In December 1913 Henry Ford introduced the assembly line, revolutionizing the production of automobiles. For the first time, cars moved while the workers and their tools did not. Productivity increased dramatically, as the time required to produce an automobile dropped from 12 hours to two hours. Manufacturing would never be the same. A few weeks later, in February 1914, the Detroit Symphony Orchestra reemerged, having ceased operations in 1910. It’s a good bet that Mr. Ford was approached by the reconstituted symphony for a donation. The world’s great orchestras rely heavily on philanthropy for their existence, as do universities and many health care organizations. It turns out that there is a classic economic explanation, and it centers on human interactions.
William Baumol, an economist from Princeton and New York University who passed away in 2017, was fascinated by sectors of the economy that depend on human input – even more pointedly, on human interaction. His examples focused on education, health care and the performing arts. In contrast to the manufacturing sector, where enormous productivity gains are possible over time, Dr. Baumol observed that labor-intensive sectors (which he called “stagnant”) struggle to achieve significant productivity strides. Mozart wrote his 41st and last symphony in 1788. Over the last 200 years, the composition of the orchestras playing Mozart’s symphony has changed relatively little, but the salaries paid to the musicians have increased to keep pace with the rest of the economy – much of which experienced dramatic improvements in productivity not shared by the performing arts.
Productivity gains in manufacturing enabled producers to lower prices and increase wages. As the economy grew and wages rose, those sectors that Baumol termed stagnant were forced to increase wages in order to prevent their labor forces from fleeing for other jobs. Costs in health care and education increased faster than general inflation, and those service-oriented sectors accounted for a growing proportion of the gross domestic product. Indexed to the overall consumer price index, the cost of new cars, furniture and apparel all increased more slowly than general inflation. As a result, the affordability of those goods improved significantly between 1980 and 2016. Decade after decade, however, health care and education have become more expensive. By 2016, health care prices were two times their levels in 1980, adjusted for inflation, while education was 3.5 times what its prices would have been had they increased at the general rate of inflation.
According to the Bureau of Labor Statistics, employment in the goods-producing segments of the economy was flat at 20 million jobs between 1965 and 2015. Over the same 50-year period, employment in service-producing sectors increased threefold, from 40 million jobs in 1965 to 120 million in 2015. An important by-product of this shift from a manufacturing to a service economy is the disproportionate increase in employment in sectors that struggle to achieve productivity gains – those that Baumol called stagnant. The overall purchasing power in the economy, and importantly, the ability to afford higher prices in service sectors, comes from productivity increases; the enormous shift to a service economy threatens to stall the growth in purchasing power. The economic coattails on which service sector wages rode are disappearing.
It is worth noting that a large portion of most government budgets is devoted to services rather than goods production – education, health care, law enforcement, etc. Given the preponderance of labor-intensive services, with their inherent productivity challenges, it is probably inevitable that the services government buys will become more expensive over time compared to manufacturing. As the goods-producing segments of our economy shrink in proportion to the services sectors, the productivity engine that drives overall purchasing power and affordability is hard-pressed to keep up. Not unlike an overweight body’s strain on a middle-aged heart, we need to take steps to get into better shape. It is incumbent on all of us in labor-intensive sectors of the economy to do everything possible to mitigate the strain on the engine.
In our recent Strategic Viewpoint, we examined the economic components of hospital margins. A number of factors, including a shift from inpatient to outpatient settings, higher proportions of government reimbursement as baby boomers age into Medicare, and softening prices in the commercially insured sector of the market, combine to exert downward pressure on revenue growth. Fixed costs have increased as newer facilities add depreciation and interest expense to hospital income statements. Non-labor variable costs have opportunities for savings but labor accounts for a larger share of hospital costs than any other input. The prospect for shortages in professional ranks threatens upward pressure on wages. Improvements in labor productivity may be the key to hospital operating margins in the years ahead.
The human interactions of health care delivery have significant intrinsic value. There is no mechanical substitute for empathy, or for a comforting touch. Healing is unquestionably a human endeavor, and there is a point at which technology is at once too much and not enough. The burden falls to us, however, to acknowledge the inherent economic drag that comes with a labor-intensive industry, and to work tirelessly to avoid exacerbating that economic drag by adding fixed costs and overhead to an already strained engine. Wherever we find inefficiencies, we must eliminate them, and wherever productivity gains can be realized without sacrificing the intrinsic value of human interactions, we must pursue them.
The technology exists to enjoy Mozart’s final symphony in a quiet room, with state-of-the-art headphones and no distractions from rustling papers or children kicking our chairs, yet we still attend live orchestral performances. Why? It must be the intrinsic value of the human involvement – the experience of seeing the music performed, not just the opportunity to listen to the notes. Similarly, we will always pay more for the human experience in health care. We may not need or even want as much productivity gain as we have enjoyed in the electronics industry, but we would benefit from some incremental productivity. And we owe it to the rest of the economy to pull as much of our own weight as we possibly can.
