Public services in a digital future

Being honest about the choices we face

This blog is part of a collaborative Joseph Rowntree Foundation project examining and exploring ideas we need to advance Social Justice in a Digital Age.

“Productivity isn’t everything” wrote Paul Krugman, Nobel prize-winning economist in 1990. “But in the long run”, he went on, “it’s almost everything.” Getting more output for each unit of input sounds great. That’s why lifting productivity growth has been a central ambition of every government in the post-war era. More productive economies enable higher living standards, not only in those sectors or firms delivering it, but for everyone.

Some sectors are harder to make more productive than others. To attract and retain workers in these less productive sectors from leaving to join more productive ones, something close to the real wage growth seen in the broader economy needs to be offered to them. In other words, workers in less productive sectors will enjoy real wage gains despite productivity growth being so hard to achieve in their sectors versus others. This was Baumol’s central insight. In this way Baumol might be regarded as the godfather of trickle-down – or at least trickle-across – economics. But, as James Plunkett explains, Baumol either missed or underplayed the ability of institutions and of government to get in the way of his ‘iron law’ holding true.

In the United Kingdom, high-touch human sectors for which productivity gains have been most elusive – social care, childcare, healthcare, education – are concentrated in areas dominated by public provision. This is the result of a political choice: as a society we have decided that there should be some universal floor for human dignity. And while more resource-intense versions of these public services are available through private channels, the universal floor is one that could not be afforded by all if not provided through the public sector.

When we look to the Office of National Statistics’ estimates of productivity growth in the public sector, the results are depressing. Outputs have lagged the rising input costs across the aggregate public sector over the past twenty years, and particularly so in childrens’ social care, adult social care, and education. Is this the dead hand of the state in action? Might putting public services entirely into the private realm deliver productivity improvements that are so desperately needed? Data from the United States does not suggest that this is the case.

Figs 1-2. Labour productivity and hourly compensation in the US nonfarm business sector, and hospital subsector, 1995-2021

Source: Bureau of Labor Statistics, October 2022

The US healthcare system is a hideously complex affair. Treatment is provided by the private sector, with different blends of private insurance and public programmes picking up the tab. It is a system in which strong commercial incentives to innovate and deliver quality care at lower prices are overwhelming, with multi-billion-dollar prizes on offer to those best able to build a better mousetrap. And yet in the highly commercialised and competitive hospital sector, productivity growth has been essentially zero since 1995 (figure 1). The wider private sector has, meanwhile, seen transformative productivity growth. Despite this vast differential in productivity outcomes, hourly compensation in the hospital sector has moved in concert with the wider private economy (figure 2) – just as Baumol would’ve predicted.

Furthermore, we can look to private sector doppelgängers in the United Kingdom like the private school system to see how much value is ascribed to a high touch human sector by those who have means. 

Over recent decades the proportion of children attending private school has remained relatively stable at c7-9%. And the ratio of the top 7-9% versus median post-tax income incomes has fallen rather than risen over the last twenty years. But spending per pupil on private day schools has increased at a far quicker pace than it has in the state sector, with the ratio of spending per pupil in the private sector versus state sector rising despite large real terms increases in state sector spending per pupil.

Fig 3. Comparing the Average Spending per Pupil in English Secondary State Schools to UK Private Day Schools in Constant 2020-21 Money, 1978-2021

Source: Institute for Fiscal Studies, Independent Schools Council, Office for National Statistics, author’s calculations.

Spending per pupil in the State versus private educational realm might provide a sense as to the degree to which our aggregate ability to afford better public services is being suppressed by government’s desire to constrain spending. Other complicating factors may be in play – for example, the degree to which private education consists of its signalling value (like a Prada handbag), or the degree to which the value of elite education is positional (helping to win the CV arms race). But despite these complicating factors we can see that the price paid for secondary education varies meaningfully depending on its limiting factor: the ability and willingness to pay the direct financial costs for private schools of one’s own children versus the collective ability and willingness – mediated by government – to pay for state schooling of other peoples’ children. And where government mediation is absent, an increasing share of income is spent – just as Baumol forecast.

What are the choices faced by society in thinking about how to manage high-touch low-productivity sectors dominated by public provision. There are three, and only three, ways forward – or some blend thereof. These three ways can be thought of as three points of a triangle of possibilities (figure 4). Let’s follow James in making this specific about a sector – social care.

