BTL 811 Cost Disease (Baumol Effect)

 

The Banking Tutor’s Lessons

BTL 811                                                                   06-08-2025

Cost Disease (Baumol Effect) 

Cost disease also known as Baumol’s cost disease, refers to the increase in the wages of certain labourers even though their productivity or skill level has not risen commensurately. This happens because there is competition between various industries for the limited supply of labour. 

So, even if the productivity of their employees has not risen significantly, employers in many cases have no choice but to pay higher wages in order to prevent the movement of labourers to other higher-paying industries. It should be noted that labour is often a kind of non-specific resource that can be used across various industries. 

The Baumol effect, also known as Baumol's cost disease, describes the phenomenon where wages in low-productivity sectors, like healthcare and education, tend to rise in line with wages in high-productivity sectors, like manufacturing, even though their productivity may not increase at the same rate. This leads to a relative increase in the cost of goods and services in these low-productivity sectors, even though the quality or quantity of output may not improve. 

High-productivity sectors: Industries like manufacturing experience significant gains in output per worker due to technological advancements and automation. This allows them to pay higher wages without necessarily raising prices. 

Low-productivity sectors: Services like healthcare, education, and the arts often rely heavily on human labour and face limitations in achieving similar productivity gains. 

Wage equalization: Despite the lack of productivity growth, wages in these low-productivity sectors tend to rise to remain competitive with the higher wages offered in high-productivity sectors. This is because workers can move to higher-paying jobs if their current sector doesn't offer competitive wages. 

Cost disease is particularly noticeable in areas like healthcare and education, where costs have risen significantly over time.

Sekhar Pariti

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