Monday, December 14, 2009

You Know Medical Marijuana is Here to Stay When the Sellers Begin Rent-Seeking

My wife pointed me to this NPR story. Some in Los Angeles think there are too many marijuana dispensaries. The City Council is considering restricting the number of dispensaries to seventy.

The obvious question would be "why should there be a limit?" The story doesn't answer that question. In fact, it doesn't even ask it. The closest they get is to suggest that dispensaries are too close to homes. I wonder if they feel the same way about alcohol sales. It is also suggested that many of the dispensaries are operating illegally, selling over-the-counter instead of by prescription only. I think marijuana should be available over-the-counter, but even if one believes that it shouldn't, the solution is to enforce the existing law, not arbitrarily limit the number of dispensaries.

As an advocate of medical marijuana points out in the story, driving sellers out of business is going to increase the black market in marijuana, with all its unpleasant effects. So given all this, why would one want to eliminate sellers of medical marijuana? Who are the "some" people that I mentioned in the second sentence of this entry? Here's a possibility: The first person interviewed in the story is the owner of a medical marijuana dispensary. Is this a classic case of the baptists and the bootleggers?

Wednesday, December 09, 2009

An Important Public Service Announcment: MST3K on Hulu

HT to Bret Butgereit for pointing this out: five episodes of Mystery Science Theater 3000 are available on Hulu (for free, of course). So far it's only episodes from seasons four, five, and six. Secret Agent Super Dragon is, I think, particularly good (and weird).

Of course, if you're really keen to watch more MST3K, they're all available free on Youtube and Google Video, and you can buy most episodes on DVD. The downside of Youtube is that quality is often poor, and one sometimes has to hunt down the different pieces of each episode. I recommend starting with shorts, like "Mr. B Natural", "Snow Thrills" and "X Marks the Spot".

An economics tie-in: When does recycling make economic sense? It makes sense when the value of the recycled product exceeds the costs of recycling. In the case of MST3K, we know that recycling these terrible old movies is worth it because people are willing to pay enough to cover the costs of doing so. With other forms of recycling, this may not be so clear--it depends on the value of the resource consumed in the recycling process, and whether or not the process itself produces pollution that harms others.

Another Question I Should Have Asked in Econ 307: Optimal Firm Size

Firms with ten or more employees are subject to regulation by the Occupational Safety and Health Administration. Firms with employee hours worked in a year exceeding 20,000 hours must report emissions of a long list of chemicals to the EPA's Toxic Release Inventory. Other regulations and taxes, such as Unemployment Compensation, begin with the first employee. In an interview I just heard on NPR, the interviewee said that firms with ten or more employees must buy workers' compensation insurance.

What effects should we expect these regulations to have on firm size, and (leaving aside the value or harm of the regulation's direct effect) is this change in firm size efficient? You might think about Coase's 1937 paper, The Nature of the Firm.

Bonus question 1: What are some other regulations that have similar effects? (I don't know the answer to this one.)

Bonus question 2: Is there any empirical work that tries to estimate the effect of such regulations on firm size? (I don't know the answer to this one, either).

Bonus question 3 (for econometrics students): Where would you ideally look to test this, and how would you do it? (I think there is a clear "best answer" to this.)

If you have responses, feel free to post them in the comments.

Wednesday, December 02, 2009

Evil Profit Maximizers Being Nice

It is common to view profit-seeking firms as evil--they do not care about consumers, or worse, they conspire to harm consumers. Many people would agree that it is wrong for firms to raise the prices of goods and services, and that doing so makes them evil.

So I wonder, when confronted with this, would one conclude that these are, in fact, virtuous firms, employing kind, sweet people who love consumers? The research firm iSuppli found that television prices fell 22 percent for Black Friday sales. Why would they do this?

Of course, they are forced to do this by competition. The intense competition for sales on Black Friday forces firms to lower their prices. It's an interesting case in which a simple supply-and-demand model can't quite describe what's going on; we need to think more carefully about expectations, economies of scale, and decreasing cost industries, and how those can affect prices.

A related question: Why doesn't this happen in health care? Again, one could say that maybe health care providers are evil and greedy, whereas providers of consumer electronics are generous and selfless, but that doesn't make much sense. If you're interested in a good overview of the problems with the U.S. system, and why it doesn't behave like the consumer electronics industry, you could do worse than to listen to these This American Life podcasts, here and here.

I linked to this post in my facebook profile, and Justin Coffey had some comments. I think his argument can be summarized as the following question:
If consumers are the people firms really care about, why do managers have a legal duty to shareholders instead?
I think I may have been too subtle in the original post. I was, in fact, not arguing that firms are virtuous and care about consumers for their own sakes. Clearly firms do not care about consumers per se; the goal of the managers of the firm is to make shareholders happy. The original post was intended to point out a contradiction. When firms raise prices, they are denounced as evil. When they lower prices, no one praises them for being virtuous. Why is that? It is because people are inconsistent in how they think about firms.

It turns out that both ways of looking at the behavior of firms are wrong. Firms are not being evil when they raise prices, and they're not being virtuous when they lower them. They are responding to the changing signals of the marketplace in an attempt to maximize profits and please shareholders. That is to say, they're just being self-interested.

To reiterate an argument I've made before, self-interest is neither good nor evil. It can have good or evil effects, depending on the institutional arrangement within which people act. So, for example, if people can pollute without paying any costs for doing so, then they drive their cars too much, operate their power plants too much, and so on. I'd be reluctant to call all drivers and power plant operators (and customers of power plants) evil, though. I'd just say they're responding to incentives. Similarly, when a company lowers prices, I would not call it virtuous. Nor would I call it evil if it raises prices. It is responding to the incentives it faces. In competitive markets, firms are forced to please consumers, for fear of losing profits. The institutional arrangement dictates their behavior. In a non-competitive market--perhaps market dominated by a government-protected monopoly--firms do not work as hard to please consumers, because they do not fear loss of profit to competitors. It's not because they're evil; they're ordinary people like everyone else. It's simply a response to the incentives they face. Expecting people not to respond to incentives is naive and dangerous, as it can create bad policy.

One final point: Higher prices can be a good thing in some circumstances. They may communicate to consumers a reduction in the availability of inputs, or higher prices may tell producers that consumers really like the product and want more of it. It is important to disconnect price changes from notions of good and evil, and instead think about the information conveyed by price changes.

Thursday, November 19, 2009

More on Consumer Protection from Costco Connection

Every month Costco publishes a magazine called Costco Connection. Each issue contains a debate between to experts on some topic of general interest. Most are dull--should kids be spanked, do timesaving devices really save time, etc. Some topics are interesting, however. For example, I commented on an illuminating debate over farm subsidies (it was illuminating primarily because it made it crystal clear how disingenuous the agricultural lobby is).

This month the topic is "Should We Have a Consumer Financial Protection Agency?" The supporter of such an agency makes a bizarre argument: Regulation failed to protect consumers from predatory lending, so we should use regulation to protect consumers from future predatory lending. Why does Ira Rheingold think that future regulatory agencies will be free from the political pressures that caused them to fail last time? He doesn't say. If consumers were genuinely defrauded by lenders, perhaps we should look at their civil law alternatives. Is there something wrong with tort or contract law that has prevented them from suing? Lawyers can take cases on contingency; it can't be a matter of consumer budget constraints. The guy on the other side of the debate, Chris Stinebert, doesn't really make any impressive counterarguments, but he does point out that better-educated and better-informed consumers might help. If there is a role for regulation here, I would say that it is at most that of mandating and standardizing information disclosure.

I'll give quick answers to some other Costco Connection questions. Last month the topic in Costco Connection was "Should We Rely More on Wind Energy?" The entire debate was silly; the answer is quite simple: We can't know until we get the prices right. That means taxing polluting forms of energy, and letting the various forms of alternative energy sink or swim. A policy that consists of picking winners according to political influence, and then subsidizing them, is sure to get the answer wrong.

