Baumol’s Cost Disease in Times of Rising Income Inequality

Abstract

William Baumol famously introduced the “cost disease” according to which the relative price of services vis-á-vis manufactured goods keeps rising because of a negative productivity differential between services and manufacturing industries. Empirical evidence strongly supports the predictions of Baumol’s model of “unbalanced growth” as we show in this article. Baumol was convinced that the cost disease need not have fatal consequences for growing economies as they can afford to earmark ever-higher shares of GDP to pay for services like healthcare and education if the overall “pie” keeps growing. Then, consumption of goods may rise as well even if its share in GDP steadily declines. However, income inequality has surged since the 1980s; and the rising price of vital services means that lower-income strata may be increasingly unable to pay for them. In this article, we develop the nexus between the cost disease and rising income inequality and sketch the ensuing challenges for social policy.

Citation

Hartwig, J. and Krämer, H.M. (2022), "Baumol’s Cost Disease in Times of Rising Income Inequality", Fiorito, L., Scheall, S. and Suprinyak, C.E. (Ed.) Research in the History of Economic Thought and Methodology: Including a Symposium on the Work of William J. Baumol: Heterodox Inspirations and Neoclassical Models (Research in the History of Economic Thought and Methodology, Vol. 40B), Emerald Publishing Limited, Leeds, pp. 27-48. https://doi.org/10.1108/S0743-41542022000040B004