Mutating (economic) disease

Just like Covid, economic ailments could be mutating into something worse

With Covid so prevalent, most people have sickness at the front of their minds. Within economic theory, there are also ailments that get economists thinking One in particular, Baumol’s cost disease, points out why wages in sectors with low productivity can rise even though the theory suggests that productivity gains are needed for this to happen. Yet, just like Covid, this illness may have also mutated into something different and perhaps more malignant.

The economic malady in question is named after William Baumol who wrote in the 1960s about rising wages in jobs where there have been no improvements to boost output of workers. Being paid more for producing no extra goes against the basic notions of economic theory which argued that workers are paid relative to their output. Baumol used the clever example of a string quartet which still took the same number of musicians and the same amount of time as it had always done (hence no increase in productivity) and yet the pay for a performance had increased.

The reasoning he gave to explain this was that the parts of the economy that did experience gains in productivity were pushing up wages across the whole economy. If pay were to only increase in the sectors in which productivity was improving, then the higher wages would attract workers from elsewhere. So, to retain their workforce, employers in the sectors without any improvements would need to pay more for their labour costs and increase the prices that they would charge their customers.

The result of wide-spread pay increases with only partial productivity gains was that the relative cost of goods from low-productivity sectors became more expensive relative to goods produced by more productive workers. The typical manifestation of this change in relative prices is the increasing cost of services relative to goods. The manufacturing sector continues to make products cheaper and cheaper as technology allows more to be produced with less labour. On the other hand, people often need to be present for any service to be offered and hence each person can only do a limited amount of work.

The most obvious examples of Baumol’s cost disease are the rising amount of money spent on education and health care. In most cases, teachers and doctors are required to be in the same room as students or patients to do their job. Covid has resulted in much of this work being done remotely, but health and learning has suffered as a result. There has been some technological improvement in these sectors, with university courses being offered online and lots of new-fangled equipment to fix us when we are sick. Yet, we still expect teachers in the classrooms and doctors at the hospital whenever we are there.

This trend means that the economy increasingly becomes geared towards the service sector as employment in manufacturing falls. There also seems to be greater demand for services such as entertainment and travel as our general level of income increases. But the flipside of this is that it is increasingly difficult to generate gains in productivity when more and more people are employed in the service sector. Slower wage gains also mean that the amount of money we have to spend is also rising less than in the past.

It could even be the case that the shift to greater employment in services has acted as a damper on wages not only among those specific service-sector workers but across the whole economy. Just as gains in productivity in some sectors had lifted wages everywhere else, the opposite could now be true. That is, stagnating productivity in most jobs acts to depress wages for all workers. One piece of evidence for this is how much of the gains in productivity have not fed through into higher wages since the 1970s.

The shifts in employment may have pushed the economy passed a tipping point to where wages no longer rose if per-worker output increased. So instead of a cost disease pushing up the wage bill for all companies, the effect might have flipped to instead be something that could be labelled as “Baumol’s wage disease” involving low wages irrespective of productivity. The original idea of Baumol may have just been relevant to the labour market at a time of abundant manufacturing jobs.

The “wage disease” may have set in with relative scarcity of high productivity jobs dissipating the need to compete for workers through offering higher wages. Manufacturing work may have also allowed workers to build up skills on the job, making them more productive and difficult to replace. On the other hand, employees could be seen as being more interchangeable with less chances to develop skills in the expanding service sectors such as workers in Amazon warehouses or drivers for Uber.

As with Covid, we can only treat a disease once we know what it is. Yet, the predominance of low-wage work typically just prompts calls for more education and “better jobs”. As well as being a misdiagnosis of the problem, technology is already making both of these measures increasingly redundant. We instead need to figure out a way of making work pay more, not only for the sake of the individual workers themselves but also for the economy as a whole. Without bigger pay packets, the “wage disease” will result in sickly levels of spending and leave the economy in an afflicted state.

Economic growth – far, far away

Prosperity is becoming more like a fairy tale to many as economic growth recedes

Many a story begins with the words – “once upon a time, in a land far, far away”. For a growing number of people in developed countries, this opening line sounds like the beginning of a tale about economic growth. Trends such as globalization have increasingly resulted in winners and losers in a way that those who gain are increasingly separated from those who miss out. Thus, economic growth can seem a world away to many people as if a mere fairy tale.

For a few decades after the world wars, it seemed as if the tale of economic growth would be one of those stories with a happy ending. In the West at least, the economy was providing decent wages for most people in jobs and mass consumerism was offering up everything anyone might want. The rest of the world was still stuck in relative poverty but the expectation was that they too could catch up later.

The narrative changed as manufacturing started up in developing countries. Factories had helped boost wages in the West by making workers more productive, but rising pay also increased the lure of cheaper labour elsewhere. The progress was gradual but eventually the growing capacity of manufacturers in Asia, culminating with the rise of China, eroded the high-wage manufacturing sector in the West that had helped build the middle class. Automation was always likely to have the same effect but globalization accelerated the trend and has thus borne the brunt of the blame.

