Baumol’s Cost Disease in the Second Machine Age

University essay from Lunds universitet/Nationalekonomiska institutionen

Abstract: Baumol argued that technologically stagnant sectors with relatively low productivity growth over time will experience relatively higher prices and increased shares of total labor, and thereby slow aggregate growth. This theory, known as ‘the cost disease’, also claims that services, predominantly found in the public sector, generally are stagnant due to their perceived dependence on human labor as an input. In addition, computerization has been called ‘the second machine age’ since it is believed to change society and increase productivity on the same scale as industrialization once did. By combining these notions this thesis examines the relation between ICT, productivity growth and share of work hour development on sector level with EU KLEMS data for six advanced economies 1998-2015. This data supports Baumol’s theory, though the explanatory capacity of the independent variables appears to be rather small. Moreover, the reliability of the study is questioned due to uncertainties in public sector productivity growth and doubts regarding ICT capital intensity quality as an ICT indicator. However, both computerization theorists and Baumol claims that GDP is an inadequate measurement tool for their purposes since it underestimates the effects of computerization and unbalanced growth, thus the real economic impact might be substantially larger than this study implies. In addition, a literature survey on labor economic theories on the computerization of the labor market is supplied to explain the historical development and, possibly, give some guidance of what the future holds.

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