The interesting implication of Baumol's Cost Disease

Sadly, letters to The Times need to be short:

BAUMOL’S THEORY

Sir, Harry Wallop (“Going shopping? Here’s the proof that you’ve never had it so cheap”, Sep 13) wonders why university, theatre and healthcare have risen in price while women’s shoes, calculators and tennis rackets seem to have fallen. It’s called Baumol’s cost disease. As a society gets richer manufactured items will fall in price relative to services. It’s one reason why the NHS budget has to increase faster than general inflation every year.

Tim Worstall

Senior fellow, Adam Smith Institute, London SW1

It’s the “what do we do next” part of this which is so interesting.

The observation is that wages - the costs of labour - are set by the general level of productivity in the society. Further, that it’s easier to increase productivity in manufacturing via automation than it is in services. For if we can automate it then it’s no longer a service, it’s a manufacture. Thus the value of the embodied labour in those services will rise more than that in manufactures. And rising wages is that very signal, proof perfect, of the increasing richness of the society.

So, services will rise in cost relative to manufactures. And thus Polly Toynbee’s repeated observation that the NHS needs a 4% budget increase every year just to stand still.

OK. But what do we do about it?

We know that the way to increase productivity is via markets and their competition. Thus we need more markets and competition in services than we do in manufactures. That productivity increase is harder, d’ye see, therefore we must make more effort to achieve it.

It’s the very fact that the NHS inflation rate is above the general one that insists we have that competition.