Leo的恒河沙

The Meaning, Roots, Manifestations, and Impact of "Cost Disease" - Huxiu#

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Highlights#

Products with continuously rising costs contain elements of manual operation in their production process, making it quite difficult to reduce labor content. ⤴️ ^456aae62

The substitutability of labor and the professionalism and personalization of services significantly affect the manifestation and severity of "cost disease". ⤴️ ^f2a2beb3

The planning and process design we do at work, as well as SOPs, are actually aimed at reducing the variables brought about by human labor, which is essentially dealing with cost disease.

The products and services most easily affected by "cost disease" include some of the ultimately important aspects of civilized society: education, healthcare, arts, etc. As the economy and society develop, these services become increasingly important to people. ⤴️ ^e06e4226

Moreover, when personal services become too expensive, most consumers choose to forgo them. However, as long as their income increases, people seem willing to pay for increasingly expensive services. ⤴️ ^0ff09ccb

This may also be one of the reasons for the continuous rise in wages in developed countries. What we need to do is raise personnel wages, so the cost of mass-produced items will decrease, including standardized products like cars and phones, while wages for people will increase, and the prices of things that require labor input will become more expensive, such as in the service industry.

For "cost disease," we should pay more attention to low-income groups, as they are the most severely affected by "cost disease." ⤴️ ^715fdda0

I cannot become a low-income group.

The Meaning, Roots, Manifestations, and Impact of "Cost Disease"#

This article discusses the meaning, roots, manifestations, and impacts of "cost disease." By analyzing the differences in productivity growth and demand increases, it explains why the prices of certain service industry products continue to rise, putting pressure on consumers. The article also mentions the impact of "cost disease" on low-income groups and the policy measures that governments should take.

• 💸 Differences in productivity growth lead to continuous price increases for certain service industry products.

• 💼 Low-income groups are the most severely affected by "cost disease."

• 🏥 The government should take appropriate measures to reduce healthcare costs and ensure the welfare of low-income groups.

Since the Industrial Revolution, the productivity improvements brought about by technological advancements have greatly enhanced the living standards of people around the world. Generally speaking, both the accumulation of physical capital and labor face the law of diminishing marginal returns, meaning that as the accumulation of physical capital increases, its contribution to output growth becomes smaller.

The Solow model has described this well. A simple example is that computers can enhance our work efficiency, but basically, one computer per person is sufficient; purchasing more computers does not significantly improve work efficiency and may even reduce it due to distraction, resulting in negative marginal returns for physical capital accumulation. Therefore, for sustained economic growth, productivity must continue to improve, meaning that a certain amount of physical capital and labor can produce increasingly more products.

Overall, many rapidly developing economies have experienced sustained productivity growth; however, the economy consists of multiple different sectors, and upon closer inspection, productivity growth is not synchronized across different sectors.

For example, a very obvious phenomenon is that productivity growth in manufacturing is relatively fast, while productivity growth in certain service industries is slower. Taking car manufacturing and hairdressing as examples, due to technological advancements and the widespread use of robots, the efficiency of car production has rapidly increased, with many car manufacturers achieving automation levels of over 99%; however, for hairdressing, the situation is completely different. Although some hairdressing tools have improved efficiency, overall, the efficiency gains in hairdressing are very limited. The differences in productivity growth between sectors have significant economic implications; even for two seemingly very different sectors like car manufacturing and hairdressing, the differences in productivity growth have far-reaching significance.

The late economist William Baumol and his collaborators deeply analyzed the economic implications of the differences in growth rates across different sectors in their book "The Cost Disease: Why Services Are Rising in Price." They systematically elaborated on the concept of "cost disease" or "Baumol's disease," detailing the roots of "cost disease," its impacts, and how to effectively respond to it.

The Chinese title of this book is quite interesting and apt; isn't economic growth a good thing? Where does the trouble come from? Baumol explains the troubles brought about by economic growth through the lens of "cost disease." Baumol conducted extensive research in areas such as innovation, industrial organization, and economic growth, and he has written a wealth of literature. During my doctoral studies, I read many of Baumol's papers and used his concept of "cost disease" to study issues related to economic structural transformation and inflation. Years later, reading Baumol's book again still provides significant insights.

1. The Meaning and Causes of "Cost Disease"

A macro perspective is an important dimension for analyzing economic issues, but for many problems, a structural perspective must be adopted; otherwise, one may fall into the trap of seeing only the forest and not the trees. There is a fact in the economy that the speed of productivity growth varies across different production sectors; at the same time, there are also significant differences in the degree of price growth for different products. A representative example is that the prices of some manufacturing products continue to decline, while the prices of service products keep rising.

