The “Cost Disease” is Really Just a Symptom

At Slate Star Codex (“Considerations on Cost Disease,” Feb. 9), Scott Alexander has a long, long, LONG article speculating on possible causes for the “cost disease — that is, the escalating unit costs and prices in certain economic sectors relative to their outputs. Or as he describes it:

“LOOK, REALLY OUR MAIN PROBLEM IS THAT ALL THE MOST IMPORTANT THINGS COST TEN TIMES AS MUCH AS THEY USED TO FOR NO REASON, PLUS THEY SEEM TO BE GOING DOWN IN QUALITY, AND NOBODY KNOWS WHY, AND WE’RE MOSTLY JUST DESPERATELY FLAILING AROUND LOOKING FOR SOLUTIONS HERE.”

Public school expenditures per student have more than doubled in real terms since 1970, while test scores have remained flat. Average university tuition has increased tenfold since 1980; you can judge for yourself whether the quality of a university education has improved in that time. Healthcare costs have quintupled since the 1970s; average health insurance premiums have risen from ten days’ pay to sixty days’ pay. And while life expectancy has risen since then, expectancies are similar or higher in many other developed countries with healthcare costs as low as 25% of ours. The final two items are costs per mile of infrastructure like subways and housing costs, both of which have skyrocketed.

The cause isn’t labor costs, Alexander notes, because in all these industries average pay has either remained flat, fallen or just roughly kept up with the general growth in wages (which hasn’t been much in recent decades). He goes on to consider a series of other possible causes, some of them more satisfactory explanations than others.

The most plausible — indeed probable — is that “markets [might] just not work” (i.e. the competitive mechanism assumed by neoclassical economics isn’t actually operating for some reason). He dismisses the possibility that it could be “pure price-gouging” because profits haven’t increased enough to account for the increased costs. But that assumes the corporation is run primarily to make profits for shareholders, as opposed to providing senior management with bloated salaries.

In any case the “Cost Disease” was observed by radical critics of capitalism as far back as Paul Goodman and Ivan Illich. Illich noted that because of radical monopolies that suppressed competition from cheaper vernacular alternatives, and rendered comfortable poverty impossible, it typically cost 300% or 400% more than necessary to make or do anything. Goodman described the way that the organizational culture of bureaucratic hierarchies systematically inflated operating costs:

To sum up: what swell the costs in enterprises carried on in the interlocking centralized systems of society, whether commercial, official, or non-profit institutional, are all the factors of organization, procedure, and motivation that are not directly determined to the function and the desire to perform it. Their patents and rents, fixed prices, union scales, featherbedding, fringe benefits, status salaries, expense accounts, proliferating administration, paper work, permanent overhead, public relations and promotions, waste of time and skill by departmentalizing task-roles, bureaucratic thinking that is penny-wise pound-foolish, inflexible procedure and tight scheduling that exaggerate congingencies and overtime.

But the “Cost Disease” really isn’t a disease at all. It’s a symptom of more fundamental phenomena, and results from structural forces at the heart of capitalism.

First, the large oligopoly corporation operates from a position of false abundance. Because each industry is dominated by a handful of corporations that follow the price leader system, price competition is replaced by administered pricing in which costs can simply be passed on to the consumer. This ability to set prices on a cost-plus markup basis results in the same cost-maximization incentives that, as Seymour Melman noted in The Permanent War Economy, prevail in the Military-Industrial Complex and in regulated utilities.

Because of oligopoly prices and restricted competition, the large corporation is typically able to finance its new investments entirely through retained earnings — and not only that, but to have retained earnings far in excess of rational projects to spend it on. So big business treats expenditures on capital improvements as “free money” and undertakes projects that a genuinely competitive enterprise would regard as a waste of money.

Because of this artificial abundance of capital for reinvestment, and the ability to pass on costs of wasteful investment to consumers as a markup, big business also has an incentive to pursue a strategy of capital substitution, in order to improve labor discipline and reduce the bargaining power of labor, to an extent that would otherwise be unprofitable.

The resulting wasteful internal capital expenditures of the large corporation resemble Friedrich Hayek’s prediction of the kinds of capital investment that would prevail in a planned economy without rational price signals.

[We should expect] the excessive development of some lines of production at the expense of others and the use of methods which are inappropriate under the circumstances. We should expect to find overdevelopment of some industries at a cost which was not justified by the importance of their increased output and see unchecked the ambition of the engineer to apply the latest development elsewhere, without considering whether they were economically suited in the situation. In many cases the use of the latest methods of production, which could not have been applied without central planning, would then be a symptom of a misuse of resources rather than a proof of success.

From this false abundance — the result of administered pricing and enormous retained earnings — everything else follows. Monopoly capitalism’s chronic tendency towards surplus investment capital creates structural imperatives for waste. This is encouraged, among other things, by accounting mechanisms that treat the consumption of resource inputs as such as the creation of value.

