In a recent guest essay for The Economist, Congressman Jake Auchincloss (D-MA) outlined a new framework for Democrats to reclaim voters' trust on the economy by treating cost disease—the economic phenomenon where prices in key sectors rise faster than wages year over year. Cost disease explains why rent and healthcare costs consume so much of Americans' wallets, and why that share keeps rising. Rep. Auchincloss sets out how treating cost disease, particularly in housing and healthcare, must be core to the Democrats' agenda for financial freedom.
Please find below Rep. Auchincloss's op-ed:
"Cost disease is also known as the Baumol effect. It helps explain why rent and health care consume so much of Americans' wallets—and why, in the case of health care, the share keeps rising. William Baumol, an American economist, showed in the 1960s that inflation is not evenly spread across the economy. Service industries with low productivity growth inflate fast. Manufactured goods and automated services deflate prices.
The Baumol effect is both esoteric and everywhere. Housing and health care are prime examples: together they consume half of a typical middle-class family's income in America. Families wondering why their rent and health-insurance premiums are going up faster than their take-home pay are asking the question that Baumol helped to answer.
Three decades before Baumol described the problem, Theodore Wright, an American engineer, had found the cure for cost disease. Wright's law observed that cost per unit goes down as more units are produced. Want a service to be affordable? Turn the service into a product. Then, manufacture the product at scale to lower the cost per unit. New manufacturing jobs will not be taken from other countries through tariffs. They will be created from services, by turning them into products.
Rep. Auchincloss ‘By Invitation’ in The Economist
Take computers. A century ago, a "computer" was a person. Sitting side-by-side, hundreds of individuals scribbled out algorithms. It was an expensive service. Then a "computer" became a product. It was a machine as big as a room. That first product was expensive, too. But then computer manufacturing took off, and cost per unit fell. Today, computing is cheap. It was cured of cost disease.
Mass production requires consistent standards. Production is an act of learning. To compete, factory managers learn how to produce more with less. This learning under competition delivers Wright's law: that cost per unit falls as production increases. When product specifications change unpredictably, though, much of the learning on the factory line has to reset. Costs go up, not down.
Democratic states and cities have been changing and adding specifications (for multi-family housing, for instance) for decades, through regulations. Frustrated by the resulting high costs, politicians then send out money to constituents (in the form of, say, housing vouchers). In the short term this does help them muddle through. In the long term, though, cost disease is inflamed by this cycle of regulations that restrict supply and then subsidies that increase demand.
To lower costs, America needs to build a lot, fast, the same way. Housing should be the priority for mass production. Americans may perceive housing as a product—something you buy and own—but most of it is a service. It is constructed, not manufactured, and construction is labour-intensive, with low productivity growth. Since the 1960s, in fact, construction productivity has actually gone down. Manufacturing productivity, by contrast, has risen by more than 500%. Manufacturing more of America's housing could help deliver the 7m extra homes that the country needs, quickly and cost-effectively. Just like with computing, turning house-building from a service into a product would cure it of cost disease.
The government can help with both permitting and financing. For example, the Department of Housing and Urban Development (HUD) could issue an advanced commitment for thousands of manufactured housing units. Fannie Mae, a government-sponsored mortgage giant, could be used to finance this at low interest rates. HUD specifications could be made the national standard for building permits. And any city accepting federal low-income housing tax credits could be required to adopt not just that permitting, but denser zoning too.
When Austin, Texas adopted land-use reforms of this sort, apartment construction boomed and rents plunged. Cambridge, Massachusetts has followed suit. Those who doubt that Democrats can think differently on regulations, take note of Cambridge: a city where Kamala Harris won 86% of the vote adopted a new zoning law in which three-quarters of the text was to do with deleting old rules.
Health care is a more traditional Democratic issue. Democrats earned Americans' trust on health care by expanding coverage. Now, we must lower its cost.
There are two ways to treat cost disease in health care. The first is more conventional: turn custom services into mass-produced goods. Generic drugs, therapy bots and over-the-counter hearing aids are examples. Each affordable product meets a need that was previously addressed through expensive clinical services. Democrats should accelerate this service-to-product pipeline, which will require taking on various special interests within the health-care system.
The other way to reduce health costs is to deflect patients from the most expensive sites of care. In America, those sites are generally intensive-care units, emergency rooms, nursing facilities and jails. Interventions that reduce demand for beds at those sites help treat cost disease. Examples include lowering co-pays (deductibles) for prescription drugs, promoting telehealth for the old, expanding community health centres' footprint and taxing sugary beverages.
Health-insurance executives are likely to object that they do this already through their plans—or so they claim to Congress. Yet health-insurance premiums keep rising faster than inflation. Democrats should square off against the big insurers and show that we can lower costs where they will not.
The policies above, from housing to health care, are diverse. Yet they are not hard to communicate if brought together in the frame of the Baumol effect. Few Americans may know Baumol, but they are familiar with the feeling of prices rising faster than their pay. Republicans are making it worse with their chaotic tariffs. Democrats can make it better by treating cost disease."
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