So, does the difference in productivity growth affect the difference in price growth? The answer is yes; in fact, the differences in productivity growth are the root cause of "cost disease." Research by 2018 Nobel laureate William Nordhaus indicates that in industries that can be well measured, productivity differences can explain 85% of the relative price differences.

In simple terms, "cost disease" refers to the fact that products from sectors with slower productivity growth see their prices rise faster, leading to increasing costs for consumers in those sectors.

A vivid example can illustrate this logic: suppose there are two sectors in the economy, called A and B, where sector A experiences rapid productivity growth, and sector B experiences slow productivity growth. Given the same capital and labor, the products produced by sector A will increase more quickly, while those produced by sector B will increase significantly slower; for labor, because productivity in sector A is growing rapidly, wages will also rise quickly. If given enough time, labor can freely move between sectors, then the wages in sector B will also keep pace with those in sector A; otherwise, under the attraction of higher wages, labor will flow from sector B to sector A. However, it is important to note that while wages in sector B will rise at the same rate as those in sector A, the wage growth in sector B is not the fundamental reason for the rising prices of its products. The root cause lies in the slow productivity growth in sector B, which leads to insufficient increases in product output. If sector B had productivity growth similar to that of sector A, even if wages increased, the underlying foundation would be rapid productivity growth, and ultimately, product prices might not rise, or even decrease.

Generally speaking, manufacturing can utilize machine production, leading to rapid productivity growth, while service industries, especially those requiring human input, experience slower productivity growth. As the author states in the book, ==products with continuously rising costs contain elements of manual operation in their production process, making it quite difficult to reduce labor content== because if labor input is reduced, the final product may not be produced, or the quality of the product may decline; whereas products with falling prices can primarily be produced through processes that can be more easily automated.

2. The Structural Characteristics of "Cost Disease"

The reasons for "cost disease" are easy to understand, but we can easily cite counterexamples. There are many labor-intensive service industries where labor wages are not high, and even the growth rate is slow. For example, the cleaning staff who work hard for our urban environment do not earn high wages, so from the perspective of final service costs, they do not appear particularly expensive. This involves the question of whether the labor in certain services is easily substitutable.

If a service industry requires human input and this input has strong professionalism and personalization characteristics, then "cost disease" is likely to emerge in that field; conversely, if the labor input threshold for a certain service industry is low and the final service is homogeneous, with strong substitutability among different labor forces, even if productivity in manufacturing and other sectors grows rapidly, wages in this industry are unlikely to rise in sync. The author does not discuss this issue in the book, but it is clear that ==the substitutability of labor and the professionalism and personalization of services significantly affect the manifestation and severity of "cost disease."==

The discussion of "cost disease" above primarily starts from the supply side; in reality, demand also plays an important role. A very obvious phenomenon during economic development is that as income levels rise, people's demand for specialized and personalized services significantly increases, which leads us to the next discussion of the demand causes of "cost disease."

3. The Demand Causes of "Cost Disease"

Before the Industrial Revolution, the productivity growth of global economies was very slow, and the differences in growth rates across different sectors were not significant. At that time, "cost disease" was not a serious issue, and there was even no such problem as "cost disease."

The Industrial Revolution marked a watershed in human social development. After the Industrial Revolution, productivity in the manufacturing sector experienced rapid growth, while some labor-intensive service sectors saw slower productivity growth, leading to the emergence and increasing severity of "cost disease." The higher the productivity, the more pronounced the "cost disease" becomes. If you visit some developed countries, you will find that the prices of manufacturing products are very low, while service products are much more expensive than in our country.

However, there is a problem: if the prices of these service products rise rapidly, can consumption be reduced or avoided? If so, then "cost disease" would not attract widespread attention; in fact, in the case of reduced demand, "cost disease" would not be so apparent. But as the author points out in the book, ==the products and services most easily affected by "cost disease" include some of the ultimately important aspects of civilized society: education, healthcare, arts, etc.== As the economy and society develop, these services become increasingly important to people.

When discussing the prices of certain products and services, talking only about supply without mentioning demand is like telling only half of a story; after all, it is the combination of supply and demand that determines the equilibrium price. People's demand structure is not static; as income levels rise, the demand for services will significantly increase. The consumption of material products involves the relationship between people and things, and at certain income levels, the consumption of goods can bring significant utility; for service consumption, it involves the relationship between people, and once income levels reach a certain stage, the utility brought by service consumption will be even greater.

