Episode Overview

Podcast: The Marginal Revolution Podcast
Hosts: Alex Tabarrok (B), Tyler Cowen (A)
Episode Title: The Baumol Effect
Date: October 21, 2025

In this episode, Alex Tabarrok and Tyler Cowen debate the relevance and explanatory power of the Baumol Effect—a foundational economic idea about why the cost of services tends to rise over time relative to manufactured goods. Drawing on decades of economic research and their own experiences as educators, the conversation delves into the empirical realities of health care, education, repair services, and more. The discussion is spirited and nuanced, balancing skepticism and advocacy as they explore when (and whether) the Baumol Effect truly explains rising costs.

Key Discussion Points & Insights

1. Introduction to the Baumol Effect

[00:00-03:28]

• Alex outlines the classic Baumol effect: productivity gains are much greater in manufacturing than in services, so relative prices of services rise over time—even if society is becoming better off overall.
• Alex: "It is true that the price of services in terms of manufactured goods has doubled... we're, of course, better off. This is a good thing. This is not a bad thing."
• Tyler immediately signals skepticism: while productivity rates vary, the ability to identify which sectors will exhibit cost disease in advance is limited.

2. Predictive Power and Relevance to Sectors

[03:28-06:40]

• Tyler: Skeptical that Baumol's original ex ante predictions remain powerful, especially in higher education, where costs have sometimes fallen or stopped increasing.
  • "There's not this ex ante generalization that we ought to hang our hats on."
• Alex: Defends the trend, pointing out the persistent, years-long rise in the price of services like healthcare and education across market structures and time periods.

3. The Role of Quality Improvements

[06:40-10:01]

• Discussion of whether higher quality in education/healthcare justifies rising prices.
• Alex: "In almost all sectors of the economy, when you have higher quality, usually you get lower prices... In general, higher quality does not mean higher prices."
• Tyler: Argues the Baumol framework “doesn’t deal with changes in quality well at all," using the evolution from Mozart performances to Taylor Swift as an example.

4. Application to Repair Services & the Consumer Experience

[11:40-15:27]

• Alex extends the effect to repair services (e.g., car repair, cobblers, tailors), noting:
  • "It's not that the new generation is more wasteful or less concerned... it's that the new generation faces different relative prices. It's much cheaper to buy new clothes than it is to fix the old clothes."
• Tyler challenges whether repair is truly a predictable “low-productivity” sector, citing possible future productivity surges (e.g., car repair automation).

5. Music Sector & Definitional Challenges

[15:45-17:52]

• They debate how productivity and prices have evolved in music, contrasting recorded vs. live music and the shift from scarcity to abundance via digital distribution.
• Tyler: "The universal jukebox now. YouTube, Spotify...It's a super high growth sector over the last 30 years."
• Alex: Insists live performance prices remain a classic Baumol example.

6. Healthcare: Baumol vs. Other Explanations

[18:51-21:07]

• Tyler: Sees multiple causes for rising healthcare costs, including product quality, third-party payment systems, and government regulation—not just Baumol.
  • "I don't start with the Baumol effect as a way of thinking about our healthcare sector; I just think it's one thing in the mix."
• Alex: Maintains the rising share of income spent on services is consistent with Baumol’s prediction.

7. International Comparison: India as Illustration

[21:38-27:36]

• Alex: Uses India to explain Baumol and Balassa-Samuelson effects; services remain cheap because labor’s opportunity cost is low.
  • "It's very telling that exactly the sorts of things which are cheap in India today were cheap in our past. So the past is a foreign country and a foreign country is the past."
• Tyler: Pushes back, noting the outsized role of institutional factors, logistics, and safety in much of the poorer world.

8. Ability to Predict ‘Cost Disease’ Sectors

[27:36-30:44]

• Debate over whether one can reliably anticipate rising-cost sectors or accordingly invest in them.
• Discussion of labor’s shifting value, the interplay of capital, and big tech companies’ rise as notable counterexamples.

