Saturday, June 27, 2015

Cochrane's 4% Growth Plan

The always-grumpy John Cochrane has his plan for economic growth. It's a predictably conservative and somewhat vague plan that consists of the following: 
  1. The tax code is thoroughly reformed to do nothing but raise revenue with minimal distortion -- a uniform consumption tax and no income, corporate, estate etc. taxes, or deductions.
  2. A dramatic regulatory reform. For example
    a. Simple equity-financed banking in place of Dodd-Frank. 
    b. Private health-status insurance (with, if needed, on-budget voucher subsidies) in place of Obamacare. 
    c. An end to the mess of energy subsidies and interference. No more fuel economy standards, HOV lanes, Tesla tax credits, windmill subsidies, and so on and so on. (If you want to control carbon, a uniform carbon tax and nothing else.) 
    d. Many agencies cease to exist. 
    e. No more endless waits for regulatory decisions. 
  3. No more witch hunts for multibillion dollar settlements.
  4. Thorough overhaul of social programs to remove disincentives. Most help comes via on-budget vouchers.
  5. No more agricultural subsidies.
  6. No more subsidies, period. Fannie and Freddie closed down.  
  7. Unilateral free trade. 
  8. Essentially open immigration -- anyone can work.  
  9. Much labor law rolled back. Uber drivers can be contractors, thank you. Most occupational licenses removed -- anyone can work.  
  10. Drug legalization.
  11. School vouchers. 
If you take a step back from the fact that the presentation is heavily conservative in tone, there is actually a lot to agree with here. But, of course the devil is in the details. For instance: 
1. Reforming the tax code is a great idea. There are too many off-budget subsidies (a.k.a. "revenue expenditures") in the tax code. Get rid of those (including the mortgage interest credit, which benefits me). But I don't think that a "uniform consumption tax" works so well. This comes from Cochrane's macro background that shows that consumption taxes distort less (and encourage more savings and investment) than income taxes. I would actually combine tax reform with points 2(c) and 4: Negative income tax (think EITC on steroids), and high carbon taxes to replace the current tax and welfare system. 
2(a) Dodd-Frank isn't a masterpiece, and I have no issue with equity financed banking, but add in Basel III capital requirements, etc, and I'm on board. 
2(b) Many of the regulations in Obamacare are senseless, and distortionary, but broad concept of direct subsidies cum mandate is good. That, or single-payer. 
2(d) and (e) Which agencies? Would Cochrane like shorter waits if it meant more government employees?  
3. Not sure. If we get rid health, environmental, and safety regulations, then you turn many externalities over to the courts. Can't do both. Problem with turning it to the courts is that now you give power over the outcomes to the guy with the best lawyers. Maybe not a great idea, so many of these regulations may need to stay (if they cannot be managed through Pigouvian taxes). 
5. Ag subsidies are a drag. Do it. 
6. Cochrane seems to think all of his "vouchers" aren't just subsidies in disguise. Problem is, they're actually worse than cold hard cash - vouchers are the government's way of telling you how you should spend the money it wants to give you. Is this conservatism? 
7. Free trade. Yes. 
8. There shall be open borders. Yes. 
9. "Much labor law." If by that he means "much occupational licensing" then great. Yea Uber. Yea, competitive hair braiding markets. But maybe my ophthalmologist should be formally licensed. Otherwise, see my comments on point #3.
10. Drug legalization. Go for it. Hard drugs too? Yes.
11. School vouchers. (Not "subsidies?") Public schooling ain't so bad. Teaching at a private university, I worry that "competition" for students leads us to make curriculum decisions that may not be in the long run interests of students. Cochrane teaches maybe 1-2 sections per semester at an elite school, so he probably spends less time ruminating on this than we do at smaller schools that capture more marginal students. 

