Sustainable Social Spending and Stagnant Public Services: Baumol’s Cost Disease Revisited

Abstract

If demand for human services is inelastic or manufactured goods are necessities, labour shifts from manufacturing to services and the budget share of services rises. Higher productivity growth in the market sector pushes up the tax rate and public employment if private goods and public services are poor substitutes, labour supply is inelastic and there are few dependants. Otherwise, private affluence and public squalor result. More dependants boost public employment if the market provides poor substitutes, but public services per dependent may fall due to tax base erosion. Extensions to market and public employment being imperfect substitutes, varying utility of money and public sector productivity depends on pay.