May 22, 2019

Why Are the Prices So Damn High?

  • Eric Helland

    William F. Podlich Professor of Economics at Claremont McKenna College
  • Alexander Tabarrok

    Bartley J. Madden Chair in Economics, Mercatus Center at George Mason University

Why are prices in some sectors increasing dramatically even as economy-wide technology and productivity improves? Education and healthcare are notable examples of sectors seemingly stricken by constantly rising prices. Educational expenditures doubled between 1980 and 2005, even as math scores remained flat during that period. Physician and nurse salaries have almost tripled since 1960.

At the same time, home appliances and telecommunications have become much cheaper. Why? Is there a common factor that unites sectors afflicted by rising prices and sectors blessed by falling prices, or are we simply seeing idiosyncratic price increases driven by random ebbs and flows in technology and demand?

In this study Eric Helland and Alex Tabarrok focus on Baumol’s cost disease, also known as the Baumol effect, and point to the increase in the cost of skilled labor as an explanation of why expenditures in education and healthcare have consistently increased while quality and productivity have risen at a much slower rate. The Baumol effect tells us that to control costs, industries must increase output from the same inputs or use fewer inputs in order to offset the rising opportunity costs of those inputs.

The closing sections of this study offer recommendations on how to overcome the minimal growth in productivity through innovations such as online college courses open to thousands of students at a time, greater integration of healthcare in HMOs such as Kaiser Permanente, and automation of diagnosis with advanced artificial intelligence.