Getting older has a way of making the world feel smaller. The novelty thins out, patterns repeat, and random observations harden into dubious little life lessons. I recently arrived at one of these lessons, only to learn from a language model that it already had a name: the Baumol effect.
In plain terms, different sectors of an economy improve productivity at different rates. Sectors that stagnate become relatively more expensive. For consumers, that means certain things get pricier not because they are better but because the rest of the economy has moved on without them.
History offers a rough sequence. The agricultural revolution made settled societies possible. Crop yields depended directly on population and land, so land and people became the main constraints. Agricultural societies fought over territory and labor, cleared wasteland, or started wars. Before the Green Revolution, output was limited. Once population exceeded what the land could carry, the four horsemen—famine, war, plague, death—arrived on schedule. That is the Malthusian trap in action. The Industrial Revolution raised manufacturing productivity; fertilizers and pesticides later raised agricultural productivity too. But then energy and minerals became constraints. Shortages of raw materials still translated into demands for land or colonies, and Europe fought two world wars over that logic.
The current international order was defined by the victors of World War II eighty years ago. Whether it lasts a century is an open question. In those eighty years, global population rose from about 2.3 billion to more than 8 billion. Part of the reason was food from the Green Revolution; another part was antibiotics, vaccines, and molecular biology. Manufacturing productivity surged. For ordinary people, the cost of survival—food, clothing, transport—fell. As those costs dropped, the long-standing inefficiency of services became more visible. A haircut took a barber ten minutes eighty years ago. It still does, maybe longer if the customer has requests. The price, however, has climbed from a two-yuan buzz cut by the city gate to annual memberships costing four or five figures. Cheap haircuts still exist; they are cheaper in poor places and more expensive in prosperous ones. An industry that has not been through a technological revolution will price itself at the maximum its target customers can bear.
We call this sector services. Services involving people, especially care for people’s needs, are hard to standardize. Without standardization, mass production is difficult, and productivity stays low. Good nursing homes advertise high caregiver-to-client ratios. Good universities emphasize faculty-to-student ratios. Good housing advertises floor area. The marketing logic in services is not to raise efficiency but to lower it in exchange for personalized attention. Education, healthcare, and housing have become the three mountains pressing on modern household budgets. This is not specific to one country. Every industrialized or modernized country faces the same three mountains. In the United States, for example, spending on basic survival has fallen over the past eighty years thanks to technology. Yet college tuition, health insurance, and housing prices have risen like rockets, especially after the neoliberal turn. Until Reagan took office, median wage growth moved roughly in step with productivity. After neoliberalism arrived, median wages sat still. The three mountains rose faster than average productivity. Industrial structure therefore tilts naturally toward services. I have visited a dozen or so American cities, large and small. In most of them, the main employers are education and healthcare. Those sectors have low productivity, tight supply, pricing power, and relatively high returns.
Relatively high, not the highest, because the information revolution followed the industrial revolution. The three mountains have technical barriers, but they remain friendly to ordinary employment. The biggest winners of the information revolution are technical experts and capital. It helps to separate services whose productivity has barely changed in a century from white-collar information-management jobs. The latter are becoming an employment sink, yet many of those jobs have no real economic reason to exist. To put it provocatively: roles detached from the frontline often have no economic purpose. They exist because of political will and legal compliance—mid-level civil servants, mid-level officials, administrative clerks, even lawyers and accountants who specialize in making simple problems complicated. Many positions exist because competitors have them, not because anyone truly needs a permanent post. Such permanent roles interfere with production and frontline work, and that interference is often what brings down industrial giants.
Can anything be done about the Baumol effect? Yes. Mainstream countries have two broad approaches. The first is redistribution: high taxes and generous welfare. This approach admits that productivity in the three mountains will not rise much, so the state intervenes in pricing and becomes either the provider or the purchaser of services. That opens the door to universal healthcare, free education, low-rent housing, and property taxes. The Nordic countries largely follow this path. The second approach is immigration and second-class citizenship. This approach denies the low productivity of the three mountains but brings in workers with lower wage expectations to keep prices down. It is a partial win-win, but it amounts to extracting human resources from migrant-sending places. China’s rural migrant workers moving into cities and unauthorized immigrants at the U.S.–Mexico border both lower service costs for urban residents. People of low socioeconomic status are easily labeled by short-sighted conservatism as high-crime, clannish, and fit only for low-end work; when the government tries to tax them, the same voices howl. Everyone is the good guy; outsiders and the government are the villains.
Beyond those two paths, modern governments inevitably invest in technology to raise productivity in the three mountains: AI-assisted diagnosis, online education, 3D-printed housing. On market-based choices, people of different ideologies have different preferences—reforming health insurance, loosening industry regulation, mandating insurance, and so on. The worst position is held by people who cling to ideology, whether they worship the government or the market. That is intellectual laziness. A better approach is to ignore the ideology behind each policy and treat policies as tools. Run pilots, compare results, and let facts speak instead of staging abstract debates inside theoretical commitments.
The three mountains also connect to the middle-income trap. Countries stuck in that trap often suffer from accumulated service costs. Rising labor costs wipe out the profits created by manufacturing. High service costs suppress consumption, so manufactured goods have to be exported. One way out is to raise service productivity. Artificial intelligence looks like a plausible breaker of the deadlock. With personal data and training, personalized AI assistants could provide emotional companionship and medication reminders for older people, reducing overall medical spending. The details will take care of themselves; plenty of people are already working on them.
The Baumol effect is close to inevitable in modern societies. Understanding how different countries and cities respond to it is useful—if only to avoid blindly pouring money into real estate, pushing children through endless academic competition, and buying dubious health supplements.