Higher education and healthcare are the only US sectors with persistent price increases, leaving economists and policymakers puzzled during decades of otherwise generally low inflation.
On Monday’s episode of “Macro Musings,” Mercatus Center economist Alex Tabarrok discussed his research into the source of those rising prices.
“Cars are far cheaper in terms of quality, when you measure including quality today. Computers have obviously come down in price. Clothing and shoes have declined in price dramatically,” said Tabarrok, a professor of economics at George Mason University.
“So, we see all these gains, and yet … we see massive increases in the price of education, massive increases in the price of health care – and with other services, typically services. And the question is why. Lots of people, again, have pointed to regulation, government involvement and so forth, and we wanted to take a look at that, and purely accidentally, I wasn't intending this, again, but I reject most of those explanations.”
Tabarrok and co-author Eric Helland delved into the question of what drives these disparate price phenomena in their recent book, Why Are the Prices So Damn High?
“So, we looked at universities. People say, ‘Oh, well, university is so much more expensive because of bloat, because look how great we treat the students,’ and we do. It is lovely here at George Mason. We have two Olympic size swimming pools. It's very nice,” Tabarrok said. “But … the data did not support the idea that those things were the cause of higher prices.”
Instead, he and Helland found that the best explanation is the Baumol effect, named for economist William Baumol who first described the phenomenon, in which demand for highly skilled labor in sectors with high productivity growth boost the cost of skilled labor even in jobs with stagnant productivity.
“The Baumol effect is the following: It's that when you have sectors which don't increase in productivity, but which do use a resource which other industries which are increasing in productivity [also] use, those industries must rise in price,” Tabarrok said.
He borrowed the example used by Baumol himself, about a professional string quartet playing a 40-minute piece in the early 1800s. “You now come to 2018 – it still takes four people 40 minutes to produce this bit of music, so there's no increase in productivity over those 100, 150, 200 years. On the other hand, the opportunity cost of those four musicians, high-skilled people, has gone way up. Those four musicians, were they not musicians, could produce goods and services worth much, much more today than in 1826, and as a result, the price of listening to a live performance of a string quartet has gone way up. And we think roughly the same kind of dynamics are occurring in education and health care, and other labor-intensive services which use high-skilled labor.”
The lack of productivity growth may be innate to the nature of education, Tabarrok said: “We're not doing all that much different than Socrates did, right? Probably less effective than Socrates, but Socrates was drawing in the sand, and we draw on the blackboard, or maybe we use PowerPoint now, okay, but really, we've got 30 people, and they're sitting around us, and it's not all that different than what Socrates did, so our productivity really has not gone up, not in 200 years, but in more than 2,000 years in education.”