IN 1946, a British newspaper shocked its readers by running an article with this ominous-sounding headline: "Nearly Half of U.K. Student Grades Are Below Average." Read that back to yourself slowly, and you'll realize, of course, that the law of averages would have it no other way. But man, does it sound bad.
In his new book, "The Cost Disease: Why Computers Get Cheaper and Health Care Doesn't" (Yale University Press) William J. Baumol uses that headline to help us understand his central idea about the diverging paths of certain costs in our economy.
Mr. Baumol and a Princeton colleague coined the term "cost disease" in the early 1960s. Put simply, it refers to the concept that the costs of health care, education, the live performing arts and several other "personal services" depend largely on human evaluative skills — a "handicraft element" that is not easily replaced by machines. These costs consistently rise at a rate much greater than that of inflation because the quantity of labor required to produce these services is hard to reduce, while costs in other areas of the economy can be brought down via technology or other factors What that means, writes Mr. Baumol, a professor at the Stern School of Business at New York University and a professor emeritus at Princeton, sounds pretty frightening: "If health care costs continue to increase by the rate they have averaged in the recent past, they will rise from 15 percent of the average person's total income in 2005 to 62 percent by 2105." In other words, our great-grandchildren will have less than 40 cents of every dollar to spend on everything besides their health. Like the British headline, that surely sounds like cause for alarm.
It's a testament to Professor Baumol's lucid prose, though, that economists and noneconomists alike will find it easy to grasp his surprisingly comforting argument for why we shouldn't panic. In fact, he asserts, we will be able to afford the cost of these services in the future — unless we fail to understand the nature of this phenomenon.
"The critical point here is that because politicians do not understand the mechanism and nature of the cost disease, and because they face political pressures from a similarly uninformed electorate, they do not realize that we can indeed afford these services without forcing society to undergo unnecessary cuts, restrictions and other forms of deprivation," says Professor Baumol, who shares research credit for the book with five other contributors.
How can his point be true? Because productivity is on the rise.
"Although costs of personal services appear to be out of control, they are actually falling in terms of the labor time required to earn enough to pay for them," he explains — in other words, consumers need to work fewer hours to afford them.
This sets the stage for an even more compelling, and paradoxical, point. The biggest threat to our quality of life comes not from these big-ticket items, he says. Rather, it comes from other products — like guns and fossil-fuel-devouring vehicles — that are continually declining in relative cost because less and less work is required to produce them.
"We can afford to pay more for the services we need — chiefly health care and education — and probably will always be able to do so," he writes. Labor-intensive things like police protection, mail delivery, sanitation, legal and funeral services will also continue to stay within our reach, he says. "What we may not be able to afford are the consequences of falling costs: environmental destruction and continual warfare."
As the cost of health care continues to be a battering ram in the 2012 presidential campaign, Professor Baumol's seemingly academic treatise contains a couple of zingers that one can imagine President Obama incorporating into his stump speech. The future is bright, this book argues, as long as policy makers don't do things that are sure to bring on the storm clouds.
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