The topic in August was "Should Mail Delivery Be Cut to Five Days a Week?" Let's end the postal monopoly on first-class letter mail and see what happens. If people had a choice of who they wanted to deliver their mail--much like their email--maybe they would choose a company that delivers five days a week. Maybe they would choose one that delivers six days a week. Maybe some people would choose one, and some would choose the other. Maybe the post office would go out of business. Let competition work and we'll see what happens.

In July it was "Should the U.S. Develop High-Speed Rail Lines?" We've massively subsidized the car with (mostly) zero-price roads. Should we subsidize high-speed trains, too? Why not just stop subsidizing the car instead, and see if trains can compete? We used to have a vigorous private passenger rail system in the U.S. prior to the highway system. Seizing private land for train tracks is one of the least-upsetting uses of eminent domain, since that's the sort of thing for which it was originally intended (not railroads specifically, but canals, roads, and transportation in general). I can imagine a future U.S. in which train travel makes sense, if we give it a chance. The key here is to let different forms of transportation compete on even footing, without encouraging or discouraging them, rather than subsidizing some or all of them.

Consumer Reports Lectures Me on Credit Card Regulation

I have a subscription to the Consumer Reports website because of the wealth of product information it contains. Occasionally, however, Consumer Reports takes positions on policies, and I nearly always disagree with them (another example: Consumers Union supports higher CAFE standards; I do not, as a higher gasoline tax would be far more effective). I received an email from Consumer Reports today regarding credit card legislation. I was encouraged to go here and support immediate regulation of credit card fees by Congress. I responded with the following.

Dear Consumer Reports,

I have a better idea. Rather than relying on government regulation to set prices, interest rates, and fees, let's lower barriers to entry into the credit card market to encourage competition. I trust a competitive market process to protect consumers much more than I trust a government to do so.

Consumer Reports's naive view of regulation and wrongheaded policy advocacy is almost annoying enough to make me want to cancel my subscription, but your valuable product information is sufficient to change my mind. If only I could get one without supporting the other.
Mike Hammock
Two things may deserve more explanation.
1) Why does competition protect consumers?
Because firms that are afraid of losing customers to competitors have an incentive to keep those customers happy. If that means keeping fees low, that's what they'll do. DVD players didn't go from $200 to $30 because Sony and Philips and Samsung like their customers; they got cheaper because these companies are trying to beat the hell out of each other in a competitive market. There are only five credit cards in common use: Mastercard, Visa, American Express, Discover, and Visa. Discover was the last new major card, and it was introduced back in 1985! Before the government starts trying to set prices and fees, it would make more sense to eliminate whatever barriers to entry exist in this market. I'm guessing they are primarily regulatory. There are probably some network effect problems (getting retailers to accept a new card may be difficult), but those shouldn't be insurmountable--especially if the new card charges lower fees to retailers than existing cards.
2) Why not just let government set all fees and prices?
Because it won't get them right. Prices can be too high, in the case of insufficient competition, but they can also be too low, resulting in shortages. In the credit card market, this would mean denial of credit to some consumers.

This has implications for other policy debates, too. If we want to make something cheaper--like, say, health care--we should look first to the way the market is structured, and look for a market mechanism that can push prices down.

Monday, November 02, 2009

Does This Seem Familiar to Anyone?

HT to Marginal Revolution for this:

Art Carden and I did basically this exact same thing at Rhodes College for the last three years, making the exact same point regarding lobbying. I'm sure Art's still doing it there now.

Wednesday, October 14, 2009

To Stimulate or Not to Stimulate

In this article, Daniel Gross argues that complaints about the failure of the stimulus package are wrong because most of the money hasn't been spent. Yet there are signs of a possible recovery. Here is Brad Delong quoting the data suggesting a 4% GDP growth rate for the quarter. I keep hearing on the radio that economists suspect the recession may be over, or will be over soon.

If the stimulus hasn't done much yet because not much of it has been implemented, and if we are nonetheless headed for recovery, doesn't this suggest that there exists a self-correcting mechanism for the macroeconomy, and that it seems to be working? Daniel Gross argues that this is all going exactly according to plan--things are starting to recover right now because of the $200 billion or so that have already been spent. $200 billion is not chump change, but if it really is responsible for the uptick in economic growth, the multiplier must be bigger than previous estimates. Once again, the inability to do the counterfactual experiment hinders macroeconomics: we will never know how long it would have taken the economy to recover had we not spent $787 billion on stimulus. If Arnold Kling's macroeconomic readjustment story is correct, we could find ourselves spending a lot of money to just postpone the pain for a little while.

Saturday, October 03, 2009

Discomfort with Unplanned Systems

My former colleague Art Carden has a great post over at Division of Labour. He points out that many people are uncomfortable with markets because markets do not have any goal or point or direction in mind (because they do not have a mind to begin with). Markets are unplanned systems that nonetheless produce results, and usually (but not always) pretty good ones--more and better stuff at lower prices. More amazingly, markets work because no one is in charge of them; the profit motive, plus a few simple rules (private property, enforcement of contracts, etc.) gets people who will never know of each others' existence to unknowingly cooperate. This is counterintuitive and even undesirable for many people--how can we let all these resources go around willy-nilly without anyone thinking about whether it all makes sense?

I think this is interesting because this discomfort is very similar to that felt by those skeptical of evolution. Evolution is an unplanned system that nonetheless proceeds toward increasing complexity. There's no one in charge of it; the outcomes are determined by random copying errors and the environment in which these mutations occur. Life doesn't have a point (certainly not a grand cosmological or moral point) in evolutionary biology. It just is, and humans aren't any more important to the universe than any other creature. There is no central planner. Many people--almost entirely religious conservatives--are uncomfortable with this view. They see it as nihilistic and morally troubling.

Furthermore, I think it is fair to say that the skepticism of unplanned market systems tends to exist mainly on the left, while the skepticism of unplanned biological systems exists mostly on the right. This makes me wonder why that would be. Why aren't people on the left skeptical of evolution, too? Why is the right more comfortable with less regulation of markets? Granted, conservatives in the U.S. tend not to be very market friendly, especially in regards to drugs and prostitution, but I still think it is fair to say that conservatives are more friendly towards markets than those on the left.

Maybe I need to reread Rubin's Darwinian Politics.

One more point: Government--that institution that many would like to use to direct markets and reorder society--is also an unplanned system. It has no single mind coordinating it, and the outcomes it produces are not always what one would expect, and (in my opinion) they are seldom what one should find desirable. Government is a maze of competing interest groups, using votes, campaign contributions, promises of post-politics employment, lobbying, and even threats to push for their goals.

That's not to say that there are not market failures that a government could conceivably address; there certainly are. Rather, the question is whether a real-world government could reliably fix them without creating new problems. I'm much more skeptical about that. I would love to see payroll taxes replaced with pollution taxes; the potential welfare gains are enormous. I simply doubt that such a policy could make its way through Congress without becoming something terrible in the process.

Wallace and Gromit: The Greatest Fictional Entrepreneurs

My wife and I have had some foster kids staying with us recently. We've used this as an excuse to rewatch the Wallace and Gromit shorts and movie (the shorts are better--I think The Wrong Trousers is the best).

It occurred to me after watching them that Wallace and Gromit are underappreciated for their entrepreneurial spirit. In three of their five outings, they start up and succeed in new businesses due to the application (or perhaps over-application) of new technology. In A Close Shave they run a window-washing businesses and Wallace has invented an automatic sweater-knitting machine. In A Matter of Loaf and Death they're running a bread delivery company. In the movie, The Curse of the Were-Rabbit, they have a successful no-kill pest control company (called "Anti Pesto").

