The Baumol effect is a mechanism for how the real costs of goods and services can rise over time: wages rise due to economy-wide productivity growth, including in sectors with no productivity growth, and this raises their overall real costs of production. The original example for Baumol was classical concerts – they use the same number of musicians as in the 19th century, but wages have increased from 19th-century levels. More generally, it’s also used to explain higher real costs of services as service productivity growth lags manufacturing productivity growth.
Unfortunately, I’ve also seen people use Baumol as a way of explaining rising infrastructure construction costs, for which it is not at all a good explanation. In fact, even though growth in average infrastructure costs over time is documented, there is very little cross-national correlation between GDP per capita and per-km subway construction costs. Notably, the Anglosphere’s very high construction costs affect not just very rich countries like the US and Singapore but also ones that are poorer than the Western European average, like New Zealand, Ireland (which has high GDP per capita due to corporate profits but unimpressive local wages), or increasingly the United Kingdom. Conversely, Nordic and Swiss wealth has not at all led to high construction costs, and until recently the Nordic countries and Switzerland had some of the world’s lowest tunneling costs.
Metro construction costs and GDP per capita
In an earlier version of the construction cost database, there was some positive correlation between GDP per capita and construction cost per km (about 0.23), but nearly all of it came from the fact that poorer countries tend to build more els and fewer subways; correcting for that, the correlation fell to about 0.04, and turned negative if New York and Singapore were dropped. We made a scattergram at the national level:
While looking at the scattergram, bear in mind that the poorest country as of 2020 on our list, Pakistan (the small gray circle touching the much larger gray circle of India), built an all-elevated line, and in general, substantially-elevated or even all-elevated lines are common in developing Asia, including Vietnam, Bangladesh, Indonesia, the Philippines, Thailand, and India. The only all-underground Indian line in our database, Mumbai Metro Line 3, cost $535 million/km in 2023 PPP dollars; Mumbai Line 11 and Chennai’s first-phase program are the only other two items that are majority-underground, both a bit more than $300 million/km.
At this point, even if we restrict our attention to Europe, the correlation between GDP per capita and construction costs per km isn’t clear. For example, Railway Gazette has just reported on the groundbreaking of the first metro line of Cluj-Napoca, to cost 13.7 billion lei/21 km, which is $8 billion in PPP terms, or $380 million/km. But then rounding up the bottom of the EU’s GDP per capita table is Bulgaria, with fairly low costs.
This is not supposed to happen if the Baumol effect is what’s going on. Grocery prices in developing countries are lower than at first-world discounters like Walmart or Aldi, even in PPP terms. Even at tourist traps, the prices are usually lower than where the tourists came from, not because retail and food service are atypically efficient in developing countries, but because these are labor-intensive industries and labor wages are lower in Thailand or China, let alone in India or Pakistan, than in the US or Germany.
The issue of the Anglosphere
The Anglosphere has atypically high construction costs. A dummy variable that takes the value 1 in the US, Canada, Australia, New Zealand, the United Kingdom, Singapore, Hong Kong, and (when it starts building) Ireland, and 0 elsewhere, has a correlation of 0.41 with per-km construction costs. In contrast, the tunnel percentage only has 0.15 correlation, due to the aforementioned effect of high-cost developing countries building els. I’ve heard the high Anglosphere costs blamed on a kind of areal Baumol effect: high pay in professional services drags the costs up, on the theory that the United Kingdom may be poorer than Germany and no richer than France, but at least it has productive London finance that drags engineering wages up, so Britain can’t just Germanize or Francize, right?
Well, no. British engineering wages are not at all high by Continental Western European standards. London finance pays a lot, but also has been stagnating for a while, and a number of professional service firms and regional HQs have left the country in response to Brexit to locate in the rump-EU, for which Amsterdam is a popular destination. British costs remain high, and if anything, they’re exploding again. The Bakerloo line extension is now projected to cost £5-8 billion in 2023 prices for what looks like 8 km, which is around $1.2 billion/km in PPP terms, somewhat more than the much more complex Crossrail and about twice as expensive as the comparably complex Northern line extension to Battersea.
