Baumol’s Cost Disease | The Acquirer's Multiple®

During their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Baumol’s Cost Disease. Here’s an excerpt from the episode:

Jake Taylor:
I’m not going there. This 1960s economist named William Baumol. He came up with this idea that you start with this thought that imagine like a quartet performing Beethoven symphony. And over the last 200 years, that has not had any gains in productivity. It takes the same amount of time, the same amount of training, the same instruments, the same number of people to perform that quartet. Four probably, right?

Tobias Carlisle:
Damn that’s a great joke.

Jake Taylor:
In general, productivity has occurred in much more in things like manufacturing and places where it’s not humans doing some kind of special required service, or labor. So what you ended up happening is really like all of our material wealth in society comes from increases in productivity. So imagine that I said, “Bill, I need you to go dig a giant hole, and I’m going to give you a big earth mover to do it.” How much could you get done in amount of time. Versus Toby, I’m giving you a spoon and you have to move the same amount of dirt. And it’s going to take you like, years to do the same amount. Well, we are all wealthier based on the capital structures that we have, based on the training that we get, based on the processes and procedures and technologies that we figure out how to do things to achieve our aims.

Jake Taylor:
Well, in the service industry in general, it’s much harder to get those same kind of productivity gains because it requires a human to do that. And they can’t all of a sudden do things 100 times faster than they could. So you imagine things like education, like grading papers. I can’t do that at 10X, the speed if I’m actually reading it and, writing notes to a student.

Bill Brewster:
[inaudible 00:39:56] help you though, right?

Jake Taylor:
It can, eventually, yeah. So nursing, for instance, applying a bandage on someone, we can’t get nurses to do that at 100X speed somehow. Even things like government, police officers, firefighters, some of their tools can improve, but in general, going to the DMV and processing a new license application has had no productivity gains, right. And Baumol, predicted in the 1960s that we would see the service sectors basically the costs of the services rising because they still have to compete with the manufacturers for the labor pool. Otherwise, no one goes and does those services. So he predicted that we would see huge price increases in things like education, government healthcare. And part of me being sympathetic to Astorian, or libertarian tendencies I would look at those type of things and say, “Oh, well, those are the things that government’s pretty heavily involved in. And that’s why they kind of suck and why the price has gone up. And there hasn’t been material improvement.”

Jake Taylor:
And the things like apparel and computers and TVs have all gotten much cheaper in the last 20 years. And I would attribute that to like, “Oh, well, that’s the free market at work.” That’s good things happening, that’s competition. And maybe that, that was a little bit of an uninformed viewpoint given Baumol’s Cost Disease. That it’s more the service versus the productivity of manufacturing and the gains that we can get there that, that are actually driving some of these results. So any comments at this point before I tell you what kind of, some of my takeaways were from this idea.

Tobias Carlisle:
I have some thoughts, but I don’t want to derail you. I want you to keep going just in case you answer them.

Bill Brewster:
I think he just asked you for your thoughts though.

Tobias Carlisle:
One is that I think that the healthcare issue is, I think that’s an interesting one because there’s an enormous amount of technology that makes healthcare so much more. The analysis is so much more penetrating than it used to be because we’ve got MRI machines, we’ve got testing and things like that, that we can do. We’ve got better drugs, we’ve got better procedures, we’ve got robotic procedures. We’ve got like the technology in there is amazing. And I don’t think that the US is sort of unique globally in that it has an enormous spend and the results in terms of life expectancy, aren’t keeping up with the spend, or aren’t keeping up with the rest of the world. And I think personally that the problem is that you have this separation of, the person who gets the service doesn’t pay for the service that goes to the insurance company.

Tobias Carlisle:
And then they bill your employer. So you’re at no stages there are any cost discipline or any shopping. And when you look at, for example, when you look at cosmetic procedures, which don’t benefit, don’t have access to that same infrastructure, cosmetic procedures have got rapidly cheaper. You drive don’t drive around the streets here you can see, you can get botulism. That’s what it is, the Botox shots, they’re ridiculously cheap now. You basically walk in off the street and get your shots done.