There are also four video games based on the characters. I've only tried a tiny bit of the first one, but Wallace and Gromit have already started up a successful honey delivery system--fresh honey, piped directly to one's home. Do they start up more new businesses in the other episodes?

I suppose they have a bit of advantage in that they're made out of clay and live in an unrealistic world in which ridiculous inventions actually work. Still, for sheer entrepreneurial spirit, I can't think of anyone else in fiction who comes close. I mean, these guys run a successful business and then quit, just for the joy of starting and succeeding in a new business! Not even Tony Stark or Archibald "Harry" Tuttle can compare.

Are there any other entrepreneurs in fiction who stack up?

Friday, September 18, 2009

Soft Drink Substitution

One of the great things about a pollution tax is that it causes people to shift toward doing things that produce less pollution. That is, it's difficult to substitute something in place of polluting production processes (although it is possible to move production overseas in some cases, although not in the case of power generation). The pollution tax revenue can then be used to get rid of taxes on work, like the payroll tax.

There is a some discussion of a soft drink tax. The argument is a bit different from a pollution tax, in that a pollution tax addresses a negative externality, whereas a soft drink tax is more like a sin tax--taxing people who do things to themselves that we don't like. There isn't much of an economic justification for this (unless overweight people impose a tax externality on others due to using state-funded health care for their expensive health care--only they don't seem to have higher lifetime health expenses because they die earlier), but even if there were, it seems to me there is a significant problem: substitution. There are plenty of ways to satisfy a sugary craving for calories, aside from a soft drink, and although they may not be perfect substitutes, I doubt a soft drink tax would be sufficient to make much of a dent in obesity.

A general calorie tax might work, although that, too has problems--it would be very costly for small-scale food producers that otherwise don't have to provide nutrition information, as they'd have to calculate the calories in their food in order to figure out the tax (and exempting them from the tax seems to be to be unfair--it penalizes large producers for being successful). Such a tax would also make it more difficult for the poor to afford food of all kinds (currently the poor are more likely to consume unhealthy food and suffer obesity). We would have to create an algorithm for determining what food is healthy or unhealthy, and therefore how much to tax it, rather than a simple calorie or soft drink tax--but that is even more elaborate and difficult to get right, and even worse, it's going to be subject to lobbying that could give us even less healthy relative food prices.

A safer start would be to eliminate agricultural subsidies and protective tariffs and see what happens. I suspect that so long as America remains relatively rural and suburban (compared to Europe), obesity will remain a problem.

Wednesday, August 19, 2009

Some Thoughts on the Health Care Debate

It’s been painful watching the ridiculous arguments and accusations in the current U.S. debate over health care. This issue in particular seems to have brought out the worst of democracy, with a rationally irrational public shouting about death panels and calling names. Health Economics is not one of my fields, but some things can be said without being a specialist in the field.

First of all, many people are comparing health systems around the world and making unjustifiably strong claims, sometimes using questionable data or results. For example, the oft-cited WHO study ranking countries’ health care systems focuses almost entirely on the distribution of health care, rather than the level, and has error bars so large that the results are almost worthless. Rankings of life expectancy are also of questionable use when comparing countries’ health care systems, as life expectancy can vary for reasons unrelated to health care systems. For example, Americans tend to be more obese, get in more care accidents, and experience violent crime more often than people in other countries. These may be serious problems with American society, but they are not problems with the health care system. Another measure that has been used recently is a comparison of preventable deaths for people under 75 years of age. This suffers from a problem similar to life expectancy—Americans may be more prone toward particular kinds of health problems, and treatment of them may be less successful, for reasons unrelated to the health care system. A real study of the subject would need to control for more variables.

Similarly, one hears that around 50 million Americans do not have health insurance. While technically correct, this number is of dubious value. What fraction of those 50 million people qualify for government aid but have not used it? What fraction are wealthy but have opted not to buy health insurance? How many actually went for an extended period without health insurance, and how many went without for a short period only?

There are also questionable statements about health care in other countries. They are sometimes presented as utopian, and at other times as hellish, depending on the position taken by the discussant. Conservatives like to claim that wait times in Canada for medical tests and procedures are outrageously long; others claim that waits lists in Canada are reasonable.

Do other countries do a better job controlling costs? David Goldhill argues that if they do, it’s not by much:

From 2000 to 2005, per capita health-care spending in Canada grew by 33 percent, in France by 37 percent, in the U.K. by 47 percent—all comparable to the 40 percent growth experienced by the U.S. in that period. Cost control by way of bureaucratic price controls has its limits.

Perhaps other systems get the level of costs down, but cannot control growth, meaning they will end up where the U.S. is eventually.

None of this is to say that the U.S. health care system could not use some dramatic changes. To explain what kinds of changes might work—and by “work”, I mean provide the same or better care at a lower cost to more people—I need to talk about some basic economics, and then some particular economics of health care.

Students in any economics class learn that resources are limited, or scarce. We cannot all have as much of anything as we want. This is true of cars, gasoline, televisions, computers, clothing, leisure, and everything else people enjoy consuming. One can have more of something, but only at the cost of giving up something else. Over time, economic growth allows us to produce more goods and services with fewer resources going into each of them, but this is a slow process. Even with growth, getting more of something is not free.

This applies to health care just as much as it applies to everything else. From society’s point of view, providing more health care means providing less of something else. When people become doctors, nurses, medical device engineers, or other medical specialists, they cannot also be computer programmers, chefs, or produce other non-medical goods and services. No health care system—government run, purely free-market, or anywhere in between—can produce as much free health care as everyone wants. They can be more or less efficient, depending on the incentives of the system (which I will discuss later), but unlimited free health care is not an option, and anyone that tells you it is possible is lying to you.

Economists call the process by which things get allocated to people “rationing”. In a purely market-based system, economists say that the price acts as a “rationing mechanism”—people who are willing and able to pay enough for something get it, and people who are not willing or able to pay enough for something do not get it. In a purely government-run system (say, Soviet-style central planning) bureaucrats decide who gets what, and base it on a calculation of needs, political influence, or some other measure. There are possibilities in between the two extremes.

In any health care system (as in every part of an economic system), someone ultimately says “no”. There are entities that decide who will get care, and who will not. In the U.S. those entities are insurance companies (who decide what to cover and what not to cover, as well as to whom policies are sold), governments (state and federal, which administer programs for government employees, the poor, and the elderly), and individual consumers, whose incomes limit the amount of health care they can afford. All these people—insurance companies, governments, consumers—can say “no” to getting a particular kind of care. Obviously a consumer would prefer never to hear “no” from the other two groups of decision makers.

One might object that doctors get to decide who gets what kind of care, if any, and to an extent that’s true—they (hopefully) will not treat a torn ACL with chemotherapy. Yet doctors are ultimately paid by someone, and if that someone (consumers, the government, insurance companies, charities, whoever) stops paying, they will eventually reduce the amount of care they provide.

In other countries the decision makers may be government officials. The NHS in the U.K. decides which treatments are acceptable for what health problems, and which ones are not acceptable (and therefore will not be funded). When controversies arise in such systems, they are often over whether the government should pay for one treatment or another (one would expect such controversies to arise most often when new treatments become available). Governments can also ration care using queues—care is given out first-come, first-serve. The waiting time for a service depends on what kind of resources a government allocates to it, and how efficiently those resources are used.

Whether government decision makers do a better or worse job than private decision makers is an interesting question, and you might have gathered from the discussion of international comparisons above, it is a difficult question to answer. Nonetheless there is a consensus that the U.S. system is not working as well as it ought to. Health care is getting more expensive rather than less (contrast health care costs with, say, the cost of DVD players). Why is this so?

There are two economic primary theories to explain why this would be the case: adverse selection and moral hazard (both having to do with the economics of insurance). Both can be expected to drive up the costs of health care, pricing many consumers out of the market.

