Not long ago I sought a body shop’s cost estimate for repairing some minor damage on my car. I was pondering whether to pay for the work myself or file an insurance claim.
I’ll be calling my agent — having learned that unbending a fender could cost nearly half the remaining value of the vehicle.
I soothed my “sticker shock” by indulging in some amateur theorizing about an explanation for this economic riddle: Why is the price of car repair so high compared with the price of cars themselves — new or (like mine) well-used?
I wondered if there could be a kinship here to a more troublesome cost mystery for American society. Namely, why are the costs of two vital commodities — health care and education — so punishingly high and ever-increasing, in an era when the price of many other highly valued things has long been falling in real (inflation-adjusted) terms, or at least has remained under control?
We seem to face no social crises concerning the prices of computer hardware or software, or of food and clothing, or of household appliances or of cars. (Unless, that is, it’s the crisis of globalization driving prices for many goods too low for the competitive well-being of American workers, farmers and firms.)
Anyway, I came up with the idea that one thing health care, education and automotive body work might have in common is markets shaped by a tangled system of third-party payment, through insurance companies and/or various government programs. The result is an arcane system of secretly negotiated discounts from sky-high “list” prices, confusion about actual costs, and distorted incentives for both buyers and sellers.
If I’d had more time, I might have worked up additional theories about “administrative bloat” in insurance, educational and government bureaucracies, or about “overregulation,” etc., etc.
But then I stumbled upon “Why Are the Prices So D*mn High?” It’s a new short e-book which argues intriguingly that the reason for soaring prices in some parts of our economy is in fact surprisingly simple — and, even more surprising, “a sign not of failure but of success.”
Economists Eric Helland and Alexander Tabarrok explain that it’s well understood how the cost of goods and services declines as people become more efficient at producing them. An increase in what economists call “labor productivity” — output per hour of human effort, fueled by better equipment, better skills, better organization, etc. — leads to higher incomes, which means lower relative prices and an improved standard of living.
But productivity, the economists add, doesn’t increase at the same pace for all types of goods in all eras. So prices change at different speeds and even move in opposite directions in different sectors of the economy.
In graphs that particularly caught my eye after my visit to the body shop, Helland and Tabarrok show that since 1950, the inflation-adjusted price of a new car has fallen by a bit more than half. Meanwhile, the real price of car repairs has nearly doubled. (Likewise, clothes and shoes have become cheaper to buy, but tailoring and cobblering are more expensive.)
See the pattern? The real price of washing machines, calculators and TVs has plummeted over the years. But real health care costs have soared four-fold since 1950, while real education costs (both higher and K-12 education) have risen by nearly a factor of five.
The riddle’s solution is, of course, that industries which remain “labor-intensive” have seen prices rise while industries that have been able to largely replace labor with technology have seen prices fall. The essential division is between services and manufacturing, and the difference is that “productivity” has risen much faster in the production of things than in the providing of service.
Henry Ford changed the world by mass producing cars on an assembly line. But wrinkled fenders still have to be dealt with one at a time. Sick patients, too. And we’re always trying to put fewer students in each classroom, not more.
Helland and Taborrok attribute the challenge in “stagnating” economic sectors to the “Baumol effect,” named for economist William Baumol and his 50-year-old “cost disease” theory.
Baumol memorably noted that performing a Beethoven string quartet, despite centuries of economic progress since it was composed, still requires four musicians to play for three quarters of an hour.
In such an endeavor, and others more or less like it, boosting “labor productivity” is no simple matter.
There is a more cheerful dimension of this view of things. “The cost disease is not a disease, but a blessing,” the economists write, because “price increases in labor-intensive sectors are a consequence of greater productivity growth in goods-producing sectors.”
In other words, costs have soared in fields like medicine and education because they use a lot of people and people have become more valuable, especially highly skilled people. They’ve become more valuable precisely because productivity has risen so marvelously in other fields like computer science and manufacturing. That productivity has raised overall income levels and thus made it more expensive to pay talented people enough as surgeons or pharmaceutical researchers to compete with what they could earn elsewhere (say, as executives in a technology or manufacturing firm).
To be clear, Helland and Taborrok do not dispute that other factors help fuel rising expenditures in health care and education — rising quality (at least in health care), market structure, waste and simply society’s demand for more care, more learning and better results.
But they persuasively argue that none of these forces are large enough, or unique enough to these sectors, to explain their distinctive rise in prices.
They show that the price rise in health care and education has been slow and steady over many decades. No sudden accelerations suggest the decisive impact of shifts in policies, technologies or attitudes. Something inexorable seems to be at work, and “long-run trends demand long-run explanations,” they write.
So, are we to count our “blessings” and give up trying to contain health care or education costs? No. But these economists recommend that we spend less time arguing about policy reforms for these industries and more time encouraging steps to boost their productivity — probably mainly through technology.
D.J. Tice is at Doug.Tice@startribune.com.