Monday, March 26, 2012

Pro-Market is not Pro-Business

Mark Thoma today links to an interesting post by INSEAD professor Niraj Dawar noting the inconsistency inherent in most business school curriculums. Dawar points out that while professing love for free markets, business schools also stress the importance of maximizing shareholder wealth. But because the best way to ensure profits is often to create regulatory barriers that create rents, business schools actively encourage their students to subvert the principles of the free market they claim to believe in.

His post highlights an important, but oft-overlooked point, in economic policy discussions--pro-market is not pro-business. One can believe markets serve as the best way to allocate resources without believing corporations--or rather the people working for corporations--always seek to do that*. Businesses making mistakes don't invalidate markets; only a failure of the market to punish those mistakes does. A belief that markets eventually get things right doesn't require a belief that the markets are getting things right at any particular time.

Oddly though, market supporters often do reflexively back corporations and the rich**--even though it does not seem a preference for markets requires them to do so. Tyler Cowen, for instance, tries to justify CEO salaries using studies that don't really help his cause. Why, though, does someone that believes in markets need to believe CEOs earn their keep? One could consistently hold the position that: 1.) CEO salaries result from a market failure and principle-agent problems; 2.) because of that, many CEOs are overpaid; 3.) but the government should not take measures to correct this, because the market will eventually eliminate firms with inefficient management structures. I'm not completely satisfied with this answer for a number of reasons unimportant to this post, but it seems to me a plausible market-based response. Yet instead of admitting CEOs are overpaid and explaining why they're not concerned, people often try to fight the underlying premise.

A worrying consequence of this is that it leads to unnecessary tension between the left and right. The focus of debates often centers around anti- and pro-business forces rather than focusing market mechanisms and whether they're working. And we end up in a scenario that shouldn't please anyone--markets don't work and businesses win***.

* Indeed, market adherents should, be skeptical of corporations for one of the reasons they're skeptical of government: central planning. Of course, if the government screws up its planning, it retains its monopoly on force; if a corporation screws up its planning, it goes out of business. But that doesn't require believing companies themselves are good.

** I find the political leanings of most college football and basketball coaches particularly galling. Rich, middle-aged men backing Republicans that believe in "competition, etc." while earning their millions thanks to a labor cartel imposed on teenagers. So much for the free market.

*** And, even worse, the MBAs that run them get rich.

Thursday, January 19, 2012

Paying for a difficult job, although not necessarily one well done

In Daniel Kahneman's wonderful Thinking, Fast and Slow, he writes about the vast number of heuristics we use in decisionmaking. One of these he calls "answering the easier question,"--when faced with a difficult question, we often unknowingly substitute an easier, but different, question to simplify our task. For instance, Kahneman says, to determine how much we would contribute to save an endangered species, our mind might instead ask how badly we feel when we think of "dying dolphins". Although this can simplify our task, it also makes it less exact. Kahneman provides a hypothetical caution:

The question we face is whether this candidate can succeed. The question we seem to answer is whether she interviews well. Let's not substitute.

As Kahneman explicitly points out, the has implications for the labor market. It's often difficult to evaluate how successfully a candidate can/is perform/ing. Instead, we rely on imperfect measures, such as grades, dress, affability, etc.*

I wonder if this doesn't have a bit to do with the growing income inequality gap. As the economy becomes increasingly complex, the demand for people that can add at least perceived certainty and order to the economy has exploded. Because of this, consultants, lawyers, bankers and other high-earning professions staffed by graduates of elite schools have seen their salaries explode. With middle-class jobs disappearing, this has, among many of factors, helped contribute to a growing gap between the rich and poor.

What I think we don't really know, though, is whether they're worth it. It's tough to figure out how well these people are actually doing their job. So instead, I'd imagine a different question often gets asked: how difficult the job itself is. And because these jobs are difficult--if not impossible (no one can really predict the future)--people will pay more for them even though it often only creates the illusion of a job well done. Companies--more specifically, their employees--may hire firms because of their status, not necessarily their quality--as the old saying goes, no one every got fired for hiring IBM.** Companies may be wasting vast sums of money to make themselves feel better that someone is doing a job, albeit poorly.

As I'm making a theme these days, the market economy should help us allocate resources better, not serve as a scorecard. If money is being spent merely to create a feeling of certainty and understanding where one never exists, we should be concerned about a massive misallocation of resources.

* Of course, not all of these are substitutes. Dress and affability might be concerns because clients will care about them. But, of course, the clients themselves are then using imperfect questioning to grade a service.

** It's why even as law students struggle to find jobs, elite law firms can still charge high hourly rates--price doesn't tell the market anything useful because you can't easily make yourself into an "elite" firm to compete.

Wednesday, January 18, 2012

Fear is Cheap

Ed. Note: I want to preface this with a disclaimer that I pretty much disdain all these paternalistic neoliberal education policies that aim to make elites feel like they're helping the poor without any real sacrifice on their part. If elites really want to address the root causes of under performance in urban schools perhaps they should consider that their own decision to take their children to the suburbs or privates schools while leaving the poor to fend for themselves*--and a failure to address the issue of poverty in general--might have something to do with it. Point being, I have a clear bias on this issue so it's worth evaluating my post in light of that.