The adverse selection argument goes like this: Suppose that there are two types of consumers, those who will get sick (the unhealthy) and those who won’t (the healthy). Suppose consumers know which type they are, but insurers do not. Then the healthy types, knowing that they do not get sick, will not buy health insurance. The unhealthy types, knowing that they will get sick, will try to buy health insurance. Should insurers sell to them?

They should not. If only the unhealthy types buy, then selling health insurance is a sure way to lose money. Each consumer is going to incur, say, $10,000 in average medical costs, which the insurer will have to pay, and then pay his workers and stockholders. But the consumer isn’t willing to pay more than $10,000 for the insurance policy, so there’s no way for the insurer to make a profit.

This is an extreme version of the adverse selection story, in which the insurance market completely disappears. A more realistic version would involve probabilities, rather than certainties, and when one creates such a model, an interesting result can emerge: If enough healthy consumers drop out of the market, health care can get sufficiently expensive that only the most risk-averse, wealthy consumers (of either healthy or unhealthy type) can afford to buy. That is, even if I am a healthy consumer, I might still want to buy insurance because I am particularly risk-averse—but I can’t, because it’s too expensive, because of adverse selection. If everyone could be forced to buy insurance, it would be cheaper for all. (Here is a clever related argument regarding car insurance, suggesting that cities that require all drivers have car insurance should experience lower rates.) Adverse selection is why health insurance companies try so hard to screen for preexisting conditions, smoking, and other factors that can increase the risk that a consumer will become ill; they are trying to sort out the good risks from the bad.

Does this argument help explain why health care is so expensive in the U.S.? I don’t think so. Recent reforms in Massachusetts have succeeded in getting almost everyone in the state (97% of the population) insured, yet health care costs have risen dramatically, and the state is having trouble with its budget. Adverse selection is really an argument about health insurance costs, not necessarily health care costs.

Moral hazard is a simple response to incentives: Once insured, people have fewer incentives to take precautions to prevent future illness, because the medical costs will be paid for by a third party (the insurer or the government). This makes small medical problems into big medical problems, driving up the cost of treatment (and the cost of insurance). In fact, in the U.S., around eighty to ninety percent of all health care expenditures are paid for by third parties (again, insurers or governments, rather than the patients). This has additional incentive effects beyond simply failing to take precaution. People stop shopping around when someone else is paying. They also request additional procedures or tests, or go to the emergency room instead of a less-costly physician. Doctors, who are paid for procedures and tests performed, have little incentive to resist, leaving it up to insurance companies or the government to say “no”—which, naturally, makes consumers angry, and they exert pressure to make “no” a difficult thing to say.

When a large portion of consumers are no longer paying attention to costs, and no longer shopping around, competition stops functioning. Competition—the process that gave us the $20 DVD player, instead of the $900 DVD player we started with—is an important mechanism for disciplining producers, whether they are producing cars, newspapers, computers, or cancer treatments. Competition keeps producers on their toes, forcing them to find better, more efficient ways to do things. I find the moral hazard/lack of competition argument compelling. In health care, competition seems broken.

Robin Hanson has argued that overconsumption of medical services means we could cut health care spending in the U.S. in half (by simply denying care or refusing to undertake procedures or tests) with almost no effect on health care outcomes. If correct, is a pretty stunning result—if we can get people to consume more carefully, we can dramatically reduce costs.

What reforms should be enacted? It is possible that moving to something like Canada’s system might be an improvement; I don’t know. I am skeptical because our government has budgetary problems with the current large medical program, Medicare. Taking on additional large expenses will be problematic. Furthermore, I do not think our federal government is good at running technocratic programs. Remember, there are more than 300 million people in the U.S. (compared to 33 million in Canada); I am not convinced that the federal government can run a health care program that serves them all. That is, I do not think the U.S. government would run Canada’s health care system as well as Canada has. The more government involvement in the system, the less competently I think the U.S. government performs. I shudder to think how badly the U.S. government would run a system like the U.K.’s NHS.

This brings me to a reform that I think would work. Bryan Caplan, Tim Harford, and others have praised Singapore’s health care system. It seems designed to address all the problems people have with the U.S system, without requiring a large amount of government management or intervention in health care markets. It is certainly not laissez-faire, but it is not single-payer or nationalization, either.

You can read Caplan’s account of Singapore’s system here. I think the most important features of Singapore’s health care system are:

1) Mandatory medical savings accounts: Every person pays into a savings account that accumulates over time, and can even be passed on to one’s children. The money in the account can only be used for medical care. This gives consumers an incentive to shop around—they are spending their own money, after all. It may also give them an incentive to undertake preventative care, as doing so increases the amount in their account in the long run. This policy puts competition back in health care markets.

2) Mandatory published price lists: All hospitals and medical facilities must say what their procedures and tests cost. This allows consumers to shop around, and even establish reputations for low prices. Try calling a local hospital in the U.S. and ask them what a procedure costs; they usually won’t be able to tell you. Your insurer might be able to tell you what they pay a particular hospital, but they might not. This policy, like the first, encourages competition.

3) Optional low-cost catastrophic coverage: When health care expenses go over a certain threshold, the government steps in and pays. Because catastrophic illness is uncommon, this coverage is relatively cheap to provide. Private insurance can also be purchased. This is sort of like the “public option” of the current health care reform proposal in the U.S., but it is far less generous, covering extreme situations rather than routine medical expenses.

There is one aspect of Singapore’s policy that I’m not so sure about: supposedly the government pays for“80% of basic health care services”. I’m not sure what that means. I’m guessing checkups and other services that catch disease early. It surely can’t mean a much broader swath of health care services, or the “buffet mentality” (as they call it) would emerge, with some people overconsuming care, driving costs up. So far, Singapore has managed to provide a high quality of care with low costs (that rise slowly!).

I think such a system might be manageable in the U.S. because the government’s role in it is simple; competitive markets do most of the hard work. There are other reforms that should also be enacted in the U.S., such as removing (or at least equalizing) the tax advantage of getting insurance through an employer, and making interstate health insurance sales legal. There may be other ways to get similar results to that of Singapore, perhaps with health care vouchers (much like education vouchers).

Realistically, however, I do not think we will get reforms that will make a significant difference, for better or worse.

Monday, August 10, 2009

Thinking Out Loud: An Idea for Stimulus

I've already talked about why I don't like the Cash for Clunkers program. In short, it is not likely to be environmentally friendly, since the process of producing new cars creates pollution, and because old cars must be disposed of. It also has a bit of a broken window fallacy aspect to it, destroying something old just so we can have the "pleasure" of replacing it.

Another reason to disapprove of this program is that the government has chosen to pick winners and losers. Car purchases get stimulated, but other purchases do not. The government is altering relative prices, encouraging them to buy cars when, absent the reduced relative price of cars, people might benefit more from buying new clothes, or a computer, or bus passes, or whatever. Resources are not being put to their highest-valued use; rather, they are going to the use the government favors.

On the other hand, the program has been hailed as one of the few pieces of clearly successful stimulus spending. Tax cuts handed out last summer were mostly saved rather than spent, for example, yet people are scrambling to take advantage of Cash for Clunkers. My in-laws were considering buying new cars at some point, but they have moved their purchasing decision up to right now, rather than later. In terms of economic stimulus, one could argue that this is a good thing--sure, people are just transferring their car purchases through time, from the future to right now, but on the other hand, we presumably need stimulus now, rather than at some point in the future when the economy has recovered.

Why is Cash for Clunkers different? Why are my in-laws running out to buy cars now, whereas everyone just saved the tax cuts? Because this program is temporary. There has been a total of $3 billion allocated to this program, and once it runs out, the program is over. Apparently the temporary nature is enough to get people to run out and buy now.

