Thursday, June 2, 2011

Economist's Notebook: A Lesson in Cost Disease

From Jack Bog's Blog I find this wonderful picture from a Radio Shack ad that was in a Popular Mechanics magazine from 1987.

Note the super duper lightweight portable cellular phone for only $1499!  That is almost $2900 in today's dollars.  Not only are cell phones remarkably cheaper, but they are an order of magnitude more capable.  You can buy an iPhone for $300 that is a super-computer by 1987 standards.

Which is a nice jumping off point for the discussion of 'cost disease.'  Which is actually a fairly simple concept.  When we measure inflation through time, we use the average price increases over a whole basket of goods which means we do it over a whole range of industries.  Some of these goods/industries (like cell phones/consumer electronics) are prone to huge productivity increases - meaning we can make the same good much less expensively now than before.  Other things are not a prone to such increases.  Books, for example, or (you know this was coming) craft beer.  

For example, I grabbed a book I bought around the same time off my shelf: In Exile from the Land of Snows. It has a cover price of $9.95.  The very same book today has a cover price of $16.00. [This was bought and ready during my time studying and traveling in India and Nepal, it is an account of the Dalai Lama and the Tibetan government in exile and is is highly recommended]  The price increase for the book is slightly lower than inflation but partly this represents the fixed costs (the price of the manuscript) being spread ever more thinly.  But in general, though we can now do electronic type setting and other productivity enhancing things, the printing of the word onto paper and binding it to ship and sell has not seen a lot of productivity enhancement over the last 25 years.

Anyway the point is that some products are less prone to productivity increases. The classic Baumol example is the symphony orchestra which takes just as many musicians just as much time to play a Mozart or Beethoven piece today as in the late 1700s.  There has been no productivity gain at all.

When you put them altogether and average the price increases across all different industries, you will see industries (like symphonies) that routinely see price increases greater than inflation and other industries (like consumer electronics) where prices actually keep falling.  We describe industries of the former type those that experience 'cost disease' because it is a natural consequence of an industry where productivity does not increase much.


Jeff Alworth said...

Don't forget the writer! That's one fixed cost that will never get more efficient: writers still take as long to produce 85,000 words as they ever did.

Patrick Emerson said...

That's what I meant to suggest in the price of the manuscript. But these days that cost is insignificant - writers are a dime a dozen and soon we'll have computers that can do it just as well.

Dann Cutter said...

(leaving aside Patrick's last comment - meant for Jeff clearly)

I would argue that books SHOULD actually be suffering some of that productivity enhancement. In the next few years I think that will be very obvious. I'll leave the argument's specifics for another time, but to address your premise of cost disease:

"To restate this more generally, over time most industries see productivity gains, some faster than others. How cheap or expensive a product becomes in relative terms is largely a function of this productivity gain." (from your 2008 post)

I would instead state that it is a function not only of the productivity gain, but the willingness and practicality of adopting that gain.

Let's look at university education for example. 90% or more of classes on campus are lecture based, with very little student interactivity. The substantial costs are born by the university as you stated are in the professor and that is fairly fixed.

However, it doesn't have to be. A number of my courses have been taken online. There is no feasible reason Math 251 (offered online and through a tools website) at OSU could not be cloned to every public and private university in the US, the best 5 instructors refine the curricula, and the cost of this course fall to nearly nothing for all colleges involved.

Right now, ecampus classes are often limited in enrollment just like regular classes, but there is no reason that must be true. Much of the first 2 to 3 years of college can (and has been) created in an online system such that professorial interaction is essentially unneeded. Those that need greater assistance can seek it out, but consolidation could take place on a massive scale.

Yet, tuition threatens to go up another 8%+ next year. The failure here is not productivity enhancements - those are clearly in place; instead, the inherent and institutionalized status quo is a difficult process to change.

Baumol's symphony fails in the same place - the assumption that to play Mozart, one needs a full symphony each time. A simple program like 'Garage Band', and exceptional setup and prerecording of individual notes, transitions etc, and individual conductors could produce unique combinations with no need to have musicians in the mix. The productivity has been enhanced - but no one would come listen, as it flies in the face of institutional expectations.

Cost Disease should be as much a function of the established process, as it is the productivity gain.

TonyFernandez said...

There are huge limits to using CPI to measure inflation, and I think you hit the nail right on the head.

Jeff Alworth said...

Patrick, it is sadly already a reality.