Understanding the Baumol Effect: Why Services Become More Expensive Over Time

Summary

The article explains the Baumol effect (also known as Baumol's cost disease), an economic theory first described by William J. Baumol and William G. Bowen in the 1960s. The theory describes how wages in sectors with little or no productivity growth (like services, healthcare, education, and arts) tend to rise in response to wage increases in high-productivity sectors (like manufacturing). This causes services to become more expensive over time relative to manufactured goods, as input costs increase without corresponding productivity gains. The article provides historical context showing that between 1998 and 2018, services became more expensive while many manufactured goods became cheaper, with only modest wage increases in the middle.