So why not apply this more generally? Instead of having the government pick this or that place to spend money--on roads here, on a solar power plant there, and on some representative's pork barrel project some other place, why not just give people time-limited cash, which must be spent at retail?

That is, the government could take, say, $200 billion of the stimulus package, and say "Every American may receive up to $1,000 in federal spending for any purchase of their choice. However, once the money is gone, the program is over. If you do not use up your $1,000 before the money is gone, it disappears."

There is no change in relative prices (except for that between consumption and saving, which is part of the point). Retailers would have a form to fill out, similar to that of Cash for Clunkers, which would allow them to receive payment from the government.

One problem is that people might have a hard time tracking their spending. For example, if I buy $800 worth of stuff at Wal-Mart, I have $200 left over for other uses. Costco doesn't know this, so when I go to Costco and try to charge $300 to the government, there will be paperwork and bureaucracy as the government tries to figure out what to do with the $100 overcharge. Cash for Clunkers doesn't run into this problem, since every new car far exceeds the $4,500 maximum subsidy. One solution may be for the government to issue everyone a debit card with up to $1,000 on it, and then when a total of $200 billion is spent, all the cards get cancelled.

There are potential public choice problems, too. This sounds like something politicians would love to abuse. They would probably love to hand these out during booms, too, defeating the counter-cyclical purpose for which I proposed them. I suppose there could also be problems with fraud.

Still, it could be an improvement over the mess that is current stimulus spending, couldn't it? I'd love to hear additional criticism in the comments.

Friday, August 07, 2009

An Answer to the Exam Question I Should Have Asked

Former student Michael Duch provides the following answer to the question I posed:

The demand for water is inelastic! The fact that total revenue rose after the price increase implies that the percent change in price > percent change in demand, which gives us an elasticity ratio less than 1.

And the price increases should have been enacted first because they would have reduced the amount of water used while allowing people to maximize their utility. If this failed, which, it probably would have (assuming I'm right about the inelasticity of water) restrictions should have been imposed. I think the conservation of water in a drought takes precedence over allowing someone to maximize utility. But that's just me.
Some comments: Michael is correct in his conclusion that the own-price elasticity of demand for water must be less than one, and his reasoning is correct, too. Own-price elasticity of demand is:

Absolute value ( (percent change in quantity demanded)/(percent change in price) )

...and total revenue is simply Price * Quantity. If price goes up, quantity must go down (that's the Law of Demand), but what if revenue still rises? Then the increase in the price outweighs the decrease in quantity. In terms of elasticity, the denominator must be larger than the numerator, meaning own-price elasticity of demand is between zero and one--which we call inelastic. Good job, Michael!

Regarding the second paragraph, I agree that it would be better to raise the price first, but I would like to elaborate on why that is a good idea. Raising the price allows people to adjust in a variety of ways. For example, someone who has fruit trees in their yard might be willing to pay extra in order to make sure that the trees bear fruit, whereas a simple watering ban doesn't allow that option. Other people might decide it's better to just forgo watering altogether, or to collect rainwater, or take other actions. A price increase allows this variety of responses, while still achieving a given reduction in use.

Watering bans are usually riddled with exceptions for car washes and golf courses; there is no economic justification for this. If the water to be used at a car wash is too valuable for that use, then it shouldn't be used. The car wash, faced with an increase in water costs, will try to pass that cost increase to customers in the form of higher prices. If customers are unwilling to pay it, they won't, and the car wash will shut down. This is exactly what we should want to happen. We should want low-valued uses of water to stop, and allow only high-value uses of water to persist. Simple restrictions on use can't achieve this, but a price increase can.

Wednesday, August 05, 2009

More on Cash for Clunkers

Here's some more on the environmental effectiveness of Cash for Clunkers. Nina Shen Rastogi argues that it was too costly. This AP piece makes the same point, claiming that the program will save the equivalent of shutting down all cars and power plants in the country for one hour--a miniscule fraction of our annual pollution production. Jeffrey Miron, one of my favorite economists (if you haven't read his 1995 Journal of Economic Perspectives article on the economics of drug prohibition, you should do so immediately), argues against the program here.

It has surely stimulated auto sales, although with a $3,500 or $4,500 subsidy, you can stimulate lots of things. It would make more sense to give people a payroll tax cut or even a direct payment, so they can spend the money on what is important to them, rather than trying to decide what specific products people should be buying.

Friday, July 31, 2009

Cash for Clunkers is for Chumps

The federal government is currently running a program popularly known as "cash for clunkers". It pays consumers (actually, it pays dealers, who pass the savings on to consumers) for giving up their older cars for newer, more fuel-efficient cars.

There are at least two problems with this. One is that it's not clear that it actually does anything for the environment. The process of building a new car creates pollution and uses energy and scarce resources; continuing to drive an old car does not. It may take years for the reduced emissions from a newer car to counteract the environmental cost of building a new car.

My second objective is that there is a better way--a way to get people to get rid their older cars when appropriate, that is, when the reduced emissions from the newer car are actually worth it: raise the price of gasoline via a tax. This will cause some people--those who drive the most--to switch to newer cars with improved fuel efficiency. Because these are the people who drive the most, the environmental payoff is likely to occur sooner (because the older, dirtier car would create more emissions over a given time period). This differs from the current cash for clunkers program, which encourages everyone with a vehicle meeting the requirements to buy a new car. A higher gasoline tax will also have other affects: It will encourage people to drive less by carpooling, combining trips, or taking alternative forms of transportation. It will encourage people to move out of rural areas, where a great deal of driving is necessary, to urban areas, where distances are shorter and alternatives to driving are more attractive.

It would be possible, with appropriate policies, to get these results in other ways than a gasoline tax. The government could mandate carpooling on certain days, issue limited licenses for cars in rural areas, or just force people to move. What if, however, some people have a lower cost of taking these actions than others? Don't we want the guy who lives in the country but has a lot of friends and contacts in the city to move their first, rather than the guy whose entire lifestyle is structured around country living? Don't we want to have the guy who drives a large SUV by himself to work every day to carpool, rather than the guy in his two-seat roadster?

In other words, it makes a lot more sense to use the price system and its system of incentives than to try to micromanage the various ways to get around, because people will tend to choose the optimal outcomes--it is in their interest to do so. Raising the gasoline tax causes people to find the low-hanging fruit on their own, rather than requiring the government to be clever and honest enough to catalogue all the fruit in the country and then send out bureaucrats to pick the low-hanging ones.

A Question I Should Have Asked on an Exam

Here's a question I should have asked on an exam, but didn't.

During a prolonged drought, Georgia (the state, not the country) implemented water use restrictions, which limited when people could water their lawns, wash their cars, and use water for other outdoor uses. The eventual result was a reduction in water usage. This reduction in water usage resulted in a decrease in revenue collected by the government-operated water utilities. In order to compensate for this, and to encourage more conservation, the state increased water prices (the rate structure was also changed, but ignore that).

Suppose that after the price increase, the amount of revenue collected by water utilities increases. If price rises, and total revenue collected rises, what can we say about the own-price elasticity of demand for water?

Extra Credit: Why would most economists say that these policy decisions were taken in the reverse order of what should have been done? That is, why would economists say that the price should have been increased first (and perhaps more than once), and only if that failed to reduce usage should other restrictions have been imposed?

Thursday, July 16, 2009

More on School Choice

Art Carden and I have another op-ed on school choice, this time in the Memphis Commercial Appeal. Our previous one was in The Tennessean. This time we are responding to comments by a school superintendent, who dismissed charters schools as unnecessary, because Memphis schools are already very good. If this were the case, however, then Memphis schools would have nothing to fear from charter schools (or vouchers or any other choice-based reform).

Thursday, July 02, 2009

Who's Oppressing Whom?