Globalization has made things worse in other ways too. The ease of transportation that is a part of globalization also means that places where goods are produced often being separated from the point of sale. So even though everyone will benefit from lower prices, any wage gains from more productive manufacturing will tend to remain close to the factories. So just as has happened in the West, China prospered as manufacturing created a new middle class there.

The site of production is important in that it takes away not only the work but also much of the future benefits of higher wages generated by productivity gains. And once a manufacturing base is established, a whole ecosystem of business builds up around it. So, the high-tech production facilities central to electronics and computing are likely to stay in Asia in the same way that Detroit dominated car making for so long.

On top of this, globalization has had an impact through offering up larger markets and hence creating bigger business. An increase in scale usually helps companies be more efficient and provide goods and services more cheaply. But bulking up in size also comes with more automation and outsourcing that are used as means to save on labour costs. Being bigger also helps business get its own way with governments as well so as to limit the extent to which policy might boost wages or provide economic support.

The increase in the scale of global markets is also good for those with skills to sell on an international level. Such skilled workers tend to migrate to the larger cities where it is easier to promote their increasingly specialised talents. And the freedom to move around within borders means that people increasingly sort themselves into likeminded neighbourhoods which often overlap with economic outcomes.

Previously, greater proximity of people from different economic classes would have meant that some of the spending by the well-off would have gone into the pockets of people from the “other side of the tracks”. With the service-based economy, much of the spending nowadays would not reach to the other side of the country. Even when able to work for big business or the wealthy, those on lower wages miss out as, even though their earnings would probably be higher, they also typically need to fork out more for higher living costs.

So previously, market forces might have been sufficient to spread the wealth. Higher consumption by some would see more money going to others who had less to spend. So even if some were doing better than others, a rising tide would have lifted all boats as JFK suggested. But the changes to the economy outlined above means that things are different from the 1960s. The greater physical and cultural separation means that market forces would not be sufficient to spread wealth as in the past.

What is true within borders is even more relevant when looking on an international scale. The growing levels of wealth in places like China could potentially offer opportunities for work in the West. Yet, the intricacies of Asian culture often mean that many consumer goods are produced locally for the domestic markets. With limited access for imports, Asia has become just a source of cheap goods and not so many job opportunities for workers in the West (bring us to the same conclusion that was expected of automation).

Out of those prospering from globalization, it is no surprise that the foreigners are getting most of the blame. The greater distance separating those prospering in the East from those struggling in the West means that it is more difficult to share around the new-found wealth. And big business is more likely to provide the precious jobs back home, which is used as a reason to argue for measures such as lower taxation to help create work.

Yet, there is a good argument for the government needing to come up with resources to do more. There is a notion in economics that, if the market is not working as one would hope, then there is scope for the government to step in. We are seeing this happening in terms of the “levelling up” policies of Boris Johnson and the stimulus package by the Biden administration. Yet more permanent policies need to be established to rectify what seems like a persistent feature of the economy and what could potentially result in a backlash. And that would be an ugly end to the story of economic growth.

Computing the Future of Work

Computers are changing our jobs but this new technology will not work out for all of us

It seems as if computers have changed everything. Some of the biggest changes have been at the workplace, as we move from a world in which we gathered together to operate machinery in factories, to sitting in the office (or elsewhere) tapping away on computers by ourselves. The effects of this go beyond what we do at work to also impact to how much we might be paid and where we might work. While a positive for many, these developments will not bring about a brighter future for everyone.

For starters, computers have changed the things that we produce on the job. Rather than physical objects that are produced, unit by unit, at one specific location, work on computers tend to be easy replicated and can be made available anywhere. These characteristics mean that output from computers has the potential to be more valuable as it can be easily delivered to multiple potential customers. One of the results of this is that workers will, in general, be paid more for work done in a digital format.

Along with the output being less about the physical, work with computers itself is also less physical. Traditional jobs in agriculture or manufacturing relied on a certain amount of physical strength and dexterity, and the machinery involves in these jobs were a complement these types of tasks. Computers, on the other hand, act as an aid to mental tasks, requiring different skills and also favouring some type of workers over others. Computer, in the same manner as every other new technology, produces benefits for society that are not even shard out.

Another difference to the past is how much computers also free up workers to realise more of their individual talents. This is because work itself is more individualistic in nature. Work is just one among many activities, which we would have done in the company with others, such as watching TV, are now done on our own. Whether working in the fields or in a factory, we have, in the past, relied on the help of others to get the job done. As much as office workers might email or message other, much of the work itself is carried out by one person using one computer.

The ease of using computer to share output means that people can increasing focus of niche tasks. Increasing the degree of specialization (focusing on specific roles) is a common means to boost productivity and some of these gains can be captured by the workers in terms of higher wages. Previously, workers would have to gather in one location and share out different tasks to capture the productivity improvements of specialization. But now computers mean that individual tasks can be parcelled out to workers irrespective of their location. Digital work can then be produced across a global production line on a scale far bigger than even the largest factories.