Bill Brewster:
Yeah. All the people on Netflix is too hot to handle it. Got all their work done with just $5,000 winnings. They also look like it to be fair. Some of those girls ruin themselves. Anyway, I digress. I would also add that on education. These are really tough issues for me, because like with education, I think that we should let students declare bankruptcy and get out of it-

Tobias Carlisle:
Its crazy that they can’t do that.

Bill Brewster:
And then you would have less incentive to lend money to it. And then you can like gouge people. So I just think it’s a little bit tougher and with the TVs and stuff, globalization, it’s so easy to just go to the cheapest country to make it. [inaudible 00:44:04] services you can’t do that with. So I don’t know. I don’t have a good sense. But I do sort of viscerally agree that service productivity is a little bit slower. Like if I think back to when I was at the bank, the ability to roll out new software and processes within a big organization, it’s just slow. Manufacturing the same, but I don’t know. I guess you get locked into how you do things.

Tobias Carlisle:
I think education is such a huge opportunity to really do something spectacular where you could have… So there’s the master class, I don’t know if you have seen that, but that’s kind of an interesting approach where I don’t see why you can’t find the best single presenter of each subject in the nation or globally. And then put them together into some sort of Netflix type lecture series. And then you gamify it the way that Khan Academy has. And then you have some-

Bill Brewster:
I’m going to give a shout out right now and hope that the three of us can get some sort of access, but in practice, have you seen what they’re building for investing?

Tobias Carlisle:
No. Is it good?

Bill Brewster:
They’ve got really good interviews. If that guy continues down this path, he’s going to have a sweet service. It’s sort of not masterclass because [crosstalk 00:45:20] interviews.

Tobias Carlisle:
Yeah.

Bill Brewster:
But it’s interviews with old CEOs, industry execs. It’s good stuff.

Tobias Carlisle:
That’s what master class is, it’s just interviews. And then they’ve been kind of systematic about the way that they’ve asked the questions and put it together into some sort of order like that. Each one is different. I think that when you see Thomas Keller cook eggs, you’re like, “I want to go and eat in that guy’s restaurant. I don’t want to cook eggs like that.” I thought that was an interesting insight. I think if you see a lot of people who are very good at what they do, do what they do, you realize that really there’s a level of mastery there that’s taken decades to kind of get to that point. And it’s not something that you can just pick up and be good at having watched a series like that. But I do think that-

Jake Taylor:
I don’t know, I’m like Steph Curry now just want to shoot [crosstalk 00:46:02].

Tobias Carlisle:
To train in three pointers from anywhere. I think that if we had independent testing centers that could verify that you can go in and take a test and pass all the things that you’ve been taught, that would be a much better system than you go to Harvard and you get some specialized teaching there. I just think there’s a better way of doing it. That would be much, much cheaper that would solve that problem.

Jake Taylor:
So that would be technology kind of disrupting, turning what was previously a human very involved thing into more of a manufacturing, almost type of scaling.

Tobias Carlisle:
It makes it sound dirty when you say it like that, but that would be the idea.

Jake Taylor:
GRD in a good way. One of my takeaways was that our fight to not have robots replacing us for our jobs, I think is actually probably a bad idea. And what we should embrace the robots who can come and do some of these service jobs for us and have that productivity gain to grow the pie enough, that would be a way of fighting some Baumol’s Cost Disease.

Bill Brewster:
You’re going to end up the first quasi Austrian libertarian that also supports UBI.

Jake Taylor:
I think there’s people-

Bill Brewster:
The robots are going to do it all. And then we’ll just collect the dividends.

Tobias Carlisle:
That’s Marxism, that’s literally Marxist utopia as the robots do all of the jobs and we go to the beach. That sounds great.

Bill Brewster:
It doesn’t sound bad, it’s awesome in a book.

Tobias Carlisle:
Who builds the robots?

Jake Taylor:
Don’t worry [crosstalk 00:47:37].

Bill Brewster:
Robots. Yeah, exactly.

Tobias Carlisle:
Look, I’m coming up with strategy, that’s tactics. That’s somebody else’s job.

Bill Brewster:
That’s fair.

Jake Taylor:
So one of my other takeaways was that a lot of the new jobs that were added in the last 10 years, I think were primarily service-based jobs. The COVID perhaps impacts those more than normal. You can’t go get a haircut, you can’t get your nails done, or go to a restaurant.