Then-Singaporean minister of transport Khaw Boon Wan excused the meteoric growth in Singapore’s MRT construction costs on the grounds that the Singaporean economy had grown rapidly as well. But we’re seeing the same cost explosion in the slower-growing United Kingdom, and conversely we’re not seeing high costs in fast-growing South Korea. New Zealand, which has had okay growth but from low levels for a Western country and remains poorer than Italy, has these extreme costs as well. It’s not that the Anglosphere is rich; it’s that it’s the Anglosphere and builds inefficiently.
So why have costs grown?
While there is no correlation between subway tunneling costs and GDP per capita, there is an evident secular growth in costs over time. It’s not uniform everywhere – German costs are barely up compared with the 1970s and Italian costs are slightly down – but it’s huge in the Anglosphere and also evident elsewhere (for examples, in France and in the Nordic countries). So what’s going on?
Well, we’ve divided the New York cost premium into three tranches: labor (mostly overstaffing, not high wages), station and system design, and procurement and soft costs. All three show evidence of having gotten worse, the first in the Northeastern United States and the other two throughout the Anglosphere and sometimes also elsewhere.
Ad labor, staffing levels in New York are just higher than elsewhere. More workers are required to service a tunnel-boring machine in New York than in Istanbul, let alone richer European cities. This is, in theory, an eexample of the Baumol effect: higher wages raise the real cost in an industry without productivity growth. But in fact, there has been plenty of productivity growth in this industry, the Northeast just refuses to make use of it. Stockholm has been able to keep up and keep its labor share of the hard costs to the same 20-something% as Turkey and Italy; New York and other Northeastern US cities are in the 40-60% range instead. Swedish construction productivity has grown at slower rates than the overall Swedish economy, but American construction productivity has fallen.
Ad station and system design, we have pointed out that stations for Second Avenue Subway Phase 1 dug a cavern twice as long as necessary for the train, for the benefit of extensive back-of-the-house spaces, where in non-UK Europe and in China, the digs are typically a single-digit percent longer than the train. This is a general North American problem, also evident in Los Angeles and Vancouver, and I believe also in London. It’s also a new problem: in the 1980s, the overage in the United States was small, comparable to contemporary European levels. Then there’s the issue of poor standardization of materials, systems, and designs; we are uncertain whether this is a growing or longstanding problem, but it is smaller in magnitude than that of excessive station size, and in general, standardization is more important in a richer economy than a poorer one since the richer economy will have more reliance on big businesses with division of labor, which is also one of the speculated causes of the falling construction productivity (it’s a less standardized sector).
Finally, ad procurement, the invention of the globalized system in which state planning is outsourced to private consultancies, and with time even the supervision of the consultants is outsourced to consultants, is an Anglosphere special, dating from the 1990s onward. This system comprises design-build procurement (confusingly called progressive design-build in New York), very large contracts sometimes growing to $1 billion apiece, lump-sum rather than itemized contracts, and privatization of risk. It’s turned entire countries, like the United Kingdom, incapable of building more than about one line per generation. The Nordic countries have been affected as well, leading to sharp cost growth from very low levels to rather average ones. Canada went from fairly normal costs in the early 2000s to building the most expensive subway outside New York with the new Ontario Line cost overruns, and this can be traced to Toronto officials visiting Madrid, a city that sticks to traditional design-bid-build procurement, and coming back convinced that to imitate Madrid’s low costs Toronto should adopt design-build.
None of this is the Baumol effect or some general cost disease. When agency officials lose interest in building things and instead want to outsource their own jobs to consultants, it’s not Baumol; it’s experimenting with a new way of project delivery and then refusing to admit that it’s a failure. The same is true when nobody bothers to say no as each operating department demands more back-of-the-house space until half the station dig is about providing high-cost underground break rooms and storage rather than about providing space for trains and passenger circulation.
It’s a comforting story for Americans, Brits, and Singaporeans to tell themselves that their infrastructure costs are so high as a byproduct of their wealth. It happens to be entirely false. It’s not even interestingly wrong; it’s just plain wrong, ignorant of the explosion in station size, of the failures of the globalized system of project delivery, and (in New York) of labor productivity innovations elsewhere. The Anglosphere is not expensive because it’s ahead in anything, but rather because it’s behind. And as we see in the United Kingdom, it doesn’t even require American or Singaporean wealth to be totally incurious of Continental European success.