Baumol's Cost Disease

Topics: Economics, Supply and demand, Productivity Pages: 7 (2400 words) Published: August 4, 2012
Current Economic Issues

“Baumol’s cost disease is unpopular with politician from both ends of the political spectrum” Why? Is that? Is Baumol’s cost disease likely to remain relevant to the debate about public services?


This essay examines Baumols’s cost disease giving reasons why it is unpopular with politicians from both ends of the political spectrum, and also presents further salient factors that makes Baumol’s cost disease relevant to debates about public services.

The discussion begins with an analysis of the meaning of Baumol’s cost disease, then looks at the characteristics of the public sector which may include lack of efficiency and low productivity due to being a sector that relies heavily on people and explains how an increase in wage - costs in one sector of the economy such as manufacturing or finance causes rises in wages across the economy in general. This essay then explores the problem(s) that arose from such theoretical standpoints and how the government has used its power to tackle the risk that the cost disease represents for long term economic growth which all countries aim to achieve and maintain.

According to William Baumol's and William Bowen (1966)Baumol’s cost disease theory says there are sectors of the economy such as education, arts, heath care that will have increases in wages not associated with an increase in productivity, whereas in other sectors wages increase as a result of an increase in productivity for example in manufacturing, and through gains achieved through the employment of new technologies.

First of all public services such as education, health service, internal law and order, should be made available to any household independently of their financial situation to prevent inequality. Despite being known as essential to any society either developed or undeveloped these services will not be provided by private investors free of charge, or necessarily to the scale of the country’s needs; as private sector firms aim primarily for profits they don’t take into consideration the country’s needs. Consequently it’s the government’s responsibility to raise revenue from indirect taxes such as VAT, and direct taxes such as national insurance and ensure these goods and service are provided and made available to every household. The government may pay a private company to provide these service however it’s the role and responsibility of government itself to supply such services.

The theory of Baumol’s cost disease applies to the public sector for the fact that even though it’s not efficient and lacks increases in productivity the demand for pay rise(s) are very constant and problematic. Baumol’s used the example that to perform a Beethoven string quartet it’s as necessary to use 4 musicians today and as much time playing as it did in 1800, and the same applies to hospital e.g. to change a bandage, and school and universities that still need the same number or more of people to complete certain tasks e.g. lecturing, marking exam papers etc.

The circular flow of income allow us to understand that the money always finds its way to households that will use it for consumption or saving, and pay taxes to the government who will use it to invest, redistribute, and create public goods and services. Firms, on the other hand, will borrow the saving by paying interest, create jobs and provide households with income in return for their service. Moreover when the economy is doing well, firms will have the incentive to invest and produce and consumer incentive to spend. All this relates directly to aggregate demand or level of spending in the economy and consists of consumption spending plus private investment plus government expenditure on goods and services and expenditure on exports less expenditure on imports. The aggregate demand is used by the government to change the dynamism of the economy and therefore to stimulate the economy the government may decrease...
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