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I'll take a stab at trying to explain it. :) First off, let's consider an economy with a single good (widgets), and no services. Any attempt to measure the e

by Lazare 10y ago

I'll take a stab at trying to explain it. :) First off, let's consider an economy with a single good (widgets), and no services. Any attempt to measure the economy as a whole (eg, to calculate GDP) is simply going to end up being the number of widgets produced per year. Further, the total compensation for all factors of production is going to be equal to that same number, which in turn means that any employee's compensation (whatever unit of currency is used) translates into a share of the widgets being produced. If everyone gets more efficient at producing widgets, the economy is wealthier (and GDP goes up). And each employee is (all else equal) receiving more widgets as their share. Conversely, if we assume that nominal wages have stayed constant, the price of widgets has gone down. So that's a basic framework we have: Productivity gains = a fall in real prices = a growing economy = an increase in employee compensation. These are all equivalent things; different sides of the same coin. If we're getting better at making widgets, then widgets will be cheaper, which means we can afford more widgets for the same amount of (real) money. That's what economic growth is. Second, let's consider an economy with two goods: Widgets and sprockets (and again, no services). Let's say half the work force is busy making widgets, and the other half is busy making sprockets. If we get better at making both, but we become much better at making widgets, then the price of widgets will start to collapse. Where 1 widget used to barter for 1 sprocket, soon it'll take 10 widgets to barter for 1 sprocket. Which is another way of saying that the price of sprockets will rise steeply. That's Baumol's Cost Disease. If you have multiple items, and they experience different productivity growth, the ones which experiences relatively lower productivity growth will become relatively more expensive. In addition, if you want to take the widget and sprocket example a step further, you might wonder what happens if productivity gains mean we're making more widgets than we strictly need. We'd probably see layoffs, as productivity gains mean fewer and fewer people are required to produce the widgets the economy needs. And of course the people left would probably earn very good wages, since they get to share the returns from the entire widget industry. Although given the high price of sprockets, they might not feel that rich. But where would the laid off people go? Well, into the sprocket industry; it's lower productivity means it can soak up more manpower. But with the returns from the sprocket industry split across more people, wages would be lower. Luckily, those wages would go further when purchasing cheap widgets, but high-price sprockets would be harder to obtain. Which is, if you squint a bit, basically what we see, with widgets taking the place of the manufacturing sector, and sprockets the services secotr. US manufacturing output is high and (the financial crisis aside) keeps getting higher; US manufacturing employment is low and keeps getting lower. Manufactured goods are cheap and getting cheaper; services are expensive and getting more expensive. Skilled engineers command excellent wages, but struggle to find material goods to spend it on. Workers in the service sector suffer from low wages, although their material standard of living is still good. Etc., etc. Sound familiar? Productivity gains are always a net good in total, however distributed. But the skewing effect of unequal productivity gains can be extremely wrenching. Telling someone that, actually, the machine shop they worked in is closing, but they can retrain as a hairdresser doesn't make people happy. Nor does pointing out that, even on the wages a hairdresser makes, they can afford a larger flat screen TV than the one they bought three years ago. They don't want a bigger flat screen TV; the last one is actually fine. They don't want to be a hairdresser with a giant flat screen TV; they want to be a machinist. With affordable health care. But that would require figuring out how to make sprockets as efficiently as we've figured out how to make widgets, and we haven't done that yet. (Although the US does seem uniquely bad at it, so maybe we can at least try to be less bad...)