Fig 4. The Triangle of Possibilities

The first choice is to pay more for social care. The proportion of national income going to social care would – taking this path – increase, and each social care worker would be paid more for each hour they worked (as the monetary value of social care increased). This is what Baumol would have predicted. What does this mean in practice? It means higher taxes, a larger state, and it could also open the door to better care. The productivity gains that are delivered in other parts of the economy allow for an overall improvement in our collective standard of living, and that universal floor for human dignity can rise. Realising such ambitions is arguably the point of economic growth.

The second choice is to get less social care – either in quantity or quality. This is what would happen if the buyer of social care is unwilling or unable to meet the rising costs and sets of a reverse auction for care (eg, takes as much social care as can be bought for a fixed amount of money; this might be less and less each year). When ministers stand up and talk about holding budgets flat in real terms, we might be tempted to think that this holds the level of care flat in real terms, but the Baumol effect means that a real terms budget freeze translates into a creeping reduction in services. On the ground this might manifest as shorter and more hurried care visits, with more clients assigned to each carer. It might manifest in the juniorisation of care work – passing work that has required significant training to the untrained or less-trained. It is even possible that such developments are recorded productivity improvements if the tricky judgements required for hedonic calculations mismeasure any juniorisation.

The third choice – although it’s not really a choice – is to work smarter and get more care for the same or less money. It is to build the better mousetrap that has eluded those seeking billion-dollar prizes for doing so in places like the United States with different models of provision. There’s something to be said for this. We shouldn’t get fatalistic about the absence of productivity growth in high-human-touch sectors. Just because these sectors have not yielded great advances before, it doesn’t mean they won’t in the future. Concerted human ingenuity has yielded incredible developments, and the door is open to innovation in the field of public service provision. But we must also prepare ourselves for the choices that arise from a continuation of the trend of the past: flatlining productivity and Baumol’s insights around the requirements to pay more for the same thing, or pay the same and get less in a growing economy.

There is no escape from the triangle. And we currently talk as if there is. So we really need to be more honest.

What story does the data tell about choices that we have made so far for social care in the UK? While never a highly paid sector, the median worker in UK Social Care in the late 1990s was paid a comparable hourly rate to the median non-social care worker. Two decades later this median social care worker earns only around three-quarters of the median worker outside social care (dark blue line, fig 1). This looks to be a direct result of the desire on the part of the government to – on the one hand – guarantee a universal floor for human dignity, but also limit the overall cost to the public purse. As such, the kind of dynamics one would expect from Baumol that we’ve seen in the US hospital sector – bereft of productivity gains – can be seen to have been constrained by the desire of the government to escape the triangle (figures 5-6). But there is no escape. Reducing the relative wage has manifested in juniorisation, recruitment difficulties, and an exodus of care workers into the retail and hospitality sector.

Figs 5-6: Ratio of hourly gross pay for UK Social Workers without Accommodation versus All UK Workers (Medians and Means); Hourly wages for workers in the US hospital sector, US private sector, UK social work sector, UK all employees 1997-2021 (1997=100)

Source: Bureau of Labor Statistics, Office for National Statistics, Authors Calculations October 2022

The bottom right corner of the triangle – higher productivity – which is so compelling because it avoids some really dramatic and unpleasant choices, looks so far to be based in fantasy. An hour of childcare/ eldercare today is comparable to an hour in 1870.

And so the big choices put us back at the opposite edge of the triangle. On this edge of the triangle there is a straight trade-off between a larger state that harnesses our aggregate economic productivity gains to maintain or lift the universal floor for human dignity on the one hand, and sequential reductions in quality and quality on the other. Whichever choice we make should be made in the open.

What would it really mean to succeed here and occupy the high productivity corner? Dystopian fantasies in which children and elders are plugged into VR headsets where they can be entertained, educated and stimulated in the metaverse, while robots operate in the physical realm to support their bodily functions or restrain them can surely be discounted. Increasing the number of children a childminder can legally look after each year would only deliver a deterioration in quality masquerading as higher productivity (ie, the bottom left corner). It would require a more granular view of things like work organisation, job design, market structure, business models; all considered for different geographies and sub-markets.

More efficiency is – and should be – a real goal, but retaining the centrality of human touch in these sectors poses limits to productivity gains that can be achieved.

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