William Baumol and Equilibrium Imbalance

Among the more notable economists from the 20th century, William Baumol is at the top of the list. It's a shame Baumol didn't win a Nobel prize, and he will be greatly missed. In recent years, I've come to realize how the "cost disease" which bears his name, is important for my own "work path", as well. Could purposeful activity along the margins of general equilibrium, help to overcome economic stagnation?

Yet perhaps it is fitting, how Baumol's confidence in the present day economy, prevented him from dwelling too extensively on this "unsolvable" problem. He highlighted the intractable nature of the cost disease fifty years ago, in Macroeconomics of Unbalanced Growth: The Anatomy of Urban Crisis. Here, I'll borrow Dietrich Vollrath's version of a quote from Baumol's paper, as it neatly condenses some of what I wish to emphasize:

If productivity per man hour rises cumulatively in one sector relative to its rate of growth elsewhere in the economy, while wages rise commensurately in all areas, then relative costs in the nonprogressive sectors must inevitably rise, and these costs will rise cumulatively and without limit...Thus, the very progress of the technologically progressive sectors inevitably adds to the costs of the technologically unchanging sectors of the economy, unless somehow the labor markets in these areas can be sealed off and wages held absolutely constant, a most unlikely possibility. We then see that costs in many sectors of the economy will rise relentlessly, and do so for reasons that are for all practical purposes beyond the control of those involved...If their relative outputs are maintained, an ever increasingly proportion of the labor force must be channeled into these activities and the rate of growth must be slowed correspondingly.

First, it's probably a good idea to note some variations in language use. Baumol refers to services (which include time as final product) as nonprogressive sectors, versus the labour included in tradable sectors as progressive sectors. Recall that Adam Smith, for instance, simply referred to the labour output of services (with no tangible product) as unproductive labour, as opposed to the productive labour of tradable product. However, common designations in these discussions, tend to focus on tradable sector versus non tradable sector outcomes, rather than emphasizing aspects of labour such as quantity or purpose. Regarding tradable and non tradable sector activity in this context, Dietrich Vollrath noted in (the above linked) "Understanding the Cost Disease of Services", the Balassa/Samuelson effect, where he writes:

For my money, the biggest insight Baumol had was to notice the differential in how labor matters to production in goods and services. The subsequent logic, by itself, is not a major breakthrough. The Balassa/Samuelson effect - developed by those authors in articles published in 1964 - is the same idea. They distinguish between tradable and non-tradable goods, rather than goods and services per se, and they are thinking about a cross-sectional comparison of countries, rather than one country in time, but the outcome is identical. Countries that are very productive in tradable goods will tend to have high aggregate price levels (an empirical regularity known as the "Penn effect"), as that productivity drives up costs in their non tradable sectors.

Vollrath added that labels matter, because after all, Baumol's cost disease is a result of incredible affluence. He reasons that given this reality, affluence as such doesn't need a "cure". So far as labels are concerned, it also helps to distinguish the aspects of non tradable sector activity which are more closely correlated with time based product. To this end, I've included primary and secondary market categories, by which to further distinguish labour functions in their wealth creation roles. Among the reasons this distinction helps me, is that real estate as a "nonproductive" feature, occurs for different reasons and includes different sets of dynamics, than the time based productivity issues of healthcare and education.

Real estate in the form of land and housing, tends to capture the nominal income of both tradable and non tradable sectors. Indeed, real estate (as a primary cost of economic access) likely bears considerable responsibility for the diffusion of productive tradable sector income across other categories. In this sense, housing and land provide a strong correlation for nominal income, even though they are not its entire representation. Today, central bankers are reluctant to encourage additional growth in nominal income, and equilibrium imbalance might be one of the reasons. This is one reason why I've experimented with an alternative equilibrium scenario, which could provide a representation between local income, real estate and land use which need not depend on the standard wage requirements of general equilibrium conditions.

Reading Baumol's paper from 50 years earlier, one is struck by what has changed, and what remains the same. While he was particularly concerned with imbalances at local levels and the problems they posed for municipalities, those imbalances have gradually become more problematic for nations as well. Doubtless, some of this is related to misguided efforts to coordinate time based healthcare product via centralized and national terms, particularly in the U.S. Nevertheless, Baumol fully understood the eventual possibility of economic stagnation - even then - for he writes:

Our model tells us that manufactures are likely to decline in relative cost and, unless the income elasticity of demand for manufactured goods is very large, they may absorb an ever smaller proportion of the labor force, which if it transpires, may make it more difficult for our economy to maintain its overall rate of output growth.