Why Services Get Pricier: Baumol’s Cost Disease and Asymptotic Stagnancy

This article partially forms the theoretical foundation of two of my earlier pieces: Trump’s Industrial Nostalgia Misses the Modern Economy and Deindustrialization Revisited.

Here, I delve into a complementary phenomenon: Baumol’s Cost Disease, and its long-term logic, asymptotic stagnancy.

Two Economies in One

Economist William J. Baumol divided modern economies into two broad types of sectors.

Progressive sectors: Those experiencing rapid productivity gains through automation and technological innovation (e.g., manufacturing, ICT).

Stagnant sectors: Labor-intensive fields where productivity remains largely flat over time (e.g., healthcare, education, performing arts).

In a competitive labor market, wages tend to equalize across sectors. Yet, while a car factory can pay more by producing more with fewer workers, a teacher, nurse, or string quartet cannot “scale up” their output in the same way.

Wages rise in stagnant sectors, but without parallel productivity gains.

This leads to ever-increasing costs in sectors that don’t become more efficient.

This mismatch is what Baumol identified as a cost disease, rising labor costs without offsetting productivity lead to sustained price inflation in services.

Asymptotic Stagnancy: The Long-Term Trend

Over time, the stagnant sectors approach a state of asymptotic stagnancy, near-zero productivity growth. Yet, their costs keep rising because labor must still be compensated competitively.

Asymptotic stagnancy refers to the long-term dynamic in which certain labor-intensive sectors, such as healthcare, education, and the performing arts, approach a state of near-zero productivity growth, not only due to technological limitations but also because of institutional constraints and social preferences. These sectors often resist efficiency-driven reforms because quality, trust, and personal interaction are central to their value. In such cases, rising costs are not the result of inefficiency but of deliberate choices to preserve human-centered service delivery.

Over time, these sectors absorb a growing share of economic output despite modest or stagnant real productivity creating structural cost pressures that are best understood not as anomalies, but as consequences of how modern societies prioritize care, education, and cultural life.

Figure: Conceptual illustration of Baumol’s Cost Disease and asymptotic stagnancy (adapted from Baumol (1967); see also Attema et al. (2018) for a preference-based reinterpretation)

In the stylized model shown above, productivity in progressive sectors (e.g., manufacturing) rises over time due to technological innovation, while productivity in stagnant sectors (e.g., healthcare, education) remains flat. Despite this, costs in stagnant sectors rise due to wage equalization and limited efficiency gains.

As a result, these sectors absorb a growing share of national expenditure, even if their output expands slowly. For instance, public services like health and education feel increasingly expensive regardless of efficiency reforms. Service inflation outpaces goods inflation, distorting overall cost structures in the economy.

What Baumol Is Really Saying

Baumol wasn’t warning against inefficiency. He was asking us to see value differently. The rising cost of essential services is not a failure. It is the inevitable result of preserving labor-intensive, human-centered work in a high-wage economy.

Not everything can or should be made more “efficient.” Some things, like teaching a child or caring for the sick, take time, and must remain fundamentally human.

Implications for Policy and Society

Healthcare, education, and the arts will keep getting more expensive, even if nothing “goes wrong.”

Public budgets must reflect this reality, cutting spending in these areas risks long-term societal damage. We need new value frameworks: one that prizes accessibility, quality, and care, not just productivity.

As I argued in the articles on industrial nostalgia and deindustrialization, modern economies are evolving unevenly. Baumol’s Cost Disease reveals why we can’t expect all sectors to follow the same growth logic, and why we must design smarter public policies that account for this imbalance.