What is the most important concept in economics that most people haven’t heard of?
The Baumol effect has got to be in the running, because it explains one of the great economic mysteries of the modern age: in a world that is immensely richer and more productive than the one experienced by our ancestors, why are governments and individuals struggling to get by without debt?
In particular, why are certain essential services – like social care or higher education – getting less affordable? It seems odd when there’s such an extensive range of other things – from artificial lighting to basic foodstuffs to computer processing power – that have got hugely more affordable over time.
A big part of the answer is that while technology has enabled some occupations to become massively more productive – for instance, farming, mining and factory work – it’s made very little difference to others. To take just one example, a barber today takes roughly the same amount of time to cut a customer’s hair as his or her 18th century predecessor.
Yet despite being no more productive (on a hair cuts per hour basis), 21st-century crimpers are paid a multiple of their forebears – the service they provide therefore becoming correspondingly more expensive.
The Baumol effect, therefore, is the tendency of wages to rise in line with productivity improvements even in occupations that don’t become more productive.
That’s because if they didn’t, then workers would switch to occupations whose rising productivity did boost wages. As long as demand for, say, hair cuts remains steady (or increases), a diminishing supply of barbers would push up prices and therefore wages.
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SubscribeWell, you could say that it is because of the housing bubble, which the authorities have been determined for decades to stop from popping. Landlords overpaid for housing, and they should have taken their losses in 2008, but governments around the world just hid the problem, pretending that they would bail everyone out, but omitting to clarify to everyone that their only source of bail-out wealth is from us. We need honesty in economic policy – stop the inflation which is caused by people making promises which they can’t keep. The way to stop it is actually to put up interest rates, which would stop people from rolling over their impossible debts.