Tuesday, June 16, 2015

An Institutional Economic Analysis of the "Consumer Model" of Higher Ed

Neoclassical economics teaches us that markets are efficient when they are competitive (with an arbitrarily large number of buyers and sellers); when buyers and sellers are "rational" by some technical definition; when the good or service they are allocating is private; when there are no externalities; and when transactions costs (including the cost of obtaining information) are low. When these conditions are met, the market will automatically create contracts (usually a simple posted price) that captures the marginal benefits an the marginal opportunity costs to the buyer and seller. However, the over-application of this model to any situation can be problematic and harmful. 
Specifically, applying this model to higher education is fraught with failures with respect to these assumptions. Knowledge is non-rival (but can be excludable in the short run); educating individual students may have spillover benefits (by making others more productive as well); and transactions costs are considerable (the costs and benefits of various types of education are uncertain, and often unverifiable by future employers). Despite these limitations, many presidents and provosts at a large number of colleges and universities (and in particular deans of business colleges) have taken up the view that students are the "customers" to the university's "firm." Other outlets have made compelling arguments against this model. I intend to express the economic case for why this view might lead to a general deterioration in the quality of education. 
Who is the customer of a university providing the service of higher education? Surely part of the answer is that the student is, but in what regard? The student attends the classes, does the coursework (usually), and learns the material. As I emphasize to my own students, "no one can learn the material for you." So, surely it is the student who receives the education who solely benefits from it!
Not really. First of all, students presumably attend college to become more productive. Attending my microeconomics class is different from buying a ticket to see Jurassic World. It is not entertainment or pleasure to be consumed and completed; rather, it is an investment to be accumulated and maintained through no small amount of blood, sweat, and tears. The beneficiaries of this effort are both the future self of the student, and also the firms that eventually employ those students. So our stakeholders in the student's education are now three: current student, future student, and future employer.
At this point we have a contracting problem: information. Students are uncertain as to how beneficial their investments will be, and may not know which investments will be most beneficial after they have graduated. Moreover, the skills that will have a value in the future (math, science, economics) may not be the same as those subjects that the current student finds most interesting, entertaining, or even "easy" (art, history, management). Then, when the student has graduated (and is seeking a job), employers are poorly informed about the true abilities of the graduates applying for positions. A college transcript may tell firms something about what and how much you learned, but not everything. Lazy graduates, or graduates who got good grades by "gaming the system" have an incentive to disguise themselves to be hard-working and thus manipulate the information (and therefore the contract) to their strategic advantage. 
On top of that, how well you are able to learn a rigorous topic (like economics) depends somewhat on "peer effects." Zimmerman (1998) shows that average students with below-average roommates fared worse in their academic standing than similarly-capable students with above-average roommates. In other words, associating with smarter people makes you more productive! So, it turns out that my little motivational quip is not entirely true: Being in the company of other good students does in fact help average students learn! Once you have graduated and found work, these peer effects continue. Glaeser (1994) suggests that workers in cities are about 33% more productive than similarly-educated workers in more rural settings. Moretti (2004) shows that workers in firms with higher percentages of college graduates are also more productive. At this point the contracting problems are really piling up because now we are having trouble isolating the private beneficiaries, and, therefore, excluding "free-riders". 
Hence, the stakeholders in any student's - even if we focus solely on the economic benefits - could be said to include: (1) the current individual student; (2) the current student's classmates; (3) the individual student's future self; (4) the student's future employer(s); (5) the student's future co-workers. I could also probably include (5) the student's alumni (who benefit from the continued value to their degree); and (6) society at large (to the extent that well-educated students today will be better-informed voters for their lifetimes). Contracting among these various stakeholders involves very high - likely prohibitive - transactions costs. 
But there is one key way in which students are, and have increasingly become, the sole consumer: paying the bills. The increasing burden of cost on the individual student gives the student much more leverage over colleges and universities. Thus, it is a group of 18-22 year old current students' preferences for increasingly high grades for increasingly little work (along with fitness centers, fancy dorm rooms, gourmet cafeteria food, and successfull athletic programs) that dictate the revenue streams (recruitment and retention) for colleges and universities. Direct public funding of colleges and universities is down substantially, and the extent to which this has been offset by redistributing those monies directly to students in the form of grants may not help. So, the likely result is that problems in higher ed will get much worse before they get better. And it is hard to blame administrators for treating students as "the consumer" because they're just following the money. 

