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.