William Baumol, a great economist, died on May 4th

ON MAY 4th William Baumol, one of the great economists of the 20th century, died. Mr Baumol, who kept working into his 90s, published more than 500 papers across a dazzling array of topics; his best-known work, describing “cost disease”, was essentially a side-project. He was a scholar whose stray thought on a sleepless night could change how people see the world.

Mr Baumol was born in the South Bronx, attended New York public schools and took an undergraduate degree at the College of the City of New York. Shaped by his family’s left-wing views, in high school he read Karl Marx, which kindled an interest in economics. He did his PhD at the London School of Economics; he defended his dissertation “over whiskies and sodas at the Reform Club”. He spent most of his long career at Princeton University. He had long been on the shortlist for a Nobel prize; sadly, death means he cannot receive one.

His contributions will endure, however. Mr Baumol’s primary intellectual focus was the entrepreneur, whose role was badly neglected by prevailing economic theories. This, he reckoned, was an intolerable omission. The difference between rich countries and poor ones rests on differences in their use of technology, he argued, and it is through enterprising individuals and firms that innovations go from the drawing-board to active use across an economy. Business theories, he lamented, inevitably treated people as automatons, rather than potential revolutionaries.

Mr Baumol did better, casting entrepreneurs as crafty strivers dedicated to raising their personal status, who plot their course in life based on the incentives they face. Policy determines whether that means climbing the bureaucracy or founding Microsoft.

He helped move economics beyond the narrow ideal of perfect competition by introducing the idea of contestable markets, in which competitive pressure comes from the worry that rivals will swoop in to vie for a market if incumbents are anything other than ruthlessly efficient. Perfectly contestable markets should be just as efficient as perfectly competitive ones, even if only a handful of firms dominate a business. His framework gave economists a way to model what they previously could not: why some industries have lots of firms and others have just a few. Firms should enter the market until all are operating at the most efficient scale (so they cannot cut costs by selling more or fewer units). He was not preaching the Panglossian infallibility of markets. Rather, he helped economists understand why some industries might be more concentrated than others—and when oligopoly is a consequence of corporate chicanery rather than market efficiencies.

Yet Mr Baumol will be remembered best for his cost disease. Its origin was unlikely: a commission to help those promoting the arts understand the financial struggles that cultural organisations faced. A report co-written with William Bowen closed with a simple but striking observation. Workers in the arts compete in the same national labour market as those in factories. As rising productivity in manufacturing lifts the wages of factory workers, arts organisations must pay their staff more to keep them from quitting to make widgets. But rising wages in the arts are not matched, as in manufacturing, by corresponding productivity growth: performing a piece by Schubert took the same time and the same number of musicians in the 20th century as it did in the 19th. Thus rising costs and stagnant productivity create increasing pressure over time to raise ticket prices, or take in more donations, or produce less art. The analysis bore relevance outside the arts, he quickly realised. Technological progress in some industries implies that in services with relatively low rates of productivity growth—like health care, education and government—swelling costs will outstrip growth in productivity. Costlier public services are a necessary side-effect of long-run growth.

Cost disease is a powerful but frequently misunderstood concept. Sectors in the low-productivity bucket are not necessarily doomed to remain there. In future, new technologies could allow fewer teachers or doctors to serve many more students and patients. Nor must cost disease always entail a crisis of affordability. The wage increases driving it are a side-effect of productivity gains elsewhere, which make the economy richer. Trouble results, Mr Baumol pointed out, when rising spending creates political pressure for cutbacks, leading to needless deterioration in the quality of services. Whereas cost-saving efficiencies are both possible and welcome, budget cuts premised on the notion that the share of spending on, say, education should remain flat hinder rather than help the economy. Indeed, if stagnant services complement an economy’s high-flying sectors (plying tech firms with educated workers, for example), then rising employment in stagnant areas raises rather than lowers overall productivity growth.

Cost disease also provides a vision of a world of large-scale automation. As machines become better at doing things, the human role in generating faster productivity growth will converge towards zero. At that point, so long as society expects everyone to work, all spending in the economy will go towards services for which it is crucial that productivity not grow, in order to provide jobs for everyone. Society could seemingly be both characterised by technological abundance and paralysed by cost disease.

Practising theorist

Mr Baumol revelled in such contradictions. In the 1990s he tackled trade, and found that in the presence of economies of scale, production could get stuck in the “wrong” place—a country with an underlying comparative advantage might still fail to dislodge production from incumbent exporters. He relished hard questions, and was happy to find that a hunch of his proved mistaken on closer scrutiny. Probing, pragmatic and humble intellects are all too rare in economics. They are now scarcer still.

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