As is the case with any economic change, the benefits are not spread out evenly. One reason for this is that mental abilities are likely to vary more than physical performance. Differences in physical attributes were normally not sufficient to generate wide variation in the value of labour. A stronger person could manage more work, but the extra labour was not valued enough to result in significant differences in wages. As computers extend cognitive capacities, existing differences balloon into vastly difference outcomes at the workplace. As a result, the smart can become rich in a way that the strong never could. Add in the other features of more valuable output, less dependence on others, and greater specialization means that talented individuals have the potential to earn vastly more than others.

Not only do computers open up the earnings potential of the clever, computers also seem to limit the skills of other workers. This is because the ease with which computers can be used have resulted in many tasks being simplified. Previously, jobs would allow workers to build up skills that would feed through into greater productivity and higher wages. For example, working in a factory would involve operating machinery that took time to master. Computers, on the other hand, increase output without the need for workers to build up skills. By being so easy to use, it is as if the technology is hidden away so that workers themselves miss out benefiting from the productivity gains.

The simplified nature of work means that the workers themselves can be easily interchanged. Think of those working on a cash register in a supermarket which has long been computerised with scanners and barcodes. The task has become so simplified that even the customers are now doing it themselves. Even the computers themselves are unimportant and are replaced every few years. In this way, economic change is becoming even more daunting as both technology at work and skills we build up on the job can be made worthless with a time frame of a few years.

All technological advancements involve winners and losers. The big difference is that those already at an advantage are benefiting even more with the less well-off likely to struggle. There is unlikely to be any respite as further technological developments such as AI will erode the value of computer work itself. As with automation in manufacturing, computing technology will increasingly eliminate the simpler tasks. Amid these developments, education will obviously take on greater importance but the rapid pace of change mean that many will fall behind. And, what will happen when computers are smarter than us at everything?

Mind the (Technology) Gap

As technology disappears from the workplace of many people, we may end up missing the machines

Machines often play the role of the bad guy, whether in the movies or in the way in which we think the economy works. Machines, whether robots or computers, are responsible for many jobs becoming obsolete, but we would struggle to make much of our labour without their help. Technology on the job takes on extra importance for those workers who have fewer skills to start with, as their labour requires more help to earn a decent wage. Without the manufacturing sector to provide the low-skilled access to technology in their jobs, we may run the risk of having a large chunk out workforce being left behind.

To earn a good wage, a worker needs to be involved in generating as much output as possible. Doing this with just our own labour is difficult except for the most talented among us. Rather we often need to work as part of a team or with the help of some form of automation. An example of this is how it is easier to grow food on a larger scale with the help of farm machinery rather than each of us trying to do it by ourselves. Whether we work in a factory with machinery or in an office with computers, we produce more when working with others and with machines.

The origins of our modern-day prosperity came with the rise of the machines with the Industrial Revolution. Despite the initial dismal conditions for workers, employment in factories allowed wealth built up as people moved away from eking out a living from the land to gathering together under one roof to make use of the power of machines. Wages for worker rose as the machines became more complicated and required increasingly levels of skills to operate. The rising level of output and the skills built up on the job helped to ensure rising wages for those working in the manufacturing sector and help bring about the middle class.

Yet, further developments of technology meant that the machinery became automated and workers were less necessary. Globalization accelerated the demise of manufacturing in Western, making the change even more dramatic. What made the loss of the manufacturing jobs hurt was the fall in wages as workers looked for jobs elsewhere. This was due, in part, to the tendency for a drop in the level of technology and smaller work teams in the service sector which was the source of new jobs.

Jobs that might be available to those without university education would be in retail, restaurants, transport, and personal services (such as haircuts or retail estate agents). The level of technology for many of these jobs has not changed significantly for more than fifty years. And the scale of operation, in terms of the number of people at the same workplace, is a lot smaller. Think of the buildings that might house a factory compared to a cafe or a barber. Even if supermarkets or warehouses take up a lot of space, the number of machines that workers use is a lot less than would be the case in manufacturing.

This is not to downplay the impact of computers and the Internet which are in many ways even more powerful machines that were ever used in manufacturing. Yet, these “machines” are often separate from the jobs of workers, or are made so simple to operate that workers can easily pick up any task. For example, electronic cash registers and bar codes are a key technological advancement in the retail industry, but are also so simple that even supermarket shoppers themselves can do the job. In this way, service sector workers cannot build up the same levels of what economists call “human capital” which is a crucial determinant of higher wages.

Without some help to make them more productive, a big chunk of workers looks likely to be stuck on low wages. Going back in time may be plausible in the movies but not in terms of reverting back to the older technology in manufacturing to protect “good jobs”. Computers do offer the promise of productivity gains, but the data suggests that progress on productivity have been halting. Many economists expect this to change but technology at the workplace looks set to remain elusive for all but the most educated. A technology gap looks set to open up at work and it may be too few, rather than too many, machines that are to blame.