baumol’s cost disease, starting with the fact that it’s awfully sensitive to how we define the boundaries of production. Sure, it still takes just as many musicians to play a Bach sonata as it did when he wrote them. But when he wrote those pieces, someone who wanted to hear one of those sonatas had to pay three musicians to come sit in their living room. Now the musicians can sit in a studio, record it once, and millions of people can listen to them on demand. Even live music performance has gotten more productive thanks to advances in music technology, so that a single performance can reach many more people at the same time.

The other problem is that Baumol’s cost disease is often presented as sectors that can’t increase productivity, but it’s often applied to sectors that won’t. A single university lecture can now reach many more people than it once did, thanks to the power of the internet. But universities still basically operate the way they did when the cutting-edge method for talking to a number of people at once was shouting at them. (This is, of course, changing now, but slowly.)  In sectors like this, it’s not clear whether the problem is actually cost disease, or the fact that monopolies and quasi-monopolies often display stagnant productivity.

That’s an answer that Alexander takes seriously: “This kind of suggests a picture where colleges expect people will pay whatever price they set, so they set a very high price and then use the money for cool things and increasing their own prestige.” The four sectors he looks at are housing, education, health care and public transportation. What do these sectors have in common? First, demand for them tends to be inelastic, which is to say that if the price goes up, people are going to have to pay it. And second, all four are of great interest to our government, which is heavily involved in their financing.

Alexander asks if this means that “markets don’t work.” But I actually think that this is backward. These are among the most subsidized sectors we have. It’s pretty easy to tell a libertarian story where markets work fine, but government intrusions into these markets have rendered them so unfree that they no longer function the way they’re supposed to. And I think that is at least part of the story here. Yes, these things are often procured from private parties. But everywhere you look you see the government: blocking new entry (through accreditation standards, “certificate of need” laws, and zoning and building codes), while simultaneously subsidizing the purchases through artificially cheap loans and often, direct price subsidies. It would be sort of shocking if restricted supply combined with stimulated demand didn’t produce rapidly rising prices. Meanwhile, in areas that the government largely leaves alone (such as Lasik), we pretty much see what you’d expect: falling prices and improving consumer service.

But that’s perhaps a little simplistic. Agriculture is also the focus of a great deal of government intervention, as are sundry things such as air travel, and we don’t see the same phenomenon there. So we need to dig a little deeper and describe what’s special about these three sectors (we’ll leave public transportation out of it, because there, the answer is pretty much “union featherbedding combined with increasingly dysfunctional procurement and regulatory processes").

First, and most obviously, they involve vital purchases made on long time horizons, and with considerable uncertainty. Food is more vital than health care to our well-being, but its price and quality are really easy to assess: if you buy a piece of fruit, you know pretty quickly whether you liked it or not. This is a robust market, and it’s going to take communist-level intervention to fundamentally mess it up so that food is both scarce and not very good.

Homes, schooling and health care, on the other hand, are more complicated products. You don’t know when you buy them how much value they will be to you, and it is often difficult for a lay person to assess the quality of the product. You can read hospital rankings and pay a home inspector, but these things only go so far.

The fact that these are expensive purchases that can go terribly wrong creates a great deal of pressure for the government to intervene. As ours has, over and over, in all sorts of ways.

And at the risk of giving up a little bit of my libertarian cred, I’ll say that government intervention in these markets did not have to be as expensive-making as it has turned out to be in America. Other countries have these sorts of problems too, but they’re nowhere near as large as ours.

Part of that is just that we’re richer than most of those other countries. We were going to spend the portion of our budgets no longer needed for food somewhere, and health care, education and housing are pretty good candidates. But that’s only part of the story. A big part of the story is that America just isn’t very good at regulation. When you talk to people who live elsewhere about what their government does, one thing that really strikes you about those conversations is how much more competent other rich industrial governments seem to be at regulating things and delivering services. Their bureaucracies are not perfect, but they are better than ours.

That’s not to say that America could have an awesome big government. Our regulatory state has been incompetent compared to others for decades, since long before the Reagan Revolution that Democrats like to blame. There are many, many factors in this, from our immigration history (vital to understanding how modern urban bureaucracies work in this country), to the fact that we have many competing centers of power instead of a single unified government providing over a single bureaucratic hierarchy. There is no way to fix this on a national level, and even at the level of local bureaucratic reform, it’s darned near impossible.

In other words, this is probably what we’re stuck with. It may not be Baumol’s cost disease -- but it’s potentially even more serious, and it’s going to be a lingering condition.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.


Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”

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Why does everything cost so darn much? More to the point, why does it cost so much more than it used to?
consumer, costs, economy, inflation
Wednesday, 15 Feb 2017 07:09 AM
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