CAMBRIDGE – As the world watches the United States grapple with its fiscal future, the contours of the battle reflect larger social and philosophical divisions that are likely to play out in various guises around the world in the coming decades. There has been much discussion of how to cut government spending, but too little attention has been devoted to how to make government spending more effective. And yet, without more creative approaches to providing government services, their cost will continue to rise inexorably over time.
Any service-intensive industry faces the same challenges. Back in the 1960’s, the economists William Baumol and William Bowen wrote about the “cost disease” that plagues these industries. The example they famously used was that of a Mozart string quartet, which requires the same number of musicians and instruments in modern times as it did in the nineteenth century. Similarly, it takes about the same amount of time for a teacher to grade a paper as it did 100 years ago. Good plumbers cost a small fortune, because here, too, the technology has evolved very slowly.
Why does slow productivity growth translate into high costs? The problem is that service industries ultimately have to compete for workers in the same national labor pool as sectors with fast productivity growth, such as finance, manufacturing, and information technology. Even though the pools of workers may be somewhat segmented, there is enough overlap that it forces service-intensive industries to pay higher wages, at least in the long run.
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© Project Syndicate