NJ Gov. Chris Christie last night unveiled his plan for reforming urban schools in the state. Not surprisingly for a proposal from a rich Republican governor, it relies on the central tenets of the plans "reformers" have pushed elsewhere--increased "accountability" and school choice. I want to focus on the first part of that today because I think it is: 1.) unlikely to work; and 2.) another example of a troubling trend in labor markets.

Christie's plan, like most others, aims to increase accountability by dismantling the institution reformers blame for the plight of K-12 education in America: tenure. First, it will make tenure more difficult to earn by measuring the effectiveness of teachers.** Second, it will weaken the protection tenure provides by making it easier to fire the "least effective" teachers. (It will also increase the pay for teachers in less desirable areas and difficult subjects, but, as far as I can tell, does not explicitly offer bonuses to more effective teachers--for the sake of argument, though, I'll grant they will provide bonuses).

But one other major change for teachers goes unmentioned in this part of Christie's speech: pension reform. Like other states, taxpayers and politicians fret over the long-term liabilities they are exposed to as a result of labor contracts signed with various public workers groups. This has led to tense negotiations with labor unions. Indeed, Christie touts the savings gained by raising retirement ages and forcing public workers to pay more. Although this pretty clearly has an impact on education policy, as I show below, Christie deceivingly avoided mentioning it during that part of his speech.

Putting this together raises what for me seems like a pretty big problem with this plan and many others: How on earth is this going to attract better teachers***? Even if we assume good teachers receive salary incentives of some type, teaching looks like a much less attractive option. You have a small chance of making more money, but that also comes with much less stability and less valuable pension and health benefits. Perhaps most people will be optimistic about their chances--"I'm a good enough teacher I'll never get fired"--but unless the expected value of the bonus--chance you'll get it times its amount--or increase in salary outpace the decrease in the value of the pension (which they probably won't, or else the taxpayers wouldn't actually be saving money), total compensation will be lower. Buying into the standard economic theory these proposals are based on, this will actually drive people away from teaching. Oops.

So what's really driving this reform is not the carrot, but rather the stick. Not that it will draw better teachers, but that it will make the ones we have work better.**** And not that it will make them work better to gain, but rather that it will make the work better to avoid a loss--either their job or tenure.

Although couched in terms like "accountability," it's pretty clear why Christie--and austerity addicts everywhere--love these proposals: they're cheap! Providing incentives to people to work better costs money; striking fear into them with a potential job loss doesn't. If reformers really believed in their plans--and were actually willing to pay for them--it seems like a proposal that merely adds incentives without decreasing the stability of a teaching job would be much more effective: it will draw more people into teaching and pushes them to work better once they're there. But that would cost money, because you'd be carrying around deadweight. The subtle move many people make is assuming that in order to hire a new teacher you must fire one. But, if you're willing to spend the money, that's not the case.*****

Ultimately, this, unfortunately, appears to be another example of anti-government advocates succeeding in turning the middle-class against itself. Instead of private- and public-sector workers banding together to fight against continued destruction of the middle-class, the "1%" has convinced private sector workers to get pissed at public sector workers that aren't suffering like them, too (misery loves company, I guess). Presumably, the government could help stimulate demand for qualified workers by raising public sector wages--forcing private companies to raise their wages, too. Instead, taxpayers want to public sector workers to be as miserable at their jobs as they are.

Yes, I know, efficiency!, but is there any point to efficiency for efficiency's sake? The fear of losing one's job looms much larger today than it did decades ago--this has no doubt had a terrible impact of workplace morale. Although this may save money in the short-term, it certainly seems bad for productivity in the long-term (if not the short-term, too). And, more generally, seems like it makes people much less happy. Again, markets serve a useful function but only if they better society. I'm not sure they'd be doing so here.

* That is, they have cause and effect backwards.
** Good luck with coming up with a good system for doing that.
*** Again, this assume you buy into the idea that we need "better" teachers, which I take to be one the driving forces behind the reform movement.
**** Granted, part of the point of this plan is that it allows you to replace underperforming teachers, but I'm not sure that can serve as a sole justification. You'd still be drawing from the same sample pool. It makes mistakes cheaper, but doesn't necessarily make you less likely to make them.
***** The fact that plenty of schools with tenure aren't full of teachers completely shirking on the job suggests the lack of a real stick doesn't deter most teachers from actually caring about their job.

Tuesday, January 17, 2012

Marketing Markets

One theme I've picked up on watching my favorite comedy show on TV--the Republican debates--is that apparently people love "markets" (and our Muslim Socialist Immigrant Left-Wing Jewish Pornographer Dictator Fascist president hates them). But assuming Americans actually care about markets, people should despise the ideals of most of the candidates on stage. These Republicans candidates don't love markets--they love business.

Although I don't expect this sort of nuance to emerge during Republican primary season, I hope the Democrats take this on during the general election campaign. The party has failed to combat claims its members are anti-market when that couldn't be further from the truth. Many liberal policies simply aim to make markets work better.

