Does Baumol's Cost Disease Account for Nonfederal Public‐Sector Cost Growth in the United States? A New Test of an Old Idea*

Abstract

ObjectivesTo examine if Baumol's cost disease of the service sector offers an explanation for the growth of state and local government costs in the United States.MethodsThe study tests whether state‐wide increases in wage rates relative to productivity influence the growth of state and local government spending using a relatively new econometric test along with a panel data set of the 50 states over the period from 1980 to 2009.ResultsFindings are robust to various multiple regression specifications and show that Baumol's cost disease does account for some of the growth of state and local government costs over time.ConclusionUnless the delivery of public services takes on a more capital‐intensive process or is absorbed by the private sector, the implication is that consumer‐voters should become better accustomed to the government sector comprising an increasingly larger proportion of their state and local economies over time.