Baumol’s Cost Disease Is Killing Me!

I first read Baumol and Bowen’s The Economic Dilemma of the Performing Arts some 20 years ago, almost 30 years after it was first published in 1965. The theory was fairly straightforward: the problem in our sector is that because there are no productivity gains associated with the creation of the work (it takes the same time and energy to rehearse and perform a Brahm’s Requiem today as it did when first performed in 1868), and because costs always increase over time and earned revenue growth is limited by a range of market forces, we are doomed to fall further and further behind, essentially forcing the more aggressive pursuit of contributed income just to balance the budget. And the problem is progressive, meaning that every year we fall a little bit further behind. This phenomenon has come to be known as Baumol’s Cost Disease.

Every year, arts administration students dutifully read highlights from the book, debate amongst themselves, agree that cost disease is a problem and move on.

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Then, last year, Richard Flanagan’s The Imperiled Life of Symphony Orchestras was published. It included the following graph:

Cost Disease

(Click to enlarge.)

After all these years, here is clear and incontrovertible proof of Baumol’s Cost Disease. The dotted line shows the growth in expenses per concert, based on data collected from the 50 largest symphonies in the country as compared to the Producer Price Index — a reasonable proxy for the cost to produce other goods and services in the economy. What the graph shows is that while productivity gains (mostly around technology) have kept cost increases in the commercial sector low (only a 40% increase over 17 years), the costs to put on a concert have increased by 300% over that same period. Why is that? It’s partly because the costs of paying musicians is rising at a slightly faster rate that wages in the rest of the economy. But the principal cause is that, with no productivity gains, the costs to create the art rise much faster than the costs of producing other goods and services.

As it happens, we’ve been working with three symphony orchestras recently. And with each group, I’ve pulled out this graph and talked about the implications for future planning. No reaction. Maybe a question or two. But no “My gosh, now I understand why this is so hard!” In fact, one musician of a technically bankrupt orchestra said “People have been predicting the demise of the symphony orchestra for 100 years, but we’re still here.”

Frankly, they’re not really here. And the research suggests harder times to come. So why aren’t more people waving this around and talking about it? Do they believe they can be the exception to the rule? Or that they’re concerned about agitating relations with the already prickly union? Perhaps. But I’m afraid that the real reason is that symphony managers are terrified of the prospect that donors might get a hold of this information and see that their donations are only prolonging the inevitable demise of the orchestra in its current form, as opposed to propelling it to future glory. And who wants to be seen throwing good money after bad?

I’m afraid it’s time for the sector to face the facts on this. There is no way around the problem of static productivity in a world of ever-increasing costs. And it’s not just the symphonies that are challenged. It’s all producing groups and those who serve them, including facilities.

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A wise man asked me a great question:

Why now? If this problem has been around forever and has even had a name since 1965, why is it suddenly something we absolutely positively have to deal with today?

My answer is that there is now a convergence of challenges (you can call it a perfect storm if you’d like) that make Baumol’s Cost Disease that much more toxic – namely, declining audiences for classical music (see the 2012 Survey of Public Participation in the Arts), growing reluctance of government to provide direct financial support to performing arts organizations, and increasing competition for private sector philanthropy for causes like the environment.

In 2010, I made a bet (for dinner) with a senior executive of the Metropolitan Opera that the organization would collapse under its own weight by 2014. I’m not going to win that bet, but frankly I don’t think I’m off by much. Here’s an organization that had, in 2004, an annual operating expenses of $211 million, with some $94 million in contributed income. By 2013, the operating budget has reached $311 million and contributed income has increased to $158 million.

How could this trend possibly continue? Do we really believe that the Met can keep growing its budget with an increased reliance on grants, donations and other types of philanthropic support? The latest set of labor agreements certainly represents some progress in slowing down the rate of cost increase, but it doesn’t even come close to reversing the trend of a growing budget supported by donors.

So what do we do? Someone at this point inevitably suggests that all we need to do is operate arts organizations like businesses — the implication being that staff with the proper skills, training, resources and motivation can fix the problem.

Well, they can’t fix this problem. Baumol’s Cost Disease is right up there with death and taxes. But there are two things we can do.

First, we have to let organizations come and go in a lot more realistic way — the way commercial sector companies come and go. The laws around nonprofit governance make it very difficult to close up shop. And the prospect of a failing arts organization often leads to a desperate and emotional campaign to “Save Our  (insert organization name/type here).” And I do think that organizations are partly to blame for this. Flanagan’s research suggests that changes in what is paid to musicians is not a function of the financial condition of the orchestra but rather the private donations made to the organization. In some cases it is only the possibility of more private support that gives management the confidence to increase pay. And that increase is not easily reversed in conditions when private support drops.

Second, we’re going to have to do is forget this idea that nonprofit arts organizations should be stable, permanent entities with all of the attendant infrastructure, overheads and benefits. I’m afraid we’re going to have to organize ourselves a lot more like the film and television industries, with smaller full-time staff and lower overheads. I’ve been telling my students that it is highly unlikely that their careers in the nonprofit arts sector will provide steady and secure employment. Rather, I’m suggesting to them that they need to develop a clear, marketable set of skills that they may have to sell to multiple arts organizations over time. They must brand themselves (ouch) as service providers, providing effective and efficient support for the creation, promotion and support of creative endeavors.

In my mind, cost disease is a dangerous thing, but it need not prove fatal for the nonprofit arts sector if we are able to reinvent ourselves in time. But make no mistake about it: time is short.

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