William Baumol, of the cost disease and contestable markets, passes away

Posted on May 14, 2017  /  0 Comments

My advisor was one of the principal expert witnesses testifying against AT&T in a series of court cases that led to the breaking up of what was then the world’s largest company. William Baumol was the principal expert witness testifying on behalf of AT&T. He was thus a familiar name. I read his work and critiqued it.

What was an easy target was his theory of contestable markets. The assumptions were the key. If you accepted them, any monopoly could be justified. That was why the theory emerged in the heat of the anti-trust case where the US Department of Justice was seeking to break up AT&T.

But if you approached the problem in a realistic manner, thinking about the ease of entry and exit in a nuanced way, the theory could be used.

That part was work related. But I was always reading up on public services. Public goods, goods and services with significant positive/negative externalities and so on. This is how I came across his original writing on the cost disease. This I could find no flaw in, which was somewhat frustrating for the pugnacious graduate student that I was.

I cannot remember whether I used it in my dissertation, but I’ve used it many times since. Thank you Mr Baumol.

Yet Mr Baumol will be remembered best for his cost disease. Its origin was unlikely: a commission to help those promoting the arts understand the financial struggles that cultural organisations faced. A report co-written with William Bowen closed with a simple but striking observation. Workers in the arts compete in the same national labour market as those in factories. As rising productivity in manufacturing lifts the wages of factory workers, arts organisations must pay their staff more to keep them from quitting to make widgets. But rising wages in the arts are not matched, as in manufacturing, by corresponding productivity growth: performing a piece by Schubert took the same time and the same number of musicians in the 20th century as it did in the 19th. Thus rising costs and stagnant productivity create increasing pressure over time to raise ticket prices, or take in more donations, or produce less art. The analysis bore relevance outside the arts, he quickly realised. Technological progress in some industries implies that in services with relatively low rates of productivity growth—like health care, education and government—swelling costs will outstrip growth in productivity. Costlier public services are a necessary side-effect of long-run growth.

Economist eulogy.

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