Why we need more markets and less government

William Baumol, that\’s why.

Tyler\’s got the abstract to a paper which shows why middle incomes have been stagnating (well, not rising very fast) and here\’s, to me, the money \’graph:

On the nontradable side, government and health care are the largest employers and provided the largest increments (an additional 10.4 million jobs) over the past two decades…..(…)….A related set of challenges concerns the income distribution; almost all incremental employment has occurred in the nontradable sector, which has experienced much slower growth in value added per employee. Because that number is highly correlated with income, it goes a long way to explain the stagnation of wages across large segments of the workforce.

So, that last sentence is really only a restatement of something Paul Krugman says in Ricardo\’s Difficult Idea (I mention this just to show that this is not a right wing, neoliberal or even libertarian idea), that average wages in an economy are determined by average productivity in that economy.

Akin to his comment that productivity isn\’t everything, but in the long term, it\’s almost everything.

So, what\’s all this got to do with William Baumol? Well, one part of his research has been into \”Baumol\’s Cost Disease\”. One way of putting which is that increasing labour productivity in services is more difficult than improving it in manufacturing. Canonically, we cannot get a symphony orchestra to be more productive by playing at twice the speed. So, ally this with wages being determined by average productivity, we\’ll see the amount we need to spend on labour to get services to rise against the amount we need to spend on labour to get manufactures. Services will become more expensive relative to manufactures over time.

However, this is not certain. A tendency, yes, but not a certainty. For it is possible, through innovation, to turn a service into, if not a manufacture, at least an automated operation. Think replacing bank clerks with ATMs. Skilled typists with dictation software. We can record the symphony once and play it many times on a gramophone/Walkman/iPod.

Which leads us to another part of Baumol\’s work. What system, what structure, boosts innovation?

Note that \”innovation\” here is not taken to mean the invention of new stuff. Rather, the dispersion of such new inventions through society, enabling people to think up ways of using it in new and interesting ways: boosting labour productivity as they do so.

One point he makes is that the Soviets invented some pretty spiffy stuff but as anyone who was there either during those times or in the rubble following 1991 will know, almost none of it ever got used by anyone.

No, it\’s a market system that encourages the use, experimentation with and thus improvements in productivity, that new inventions allow. Planning doesn\’t, the State doesn\’t, markets do.

Which brings us to our conclusion.

Let us agree that middle incomes in the US have been stagnating (they haven\’t, just not growing very fast but….). Let us also agree that we\’d rather like to get them rising again.

It\’s that nontradeable sector, healthcare especially, which we need to worry about, the one where innovation, which determines labour productivity and which in turn determines general wage levels, is more difficult. And the way we know how to increase innovation is through having a market based economic system.

So Obamacare is moving in the wrong direction, isn\’t it? We want more, not less market, less not more government.

This point is discussed at greater length in my favourite book.

7 thoughts on “Why we need more markets and less government”

  1. But you want market in the right place, not necessarily market for market’s sake. In your example of Obamacare, the proposal is effectively to nationalise the means by which a lot of people pay for their healthcare. It’s being done partly for ideological reasons but also partly because the market for healthcare is manifestly not serving the demands of its customers. Quite aside from the people locked out of the system altogether, there are many examples of insured Americans not getting what they have paid for, clear problems of inflexibility such as non-portability of insurance from one employer to the next or one state to the next, and so on. These issues may or may not improve under a nationalised system, but politically, the question is simply whether healthcare (or rather, what degree of healthcare) is something that citizens should be obliged to collectivise, alongside the things even hardcore libertarians wouldn’t object to obligatory collectivisation of (such as defence, criminal justice, basic pension). The implications of collectivisation for price are probably quite low, assuming much of the provision will remain in the private sector as at present -for healthcare it is there, among providers, where the market has the best chance of reducing costs.

    Productivity increases in healthcare are never going to be driven by purchasers because purchasers are always insulated from price – either because their public or private insurers pay for it (or don’t pay for it), or because they are fabulously wealthy therefore don’t care about price, or because they are ordinary but uninsured, therefore can’t afford it. Actually most people would be better off with 100% personally funded healthcare (if they saved for it properly), but some proportion, around 10% of people, will get some disease that is so phenomenally expensive to treat that they couldn’t manage it without collective funding. So your healthcare (if funded privately) is either affordable or not at all affordable thus you have negligible influence on price, and if funded collectively you by definition have negligible influence on price.

    Productivity increases in healthcare can therefore only really be driven by providers, and I am not sure more government on the purchasing side will influence productivity one way or another, compared to having less government on the purchasing side. This is provided provision is largely private, of course. If both provision and funding are in government hands of course, you get the NHS.

  2. “we cannot get a symphony orchestra to be more productive by playing at twice the speed”: I once read about a conductor who complained that the balance of the orchestra had been ruined when the trombones became too loud, because the trombonists had copied “Swing” players. He should have sacked some of them then. If he’d bought microphones he could have sacked some of his army of violins too.

  3. Why would you expect wages to be anything other than “stagnant”? (Ignoring inflation of course).

    The national income cannot rise. Even if you print more money, it will eventually aportion itself in the same proportions as before (if Joe was earning £100, after doubling by inflation, he has £200 which buys the same quantity of double priced goods). So it is inevitably “stagnant”.

    People get wealthier because the cost of goods and services produced by other people falls over time due to productivity increases. They can’t do anything about their own real income by increasing productivity. They can only wait for cheaper goods and services from other people. We shouldn’t expect anything but “stagnation” of wages.

  4. @IanB

    People get wealthier because they charge less and less to make more and more. Lefties of course, don’t get it.

  5. JamesV- One of the biggest problems in US healthcare is that the insurance companies are exempt from antitrust laws, leading to some of the lack of flexibility and portability that you point to.

  6. Pingback: High-hanging fruit | The Rational Optimist…

  7. @JamesV “the market for healthcare is manifestly not serving the demands of its customers”

    Market? What market? Half of health care spending comes from government, and the rest is regulated to the nth degree. Logic suggests that if a system so dominated by government is faulty, the most effectively solution is unlikely to be more government. To take just one example. you talk of “non-portability of insurance from one employer to the next.” That’s not a problem created by a market, but rather by the regulatory system!

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