This story (update: link corrected) on PRI's "The World" says that Spanish police have found sweatshops in Barcelona and "freed" more than 300 Chinese immigrants working in them. The immigrants, however, are now protesting the loss of their jobs.

The reporter somewhat incredulously explains that the workers are apparently comparing their conditions in Barcelona to those back home, and finding the new conditions better, voluntarily accepting them. As with any voluntary exchange, both sides are made better off.

Clearly, then, preventing this workers from working at the agreed-upon wage is making them worse off. Why wouldn't they just take jobs at the legal minimum wage rate? Spains unemployment rate is around 17%, and expected to go higher. Chances are good that they would not be able to find jobs at the legal minum rate, because they are not productive enough to justify such a wage rate.

We do not get such protests over the minimum wage in the U.S.; partly this is because it is increased by relatively small increments, so that the unemployment increases that result are small. If we went to a $40/hour minimum wage, I suspect there would be a large number of people laid off, and protests as well.

I take slight issue with the arguments advanced by the Spanish economist in the piece; he suggests that Spain will have to move to a twelve-hour work day, and take other actions to "remain competitive". Countries don't actually compete like that, though, as Paul Krugman has argued in his better works, like Pop Internationalism. A simpler policy would be to simply let people work as much or as little as they like, rather than imposing some official number of hours. If they really want to work less, then companies will find it too expensive to ask them to work more. If they want to work more, let them! A competitive labor market can deal with these matters pretty easily. Different people may well end up working different amounts.

So who is doing the oppressing here? Is it the sweatshop operators, whose employees want to go back to work, or the Spanish government, which wants to prevent workers from working on terms they find acceptable? Is it right for some people to dictate the terms at which others may work, even if it throws these others out of work?

Sunday, June 28, 2009

Confusion and Misinformation on Cap-and-Trade

Republicans in Congress have been reciting a set of talking points regarding the recent cap-and-trade legislation that are misleading. In this entry I'm going to explain a bit about how cap-and-trade works, and why "it will drive up energy prices" is a dumb complaint to make.

First a bit about pollution. The problem with pollution is that the person making it doesn't pay the full costs of it, so he or she does too much of it. That is, the owners of the power plant emitting carbon dioxide will not bear much of the costs of global warming, so they emit whatever amount they find convenient, unless forced to do otherwise. This is called a negative externality--the costs are external to the person creating them. Economists generally prefer two tools to control pollution (whether CO2 is a pollutant or not isn't really important; if we want to reduce it, all the economics in this post applies): pollution taxes or tradeable emission permits, the latter of which is also known as "cap-and-trade". If done correctly, these programs will internalize the externality--that is, they will cause the people producing and consuming the polluting goods and services to recognize the costs they are imposing on others.

I've talked a bit about pollution (or "pigouvian") taxes and cap-and-trade before. Both tools are known as market-based regulatory devices because they attempt to alter incentives and let the market do the rest. For example, a pollution tax raises the cost of emitting pollution. If a firm is charged, say, $5 by the government for each ton of pollution emitted, then if a firm can clean up that pollution at a cost of less than $5, it will do so and avoid the tax. It is in the firm's interest to find the cheapest way to clean up, because it will save money by doing so. If it costs more than $5 to eliminate that ton of pollution, then the firm will go ahead and pollute.

How does cap-and-trade work? In the economist's preferred setup, the government would auction off permits, selling for whatever price emerged from the auction. Each permit allows a firm to emit one ton of pollution. Suppose a firm buys a permit for $5, then finds out that it can actually reduce that ton of pollution for a cost of only $3. Now the firm can sell that unnecessary permit to another firm, which can avoid eliminating its pollution.

At this point some environmentalists get confused, suggesting that this means firms can simply buy their way out of polluting. For a particular firm this is true, but it is not true in the aggregate. A particular firm could buy a bunch of permits, which would allow it to pollute as much as it wants. This means that some other firm must be selling permits, however, which means that it must be reducing its pollution. The total number of permits is limited. That is, the government might issue permits for, say, 5 billion metric tons of CO2. Any increase in emissions by one firm must be matched by an equal decrease from another firm. This regulatory method is currently used for Sulfur Dioxide (which causes acid rain as well as health problems) and has been wildly successful, reducing pollution significantly and at a much lower cost than expected.

Both the programs I have described raise revenue. In the first case it is tax revenue, and in the second it is auction revenue. In both these cases firms will have to reduce their pollution, which is costly to them. Higher costs will mean higher prices for pollution-intensive goods and services, such as electrical power from coal plants. The Republicans have been repeating this point over and over, saying that for this reason (higher energy costs for consumers), the cap-and-trade program is a terrible idea.

They have it precisely backwards. Higher energy costs is the primary point of the program. It is supposed to raise energy costs. The reason why this is a feature, and not a bug, is that it communicates to consumers the harm that is done by their purchase of energy that creates CO2. That is, by raising the cost of energy, consumers are induced to buy less of it. If CO2 is harmful--and the strong consensus is global warming is real, and will probably be harmful--then we want consumers to consume less energy. It is as though the Democrats passed a bill to reduce pollution, and the Republicans objected that it would reduce pollution.

Another objection is that reducing pollution may be too costly for some firms, which may shut down. Again, this is a feature, not a bug. Firms which produce goods of such low value that they cannot justify the harm produced by their pollution should shut down.

Finally, another advantage of pollution taxes and cap-and-trade is that they encourage development of cleaner alternatives. Cleaner sources of energy pay less tax or buy fewer permits. This gives them an advantage, and causes dirty energy producers to switch to cleaner technologies. It also causes firms to research new technologies which might be even cleaner still. Best of all, it gives firms a strong incentive to find the best new clean technologies. By contrast, the government has in the past tried to subsidize research into clean technologies, with mixed results. Why have these results been poor? Because the government has little incentive to find the best, lowest-cost ways to reduce pollution, because it has little at stake. By contrast, firms that find fantastic new technologies stand to profit substantially.

One way to make higher energy costs less painful for consumers is to give the revenue collected to them. A simple way to do this would be to use the revenue collected to simply eliminate a tax, such as the payroll tax. This could result in efficiency gains (known as the double dividend), although for complex general equilibrium reasons (having to do with the form of taxation eliminated and the response by consumers to the tax cut), it might not happen. Still, for distributional or for efficiency reasons, it may be desirable to give the money back to consumers.

Here's where a legitimate complaint about the current bill might be made. The proposed cap-and-trade program does not auction off the permits. It simply hands them out for free. It still reduces pollution, and firms can still buy and sell them, and energy prices will still go up, but there is no revenue collected by the government. This is equivalent to taxing the firms for polluting, and then giving them all the tax revenue back. Most economists would prefer that the money be used to eliminate distortionary taxes, or at least to reduce the level of government borrowing. Republicans are not making this complaint. They could also complain that there are inefficiently few permits being issued, but they're not doing that either. They are instead complaining that the regulation might do exactly what it is designed to do. That is confusing and misleading, but I suppose that's politics.

Update: From Greg Mankiw's blog, here are two articles describing legitimate problems with the current cap-and-trade bill. One of the problems discussed is the free distribution of permits (as opposed to an auction) that I mentioned before.

Friday, June 26, 2009

Boudreaux on Globalization and Local production

Don Boudreaux has a great "ask the professor" post on globalization and, even better, the current fad for local production. As far as I'm concerned, there's only one reason to buy locally produced anything, and that's to get fresher fruits and vegetables. The question-and-answer section after the main article is great, too.

Hat tip to Arnold Kling.

Future Imperfect and the Disputed Iranian Election

One of the arguments David Friedman makes in Future Imperfect (which I sort of review here) is that it is hard to know which way information technology will take us--to a panopticon in which the government can watch everyone, or a world in which everyone can easily monitor the government, or both. Would a world in which everyone can watch everyone result in more happiness or less?

