If you want a performance of a Beethoven string quartet, you need four people - exactly as many as in Beethoven's day. In this sense, labour productivity in live music hasn't changed for 200 years. But productivity in most other businesses has increased enormously; four farmers or four manufacturing workers can produce far more than they did in 200 years ago. And higher productivity should mean higher wages: real wages today are 11 times what they were in 1815. This doesn't just mean rising wages in those sectors where productivity has increased, but also in those where it hasn't; if you try to pay a string quartet 19th century wages even the viola player will get the hump and leave. This means that the cost of performing a string quartet, relative to other things, will rise over time - because you're paying the same wages as in other sectors without seeing higher productivity. This is one reason why many people believe the arts need subsidising.
What I've just described is the Baumol effect, named after New York University's William Baumol who first pointed it out in 1966. It's this that explains why school fees are so high; teachers' wages rise over time but their productivity doesn't so much.
It also explains rising house prices, as a new paper by Nicola Borri and Pietro Reichlin of Rome's Luiss University shows. They point out what anyone who walks past a building site knows - that productivity growth is weak in construction. The ONS estimates that productivity in the sector has risen by only 9 per cent since 1990 while that in the whole economy has risen 41 per cent. This alone would mean that the relative cost of houses would rise over time, even without silly planning restrictions or reckless bank lending - for the same reason that school fees and orchestras are so expensive. Sure enough, the Nationwide building society estimates that the ratio of house prices to earnings for first-time buyers has trended upwards for the last 30 years: it is now 5.1 compared with less than three in the mid-80s.
There's worse. Demand for housing is price-inelastic: a 1 per cent rise in house prices leads to a less than 1 per cent fall in demand. This means that as house prices rise we spend more of our incomes on housing and less on other things - which means that a stagnant sector is getting bigger with the result that aggregate productivity falls because the more dynamic industries get squeezed.
You might think this justifies investing in housing. I'm not so sure. For one thing, pric:earnings ratios are above their long-run trend, which implies that prices might fall temporarily even if the long-run upward trend continues.
And for another, house-buyers are tasking on policy risk - not just the danger of higher mortgage rates but also the possibility that governments will eventually relax planning restrictions or take other measures to increase housebuilding, thus increasing supply and reducing prices. The fact that rising house prices contribute to economic stagnation would justify such policies.