When supply grows slowly while demand continues to rise, the end result is continuous price increases, with the increase in demand further amplifying the price rise. The author writes in the book: "Most of our needs and desires, such as the demand for food and clothing, will ultimately be satisfied through productivity improvements and declining commodity prices. Moreover, when personal services become too expensive, most consumers will choose to forgo them. However, as long as their income increases, people seem willing to pay for increasingly expensive services."

Taking healthcare as an example, from the experience of global economies, there exists a concept known as the "first law of healthcare economics," which states that there is a significant positive correlation between per capita GDP and per capita healthcare expenditure. As people's income levels rise, they become increasingly concerned about health, and their spending on healthcare also increases. In economic terms, the income elasticity of these services is even greater than 1.

In the book "The Great Reversal: Aging, Inequality, and Inflation," co-authored by Charles Goodhart and Manoj Pradhan, it is argued that as the population ages, the demand for healthcare and caregiving will significantly increase, and these service industries require substantial human input, which machines cannot replace. In the context of a declining young population, this may ultimately lead to high inflation. In fact, the "cost disease" proposed by Baumol and others is also a manifestation of inflation, just viewed from another angle.

Various cultural performances are also a clear example of slow productivity growth. As people's income levels rise, the demand for culture, entertainment, and performances significantly increases, yet the number of people required for many performances has not changed much over the centuries. Mozart's quartet requires two violins, one viola, and one cello; many years ago, it required four people to perform, and it still requires four people to perform today.

4. The Other Side of "Cost Disease"

From a dialectical perspective, everything has two sides. If you only perceive the good side of something, it is likely that the bad side has not drawn your attention, or the bad side is being borne by others.

"Cost disease" also has two sides: one side is that the prices of products in sectors with slow productivity growth continue to rise, while the other side is that the prices of products in sectors with rapid productivity growth continue to decline. For individual consumers, if the goods consumed are normal products, the decline in prices will encourage consumers to consume more, thereby improving their welfare levels; but there is another side to this. For the entire country and humanity, as the production of material products increases, there will be significant pressure on resources and the environment. Many of the environmental problems we currently face are generated during the production and consumption of material products, and such examples seem to be numerous. The paradox lies here: rapid productivity growth brings significant benefits, but at the same time, it also creates many problems that cannot be ignored.

The author cites the example of the AK-47 rifle, where the continuous decline in the price of the AK-47 assault rifle allows this weapon to be obtained at a lower cost, thereby exacerbating terrorism. The author quotes a statement: "The AK-47 assault rifle is 'the most produced and effective combat weapon in the world; this killing machine is very cheap and easy to obtain; in many countries, an AK-47 assault rifle costs even less than a live chicken.'" In fact, it is the other side of "cost disease," namely the significant increase in productivity in the weapons manufacturing sector, that allows terrorists to acquire weapons at very low prices, leading to occasional terrorist attacks that pose a significant threat to human life.

From an environmental perspective, consumerism is a phenomenon that almost every economy experiences during its development. If we think carefully about ourselves, many people are still in a stage of consumerism, considering our attention to events like "618 Shopping Festival" and "Double 11." More and better quality material products directly and effectively enhance our utility and welfare.

As productivity increases, the prices of many consumer products decline, at least for a period of time, and increasing the consumption of these products will significantly enhance people's welfare levels. Although productivity continues to improve, producing these products still consumes various resources, and the various waste generated during and after consumption puts new pressure on the environment. The book "Resilient Business Models" that I translated delves into this issue and seeks to reduce the destructive impact of human consumption activities on the environment by constructing a circular economy model.

5. Will "Cost Disease" Make Certain High-Cost Services Unaffordable?

An important purpose of discussing "cost disease" is to clarify its economic implications, specifically how much burden it can impose on people. Overall, rapid productivity growth will raise people's income levels; even if the prices of some service products rise faster, people can still afford them. From this perspective, "cost disease" does not seem to be a significant problem. However, a one-size-fits-all approach may overlook many issues. Just as we adopted a structural perspective when analyzing the roots of "cost disease," we need to look at problems structurally; after all, not everyone's income growth levels are the same, or else inequality would not exist.

For high-income groups, a significant rise in service prices is not an issue. What is worth noting is that in some economies, as income levels rise, the problem of inequality is also worsening, which means that the income growth of low-income groups is very slow, and for them, continuously and rapidly rising service prices become an inescapable shadow. Some services, such as cultural performances, are not essential for low-income groups, and they can choose not to consume if prices rise; however, some services, such as healthcare, cannot be avoided even if prices are high. Serious illnesses inevitably require hospital visits, and exorbitant medical costs can be daunting, even unbearable.

