The millennial generation in America is suffering from the ill effects of Baumol’s disease. But despite its name, Baumol’s disease isn’t an illness, it’s an economic phenomenon. First described in the 1960s by William J. Baumol and William G. Bowen, it explains how we can possess luxuries barely dreamed of in our childhoods—like smart phones and 60” televisions—while the necessities such as quality housing, medical care, childcare and education are too often drowning young adults under piles of debt.
So how did we get here? How does Baumol’s disease offer an explanation as to what is going on? Baumol’s disease is the economic paradigm which models to us the ill effects of what an imbalance of growth and innovation in different industries does to prices of goods and services in our society. The result of uneven productivity growth is that the prices of innovative goods, like computers, get cheaper, but the prices of goods and services produced by noninnovative industries go up instead. And unfortunately, many of the goods and services that are the foundation of a middle class lifestyle, like education, medical care, and affordable housing, are all provided by noninnovative industries.
As industries innovate, the price of their goods decline over time because they become cheaper to produce, like our smart phones. However, this growth not only affects the industries in which it occurs, it also causes the prices of noninnovative industries to rise. This is because productivity growth in industries is also accompanied by wage growth—at least the wages and wealth that make up the top of the industry. This increase in wages causes labor to become more expensive in the economy as a whole, meaning that even noninnovative industries have to pay more in labor costs, causing the price of the labor needed to produce all goods to increase. However, without the the innovative growth that leads to smarter, cheaper production, noninnovative industries are forced to pass on these costs to the consumer. And when consumers find the goods and services to be essential to life, the demand for the goods and services from noninnovative industries does not decrease despite the rising cost. This means that we end having to pay increasingly more for these goods as their prices increase at a more rapid rate than overall inflation and wage growth. And it does not matter whether we can afford these increases or not.
So why are so many of the industries we consider essential to good quality of life fall into the noninnovative category? Because, as significantly labor intensive industries, they require an amount of domestic human capital not needed in other businesses. And it is often extremely difficult, if not downright impossible, to grow the productivity of labor intensive industries because you cannot increase the speed or volume at which a human can perform certain tasks. For example, a doctor can only visit one patient at a time so many times per hour and a classroom can only get so big before we lose the quality of the labor we are paying for. Even now, most of our society agrees that doctor visits are too short and classes are too crowded. As for the building industry, most aspects of construction is hands-on. Also, a portion of that labor is highly skilled and those workers must be well paid for their skills in order to attract them, if they can even be found. And while other industries like childcare often employ less specialized workers, it would be detrimental to our children if we allow the ratio of babies to caretaker increase above the current ratio of 3:1 in our daycares.
I’m not sure what we can do as a society to quell these rising costs. The lack of innovation and growth isn’t the only thing causing prices of housing, education, childcare and medical care to rise; but a deeper understanding of the factors that got us to where we are today can help us grasp why it’s so much harder for this generation than the last few before us to make a middle class life for ourselves. Because we know that the problem isn’t just indulging in too much avocado toast.