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What’s Stalling the Next Economic Revolution?

Thursday, September 9, 2010

The next economic revolution is likely to come in healthcare and education. Two things stand in the way: credentials cartels and state-subsidized incumbents.

Technological revolutions create economic revolutions, but with a lag. It takes time for new patterns of production to emerge. I believe that the computer and communications revolutions ultimately will transform two important sectors of the economy: education and healthcare. They will become more effective, more productive, and more important as a share of our nation's output and employment.

There are, however, many impediments to transforming these sectors embedded in government policy. The regulations and subsidies that protect outmoded methods may delay the revolution for years, or even decades.

Earlier Revolutions

The lag between technological innovation and economic transformation seems to be several decades. Steam-powered rail transportation became practical around 1830, but not until well after the Civil War was its impact fully felt. Key industries, including meatpacking and steel, became highly concentrated in response to the reduced cost of transportation.

Education and healthcare are ripe for disruptive innovation.

By about 1880, the technology for a new revolution based on electricity was already available. According to a famous paper by economic historian Paul David, however, it took almost 40 years for electricity to achieve over 50 percent penetration in manufacturing and lighting.1

The internal combustion engine powered cars by the early 1900s, although it was not until the 1950s that the United States adapted to the possibilities created by mass adoption of the automobile. In that decade, there emerged the first suburban tract housing (Levittown), the first national fast food restaurant (McDonald's), the first large suburban discount store chain (E. J. Korvettes), and the first national motel chain (Holiday Inn).2

In 1871, Chicago suffered a massive fire. Although the initial account that blamed this fire on a cow kicking over a lantern was later disavowed, the fact this story was even plausible suggests how different cities used to be. By 1950, there was no reason to have a cow anywhere near a city. But prior to the advent of modern transportation and refrigeration, cities needed to be surrounded by farmland in order for residents to be fed. The 1950s saw this farmland taken out of production, with some of it going to suburbs and the rest returning to wilderness.

The economic transformations that follow technological revolutions take several decades, because they require a number of developments.

The economic transformations that follow technological revolutions take several decades, because they require a number of developments. The technology must be refined in order to become more cost-effective. Complementary goods and services must emerge (e.g., automobiles required gasoline, better roads, and mechanics). Entrepreneurs have to envision innovative products and undertake the trial-and-error process of attempting to bring those products to market. Finally, the economy may need to undergo painful dislocation, as outmoded industries and processes die out. This dislocation may have been a factor in the Great Depression, when the internal combustion engine was already having an impact on productivity, dumping large numbers of farm laborers into the urban labor force.3

The Next Revolution

The next economic revolution is likely to come in healthcare and education. These are two sectors where demand will likely grow and where the impact of the computer and communications revolution has been slow to be felt.

Economic historian Robert Fogel pointed out that the long-term trend is for spending on food, housing, and durable goods to grow more slowly than overall output. The two main sectors where spending rises with income are education and healthcare. Even in the recent downturn, BusinessWeek’s Michael Mandel points out that, from the fourth quarter of 2007 to the second quarter of 2010, education and healthcare were two of the fastest-growing sectors, with consumer expenditures rising by 13.4 percent and 10.8 percent, respectively.4

Meanwhile, however, the performance of these two industries has been widely questioned.

— According to many studies, much healthcare spending is wasted.

— Public education, in spite of massive increases in spending, shows little or no improvement.

— The quality of education at colleges and universities in doubt. For example, one recent paper shows that students spend 40 percent less time studying than was the case 50 years ago.5

Education and healthcare are credentials cartels. Licensing and accreditation are key requirements to compete in those fields, and incumbents are in control of the process.

Many observers question the service delivery methods in healthcare and education, which have changed very little in response to changes in the economy and information technology. Primary school still has a summer vacation, even though children no longer are needed to bring in the harvest. Colleges still have an “edifice complex,” putting up ever-more elaborate buildings, even though technology makes it easy for students to obtain information without even coming to campus. Our medical schools turn out a decreasing share of general practitioners and gerontologists, even though all indications are that this is where the need is the greatest. Hospitals are adopting the most expensive new equipment, while failing to instill low-cost routine procedures that could improve treatment.6

What this suggests is that education and healthcare are ripe for disruptive innovation. Clusters of entrepreneurs could introduce new processes and service models, improving cost-effectiveness and dramatically reconfiguring these industries.

Credentials Cartels and State-Subsidized Incumbents

Entrepreneurs in healthcare and education face unusually strong barriers to entry. Both industries are credentials cartels. Licensing and accreditation are key requirements to compete in those fields, and incumbents are in control of the process. In addition, particularly in education, the government subsidizes major service providers.

To improve healthcare delivery, entrepreneurs need the freedom to experiment with new processes. Managers need to be able to train and deploy the work force.

The two main sectors where spending rises with income are education and healthcare.

Instead, government laws and regulations set labor management practices in healthcare and dictate the licensing requirements and work rules for healthcare providers. Instead of allowing the hospital or clinic to determine the best way to train and utilize workers, government insists that particular tasks be done only by workers with particular credentials.

In the field of education, imagine that there were no government-sanctioned process of accreditation. Instead, colleges and primary schools would have to demonstrate their value directly to parents, students, and employers. Most importantly, anyone could offer a new educational service to compete with today's schools.

Of course, today the incumbent institutions enjoy the advantage of taxpayer support. Even when a competitor can obtain accreditation, it is difficult to compete with state-funded educational establishments. To have a level playing field, government would have to get out of the education business, either by eliminating funding or by transforming spending into vouchers.

Impediments to Recovery

Government-created barriers to entry and innovation in education and healthcare impede progress in those industries. More importantly, they retard the process of restoring full employment to the economy.

The most promising sectors for growth and job creation are healthcare and education. But by reinforcing the credentials cartels in these industries, government is making it more difficult for the economy to return to full employment.

Arnold Kling is a member of the Financial Markets Working Group of the Mercatus Center at George Mason University. Read his blog.

FURTHER READING: Kling also wrote, “When Labor Is Capital: The Limits of Keynesian Policy,” “Why Our Current Budget Situation Is a Crisis,” and “Not Your Grandfather’s (or Keynes’s) Economy.” He is co-author, with Nick Schulz, of From Poverty to Prosperity, “Is Mandated Health Insurance Constitutional?” and a suggestion for privatizing “Airline Security.”

Image by Darren Wamboldt/Bergman Group.

Notes

1. Paul David, “The Dynamo and the Computer: An Historical Perspective on a Modern Productivity Paradox,” American Economic Review, May 1990.

2. The formation of these enterprises is recounted in David Halberstam's book, The Fifties.

3. See Alexander J. Field, “The Most Technologically Progressive Decade of the Century,” American Economic Review, September, 2003.

4. Michael Mandel, “Where Americans are Spending More.”

5. Philip Babcock and Mindy Marks, “Leisure College, USA: The Decline in Student Study Time,” American Enterprise Institute Education Outlook, August 2010.

6. For example, see Atul Gawande, The Checklist Manifesto.

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