The enormous medical expenses impose a disproportionately large burden on low-income groups. The phenomenon of falling into poverty due to serious illness is quite common even in the United States. The book mentions a statistic: "In 2005, at least half of the bankrupt American families were caused by medical accidents and catastrophic medical expenses," which has made ensuring medical services for ordinary citizens a major concern for governments worldwide. Public healthcare expenditure has also become an important component of fiscal spending.

Therefore, we should pay more attention to low-income groups regarding "cost disease," as they are the most severely affected group. So, how should this problem be addressed? The most direct idea is that the government should take appropriate policy measures to reduce healthcare costs for low-income groups, providing certain guarantees through subsidies, insurance, etc., to ensure that these individuals do not fall into hardship due to medical issues. Additionally, the government should also take appropriate measures to raise the income levels of low-income individuals to avoid excessive disparities in income and wealth distribution in the economy, which is the fundamental solution.

6. Unnecessary Aspects of "Cost Disease"

Some price increases in "cost disease" are unavoidable, while others are not entirely necessary. The author mentions in the book: "The explosive development of medical technology has greatly enhanced doctors' diagnostic capabilities and provided them with more new treatment options; however, the continuous emergence of new medical equipment and technologies has also increased the costs of healthcare services." The emergence of new technologies and equipment is beneficial for patients who genuinely need them, and even if it raises healthcare costs, it is worth it. However, for patients who do not need them but are subjected to unreasonable applications, it becomes an unnecessary burden. For example, if a patient's illness can be clearly diagnosed through symptoms, they should not be subjected to additional instrument checks that only increase their expenses.

The author quotes an interesting statement from a doctor: "I sometimes joke that if you come to our hospital and say you are missing a finger, no one will believe you unless we do a full set of CAT scans, MRIs, and orthopedic consultations." This humorous yet ironic statement conveys a very clear message: some medical services are unnecessary, and over-medicalization causes patients to incur many unnecessary costs.

Many of us have had personal experiences of over-medicalization. When going to the hospital, regardless of the department, one generally has to undergo a series of instrument checks. Some of these checks are necessary, but others can be completely avoided, and importantly, the costs of these checks are high. Furthermore, in different hospitals, for the same illness, the relevant checks done in the previous hospital may not be recognized by the next hospital, requiring the same checks to be done again. This is not just a "cost disease" issue but an unreasonable requirement. What complicates matters is that medical services are highly specialized and have a strong information asymmetry, making it difficult for laypeople to judge which checks are necessary and which are not; patients can only follow the doctor's arrangements.

Health insurance also plays a role in increasing medical costs. Normally, the role of health insurance is to reduce consumers' medical expenses, but some insurance clauses require certain standards to be met for reimbursement, such as needing to be hospitalized or having medical expenses reach a certain amount. This may incentivize patients to engage in unnecessary medical consumption, wasting limited medical resources, and ultimately, consumers may not see a reduction in their medical expenses.

To avoid high medical expenses, we are gradually realizing that it is better to prevent problems than to deal with them after they occur. We should pay more attention to our health in our daily lives and work, adopting healthy lifestyles and diets, such as increasing exercise and eating lighter foods. Although getting sick is always unavoidable, a healthy lifestyle can prevent certain diseases. A statistic mentioned in the book states that by 2023, if everyone adopted a healthy lifestyle, it could save over $2 trillion in healthcare costs.

Rapid productivity growth is almost a goal pursued by all economies; only with continuous productivity improvement can sustained economic growth occur. However, while enjoying the benefits brought about by productivity improvements, the differences in productivity growth between different sectors have also led to the problem of "cost disease," especially with the continuous rise in prices for products in certain service sectors, putting significant pressure on consumers' lives and public fiscal expenditures.

The consumption of material products can enhance our quality of life, but the consumption of services may be even more important for our quality of life. However, relying solely on the market cannot solve the "cost disease" problem, which seems to be an example of market failure. Therefore, government departments need to take appropriate measures to mitigate the negative impacts of "cost disease" on our lives, especially for rigid demand services like healthcare and elderly care, to avoid creating a world where material products are abundant, but the services needed to maintain a high quality of life continue to deteriorate. Additionally, it is crucial for the government to recognize the internal mechanisms behind the emergence of "cost disease" to avoid adopting inappropriate policy measures that lead to counterproductive results.

This content represents the author's independent views and does not reflect the position of Huxiu. Reproduction without permission is prohibited; for authorization matters, please contact hezuo@huxiu.com
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