Bastiat’s Bastions

There are many words used to describe people who have some strong difficulty that might put them at a disadvantage to others. Yet, I am constantly reminded by a major finding in my discipline, economics, in one of its core concepts called “comparative advantage.” The idea is that any person who can interact with others has a place in the society where they can be productive and can engage in trade that is both beneficial to them and to other members of the society. Even someone who is especially good at everything is in need of trading with others: being able to do all things does not mean that a person can do all things, since we all face only 24 hours in a day and cannot possibly do all things.

Now, I should point out that having a place to produce goods or services that others will demand does not mean that all of us are especially good at any one thing, nor does it mean that all of us can provide others with goods or services of sufficient value that we can support ourselves without help of others. It does mean we all have a place and something we can do to help provide something to others of value. I often mention in classes that there are two paths to comparative advantage: one is to be relatively good at that one thing, and the other is to be relatively bad at everything else.

Still, there are some people who face certain substantial difficulties in life that it is amazing that they excel and even lead their fields in what they have chosen to do. Here are some personal recollections of three people I have come across at one time or another who were so astounding to me that the difficulty in their life was, for a time, invisible to me. Perhaps, I am just not that observant.

Walter Oi

Walter Oi is one of those economists whose articles were required readings in economic theory classes in graduate school. The most important of his theoretical works was an article titled “A Disneyland dilemma: Two-part pricing for a Mickey Mouse Monopoly.” The subject of that paper is something that I teach to my MBA students in managerial economics.
More socially importantly though, his paper in the American Economic Review in 1967, “The Economic Cost of the Draft,”  and his related book, The Costs and Implications of an All-Volunteer Force, were instrumental in bringing an end to the military draft in the nation, showing that the draft was a more costly way to raise a military force than was an all-volunteer force of the same size.

In graduate school at Virginia Tech (better known as VPI back then), on Wednesday evenings and Friday afternoons, we had seminars that all graduate students were expected to attend. These seminars almost always had guest lecturers. One Wednesday night I arrived right after Professor Oi had been introduced. I do not recall the subject of that evening’s lecture. Professor Oi, though of Japanese descent, spoke perfectly clear English, as he had grown up in California (and was one of those Japanese Americans sent to a concentration camp during WWII). While his English was perfectly clear, when he furiously wrote equation after equation on the blackboard I had trouble reading his handwriting on the board, even though my own handwriting is difficult to make out (one reason I am a fan of Powerpoint). I could make out a few lower-case deltas and alphas in the equations and could read some of it, but with great difficulty.

While after about 30 years I do not recall exactly what Professor Oi’s lecture was about, I do recall that it was brilliant, as his work usually was. At the end of his lecture, the moderator thanked him for coming and giving his talk, and Dr. Oi received the usual round of appreciative applause. As he was leaving, I discovered the reason for Dr. Oi’s illegible blackboard handwriting when a German Shepard came around from the other room to Dr. Oi’s side. It was his seeing-eye dog. As it turns out, Oi, who received his Ph.D. from the University of Chicago in 1961could not read ordinary text at all when he began college.

Incidentally, Oi also once served as the Vice-Chair of the President’s Commission on Employment of People with Disabilities. For more on Oi, this Wikipedia entry is rather accurate.

Vernon Smith

Several years after I finished my degree at Virginia Tech, I was at a meeting of the Public Choice Society (devoted to using economic methods and theories to study political, sociological and other non-market activities), which met jointly with the Economic Science Association (devoted to experimental methods) in Tucson. At that time, Vernon Smith, who is credited for beginning the study of experimental economics was at the University of Arizona in Tucson, as was Gordon Tullock, one of my Virginia Tech professors, who was one of the most influential originators of public choice economics. About 10 or so years later, Smith, along with the psychologist, Daniel Kahneman won the Nobel in economics in 1999. While there in Tucson, Vernon Smith, invited me and several other young professors out with him and his graduate students, to a Western bar, which had a country and western band.

Smith was friendly and courteous, but a barroom was obviously not home for him. Some years later, Smith began to talk about his Asberger’s Syndrome, which is a type of Autism. As a result, Smith, unlike many of us, seems to function just fine for long periods of time isolated from others. Actually, Smith’s autism may have worked well for him, allowing him to become a very prolific writer, even for someone who is such an original thinker. (For more on Smith, see
http://en.wikipedia.org/wiki/Vernon_Smith.)

Evelyn Glennies

Some years later, sometimes in the 1990s, I attended the meetings of the Atlantic Economic Society to present one of my papers. One of the more enjoyable aspects of the Atlantic meetings is that they often arrange for attendees to go to some very nice cultural event and at reduced rates. I went to hear the Philadelphia Symphony at one meeting, but I especially recall hearing the National Symphony at the Kennedy Center in Washington at another.

