The Baumol effect is a mechanism for how the real costs of goods and services can rise over time: wages rise due to economy-wide productivity growth, including in sectors with no productivity growth, and this raises their overall real costs of production. The original example for Baumol was classical concerts – they use the same number of musicians as in the 19th century, but wages have increased from 19th-century levels. More generally, it’s also used to explain higher real costs of services as service productivity growth lags manufacturing productivity growth.
Unfortunately, I’ve also seen people use Baumol as a way of explaining rising infrastructure construction costs, for which it is not at all a good explanation. In fact, even though growth in average infrastructure costs over time is documented, there is very little cross-national correlation between GDP per capita and per-km subway construction costs. Notably, the Anglosphere’s very high construction costs affect not just very rich countries like the US and Singapore but also ones that are poorer than the Western European average, like New Zealand, Ireland (which has high GDP per capita due to corporate profits but unimpressive local wages), or increasingly the United Kingdom. Conversely, Nordic and Swiss wealth has not at all led to high construction costs, and until recently the Nordic countries and Switzerland had some of the world’s lowest tunneling costs.
Metro construction costs and GDP per capita
In an earlier version of the construction cost database, there was some positive correlation between GDP per capita and construction cost per km (about 0.23), but nearly all of it came from the fact that poorer countries tend to build more els and fewer subways; correcting for that, the correlation fell to about 0.04, and turned negative if New York and Singapore were dropped. We made a scattergram at the national level:
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This is an under-appreciated article for the amount of cross-sector insight it provides about inflated construction costs.
Essentially, it seems political ideology has created a system of procurement that needlessly inflates costs by creating and reinforcing labour inefficiencies through outdated and failed methodologies.
Adding my view – these inefficiencies persist because the main beneficiaries are the large consultancies who advise on optimising them.
As the article puts it “The Anglosphere is not expensive because it’s ahead in anything, but rather because it’s behind”