Investment in healthcare and education technology will deliver the next great leap in living standards.
The cogs in an economy
According to a much-used model of how economies work, there are three inputs that keep the cogs turning in an economy:
1. Labour – people going to work to produce things or provide services.
2. Capital – the machines that people use at work to produce things or provide services.
3. Technology – increases in the efficiency with which people use machines to produce things or provide services.
It is not difficult to imagine that if one of these inputs was absent, the world would be a vastly different place. To get your imagination going, here’s one construct for you to mull over: a world operated mainly by labour, with very little capital and only the most basic technology, is a world of the past; a world operated mainly by technology and capital, with very little labour input, is a world of the future. We’ll come back to this construct a bit later in the article.
The evolution of the cogs
Strictly speaking, only labour and capital are actually inputs, while technology is a measure of efficiency with which the two inputs can produce things and provide services. As an economy develops and matures, the composition of labour and capital changes, and technological progress increases the combined productive capacity of the two inputs. Consider for example that sewing machines took over much of the work that people used to do with a handheld needle, even though people were still required to operate the machines. It was technological progress that invented the sewing machine, and then it was technological progress again that transformed that sewing machine from a manually operated one into an automated, programmable one. In technologically advanced factories today, a person is merely required to supervise the sewing machines, as opposed to continuously operate them.
Changes in the composition of the cogs didn’t happen in smooth and continuous fashion; there were key milestones in the history of the development of the US economy such as the industrial revolution and the dawn of the internet. These milestones mark significant improvements in technology, which mean higher productivity and therefore a lower need for labour to produce the same amount of goods and services with a given amount of capital (or, for completeness, more goods and services with the same amount of labour and capital).
All inflation is not created equal
None of this should be particularly surprising so far, but what we really want to uncover in this article is a related effect: the divergent inflation rates of labour-intensive and capital-intensive activities in an economy. Labour-intensive sectors experience higher rates of inflation than capital-intensive sectors over time. This bifurcation of inflation rates among sectors can be explained by the fact that technological progress benefits some sectors more than others. More specifically, technological progress increases efficiency (is able to reduce the requirement for labour) in sectors that are already capital-intensive.
Although labour-intensive sectors are not getting less efficient – or less productive – in absolute terms, they are getting less efficient relative to capital-intensive sectors in the economy, which are able to use technology to a greater extent. Put another way, the more skilled the labour (think doctors, teachers, artists), the less that labour is able to be displaced by capital, and so the smaller the increases in efficiency (output per unit of labour) over time. The more skilled the labour, the more advanced technology needs to be to invent something to replace it. Given the deflationary nature of technological progress (think of the falling price and increasing quality of TVs over time), labour-intensive sectors are inevitably subject to higher inflation.
A knock-on effect of this bifurcation in inflation rates is that an increasing proportion of people’s incomes are spent on goods and (mostly) services produced by labour-intensive sectors.
What does this mean in the real world?
All of this has important implications in the real world. First, it means that the wages of people working in labour-intensive sectors fall relative to those in capital-intensive sectors. Wages might still rise, but they rise at a much slower rate. While a worker at a car manufacturing plant can make hundreds of cars a day with the help of robots, doctors can still only see a limited number of patients in a given day. Since workers in labour-intensive sectors are less able to increase their productivity, they’re able to produce less output per unit of time (relative to the capital-intensive sectors), so the people paying them are less inclined to pay them more, because that would mean higher costs for the same amount of output. Crucially, since an increasing proportion of people’s income is spent on services provided by labour-intensive sectors, those working in labour-intensive sectors are both paid (relatively) less, and subject to the higher rates of inflation of those services.
At an aggregate economy level, the total amount of income attributed to labour-intensive sectors must increase at a faster rate than the overall level of inflation in the economy, since capital-intensive sectors are bringing down the inflation rate. This makes labour-intensive sectors, like healthcare, appear increasingly expensive over time. For those countries with public healthcare systems – such as the NHS in the UK – governments have felt the need to constrain costs to stop them from seemingly ‘spiralling’ out of control as a proportion of the overall budget. But that is a miscalculation. The increase in the proportion of the budget being spent on labour-intensive sectors is a natural phenomenon driven by the inflation bifurcation, which is in turn driven by the adoption of technology in capital-intensive sectors. In the example of public healthcare, by constraining healthcare spending to less than its natural rate of inflation, governments are underfunding their healthcare systems.
Although this phenomenon – first described by William Baumol and later called ‘Baumol’s Cost Disease’ – applies to all labour-intensive sectors, arguably the most important are the healthcare and education sectors. Continuing with the healthcare example, rather than constrain spending on healthcare, the solution to the cost disease phenomenon is for governments to invest in healthcare. More specifically, governments (and the private sector) should invest in healthcare technology, so that the healthcare sector can benefit from the deflationary, productivity-enhancing benefits of technological progress the way that capital-intensive sectors have been for so long.
While this may mean some job losses in labour-intensive sectors, technological progress is a necessary evolution to allow increases in – and rebalancing of – standards of living in an economy. Over time, education systems (also labour-intensive) will need to evolve so that people can be trained to provide labour for tasks in the economy that still require labour input. Over time, the total number of labour hours worked will fall (a trend that has been in place for almost 100 years), increasing the number of hours spent on leisure. That’s the next stage of maturity for advanced economies, and it will reflect increasingly higher standards of living in those economies.
Fortunately, technological progress is happening at an exponential rate. Applications of technology in healthcare and education that were once the stuff of science-fiction movies are quickly becoming a reality. The technological revolution of the 21st century has made it possible to increase productivity in labour-intensive sectors, providing a cure for the falls in relative wages of people working in those sectors and unlocking the next great leap in living standards.
So, what do we want you to do with this article?
Well, if you’re a policymaker in government of a country with a public healthcare system, stop constraining living standards by erroneously constraining healthcare spending. The same goes for the education sector. You should be investing in healthcare and education technology.
If you’re a private investor, invest in healthcare and education technology. By providing the impetus for productivity gains in sectors that were previously productivity-constrained, technology firms will help to deliver the one thing everyone wants – increases in standards of living. That means profit for shareholders (over time).
If you are a worker in healthcare, education, or another labour-intensive sector, don’t despair. There is some understanding of your predicament, there is a solution, and technology is quickly moving towards it, with or without government help. Also, for what it’s worth, take some comfort in the fact that technology has been finding it hard to replace you.
We’d love to hear your thoughts. Please comment below or send us an email.
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