Wednesday, June 10, 2015

Intellectual Property Rights, Innovation, and Regulatory Capture

There's quite a bit out there right now about the Trans-Pacific Partnership (TPP) and its supposed provisions on Intellectual Property Rights (IPR). The nature of the current dispute is that US negotiators (in some cases rightly) claims that IPR laws in many countries are too lax, whereas negotiators in other countries claim that US property rights laws (which the US seeks to embed in a proposed agreement) are too strict.
Who's right? Answer: Both of them, but not necessarily for the reasons we might think.
The claim for the US is pretty straightforward: Without IP laws, innovators cannot profit from their ideas because copycats will steal those ideas with disastrous consequences for the incentive to innovate. This is a true enough claim, and one might think that if some protection is good then a lot of protection is even better, and so the US IPR system should be transplanted - even strengthened and made more strict - worldwide.
The flip side of the argument is that IPR law grants big firms (Pharma, for example) monopolies that increase prices, make technologies (and other innovations) unaffordable in poor countries, and hence make development unachievable. While this is true, it partly misses the point: After all, stricter property rights enforcement would presumably give all countries the opportunity to benefit from the innovations of its work forces.
Instead, the real problem with very strict IPR laws is that it may actually stifle innovation on some margins. In the US, any patent that would improve existing technologies requires the patent applicant to attain permission from each and every patentholder on the technology she wishes to improve. Many technological improvements in the Industrial Revolution were in fact this type of marginal innovation by nameless, faceless workers looking to make their own jobs easier. These innovations are somewhat restricted under current IP law.
Another problem with strict IPR laws is that it changes the nature of innovation. Take pharma for example. A number of the biggest problems facing medicine today are "public health" issues. These issues may disproportionately affect poorer citizens or countries, or they may be relatively randomly distributed. However, the most profitable innovations are the ones that provide private benefits. Thus, the industry is more apt (under current laws) to "innovate" new cholesterol pills and boner pills - medicines that solve private health issues, or problems that may disproportionately affect richer people. How's a firm to profit from creating a vaccine for ebola or HIV?
So, in many ways, the optimal strictness is probably somewhere between the US patent troll system and a Hong Kong free-for-all. In other words, and stealing (but innovating on!) an idea by Alex Tabarrok:

Productivity Growth CAN Reduce Middle Class Incomes!

Tyler at Marginal Revolution asks the question "How can faster productivity growth NOT raise middle class incomes?"
Am I missing something? Is it a trick question? It seems like there is a simple principle-of-economics answer. Faster productivity growth could lower (real) middle class incomes if the following are all true:
1. Productivity growth only increases productivity for capital and not for labor. Hence, the direct impact of the growth will be to shift demand for capital to the right, and increase the price and quantity of capital.
2. Middle class households mostly earn income from selling labor (and not capital). This seems to hold up empirical given the very high concentration of wealth relative to income.
3. Middle class households' labor is a strong substitute for capital. In other words, the increased productivity of capital leads to a (large) shift in relative factor demand away from labor and towards capital.

Scott Walker's War on Tenure: An Institutional Economics Analysis

Scott Walker has declared war on tenure, and it has been reported on nationally (in the NYTimes or Inside HigherED and the Washington Times) and blogged about by some economists (Tyler Cowen and Menzie Chinn) But Scott Walker only half-understands tenure, and the half he understands leads him to miss the point of it.
Granting a faculty member indefinite tenure is a mutually-beneficial contracting mechanism that benefits both faculty and colleges. To understand this, we have to understand the different aspects of a faculty member's productivity:
1. Teaching. At most colleges, teaching is the most important service a faculty member provides for her institution. This involves teaching a subject area well, and defending academic standards.
2. Service to the Institution. This might include curriculum/course development, advising, committee work, or generally helping out with administration of academic programs.
3. Research. This mostly includes publications.
4. Service to the Profession. This might include serving as a referee for journals, membership and service in professional organizations, etc.
Aspects (1) and (2) involve "firm-specific human capital investments" and mostly benefit the institution, whereas (3) and (4) involve "general human capital investments," and mostly benefit the individual faculty member (and her ability to find a job elsewhere!). More generally speaking, there are a lot of high-skill jobs that involve similar types of tradeoffs in the allocation of effort for investing in human capital, but this is especially pronounced, I think, in Academia.
This presents an interesting contracting challenge. Institutions would like high levels of effort in all areas, but would especially like high effort in firm-specific areas (teaching and administration). Tenure partially helps achieve this, and this is where the half of tenure Walker doesn't understand comes into play. On the one hand, Walker is correct that tenure has a general tendency to reduce the overall incentives facing a faculty member and thus may reduce total effort (although even this is not fully clear since tenure reduces aggregate uncertainty, and uncertainty can sometimes be a disincentive to work). On the other hand, Walker fails to recognize that tenure also increases the relative incentive for making "firm-specific human capital investments" - investments in teaching and curriculum development. (Side note: tenure is also creates similar substitutions within the allocation of research time away from small "marginal discoveries" and towards bigger projects that may attract acclaim for the institution.)
Hence, university presidents should be wary of abolishing tenure, and not only for altruistic reasons. By increasing uncertainty about continued employment, educational quality suffers. Regular faculty members will invest more time in research (who knows, I may need a job somewhere else?) and retreating on standards (students better like my teaching - and populate my classes - or I won't get to stay).

