In July 2024, Britain's incoming Labour government faced a significant challenge as independent pay review bodies recommended a 5.5% pay increase for millions of public sector workers. This recommendation contributed to a staggering £20 billion budget deficit inherited by Chancellor Rachel Reeves [44cd6bf1]. This situation exemplifies 'Baumol's cost disease,' a concept introduced by economist William J. Baumol, which describes how costs in labor-intensive sectors, such as healthcare and education, tend to rise faster than inflation due to stagnant productivity [44cd6bf1].
The implications of this phenomenon are profound, affecting over 500,000 teachers and 1.3 million NHS staff in the UK. Baumol pointed out that while productivity increases in other sectors drive wage growth, stagnant sectors must still match these wages despite not experiencing productivity gains. For instance, the average cost of cremation in Britain rose by 43% from 2011 to 2020, significantly outpacing the 16% rise in the Consumer Price Index during the same period [44cd6bf1].
Baumol suggested that while overall economic growth could enable increased spending on healthcare and education, it also raises concerns about the public sector's share of GDP, which could rise significantly. This trend echoes worries typically associated with planned economies, where public sector expansion can lead to inefficiencies and budgetary strains [44cd6bf1]. As the Labour government navigates these challenges, the balance between necessary wage increases and fiscal responsibility will be critical to ensuring the sustainability of public services in the UK.