lr4444lr 10y ago
Thank you. This helps me better articulate the thorn still stuck in my side. Putting together paragraph 2 and paragraph 4 from your response, why don't the following things happen: The widget company owner starts laying off widget makers to increase profit he can get the same output. Is there no diminishing margin utility for buying more widgets? Paragraph 2 by itself implies that the cost of widgets falls, if wages aren't rising and these increased widgets are being purchased. There's got to be some movement in one or both of cost and salary metrics in order to increase widget consumption if the employer is going to ramp up production so long as the net cost of each widget is positive. What's the incentive otherwise to greater production even if the capacity is there? Paragraph 4 adds another good with these same questions I didn't feel the article answered well, and introduces the variable of product exchange rates. What unsettles me here is the obfuscation between the total resources poured into the industry and the per-person expenditures, especially in service-oriented work where the productivity isn't simply "widgets" or "sprockets". Teaching is a great example: the number of teachers (in the US) increased about 48% from 1988 - 2012 but the population increased 29%. Did we get voluntarily make education "less productive" by increasing the decreasing the student:teacher ratio? Did we get better educational quality for it? Not so easy to say. Could it not be that musicians were paid more by the mid-20th century because there a longstanding oversupply had been steadily declining due to cultural factors, or that concert financiers realized people valued and would pay more for music than had been assumed, i.e. basic supply and demand equilibration? I'm trying not to be ornery or argumentative, I'm just having a hard time understanding what Baumol's assumptions were on these points, and I think they're important.
- Lazare 10y ago
  > The widget company owner starts laying off widget makers to increase profit he can get the same output. Is there no diminishing margin utility for buying more widgets? In the simple example where widgets are the entire economy, this doesn't work, because profit is defined in terms of widgets, and because we can assume that there's no diminishing marginal utility for economic production as a whole. At the level of the entire economy, you never become richer by cutting production. (Because again, if the only good or service in the economy is a widget, then you have no way of expressing your profit or wage except in the number of widgets you have. If total production declines, the only way for you to increase your compensation is by obtaining a larger share of the overall pie.) For the more complex example with widgets and sprockets, there's absolutely diminishing marginal utility; I dealt with this in the passage starting "you might wonder what happens if productivity gains mean we're making more widgets than we strictly need. We'd probably see layoffs". And in general we can assume that goods will suffer much more sharply diminishing marginal utility than services. That, in turn, is what drives the shift in employment from more productive industries (which is another way of saying "industries which don't need as many people any more to fill societal demands") to less productive industries. If it helps, consider the earlier shift from agriculture to manufacturing: Around 50-150 years ago, we saw an incredible increase in productivity, a very very small increase in per capita food production, a very large drop in food prices, a very large drop in the % of income the average person spent on food, and the utter gutting of agricultural employment. New technology gave us the power to make 40 times more food than we were previously making, or the same amount of food with 1/40th the people. And at the big picture level, that freed up labour ended up in manufacturing, which had not yet had the same productivity increase. That's a good example of what Baumol's theory would predict. Does that make sense to you? Does your understanding of the theory suggest it would predict something else? > Did we get voluntarily make education "less productive" by increasing the decreasing the student:teacher ratio? Did we get better educational quality for it? Yes, we did lower productivity. And no, not really. But keep in mind, that when we say productivity here we're talking about labour productivity, so increasing employment will (basically) always lower productivity.

by Lazare 10y ago

lr4444lr 10y ago

Thank you. This helps me better articulate the thorn still stuck in my side. Putting together paragraph 2 and paragraph 4 from your response, why don't the following things happen: The widget company owner starts laying off widget makers to increase profit he can get the same output. Is there no diminishing margin utility for buying more widgets? Paragraph 2 by itself implies that the cost of widgets falls, if wages aren't rising and these increased widgets are being purchased. There's got to be some movement in one or both of cost and salary metrics in order to increase widget consumption if the employer is going to ramp up production so long as the net cost of each widget is positive. What's the incentive otherwise to greater production even if the capacity is there? Paragraph 4 adds another good with these same questions I didn't feel the article answered well, and introduces the variable of product exchange rates. What unsettles me here is the obfuscation between the total resources poured into the industry and the per-person expenditures, especially in service-oriented work where the productivity isn't simply "widgets" or "sprockets". Teaching is a great example: the number of teachers (in the US) increased about 48% from 1988 - 2012 but the population increased 29%. Did we get voluntarily make education "less productive" by increasing the decreasing the student:teacher ratio? Did we get better educational quality for it? Not so easy to say. Could it not be that musicians were paid more by the mid-20th century because there a longstanding oversupply had been steadily declining due to cultural factors, or that concert financiers realized people valued and would pay more for music than had been assumed, i.e. basic supply and demand equilibration? I'm trying not to be ornery or argumentative, I'm just having a hard time understanding what Baumol's assumptions were on these points, and I think they're important.

Lazare 10y ago
> The widget company owner starts laying off widget makers to increase profit he can get the same output. Is there no diminishing margin utility for buying more widgets? In the simple example where widgets are the entire economy, this doesn't work, because profit is defined in terms of widgets, and because we can assume that there's no diminishing marginal utility for economic production as a whole. At the level of the entire economy, you never become richer by cutting production. (Because again, if the only good or service in the economy is a widget, then you have no way of expressing your profit or wage except in the number of widgets you have. If total production declines, the only way for you to increase your compensation is by obtaining a larger share of the overall pie.) For the more complex example with widgets and sprockets, there's absolutely diminishing marginal utility; I dealt with this in the passage starting "you might wonder what happens if productivity gains mean we're making more widgets than we strictly need. We'd probably see layoffs". And in general we can assume that goods will suffer much more sharply diminishing marginal utility than services. That, in turn, is what drives the shift in employment from more productive industries (which is another way of saying "industries which don't need as many people any more to fill societal demands") to less productive industries. If it helps, consider the earlier shift from agriculture to manufacturing: Around 50-150 years ago, we saw an incredible increase in productivity, a very very small increase in per capita food production, a very large drop in food prices, a very large drop in the % of income the average person spent on food, and the utter gutting of agricultural employment. New technology gave us the power to make 40 times more food than we were previously making, or the same amount of food with 1/40th the people. And at the big picture level, that freed up labour ended up in manufacturing, which had not yet had the same productivity increase. That's a good example of what Baumol's theory would predict. Does that make sense to you? Does your understanding of the theory suggest it would predict something else? > Did we get voluntarily make education "less productive" by increasing the decreasing the student:teacher ratio? Did we get better educational quality for it? Yes, we did lower productivity. And no, not really. But keep in mind, that when we say productivity here we're talking about labour productivity, so increasing employment will (basically) always lower productivity.