This is the case with the standard corporate accounting rules, which treat labor — and labor alone — as the sole source of direct costs. The result is efficiency experts obsessively looking for ways to shave off every possible minute of labor time — often at the cost of severe degradation of efficiency from eviscerating the human capital, the human relationships and distributed knowledge, that are the sources of so much of an organization’s productivity. Meanwhile, even as management strains at a gnat in order to reduce labor costs, it swallows a camel in its prodigiously wasteful spending on administrative salaries and capital projects.

Under these same accounting rules, management salaries and capital expenditures are treated as indirect costs, which become part of general overhead. And this overhead is disposed of by a bit of accounting legerdemain known as “overhead absorption,” in which it is figured into the internal transfer price of goods which are “sold” to inventory. And since inventory is an asset, the higher the level of overhead and the resulting markup of these artificial transfer prices, the higher the asset value of the goods sitting in the warehouse.

So we see corporations constantly downsizing workers and speeding up production in order to “save money,” yet at the same time paying monstrous management salaries and pouring money down irrational capital spending ratholes that would rival the irrationalities of the old Soviet planned economy.

The same accounting principles operate in calculating Gross Domestic Product: Any expenditure entailed in producing a good or service adds to the total GDP, and is therefore counted as producing value. So the more inefficient production is, the more resources wasted in producing goods and services, and the higher the rate at which natural resources are briefly channelled through our living rooms on their way to the landfill because of planned obsolescence, the higher the measure of our national “prosperity.”

Alexander argues that the Cost Disease casts new light on the conventional framing of a lot of political issues. Most of the controversy over things like universal healthcare, free college, or right-wing approaches to education reform that treat “the teachers’ unions” as the primary enemy, actually results from a zero-sum fight over how to “distribute our losses.”

For example: some people promote free universal college education, remembering a time when it was easy for middle class people to afford college if they wanted it. Other people oppose the policy, remembering a time when people didn’t depend on government handouts. Both are true! My uncle paid for his tuition at a really good college just by working a pretty easy summer job – not so hard when college cost a tenth of what it did now. The modern conflict between opponents and proponents of free college education is over how to distribute our losses. In the old days, we could combine low taxes with widely available education. Now we can’t, and we have to argue about which value to sacrifice. Or: some people get upset about teachers’ unions, saying they must be sucking the “dynamism” out of education because of increasing costs. Others people fiercely defend them, saying teachers are underpaid and overworked. Once again, in the context of cost disease, both are obviously true. The taxpayers are just trying to protect their right to get education as cheaply as they used to. The teachers are trying to protect their right to make as much money as they used to. The conflict between the taxpayers and the teachers’ unions is about how to distribute losses; Somebody is going to have to be worse off than they were a generation ago, so who should it be?

The typical progressive approach is to guarantee a product like education as a healthcare as a human right, which in practical terms means leaving the bureaucratic, high-overhead institutional culture intact but spending enough taxpayer money to buy the product for everyone at the godawful monopoly price.

In the context of cost disease, these look like industries constantly doubling, tripling, or dectupling their price, and the government saying “Okay, fine,” and increasing taxes however much it costs to pay for whatever they’re demanding now. If we give everyone free college education, that solves a big social problem. It also locks in a price which is ten times too high for no reason.

Not only is this fiscally unsustainable, but it stigmatizes people as “freeloaders” who wouldn’t have needed assistance in the first place absent unbelievable waste and price gouging by unaccountable bureaucracies.

Technologies of abundance are, by their nature, radically deflationary. Their ultimate tendency is to reduce the marginal cost of goods and services, and the labor required to produce them, closer and closer to zero. Only in a profoundly dysfunctional economic system could the technologies of abundance and resulting reduced need for labor be regarded as catastrophic for workers. Nevertheless, catastrophic they are — the reason being that the cost savings from increased productivity, rather than going to benefit labor in the form of receiving the same standard of living for fewer hours of work, are instead extracted by the propertied classes in the form of artificial scarcity rents.

And the response of “progressives” is essentially Hamiltonian: first, to prop up the price of goods and services through unnecessary management and overhead, and embedded rents on copyrights and patents, in order to generate a sufficient revenue stream to pay workers; and second, to make production artificially labor-intensive in order to provide sufficient “jobs” to earn the wages to buy these goods and services at their gross inefficiency-based prices. The result is something like one of those machines designed by Rube Goldberg.

What we should be doing instead is:

1) Destroying all unnecessary waste of inputs, all unnecessary production, all planned obsolescence, and unnecessary labor, in order to reduce necessary labor time and production costs to the absolute minimum; while at the same time

2) Abolishing the privileges and monopolies by which the propertied classes enclose the productivity gains of technological improvement for themselves, as a source of rents, and

3) Taking advantage of small-scale, ephemeral means of production to remove the largest share of production possible from the sphere of paid employment to direct production for use in the social sphere; so that

4) All the cost savings of increased efficiency go to the public in the form of reduced work hours and reduced prices, while the remaining hours of paid labor are evenly distributed and pay enough to buy back the full value of everything produced.