The Curse of Material Progress
Confronting cost disease
Risk & Progress| A hub for essays that explore risk, human progress, and your potential. My mission is to educate, inspire, and invest in concepts that promote a better future for all. Subscriptions and new essays are free and always will be. Paid subscribers gain access to the full archives.
A disease, one that threatens to spread throughout our socioeconomic and political systems, is growing. This disease is a cancer that has the potential to stifle future prosperity by misallocating limited resources and stunting productivity. Here, we look at “cost disease,” how it manifests, and why most prescriptions offered by policymakers only further feed the disease to the detriment of our future.
What is Cost Disease?
William Baumol observed that differences in productivity growth in various sectors of an economy can cause the cost of goods/services in those sectors to inflate rapidly over time. He used the example of a string quartet to explain this phenomenon. Violinists today are no more productive than those of a century past; a string quartet still requires four musicians. Yet, despite no improvement in productivity, musicians today are paid significantly more than those in the 19th Century.
On the surface, this appears irrational. But to assemble a quartet, one must still hire musicians. Their compensation is determined, not on the marginal value of their work as musicians, but instead on the opportunity cost lost by not taking more productive jobs. As a consequence, sectors of the economy that are disproportionately labor-intensive will tend to become more expensive relative to those that are not.
For the purpose of this article, I am going to expand the definition of Baumol’s cost disease to include any sector of the economy where demand is inelastic and supply/productivity is artificially restricted. With this expanded definition, four sectors of the economy stand out as afflicted by cost disease: healthcare, higher education, housing, and childcare.
Cost disease is the curse of highly advanced and developed economies. Ironically perhaps, in the United States, healthcare ranks among the most diseased. Beyond the issues that I identified in a prior essay, healthcare has deep, structural constraints that greatly limit the productivity of the sector. Federal limits on physician-owned hospitals, for example, and state-level requirements for Certificates of Need, give incumbent hospital systems the power to block new hospitals from purchasing equipment and effectively stifle competition.
In addition, the US greatly restricts the supply of physicians by requiring that they undertake at least eight years of expensive post-secondary education and then an additional three to seven years of training in residency; in Europe, a medical degree can be obtained in six years. Furthermore, because of these stringent, perhaps overzealous, requirements, foreign practitioners are largely barred from US practice.
In higher education, a teacher is still required to teach a small classroom of students; little has changed since the 19th Century. Government efforts to make education affordable have exacerbated the problem, further inflating tuition prices. Government-subsidized loans have aided an explosion in administrative staff, with some universities now having more staff than students. We will revisit this in a moment.
I have already discussed the issues with the housing sector at length, so I will not repeat them here. But in short, overzealous zoning regulations in much of the nation now prohibit high-density housing and restrict where new housing may be built, creating an artificial limit on the supply of homes. The supply/demand mismatch is the primary cause of high housing prices in many parts of the world today.
Lastly, with childcare, here again, there is inelastic demand coupled with a supply of caregivers that is greatly restricted by the legal and natural constraints governing the ratio of caregivers to children. As the economy becomes more advanced, caregivers might become no more productive, but their pay must rise to compensate them for not taking more productive jobs elsewhere.
When something important like healthcare or childcare becomes difficult to afford, the knee-jerk reaction of the government is to subsidize it, either by redistributing taxpayer funds and/or borrowing those funds from the future. The problem is that subsidization will increase the demand for these goods and services, obscuring the price signals that would normally (we hope) ease the problem and instead exacerbate the disease.
Furthermore, it achieves this by redirecting hard-earned tax money away from productive sectors of the economy toward less productive ones. This means that limited resources are increasingly being directed toward non-productive parts of the economy, suffocating growth and human capabilities across the board.
Worse still, remember that the government will not subsidize just any daycare, school, or hospital. Naturally, funding will come alongside regulation to ensure that the recipient of those funds meets a minimum standard of quality and care. But since such regulations will naturally favor incumbent industry players (which are already not very productive by definition), the subsidies could “lock in” the unproductive environment that gave rise to calls for subsidies in the first place.
What begins is a kind of cost disease “Red Queens Race” where we must ramp up subsidies in perpetuity to keep up with rising costs. Directing a larger and larger share of total resources toward relatively non-productive sectors of the economy. In other words, throwing good money after bad.
As previously mentioned, this has already happened already in higher education. The rise in tuition prices was “solved” by government-subsidized student loans that were only available to accredited institutions. But cost disease didn’t improve, it got worse as demand was further fueled. Indeed, it has metastasized so badly that the very beneficiaries of these loans are now clamoring for debt cancellation and to be released from them.
Healthcare is not far behind. Healthcare is already subsidized through a variety of ad hoc programs such as Medicare, Medicaid, and ACA exchanges. Now, as the disease further metastasizes, credit bureaus are beginning to ignore unpaid medical bills; just another form of “forgiveness” that merely shifts the burden of inflating costs onto others.
I have compared cost disease to cancer for a reason. Cancer is merely the uncontrolled growth of cells in the body that eventually kill the host. Cost disease is an economic cancer, one that continues to grow and spread, sapping resources from everything else, dragging down growth, productivity, and human progress with it.
Indeed, you’ve probably noticed by now that the diseased sectors don’t act independently; cost disease in one sector spreads to the other. Healthcare is expensive, in part, because higher education is expensive. Higher education is expensive because professors must pay inflated prices for childcare…and so on.
Instead of merely papering over the problem and feeding the disease, we need to confront the lack of productivity and supply at the source. In healthcare, for example, we can reduce artificial limitations on the number of physicians and abolish Certificates of Need. Coupled with the Risk-Adjusted Vouchers that I described here, care could be both affordable and universal.
In higher education, we could end government-subsidized loans and turn to financing education through equity instead. This would shift all risk off of the student and incentivize schools to offer cost-effective programs that lead to good-paying jobs.
In housing, we need to address supply by abolishing Euclidean Zoning, which restricts land by use type, and by legalizing higher density housing, perhaps along the model of “Form-Based Codes,” as I described here. When this is coupled with a Land Value Tax, the literature suggests, housing prices would decline significantly, as would wealth inequality.
Finally, with child care, we could relax regulations on home daycare centers, removing licensure requirements for centers with few children. Beyond this threshold, licensure and inspections would still be required, but there should be no need for overzealous credentials, such as requiring caregivers to become Registered Early Childhood Educators.
All Roads Lead to Fertility
Cost disease is not merely an economic problem, it’s a social affliction. Astute readers will recognize that the high cost of housing, education, childcare, and healthcare are often fingered as the primary reason families opt to have fewer children. In other words, all roads lead to lower fertility. The heavier the burden on families, either directly or indirectly, the fewer children they will have. This, as I discuss here, has dire consequences for the future of humanity. It is essential that we tackle cost disease at its root causes to ensure continued growth and progress.
You also may like…