Baumol Effect


Health Economics

  • An argument initially promulgated by William Baumol that accounts for the increasing share of service industries (like health care) in gross domestic product. The phenomenon is explained in terms of steadily increasing productivity in capital -intensive industries, leading to steadily declining relative prices in those industries. The opposite effect occurs in labour-intensive industries like health care. The value (or the productivity) of health care is in general extremely imperfectly revealed in any known markets, even in situations where there are markets for health care, so the story is a bit like Hamlet without the prince - the increasing share is visible but not the slow productivity growth that underlies it. Despite this, and despite the high capital-intensity of some modern medicine, and despite the fact that the efficiency of much health care remains untested, many regard Baumol's conjecture as having broad plausibility in health care.