Tobias Carlisle:
Turns out you don’t need a haircut.

Jake Taylor:
I beg to differ.

Bill Brewster:
I’m going for three more inches here. I’m going to really grow it out.

Tobias Carlisle:
Longer hair too.

Bill Brewster:
Because its great.

Jake Taylor:
Good one. So if you imagine that [crosstalk 00:48:29].

Bill Brewster:
[inaudible 00:48:32] I’m not looking to double things, Toby, come on that’s greedy.

Jake Taylor:
Speaking to [crosstalk 00:48:38] Oh God. Right now we’re at about two times profit margins for S&P 500 over compared to historical mean. Gosh, you have to imagine that if we back off of some of this globalization, because of COVID, which I think is probably a very rational response and something we could expect to see, it has to impact profit margins. Right? Like we can’t…

Bill Brewster:
I don’t know, man.

Tobias Carlisle:
That’s loser talk. We’re going straight through this.

Bill Brewster:
No, I’m not trying to go there with you, but like, I’ve been thinking of it. Like OMAB, O-M-A-B it’s a Mexican airport, conglomerate or not conglomerate, but they own airports in Mexico. Something that I was thinking about is like, if we onshore more stuff to North America, I could see that it helps enough people that I am unclear what happens. So let me just put it that way.

Jake Taylor:
So I would agree that, that would help people, which they are increasing your productivity, but then some of that has to be shared with the workers and their wages coming up. Right? I think, and also to the… as government, everything gets more expensive because it’s more cost based, or it’s more service-based. Don’t we have to have higher corporate taxes again, at some point-

Bill Brewster:
Yes, I do think that’s a fact.

Tobias Carlisle:
Capital’s had a really good run against labor. And this is-

Bill Brewster:
A lot like 50 years or something.

Tobias Carlisle:
This is about as stretched as it’s ever got before.

Bill Brewster:
I agree with that.

Tobias Carlisle:
I personally think the FED has a lot to do with that. If you pump up asset prices, that’s what happens. You set interest rates too low, you get bloated asset prices makes…

Bill Brewster:
Yeah, man, and the thing that sucks about that shit is like the people that don’t understand the game and are just like savers, get just fuck. You know what I mean? What do you want-

Tobias Carlisle:
There’s no savers anymore. You can’t be a saver and survive.

Bill Brewster:
That’s a problem.

Tobias Carlisle:
You have to move out the risk of the FED loves taking people right at the risk of.

Bill Brewster:
That said something that I do think that we have talked about. And I don’t necessarily, I don’t know how I feel about this, but the way that we’ve talked about like companies are so lean and they run optimally, like levered and stuff like that. I do agree that you’re giving up fragility, but you are getting a benefit in velocity of money going through the system. I mean, it is more efficient. I don’t know-

Tobias Carlisle:
Isn’t velocity of money like, isn’t it flatlining?

Bill Brewster:
well, yeah.

Jake Taylor:
It has been for…

Bill Brewster:
But what I’m saying is if you then say, well, we should just accumulate all this cash on the balance sheet, you should see velocity implode. Right. Because I mean, like if you reduce buy backs and you just accumulate cash… If corporations become huge savers, that’s not good.

Tobias Carlisle:
That’s Japan type scenario. Right. Where they just load up the balance sheet and that they’ve got the interlocking holding. So there’s nothing you can do.

Bill Brewster:
Yeah. And you’re just like trapped in there.

Tobias Carlisle:
Toss any questions guys?

Jake Taylor:
[crosstalk 00:51:45] buy that… I know that that like consumption as it’s a good thing for us. And people like to make that argument like, “Oh, I’m stimulating the economy by going and racking my credit card up.” Which, is kind of what corporate America did. I don’t know if I buy that, pulling forward demand from the future through credit doesn’t necessarily to me sound like the smartest behavior.

Tobias Carlisle:
No, that sounds like it’s so that you might run out of runway [crosstalk 00:52:16].

Bill Brewster:
Leverage equity, bro. It keeps…

Jake Taylor:
You’re so right until you’re wrong.

Bill Brewster:
I’m going to show, I’ll send you a DCF. You’ll get it.

Jake Taylor:
Fair enough. All right, it’s Q&A time.

Tobias Carlisle:
Throw out the questions.

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