The Recession Is Dead! Long Live the Recession!
It’s finally official, or at least as official as it gets: the economy began to grow again in June 2009, eighteen months after it began shrinking. The National Bureau of Economic Research, the Cambridge, Mass.-based think tank that calls turns in the economy, was careful to note that its business cycle dating committee “did not conclude that economic conditions since that month have been favorable or that the economy has returned to operating at normal capacity.” The NBER, as its friends affectionately call it, is well advised to be cautious. Unemployment remains very high, 9.6% as measured by the government but in fact much higher due to large numbers of “discouraged workers” no longer seeking employment. One estimate of total unemployment, by John Williams’ Shadow Government Statistics, is no longer trending upward but is north of 20 percent, and millions of Americans remain underemployed. In the short-term, all those idle hands and minds leaves the economy in a catch-22: the unemployed have no disposable income, so they do not buy much, so employers are pinched and can’t hire them back, so they remain unemployed.
The long-term outlook for the U.S. economy does not look very good either. Baumol’s disease, the seeming inability of service providers like nurses, educators, and custom contractors to improve their productivity, was thought to be in remission but like syphilis has reappeared in a more potent form. Economist Will Baumol, who at age 88 still teaches at New York University, developed (with William Bowen) the cost theory that bears his name in the classic 1965 article, “On the Performing Arts: The Anatomy of Their Economic Problems,” and subsequent work. The gist of the idea is that it will always take five people to play Mozart’s String Quintet and they will always take the same amount of time to do it, yet they get paid much more today than performers in 1787 did. Ergo, their productivity (in output terms equals one performance/person hours or dollar terms equals revenue/salaries) is flat. The idea can be generalized to most service industries and helps to explain why healthcare and tuition costs have increased faster than inflation for decades. During the economic malaise that gripped America during much of the 1970s and 1980s, Baumol’s disease offered a degree of comfort because it made us feel like victims of forces beyond our control rather than lazy dullards.
But then in the 1990s the economy hit a long patch of mostly good news, igniting a zeitgeist of economic optimism that created a veritable bouquet of rosy predictions such as the end of the business cycle in 1997, Dow 36,000 in 2000, and in 2003 the cure of Baumol’s disease thanks to “increased use of IT capital services” [networked computers] and “multifactor productivity” [a bunch of stuff scholars couldn’t specifically identify]. Alas, such optimism was not just premature, it was fundamentally flawed. We’ve just suffered the longest recession since World War II, the Dow topped 14,000 in late 2007 but sank below 7,000 in early 2009, and Baumol’s disease is more virulent than ever. According to the latest release from the Bureau of Labor Statistics, medical commodity and medical services prices rose three times faster than overall inflation (~3 percent vs. ~1 percent) between August 2009 and August 2010, college tuition costs have been rising even faster, and there are no signs that custom contractors or philharmonic orchestras are getting any more productive.
The biggest threat of Baumol’s disease is not runaway costs, as damaging as those already are for people who pay for healthcare, higher education, construction, and other services. It is that the economy increasingly needs sustained productivity gains in the service sector if it is to continue to grow at the robust pace it has since 1790. The forty-fold increase in real (inflation-adjusted) per capita GDP since 1790 is largely attributable to productivity gains in agriculture, transportation, and manufacturing. Further gains in those areas are likely but increasingly unimportant as their overall impact on the economy declines. Agriculture now accounts for a mere 1.2 percent of GDP and manufacturing only 21.9 percent. The remaining 76.9% consists of the disease-riddled service sector.
So while the official recession has ended, the U.S. economy may be headed into a long-term funk, a period of anemic growth that will feel very much like a recession. The economy probably won’t collapse but it may tread water, like Japan’s economy has been doing since 1990, until a real cure for Baumol’s disease can be found and the political will created to swallow the bitter pill of reform.
A pill may already be at hand. The weakness of Baumol’s disease as an economic concept is its failure to account for incentives. While there can be no possible inducement to perform Mozart’s String Quintet live with fewer than five musicians or at a faster pace, incentives to reduce practice and preparation time would abound in the right environment. The same goes for construction, education, and a wide range of financial and other services. The reason that so many services appear disease ridden is that producers have little incentive to improve them. Professors continue to lecture much as Adam Smith did in the middle of the eighteenth century because as mere employees (usually of non-profit organizations or governments to boot) they have no reason to implement something better and indeed good reasons not to. Health care professionals bring contagious people together in offices and hospitals, prescribe drugs with dangerous side effects, and order more tests for insured patients because they are paid to treat patients rather than to cure them. The big question is whether the political system has the wherewithal to fix such perverse incentives. Thus far, it appears not. Long live the recession!
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A previous version of this article incorrectly identified the author as Robin A. Wright. HNN regrets the error.