Baumol's cost disease, productivity and the future of growth

William Baumol, one of the most famous economists you've never heard of, died recently. Baumol's fame came out of the observation that there are sectors of the economy in which productivity is rising swiftly, for example, manufacturing, and sectors where it is rising slowly or not at all, for example, string quartet performances.

The conclusion he drew from observing the behavior of wages in these sectors was that wages had to rise in the low-productivity growth sectors even as they do in high-productivity growth sectors. This is because people will over time simply leave the low-productivity growth sectors for the better wages of the other sectors. This theory became known as Baumol's cost disease.

In practice, society still values string quartet performances enough to pay their practitioners sufficiently to keep them playing. Baumol extended his theory to any economic sector in which personal service is essential to that sector. Examples include education, health care, child care, and legal services. As it turns out, nobody (yet) wants a robot lawyer or nanny.

Anti-progress: The case of airline travel

We are so used to rapid progress in so many fields, especially in the communications devices and computers that we can hold in our hands and that keep getting cheaper. In addition, the media is filled with thrilling advances in biotechnology, robotics and artificial intelligence. It's hard to imagine that there might areas of our lives in which progress has not only ceased but been reversed.

One area with which many readers are certainly familiar is air travel. I was struck by Robert Gordon's account of this phenomenon in his marvelous tome, The Rise and Fall of American Growth. Here is what Gordon discovers:

Stock hedges, home insurance, and our misunderstanding of risk

"If you own stocks without a hedge, it's not rational." So says the world's most famous student of risk Nassim Nicholas Taleb in a recent interview with Bloomberg as many of the world's stock markets hover near all-time highs. "It's like buying a house without insurance," he explained. "We have tail risks today that we didn't have before, and every day it gets worse."

"Tail risks" refer to the possibility of unusual, rare, catastrophic events, often of a nature that cannot be anticipated or even imagined. Such events are frequently dubbed black swans, a term made famous by Taleb's book called The Black Swan.

So, what is the perceived difference between houses and stocks and what does that tell us about how we judge risks elsewhere in our lives and societies? First, houses. Houses are very expensive consumer items or investments or both, depending who is buying them and why. Taleb's point is that the value of a house will not track the market if the house burns down.

The trouble with infrastructure

The trouble with infrastructure is that it breaks down and needs to be repaired, it wears out and needs to be replaced, and it gets destroyed and needs to be rebuilt. All that requires energy, resources, labor and money.

Conceptually, here's the problem we face. The bigger we make any part of our infrastructure--roads, pipelines, electricity grids, water and sewer systems--the more expensive it becomes just to keep it in operating order. The same is true for our industrial plant, transportation system, commercial buildings and private homes. Things fall apart over time; entropy makes sure of that. To keep things from degrading to the point where they cannot function requires resources, labor and money--all of which cannot be spent on new infrastructure or productive investment, that is, all of which must go to maintain what we have rather than grow the economy.

The ancient Romans came face to face with this reality. Expansion of the empire had been paid for with booty seized from conquered populations. But once the expansion stopped, so did the booty. The Romans increasingly had to tax themselves in order to pay for large armies to protect the now very long border and for the necessary improvements in roads and other infrastructure to maintain their administrative and military presence throughout the empire.

It didn't last. Eventually, the Romans had to pull back. They had to shrink the empire.

Taking a short break - no post this week

An exceptionally heavy consulting and writing workload has forced me to take a short break from posting. I expect to post again on Sunday, May 14.

Oil production cuts: Fool me once...no, make that any number of times

The jawboning of oil prices by the Saudi Arabian/Russian tag team should be wearing off after more than a year of actions that don't measure up to the words. Oil prices slumped recently, dropping from around $54 per barrel to just below $50 as of Friday's close.

As if on cue, the Russian energy minister announced Friday that Russia has now met its target of reducing oil production by 300,000 barrels per day. It only took four months to do something that should have taken just weeks. (The agreement came into force on January 1.) And, of course, we'll have to see if the Russians have actually done what they say they've done.