Thursday, April 9, 2015

Cost Curves: Don't "Let Me Google That for You"

It's amusing reading students' responses to take home exams. Some would clearly benefit from a even the most meager level of effort, while others show a clear and sometimes deep understanding of the material. Then, there are the kids who Google shit.
Of course, when they do this, they're rarely clever enough to put information they take from Wikipedia or Quizlet into their own words, and it's not too hard to catch them by selecting the plagiarized text and search for it using the context menu in Chrome (or Firefox).
But, I digress. In my police work, I stumbled across the Wikipedia page for "Cost Curves." Near the bottom there is a heading labeled "Cost Curves in Reality." Under this heading, the entry notes,
The U-shaped cost curves have no basis in fact. In a survey by Wilford J. Eiteman and Glenn E. Guthrie in 1952 managers of 334 companies were shown a number of different cost curves, and asked to specify which one best represented the company’s cost curve. 95% of managers responding to the survey reported cost curves with constant or falling costs.
Alan Blinder, former vice president of the American Economics Association, conducted the same type of survey in 1998, which involved 200 US firms in a sample that should be representative of the US economy at large. He found that about 40% of firms reported falling variable or marginal cost, and 48.4% reported constant marginal/variable cost.
The question is: Should I be surprised at these findings? It doesn't seem that these empirical findings suggest anything abnormal about the actual costs of production.
Why? First, it would seem to me that managers most likely are familiar with the range of production below and including the current range of output they are producing. If the industry is anything other than perfectly competitive, the current range of output will be on the decreasing side of average costs. Second, technology reduces costs over time, and therefore as firms expand they are also improving technology, and thus reducing their costs. None of this disproves the existence of upward sloping average costs at some level of output way out past the firm's current production horizon.
Now, what would be interesting would be to put this on an upcoming take home exam to see how many students Google it, and hit to this post. Will they have the gall to plagiarize their own professor?

Wednesday, February 4, 2015

Grades and Public Goods

I do little experiments in class. Today's topic was "public goods" and I did the following exercise: 
Each may voluntarily 'contribute' any number of points from 0 to 10.
I will increase the amount collected by 20 percent
The resulting total will be divided equally among all class members who are present.
You may interact before contributions are declared but you will make your contributions anonymously and in private.
All contributions will remain anonymous. 
It's basically a version of a game lifted from Games Economists Play. Anyway, there were 17 people in class, and there were 107 points contributed so everyone got back about 7.6 points. But, a few people put in 10 points and ended up with negative points. Needless to say, it's not the most popular game we do in class, but the grumbling subsides when I tell them that on average, students win between 15 and 30 points playing these games. 
Anyway. One kid who thought he was particularly clever asked, "let's just make the 107 everybody's score on the exams." 
I took the bait, and asked, "well, is that good for everybody?" 
Naturally, the first response was overwhelmingly positive, until I asked "why do we have grades?" Eventually the answer settled somewhere in the vicinity of the fact that they provide information about what we know or what we learned or how smart we are. Of course, the signal grades send is noisy, but that's a topic for another day (two classes from now, in fact!). 
Getting back to the grades, I asked what would happen if I announced (or if everyone knew from their friends for example) that everyone's going to get an "A" in the class. Someone said "I wouldn't do shit." AAAAND (wait for it) .... If everyone gets an A (or if all of the teachers give A's), then an A becomes a public good, and no one (students especially) has any incentive to work hard and make sure their grades and degrees mean something. AAAND.... ..... BOOM! we're back on public goods! If we make A's public goods (instead of private goods that have to be earned individually) then the whole value of education is degraded.