Baumol's Disease isn't inevitable, it's just difficult

Baumol’s Disease is an entirely true observation that gets politically misused. It’s used as the justification for the NHS having its own inflation rate, requiring a 4% real rise in budget each year for example. So too some insist that government should always get ever larger. What government provides is largely services, these will become relatively more expensive over time, therefore we should inevitably have more government over time. Along with the tax bill to pay for it.

This is to slightly abuse the insight. Which is that wages are set by the average productivity of the economy - a truth. It is easier to increase productivity in manufacturing than it is in services. Therefore the labour embeded in services becomes more expensive, over time, relative to that in manufactures. Services become more expensive relative to manufactures. Or, another way of saying the same thing, services have their own, higher, inflation rate than manufactures.

The misuse is in insisting that services cannot be improved in their productivity. That’s not true. It’s just more difficult. And the way to do it - or one way - is to turn the services into a manufacture. As has just happened:

Novo Nordisk today announced the decision to stop the kidney outcomes trial FLOW (Effect of semaglutide versus placebo on the progression of renal impairment in people with type 2 diabetes and chronic kidney disease).

The decision to stop the trial is based on a recommendation from the independent Data Monitoring Committee (DMC) concluding that the results from an interim analysis met certain pre-specified criteria for stopping the trial early for efficacy.

Semaglutide is that same drug that is shrinking waistlines and also, in a different formulation, treating diabetes. The impact here is that this trial shows that it slows to ceases the progression of chronic kidney disease. Meaning that many fewer will need to have dialysis to treat kidney failure.

At which point we can marvel at the information efficiency of markets for the share prices of the major dialysis providers dropped 20% within hours of this press release. That’s the efficient market hypothesis - which, recall, only says that markets are efficient at processing information - tested and rather supported then.

But rather deeper we can see that this is a solution to Baumol’s Disease. We’ve just converted that service of dialysis into a manufacture of an injection. This is a large increase in productivity - we’ve beaten Baumol by converting that service into that manufacture.

All of which is interesting by itself. But it also gives up the political plan. Baumol doesn’t say that increasing services productivity is impossible, only that it’s difficult. That means that we have to apply more effort to that productivity improvement then - difficult things do require more effort. And what system do we know of that increases productivity? Pushes forward innovation? Quite, that’s markets - a result derived from another part of Baumol’s work in fact.

That is, Baumol tells us that the very problem identified, the rising cost of services, is exactly why we must have markets in the NHS. Because that’s the necessary system to overcome that difficulty over productivity.

Isn’t economics fun?