Only a week earlier, the Saudi energy minister indicated that there is momentum growing in OPEC for extending production cuts beyond June for another six months. This announcement comes only six weeks after the same minister said that OPEC would NOT be considering extending the cuts. This is reminiscent of last year's run-up to the production agreement in which Russia and Saudi Arabia kept alternating in making often contradictory announcements to sow confusion about the possibility of a production agreement and keep markets on edge without actually having to do anything.

"Reform" won't solve our biggest problems

"You never cure structural defects; you let the system collapse."

As I contemplated this proposition taken from a recent piece by Nassim Nicholas Taleb, I realized what profound implications accepting it would have for all those engaged in attempting to address our current social, political and environmental ills.

If it is true that modern capitalism is incompatible with effective action on climate change, if it is true that top-heavy, bureaucratic nations always eventually become captive to their wealthy citizens, if it is true that our centralized, complex, tightly networked systems in finance, agriculture, shipping and manufacturing are exceedingly fragile and prone to failure--if these all represent structural defects, then they cannot be addressed by tinkering or "reform." Those in charge cannot be persuaded to "do something" which is contrary to the structural necessities built into these systems.

The choices then are: 1) Do nothing, 2) insurrection (for which you might be jailed or worse) or 3) start building a decentralized replacement. Since I'm discarding choices one and two, I'll address choice three.

Split personalities: We like some science, but not all of it

We modern folk are in a bind. We embrace what the sciences and the technology that flows from them have to offer, but we refuse to believe that we live in the world described by those very sciences.

Here I'm not merely talking about climate change deniers who, of course, fit this description. They merrily dial number after number on their cellphones, but they do so without realizing that in their climate change denial they are rejecting the very same science that underpins the phone they are using: physics.

But so many others live in this dual world as well. We humans imagine ourselves set apart from the natural world. And yet, our very bodies are the subject of scientific investigations. So we turn to our minds which we imagine set us apart from the natural world. But what is the mind? Do we not place the mind in the body? Are its manifestations not speech, writing, music, dance, and graphic arts which require the body for their expression.

The science of physics tells us that we live in a thermodynamic system. The universe is a thermodynamic system and so by definition must our Earth be one. Thermodynamic systems produce entropy, lots of it. Some two-thirds of all the energy we use in the United States is wasted. That's right, wasted. That entropy shows up as climate-changing carbon dioxide in the atmosphere which is also acidifying the oceans. It shows up as barren landscapes left behind by coal and other mining. It shows up as waste heat and waste products flowing from our factories, our homes and our vehicles.

Living world: Should natural entities be treated as legal persons?

This year the New Zealand parliament voted to give legal personhood to a river and provided for the appointment of two guardians to represent it. In India a court extended legal personhood to the Ganges and Yamuna rivers and the glaciers that feed them.

It defies our normal modes of thinking that natural entities such as trees, rivers, mountains, lakes, and glaciers should be given legal standing in courts and public life. And yet we take as a matter of course the legal rights of other inanimate entities:

The world of the lawyer is peopled with inanimate right-holders: trusts, corporations, joint ventures, municipalities, Subchapter R partnerships, and nation-states, to mention just a few. Ships, still referred to by courts in the feminine gender, have long had an independent jural life, often with striking consequences.

The quotation comes from a famous law review article on the topic of rights for natural entities entitled "Should Trees Have Standing? Toward Legal Rights For Natural Objects," written in 1972 by Christopher Stone, a professor of law at the University of Southern California.

Communications breakdown: Can we even talk about our environmental and energy problems?

Conversations that seek genuine understanding by all sides ultimately require a common frame of reference. If we aren't talking about the same things, how can we understand one another?

We usually refer to this as talking past one another. Sometimes this happens because we haven't taken the time to understand what our conversation partner is trying to say. We are distracted and focused on something else. Increasingly, our public discourse--that which we all see on the airwaves, on the internet and in print--is mere polemic in service of some political or economic interest. There is no genuine attempt to explore the issues, only to advance a particular view of them--often for pay as is the case with public relations agencies and also fake think tank academics who merely parrot the positions of their funders.

We like to regard ourselves as living in an age of enlightenment. But enlightenment only occurs when we are intellectually honest. What intellectual honesty requires is the ability to entertain ideas and accept evidence that contradict our current views and to evaluate those ideas and evidence on some basis other than a financial or political interest.