Take, for instance, health care. Setting aside any moral claims about whether or not we should provide some sort of universal health care system, it seems like it can be justified on market-based ground in a number of ways. Democrats should use this to counter arguments the system is somehow the antithesis of a "free" market economy.

First, some broader scheme is needed to ensure people internalize the externality of people that can otherwise afford it failing to get their own health coverage. Although some Republicans are happy letting the uninsured die, most people, I think, find something morally repugnant about denying health care to someone in a time of need. Without a single-payer system or some sort of mandatory insurance scheme, this arguably creates the incentive not to pay for health care--if you get sick, someone else will have to cover the costs of it anyway. By mandating everyone that can afford it pay into the system, we can minimize this problem and incentivize people to better care for themselves and others. This creates "skin in the game" as the Republicans are so fond of saying.

Second, this will arguably create a more flexible labor market. People often feel tied to their jobs because of the health benefits. If we uncouple health insurance from work, employees would have much more freedom to move workplaces, and employers would have much more freedom to add employees (no longer concerned with the increasing cost of health benefits). Wages would also rise because health care is no longer included in our total compensation.* Although this will seem foreign to most workers, the deep connection between work and health benefits is the result of an historical anomaly anyway--it started when the Roosevelt Administration imposed wage caps on workers to prevent inflation during WWII.

* Whether this is a net positive or negative for the pocketbook of workers depends on the ability for cutting health care costs which in turn depends on which system we implement.

Moving away from healthy care, a similar argument can be made for a broader social safety net. Republicans often talk about the need to stimulate "innovation", but they often focus on tax policy. This seems misplaced. Most people are risk-averse. What's keeping them from quitting their job to create a start-up is likely not that they're worried taxes will cut too much into their profits, but that failure means losing their house and ability to care for their family. If people knew a risk like this wouldn't mean economic devastation, they'd be much more likely to take it. Obviously we need to maintain some tradeoff between risk and reward, but it seems like most mainstream arguments about the topic fail to take into account what we can do to better balance the risk part of the equation.

In theory, markets can help us by allowing us to efficiently allocate resources to better all of society (not, as some people seem to want them to act, as some sort of Darwinian accounting system). Unfortunately, they sometimes fail to work. I personally think we should use the law to help fix these problems, but there are certainly plausible argument against that--many professors at GMU could make good ones.

But whether or not liberal proposals make policy-sense, Democrats should at least emphasize their heart is in the right place. Whatever their viability as a policy matter, their goal is usually to correct some perceived market failure to make things function better. Republican policies that focus on helping business instead of markets work directly counter to that goal.

Monday, January 9, 2012

When Markets Fail

Washington Post's Wonkblog today highlighted a Daily post on the rising cost of a college education (h/t Evan):

The Daily crunches the numbers on rising university tuition costs and finds that, if they keep growing at the same rate they have for the past three decades, a four-year degree at a private institution will cost $274,684 by the time a baby born this year is ready to enroll, in 2031. At the top 10 most expensive, private universities, one year of tuition would come with a $110,432 price tag.

That would, incidentally be nearly double the projected annual income of a family with a child under 18, of about $58,000 if income continues rising at the same rate it has since 1987.

Most troubling is not the eye-popping six-digit figure, but that even at that level, it's likely underpriced! The market at top-tier schools doesn't clear--supply provides the limiting constraint. Harvard, for instance, has an admissions rate of around 6%. It could easily raise tuition and maintain a full enrollment without any material impact on the quality of its incoming class.

I don't see this trend as abating. Americans treat education as a status good. People don't want to get a good education--they want (or want their kids to get) an education that's considered better than others. People don't choose Harvard because they'll learn more than they would at Big State U--they choose Harvard because employers perceive students learn more at Harvard (or believe graduation from Harvard signals other qualities they covet). This leads to arms race among parent and school administrators to top the school next door.

This undercuts one of the major justifications for having a market-based economy--prices serve no role as an information revealing mechanism. The market telling Harvard it's underpriced doesn't lead Harvard to create more seats--indeed, the majority of the value of a Harvard degree derives from the fact Harvard doesn't let in everyone willing to pay. Nor can an entrepreneur capitalize on Harvard's reluctance to admit more freshman. People want a degree from Harvard, not Gary's Roadside Edu-mart.

This suggests only radical reform can stem the ever increasing rise of tuition rates. We need to reassess our assumptions about how our education system should function. Should free public education end after high school? Should our education system be so geography based (the importance of a "good" K-12 education system just leads to wasteless bidding in the real estate market)? Should spots in college be awarded on the basis of "merit"--maybe schools should award spots based on chance (which would, of course, reduce the signaling value of a degree from any given school)? Is education even a good that should be bought and sold? There's a risk this leads to another wealth-based form of signaling, but if we're serious about giving everyone an affordable college education, they're questions we can't ignore.

Thursday, December 1, 2011

Future Stenographers of the Rich and Famous

The Harvard Crimson:

"For example, an excellent argument could be made that the millions of Americans who took on mortgages beyond their means are equally responsible as a group for the financial meltdown."

So much for comforting the afflicted and afflicting the comfortable.

Unfortunately, The Michigan Daily not exactly taking advantage of its "editorial freedom" either.