Memorable Quotes & Moments with Timestamps

• On Baumol’s Essence:

  • Alex: "It's all about the fall in the price of manufactured goods, the change in the relative price of services." [02:41]

• Tyler’s Skepticism:

  • "When I observe something being called the law, the next thing I see is that it stops holding for some period of time." [03:28]

• Car Repairs as a Baumol Example:

  • Alex: "The price of the car has gone way down relative to the price of fixing the car. So the repair services, okay, have gone way, way up." [12:33]

• Tyler on the Shifting Productivity Frontier:

  • "Car repair is one of the last places I would look for [cost disease]... So I would predict moving forward that you have a lot of productivity growth in that area." [14:25]

• Alex on India:

  • "When you and I go to India, okay, what do we see that's really cheap in India? ...haircuts, right. Yes. It's services." [23:11]

• Tyler on Prediction Skepticism:

  • "But these ex ante predictions about where productivity will grow, I mostly don't buy them. And like, has cost disease helped people do better in the stock market because they see where the productivity gains are coming? I don't think so." [27:36]

Deep Dive: Childcare as a Classic Baumol Case

[34:51-37:52]

• Childcare and pet care services (e.g., doggy daycare) have seen price rises consistent with Baumol.
• Tyler: "If you said I, Alex Tabarrok, predict childcare, we're just stuck there because parents dogmatically want humans rather than robots... that's probably going to be explained pretty well by the Bamal effect."
• Alex: Relates anecdote about $80/day doggy daycare, drawing analogy to human childcare's rising costs.

Technology, Substitution, and Product Quality

[41:16-44:16]

• Tyler reframes “repair” as a consumer’s quest for a stream of music, which can now be solved via new tech—showing how technological substitution complicates the Baumol story.

  • "The service for me if my CD player breaks is getting a stream of music again. And that is much easier now and cheaper than it used to be.” [41:49]

• Alex concedes substitution, but frames it as a consequence of Baumol:

  • "Because of the Bommel effect, repair becomes much more expensive over time, so people look for substitutes." [42:21]

Soviet Union Example & The Universality of Baumol

[44:41-47:18]

• Alex gives the ballet in the USSR as evidence for the Baumol effect’s depth—even without market prices, opportunity cost rises for labor-intensive services.

The Linder Effect & The Harried Leisure Class

[47:18-51:03]

• Brief discussion of the related Linder effect: as people become wealthier, their leisure time is more goods-intensive and more “harried.”
• Alex: "The richer we become, the more valuable time becomes. So people want to squeeze more and more utils... into a shorter period of time.” [47:44]
• Tyler: Remains unconvinced, noting ambiguities in which activities count as work or leisure.

Notable Exchange: On Pessimism

[44:24-45:13]

• Alex: "...the pessimism was wrong and it's wrong because of the Baumill effect...the rise in the price of services is always caused by an increase in the productivity of the manufactured goods. So we're getting richer."
• Suggests rising service prices aren’t cause for despair—they signal progress elsewhere.

Key Takeaways

• Baumol explains rising relative prices of services due to stagnant productivity, but the empirical record is messy.
• Quality improvements, regulatory changes, and market evolution mean each sector deserves its own analysis.
• Baumol’s ex ante predictive power is disputed: Tyler is skeptical, Alex is more confident.
• Technological change can transform “labor-intensive” sectors, rendering some classic examples moot.
• Childcare remains a strong case for the Baumol effect, according to both.
• Comparative insights from India and the former USSR further illuminate the effect’s reach and limitations.
• Related theories, like the Linder effect, add further nuance but come with ambiguities on work vs. leisure.

For Further Exploration

• Alex’s promised upcoming blog post on the cost of childcare ([35:15])
• The evolving role of technology (AI, automation) in shifting the boundaries between labor-intensive and capital-intensive services.
• Historical and cross-country comparisons of service sector pricing.

Rich, lively, and with classic Marginal Revolution intellectual banter, this episode offers an accessible yet rigorous exploration of one of economics’ most intriguing puzzles.