The press has been talking a great deal about the use of information technology, particularly twitter, by the protestors in Iran. It has been used to get information to the outside world, and it has probably been used to organize protests. Here is an article, however, which argues that the government can just as easily use this technology to sow confusion and misinformation, or to stifle discussion.

Monday, June 22, 2009

Hot Town, Summer in the City

Finally, the hydrant has been opened! It took them much longer to get around to it this summer.

It's so hot that Charlie is (misguidedly) hanging out on top of the air conditioner.

Monday, June 15, 2009

More on Schooling

Art Carden and I have an op-ed in The Tennessean that was originally based on this blog post. It changed quite a bit, in large part because of space constraints (550 words or less), and also because Art's take on the subject is slightly different--perhaps only in style--from mine. Art's focus is more on getting government out of education completely. The original blog entry focused primarily on vouchers, and on the lack of a compelling argument for having schools operated by the government. I'd like to use this entry to add nuance to the arguments in the newspaper op-ed.

To reiterate the initial thrust of both pieces, there is little reason to think that having the mayor run the schools will result in an improvement in the quality of education. This is not because the mayor is evil or stupid or anything nefarious; it is simply because he is trying to solve a very difficult central planning problem, while facing pressures from various lobbies. Just as when production of cars or food is centralized, the result of centralizing education tends to be a one-size-fits-all, bureaucratic, poorly-run mess. There simply aren't incentives in place that would encourage or even allow the mayor to find the right ways to run a school system. Competition, on the other hand, should help with this problem. We don't need to find the "right way" to build a car; we let many companies build cars, and let consumers decide which ones are right. Firms compete over consumers' dollars, and in so doing try to find new and better ways to make those consumers happy.

Markets are not perfect, but perfection should not be enemy of the good. We're simply not likely to get persistent improvement in schools so long as schools are in the hands of a government-enforced monopoly. The piece in The Tennessean contains the following:
When markets are left alone, people are usually compelled by competition to serve one another in spite of our natural disinclination to do so...
This is simply Adam Smith's invisible hand argument. The idea is that individual self-interest can lead to cooperation and service of others, even if that is not one's intent.

The word "usually" is in there for good reason. There are particular ways that markets can go wrong--negative externalities, such as pollution, or public goods that might be underprovided by the market, such as national defense, as well as other "market failures" that I won't go into here. There may very well be positive externalities from education. That is, there may be external benefits from having everyone able to read--you benefit from being in a society in which I can read, but I don't take that into account when I decide whether or not to learn to read. As a result I may underinvest in education. It seems to be the case, according to Kerry King, that even if these external benefits exist, people would choose to buy enough education to create them anyway. That is, those very basic skills that make for a better society--literacy and numeracy--are likely to be almost universally obtained out of self-interest.

Even if King is wrong, however--even if people, left to their own choices, would not choose enough education--that is not an argument for schools run by the government. It is an argument for subsidizing privately run schools. That is what vouchers do--they are a government payment that can only be used to purchase schooling (the G.I. Bill and Pell Grants were really vouchers for higher education). These vouchers could be restricted by income, although I see little reason to do so. The D.C. voucher program was targeted at low-income families. The result was that a lot of poor, mostly black families were able to send their children to schools of their choice, rather than being locked into their local monopoly. Right now, only the wealthy have that option, since only they can afford to move based on school district quality, or to send their children to private schools.

A concerned neighbor commented via email on my original blog entry, suggesting that the result of vouchers might be that people end up sending their children only to schools with people who are just like them. I agree that this is possible; bigots might choose to keep their children out of schools with black students, for example, or Christians might not want their children associating with heathens. I have several responses to this, however:

1) I don't think this would happen today to the same extent that it would have, say, thirty years ago. It would surely still happen, though.
2) The wealthy already have this option. We currently have a system that allows the wealthy to be bigots, but does not allow the poor to be bigots. The only way to prevent this is to make it illegal for parents to send their children to private schools, make it illegal to home school them, and to somehow prevent them from taking advantage of majority-white school districts, perhaps with busing.
3) I see this kind of voluntary bigotry as offensive, but I think it should not be equated with the government mandated segregation of the past. That is, it is one thing for people to choose to send their children to schools with a particular makeup. It is another thing for the government to force black children to go to black schools. Rememember the children in D.C.: They were poor and mostly black, and they were able to choose to go to private religious and secular schools of varying racial makeups. If it came down to it, I would prefer a voucher system targeted at poor families to no voucher system at all.
4) I would prefer to have students--particularly poor students currently worst served by the system--getting high quality education on a competitive market, even if that leads to some self-segregation, to having students forced into more diverse schools that provide poor education. I admit that this is a value judgement.

A related argument was that some schools might try to keep out black or poor students, perhaps by raising tuition above the amount of the voucher. This is possible, but I think it is unlikely unless parents have a very strong preference for bigotry or classism. Schools do not want to turn down money; I do not think they will turn away the students that go with the money. It is possible that some schools will offer some sort of very expensive education, and may therefore charge tuition that exceeds the amount of the voucher but that would be because of higher costs, not because of racism. Again, I am not saying that such bigoted influence on tuition is impossible; merely that it is unlikely. I am not familiar with such a thing happening with past voucher experiments. If anyone has evidence on the subject, please pass it along.

Finally, the article says that I am a "free-spirited economist"; that was intended to be a humorous euphemism for "unemployed economist". I am currently looking for teaching work in Nashville. I was curious to see if The Tennesseean would keep that in there, and surprised to find that they did.

I have always wondered why op-eds seem so simplistic and one-sided. Now I know: space constraints. Unfortunately, the freedom afforded by a blog probably causes me to go too far in the verbose direction.

Thursday, June 11, 2009

A Question About Happiness

This entry (and the more detailed explanations linked therein) by Justin Wolfers on happiness research and the Easterlin Paradox is interesting. In short, they find that, contrary to previous research, being wealthier does in fact make an individual happier, and wealthier countries are, on average, happier.

This is a study of the relationship between levels--the level of wealth and the level of happiness. I wonder, is there a relationship between the growth of wealth and the level of happiness? A long time ago I read Brad Delong's review of a book by Ben Friedman, in which Delong wrote:

...modern society is a bicycle, with economic growth being the forward momentum that keeps the wheels spinning. As long as the wheels of a bicycle are spinning rapidly, it is a very stable vehicle indeed. But, he argues, when the wheels stop—even as the result of economic stagnation, rather than a downturn or a depression—political democracy, individual liberty, and social tolerance are then greatly at risk even in countries where the absolute level of material prosperity remains high

I wonder if this would show up in happiness data. Has anyone done the simple panel data regression of happiness on growth rates of GDP, rather than per capita GDP?

Update: Thanks to Jonathan nation for a correction.

Sunday, June 07, 2009

Trading One Monopoly for Another

An article in The Tennessean today explains that the mayor of Nashville may be taking over the schools in the district (rather than having them run by elected school board officials). The argument in favor is that it streamlines the system, making it easier for changes to be implemented. Working with a board can be difficult, as competing interests battle for control of the system.

I don't really see why handing over control to the mayor would be an improvement, however. Sure, it eliminates bickering between board members and the interest groups (parents, teachers' unions, and the government school bureaucracy), but without some sort of competitive pressure on the mayor's administration, why would he be able to do any better? All he can do is decisively favor one group, or no group--I see no reason why he would be better able to get things done, and I see no strong incentives for improvement.

Suppose we built our cars like we provide education. We would have local factories, run by the government and paid for with property taxes. What car you would get would depend on where you lived. If you didn't like the car you got, you could move to another area, or go to local car factory meetings (where you must battle the workers' union, which wants maximum wages for minimum effort, and does not want their quality scrutinized, and the government bureaucracy, which cares little about the outcome). You could also buy a privately produced car, but that would mean that you would forego all that money you paid into the property tax system, and you'd have to pay the full price of a private car on top of that. Does anyone think this system would give us better cars? Surely not. It provides choice of cars only for the wealthiest buyers; the rest must consume the cars produced by the local monopoly.

