The acheivements of two outstanding economists who died recently illustrate just how diverse the profession is.
I first came across William Baumol when, as a student, I valued greatly his two text books: Economic Dynamics and Economic Theory and Operations Analysis, both lucid, intellectually challenging and with a gentle humour. (Rather than the conventional tradeoff of guns versus butter, he illustrated the principle with cummerbunds and zabaglione.)
I also read his Business Behavior, Value and Growth with its insightful notion that firms maximised revenue subject to a profit constraint. Neoliberal economists got very agitated and constructed elaborate explanations to show he was wrong – they were used in the 1980s to justify privatisation. They have been largely discredited since but the profit maximising firm is the standard assumption if not always evident in reality. (J.K. Galbraith used Baumol’s insight in his New Industrial State)
Baumol continued to do path-breaking work, not least in environmental economics and the economics of the arts. Later he contributed to the literature in which entrepreneurship has a central role in economic growth.
He (with some colleagues) almost made a major breakthrough with contestability theory, which showed that if there were no barriers to a firm entering or exiting a market, even a monopoly behaves as if it was in a competitive industry. It was very popular among Rogernomes who ignored the caveats. In particular, it is not a robust theory in which deviations from the rigorous assumptions left the conclusions intact. For instance, the theory of competitive markets assumes an infinite number of firms but in practice an industry with only a handful behaves as if it were competitive. In contrast, minor barriers to entering or exiting ruin the result that a monopoly behaves as if it is competitive and there are no monopoly profits.
A related issue was the Baumol-Willig pricing rule which suggested how prices might be set in a market dominated by a firm. It was used to protect Telecom’s monopoly for it locked in existing monopoly profits; I doubt Baumol would have been as enthusiastic as were Telecom’s defenders. Eventually the long (and expensive) legal dispute was resolved by the Telecommunications Act 2001, which specifically rules out the use of the Baumol-Willig rule. Apparently Baumol and his colleague, Robert Willig, are the only two economists mentioned in a New Zealand statute.
Baumol is best known for the ‘Baumol cost effect’ (a.k.a. ‘disease’ but that puts a judgmental dimension on an empirical phenomenon). It points out that the costs of many services will rise faster than the costs of goods because they do not experience the same productivity gains. The original illustration was that the same number of musicians is needed to play a Beethoven string quartet today as was needed in the nineteenth century so the productivity of classical music performance has not increased. On the other hand, the real wages of musicians have increased greatly since then, so the relative cost of concerts have gone up.
The Baumol effect particularly applies to government activities which are almost entirely services. I once mentioned this to a group of economists working on projecting government spending, pointing out that (with a few extra assumptions added) this meant that tax revenue would have to rise over time to cover the rising costs. There was a stunned silence and the meeting quickly moved onto other matters – raising tax levels, even to supply desired public services, is not high on our agenda.
Baumol’s innovative research covered an extraordinary range of economics and other issues (he had a minor career as a creative artist), illustrating Hayek’s ³nobody can be a great economist who is only an economist.’. Master all his writings and you would have a good training in economics. Yet, he never was awarded the Nobel prize in economics, illustrating the limitations of the prize and the eccentricities of the selection process.
Mike Cooper was one of a group of British economists who pioneered health economics in the 1960s. (There were American contributors, including Ken Arrow, whose seminal 1963 paper ‘Uncertainty and Welfare Economics’ appeared to be unknown to the Rogernomes who were redisorganising the health system three decades later. Had they known it, they would have seen how deeply flawed their approach was. Incidentally, Arrow’s paper cites an earlier work by Baumol as foundational.)
Mike first came to my attention in 1968 when he published, with Tony Culyer, The Price of Blood, arguing that blood-donors should be paid, thereby making it a market commodity in which supply balanced demand. (Yes, the booklet had a blood red cover.) Richard Titmuss replied in 1970 with his brilliant The Gift Relationship: From Human Blood to Social Policy, one of the great social policy books of the twentieth century, pointing out that commodifying blood leads to a deterioration in the quality of its supply. (That is why we don’t pay blood donors). To Mike’s credit he recognised he was wrong – a humility which is not common enough in other professions either.
Mike wrote many other books including Rationing Health Care which some health economics teachers still use such is its ‘exemplary clarity’, as one reviewer said. In 1975 the notion was revolutionary, for the conventional wisdom assumed a public health system could meet all the demands on it. Today we accept that there have to be restrictions, although while waiting lists may be acceptable providing the wait time is not too long, the current practice of the not-on-the wait list – that is, having a need which the system does not recognise – is not, even if it is increasingly pervasive.
In 1976 Mike took up the senior chair in economics at the University of Otago which he held for two decades while actively working in a range of health areas; he was an applied economist. (He held many other positions but they are not relevant to this column except that he was at one time the chair of the Otago Area Health Board.) His tenure laid the foundation of the successful department we know today. For despite Mike’s international reputation in health economics, he worked in many other economic fields. (On retirement he took up cooking and producing award winning olive oil from trees on his and Joy’s estate in Martinborough.)
As befits a strong department led by a strong head, he inspired many graduates. Perhaps the jewel was Nancy Devlin who, I regret to report, holds senior positions in Britain Her tribute at the funeral service included ‘I would not have had the career I have enjoyed if it hadn't been for Mike. .... [His] lectures were inspiring, challenging, and always thought-provoking. Theory was effortlessly mixed with examples, issues and applications to real life problems in health care. Mike gifted to me a life-long passion for health economics.’
Surprisingly Mike was never made a distinguished fellow of the New Zealand Association of Economists. I am not sure why. Perhaps the Baumol explanation will do: the limitations of the award and the eccentricities of the selection process. Such failures by selection committees are an inherent part of many of the awards in New Zealand.