Saturday, 9 April 2016

Are robots the cure for the cost disease?

I just finished reading William Baumol's book "The Cost Disease", which is based on his long-standing research explaining why costs in education and health care are spiralling out of control. In short, the premise of the cost disease can be fairly easily summarised, as follows.

Baumol contends that there are two sectors in the economy: (1) a "stagnant sector" where labour productivity growth (the growth in the amount of 'stuff' that can be 'produced' in each hour of a worker's time) is slower than average; and (2) a "progressive sector" where labour productivity growth is faster than average. Activities that fall into the "stagnant sector" are those that require substantial human input that cannot be easily reduced (at least, not without a consequent reduction in quality). For example, it is difficult for a doctor to see more patients per hour, without the quality of care being reduced. In contrast, activities that fall into the "progressive sector" are those where technology is making workers much more productive, such as in manufacturing.

Now, because these two sectors have diverging productivity trends, Baumol argues that this has implications for costs. Because workers in the "progressive sector" are becoming more productive over time, their wages increase. This should be familiar to students of economics, as we expect that in competitive labour markets the wage will be equal to the value of the marginal product of labour (VMPL; the value of stuff that the next worker employed will produce). If productivity increases, the VMPL increases, and so will wages. However, the situation in the "stagnant sector" is different. In that sector, wages increase not because of productivity gains, but because if wages didn't increase the labour force would increasingly move into the "progressive sector" to take advantage of the higher wages (which would reduce labour supply in the "stagnant sector", increasing wages there).

Now, think about the implications for costs. In the "progressive sector", wages are increasing, but the workers are producing more, so the cost of producing each unit of output are stable or declining. In contrast, in the "stagnant sector", wages are increasing but productivity gains are low, so the cost of 'producing' each unit of output are increasing.

Which brings us to the central conclusion of the cost disease: that costs (and prices of things produced) in the "progressive sector" will tend to decline over time, while costs (and prices of what are typically services) in the "stagnant sector" will tend in increase over time.

I think there are a number of interesting implications that flow from this realisation of the cost disease. First for me is that this has implications for the "throw-away society". Because manufacturing goods (from the "progressive sector") become cheaper over time, while most repairs must be conducted hands-on (in the "stagnant sector"), then it will get increasingly less expensive to throw away and replace items that cease to function rather than repair them. So for example, when my watch strap broke the other week, it was much cheaper for me to buy a new watch than it was to pay to have the strap repaired (helped of course by the watch being an inexpensive Warehouse watch).

The second implication of interest is the implications for economic growth. Over the long term, economic growth is essentially based on increases in productivity. However, if the "progressive sector" is becoming more productive (through labour-saving technology), it seems to me that an increasing proportion of the labour force will end up working in the "stagnant sector" (e.g. low paid service work). Since the "stagnant sector" is not increasing in productivity as fast, then the implication is that economic growth will slow down as a result.

Finally, it was interesting to read this book while the Labour Party's Future of Work Commission was in the news. In particular, we heard a lot about the 'rise of the robots'. No, not this:

But this: "Robots could do 46 percent of NZ jobs". Many of the jobs cited in that article (drivers, clerical workers, technicians, accountants) would probably be considered to be in Baumol's "stagnant sector". Even baristas might be at risk. So, that suggests to me that the "stagnant sector" may not remain stagnant for much longer. As labour-saving robots (and drones, and machine-learning algorithms, and other new technologies) increasingly take over these jobs, productivity growth in those industries will increase and costs should eventually fall. So, perhaps robots will cure the cost disease?

But in the process put a lot of people out of work. As Brian Fallow notes in this interesting New Zealand Herald article:
You might have every confidence people will come up with plenty of new ways of earning a living that do require the intelligence of the human brain, the dexterity of the human hand or a sympathetic heart.
And that the time and effort digital technology saves will get distributed as more leisure for everybody.
In the meantime, however, it is clear that the scale and pace of the technological revolution we are in the midst of is overwhelming the ability for those good things to happen.
Though technology boosts some people's productivity, it collapses others' to zero as they become redundant or struggle to find their first job.
Fallow concludes that a universal basic income might be necessary. However, the cost is large, but Fallow argues that this could be covered by broadening the tax base - starting with taxing capital gains. However, I'll leave that discussion for a future post.

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