Baumol's Cost Disease

Origins: the string quartet paradox

Baumol and Bowen (1966) discovered the phenomenon while studying the finances of the performing arts. Performing an eighteenth-century Mozart string quartet still takes four musicians and the same amount of time, so labor productivity barely rises. Yet musicians' wages must keep pace with those in industries where productivity has soared, or musicians will leave. As a result, the cost of each performance keeps rising relative to other goods. Jean Fourastié (1949) had similarly foreseen that stagnant productivity in services would reshape economic structure.

The unbalanced growth model

Baumol (1967) generalized the idea in a two-sector model. In the progressive sector, technology raises productivity steadily; in the stagnant sector, labor is itself the output, so productivity barely grows. If wages rise together in both sectors, unit costs in the stagnant sector climb without end. Where demand for the stagnant sector is price-sensitive, it shrinks, but where demand is robust, as in education and health care, its share of spending and employment grows and aggregate productivity growth slows. Baumol, Blackman and Wolff (1985) added the idea of asymptotic stagnancy, in which some services start out progressive but gradually stagnate, and Baumol (1993, 2012) used the framework to explain why education and health costs outpace income. He stressed that this does not make society poorer: productivity gains in the progressive sector mean the stagnant sector's services remain affordable overall.

Evidence and current debates

Using U.S. industry data, Nordhaus (2008) confirmed that industries with slower productivity growth see rising relative prices and growing shares of nominal output, and Hartwig (2011) found similar results with European data. Triplett and Bosworth (2003), on the other hand, argued that after 1995 productivity rose sharply in service industries such as retail and finance, so that in some services Baumol's disease had been cured. Ngai and Pissarides (2007) and Herrendorf, Rogerson and Valentinyi (2014) developed growth models in which sectoral productivity differences drive structural change. Helland and Tabarrok (2019) argued that much of the rise in education and health costs reflects the cost disease, and Aghion, Jones and Jones (2019) applied the logic to the age of artificial intelligence, suggesting that even if AI automates many sectors, those hard to automate may become bottlenecks to growth. The theory shares the logic of cross-sector productivity gaps with the Balassa–Samuelson effect.

FAQ

What is Baumol's cost disease in simple terms?

Factory production grows ever more efficient, but services where people's time is the product, like live music or teaching, do not. Since wages rise everywhere, those services keep getting relatively more expensive.

Is the cost disease bad for the economy?

It can raise the relative price of stagnant services and slow overall productivity growth, but Baumol argued that productivity gains elsewhere keep these services affordable for society as a whole.

Sources reviewed: 2026-10-26

References

1. Baumol, W. J., & Bowen, W. G. (1966). Performing Arts: The Economic Dilemma. New York: Twentieth Century Fund.
2. Baumol, W. J. (1967). Macroeconomics of unbalanced growth: The anatomy of urban crisis. American Economic Review, 57(3), 415–426.
3. Baumol, W. J., Blackman, S. A. B., & Wolff, E. N. (1985). Unbalanced growth revisited: Asymptotic stagnancy and new evidence. American Economic Review, 75(4), 806–817.
4. Baumol, W. J. (1993). Health care, education and the cost disease: A looming crisis for public choice. Public Choice, 77(1), 17–28.
5. Baumol, W. J. (2012). The Cost Disease: Why Computers Get Cheaper and Health Care Doesn't. New Haven: Yale University Press.
6. Fourastié, J. (1949). Le grand espoir du XXe siècle. Paris: Presses Universitaires de France.
7. Nordhaus, W. D. (2008). Baumol's diseases: A macroeconomic perspective. B.E. Journal of Macroeconomics, 8(1), Article 9.
8. Triplett, J. E., & Bosworth, B. P. (2003). Productivity measurement issues in services industries: 'Baumol's disease' has been cured. FRBNY Economic Policy Review, 9(3), 23–33.
9. Ngai, L. R., & Pissarides, C. A. (2007). Structural change in a multisector model of growth. American Economic Review, 97(1), 429–443.
10. Hartwig, J. (2011). Testing the Baumol–Nordhaus model with EU KLEMS data. Review of Income and Wealth, 57(3), 471–489.
11. Herrendorf, B., Rogerson, R., & Valentinyi, Á. (2014). Growth and structural transformation. In P. Aghion & S. N. Durlauf (Eds.), Handbook of Economic Growth, Vol. 2 (pp. 855–941). Amsterdam: Elsevier.
12. Helland, E., & Tabarrok, A. (2019). Why Are the Prices So D*mn High? Arlington, VA: Mercatus Center.
13. Aghion, P., Jones, B. F., & Jones, C. I. (2019). Artificial intelligence and economic growth. In A. Agrawal, J. Gans & A. Goldfarb (Eds.), The Economics of Artificial Intelligence (pp. 237–282). Chicago: University of Chicago Press.