Education is a very complicated good (or if you prefer, a very complicated investment), but I don't think the comparison to cars is unfair. Cars are also complicated bundles of characteristics--fuel economy, acceleration, comfort, appearance, reliability, safety, convenience features--that must be bought together. Some characteristics, such as reliability, cannot be immediately observed. Organizations, such as Consumer Reports, exist which try to collect data on reliability, so that consumers can make informed judgements about the long-term wisdom of buying a particular car. Is education really so different? Surely it makes a great deal more sense to set up a system of incentives that encourages schools to compete to improve quality, in order to attract students, rather than debate which whether we should place the government monopoly under a board's control or a mayor's control. Sure, we might get lucky and elect a particularly motivated, competent school-board director, but what about when he is gone? A system that relies on the public electing brilliant, motivated officials, rather than relentless competition, does not inspire my confidence. A system of incentives is more powerful and reliable in the long-run than a system of "big men".

A voucher system is one such method; give each student a voucher good for some amount of money, and let the student (and his or her parents) spend it on whatever school the student wants. Schools must lure students, and their money, to their doors, by providing education that people want. A common objection to this system is that, because students could choose private schools, this removes resources from the public school system. This is true, but it is also true that this system removes students from the public school system; with fewer students, the public school system does not need as many resources. The evidence on voucher systems that have been tried in the U.S. so far is mixed; the experiments are sometimes short-lived (teachers' unions strongly oppose them), and the lag times involved from input to output may mean we haven't given them enough time. Other countries, particularly some European countries that do better than the U.S. on standardized test scores, use a voucher-like system. (There are other reasons why they may do better on standardized tests, including the possibility that they test fewer of their students.)

Even if vouchers are not a panacea, I nonetheless see no good reason why education must be produced by government schools. Why should we expect the government to be better at producing education than a private institution? If equity or access are concerns, vouchers address them. I can think of a bad reason why government would want to provide education: to indoctrinate. Looking back on my own education, I find it bizarre that I was required to stand up and salute the flag, and in elementary school, we even had to sing The Star Spangled Banner every morning.

Thursday, June 04, 2009

Learning by Doing

Tesla Motors, producer of the Tesla Roadster all-electric sports car (0 to 60 in 4 seconds with a 240 mile range!) has produced their 500th car. Their next product will be an electric luxury sedan at a significantly lower price than the $100,000 Roadster.

Aside from being an interesting example of technological change, this story is interesting because it's an example of what economists call learning effects, or learning by doing. It took Tesla Motors eight months to produce the first 100 Roadsters. The next 400 roadsters took only another eight months. Some of that is probably due to increased capital, but a lot of it surely has to do with simply getting better at what they're doing through practice. The most famous example of this is the production of weapons and vehicles during World War II, during which factories found that they could rapidly expand their production, producing more planes, faster, and at lower cost, simply because workers learned more efficient ways to do their jobs.

These sorts of gains are one reason why we should be optimistic regarding the production of alternative energy vehicles. They may be expensive now, but they will get cheaper with time. It is true that some inputs--such as lithium for lithium-ion batteries--are very scarce. They may even get more expensive. This isn't an insurmountable problem, however. Julian Simon pointed out that there is more than one way to make wire for communications when copper becomes scarce. One way is to find more copper. Another is to come up with a substitute, such as fibers that transmit light. The substitute may even be better than the original. The more scarce the original resource becomes, the more pressure there is to find an alternative, and the more profitable such a discovery becomes. Recycling old resources may also be an option, if the recycling process is not itself too resource-intensive.

Sunday, May 31, 2009

The Unpredictable Future

I've finished reading two interesting books, David Friedman's Future Imperfect, and Edward Castronova's Exodus to the Virtual World. Both are attempts to forecast what the future looks like, and I would say that both have a time horizon of about fifty thirty years into the future, although Friedman is explicit in that estimate, whereas Castronova is vague about the amount of time involved.

Future Imperfect tries to work out the implications of a variety of technological changes that will occur, starting with changes in privacy related technology online--encryption, electronic snooping, etc. I found this part of the book somewhat dull. The implications are sometimes interesting: Will the world become a place of zero privacy, where everyone knows whateveryone else is doing? Will this be an oppressive place where the state can easily control everyone (as in 1984), or will the ability to spy on the police, too, make it a better place? The second part of the book is much more interesting, and deals with changes in nanotechnology and biotechnology. What happens if we can build tiny machines that eat and sequester carbon? Could this eliminate global warming? Could we make machines to go into the body and repair it? What are the implications of medical innovations that allow immortality, or the uploading of the content of our brains into computers or new bodies? It could lead to a wonderful paradise. On the other hand, self-replicating nanomachines could mutate, consuming everything they encounter, converting the world into inanimate, lifeless matter--the "grey goo scenario".

Castranova's book looks at the burgeoning world of Massively Multiplayer Online Role-Playing Games, such as World of Warcraft and Everquest (the latter now being a dated reference). His view of the future is almost completely positive. Only at the very end of the book does he consider the possibility that the use of artificial worlds could be pathological--that plugging into an experience machine could be unhealthy. Friedman discusses this possibility as well, and comes to the conclusion that given Nozick's choice between existing in the real world or a slightly better imaginary world, he would choose the real world. He notes that he plays a good deal of World of Warcraft himself, though--I wonder at what price would he be willing to switch to the imaginary world? What if it were not just slightly better, but a great deal better, more fun, and more rewarding?

What I take away most from these books, though, can be summarized in the following graph (for which I am to blame; it's not in Friedman or Castronova):

The vertical axis measures well-being, perhaps measured in per-capita GDP or a happiness index or some other measure. "Business as usual" means continued economic growth around two percent per year over the next fifty thirty years. This is the view most economists take, and radical technological change aside, it's pretty nice. Two percent growth per year for the next fifty thirty years means that the average American will be making a salary well over $100,000 $80,000 in real terms (i.e., adjusted for inflation). That's a pretty amazing standard of living.

What's really striking, though, is how much better or worse things could be, and how uncertain that is. These technological changes could push things strongly in one direction or another. Medical advances that eliminate disease could push our well-being far above what ordinary economic growth would suggest. On the other hand, if these advances are based on a technology that ultimately wipes out all life, that's pretty much the worst outcome possible. Seen in this light, global warming seems like a pretty small problem. Even the worst case scenario of twenty-foot sea level rise pales compared to the extinction of all life. Furthermore, if nanomachines really do pay off (and don't kill us), they could eliminate the problem of global warming altogether, either by eating the stuff that causes it, or by addressing the effects of global warming (imagine an army of nanomachines that reduce ocean acidification, for example). We really don't have any idea how this will work out, and the range of possiblities, from disastrous to heavenly, is staggering.

It's not clear that policy can allow us to avoid the undesirable outcomes. Even if the U.S. government were to strictly regulate nanotechnology, they would be unlikely to be even as (un)successful at that as they have been at preventing the development of nuclear weapons. The U.S. government can't regulate everyone everywhere. Whatever is going to happen is going to happen, and there's not a lot "we" can do about it through government.

Personally my view is optimistic, but I'm not sure that there is good reason for that. My optimism is heavily based on the last two hundred years of technological change, which has mostly made people better off (granted it has also killed millions of people along the way due to improved military technology, but that must be weighed against the lives saved and made better). If Friedman is to be believed, the next fifty thirty years are going to result in changes so radical that the last two hundred years will pale by comparison.

Update: Thanks to David Friedman for a correction in the comments, and for linking to the online version of the book.