While I still recall the grandeur of the Kennedy Center, mostly I recall the performance. The audience was told that the performance was being recorded for later broadcast on National Public Radio or for Public Television. There were just two pieces on the program, with the second being a rare percussion concerto. The percussion concerto called for the soloist, Dame Evelyn Glennies, to play almost 30 different percussion instruments that were arranged around the stage. Dame Glennies must have been in her mid thirties at the time, and this very beautiful and talented woman came to the stage in a flowing, gauzy white dress that made her appear as a forest faery as she flitted from instrument to instrument about the stage the way a humming bird flies from blossom to blossom. What was out of place, though, in this most formal of musical performances for a soloist with the National Symphony at the Kennedy Center, was that she was barefooted. I thought perhaps this was to make as little noise as possible as she went from drum to marimba to water tympani across the stage. She finished the evening with a brilliant encore with just her and a snare drum on the stage.

The next morning, I had a 7:30 flight out of Reagan National Airport. This flight was one of the few I have been on where they showed an in-flight interview program. Imagine my surprise to see an interview with the very performer featured at the performance the evening before, Evelyn Glennies. I was even more surprised when the interviewer asked Dame Glennies how long she had been completely deaf. Yes, this Scottish musician, and the only solo symphonic percussionist in the world at the time (she still may be for all I know), was completely deaf. Anyone who has ever performed with a musical ensemble, a band, a choir, an orchestra, a trio or quartet, knows that being able to hear the others you are performing with is essential for proper balancing, blending and timing. Then I understood the reason for her bare feet at this performance. Bare feet enabled her to “listen” to the rest of the orchestra through her feet from the stage floor.

You can hear Dame Glennies talk about listening as a deaf person and, more importantly, as a deaf musician at the TED conference. Listening to her over and over (and “listening with my whole body”), I still cannot detect any signs of deafness.

Extraordinary people and the rest of us

Some people are just extraordinary and would be extraordinary almost no matter what difficulty faced them, making their adversities seemingly disappear before their brilliance. Most of us are not so gifted. Each of us does, however, have something to offer, something to make the world better for others, some comparative advantage, even if it is just that one thing we can do. We should all understand and appreciate others for what they do for us, from the musician that thrills us, to the shortstop who amazes us, to the doctor who saves the life of a child, and on to the person who takes away our garbage or cleans restrooms. Everyone has something of value to contribute, and they should be valued and appreciated for making our lives better.

The question posed at the beginning was “what was the right word for those with disabilities?” Under various circumstances, any of those words may be appropriate, but remember that most of us have some area where we fall short, for some of us it is noticeable and for others, our disabilities are as invisible as Professor Oi’s and Dame Glennies’ disabilities were to me. I am constantly reminded of the words of the great American humorist, Will Rogers, who noted “everybody’s ignorant, only on different subjects.” We all fall short somewhere, even the brilliant and the beautiful. The word I tend to prefer is “human.”

-MC

As I discuss in my Health Economics class, hospitals are, in most places, the largest employers of nurses.  With the nursing profession still dominated by women, often as second earners in their household, nurses tend to be less mobile than many other professionals.  In addition, in many communities there are few hospitals within commuting distance, giving those hospitals in commutable distance what economists term as a “monopsonistic” position in wage determination.

A monopoly is a market type characterized by having only one seller or by a very dominant seller. A market that is monopsonistic, or simply a “monopsony,” on the other hand, is a type with just one buyer.  The “mon” (from Ancient Greek “monos”) part of the word means “single,” while the “opsony”  (from Ancient Greek “opsnia”) part means “purchase,” so “monopsony” means a single-purchaser market.

When a market has a single buyer, that buyer has an extraordinary amount of bargaining power and can strongly influence the market price.  To get more nurses, better pay and/or better benefits must be promised or the hospital will be unable to attract more people to be nurses at their hospital.  That is, the supply curve of nurses is upward sloping, so if a hospital wants more nurses, they would have to increase nurses’ pay, new and incumbent nurses alike, or incumbent nurses may just quit to be rehired later at the higher pay.  Or they may just make things difficult for the hospital administration that pays new nurses more than loyal workers.

Let’s look at a simple numerical example.  Suppose that a hospital could attract and maintain a workforce of 500 nurses by paying them each $50,000 a year, for a labor cost of $25 million a year.  Now suppose in order to increase this workforce up to 600, pay would have to go up to $60,000 a year to attract the next 100 nurses, often from greater distances.  In this case, labor costs increase from $25 million to $36 million, or 44% more in labor costs for a 20% larger force.  This is because both the additional 100 nurses had to be paid more, but so did the 500 incumbent nurses.

How can the higher pay be limited to just those new nurses without paying more to the existing nurses?  This is where nursing contractors come in.  The contractors work for someone else and usually commute great distances.    The pay is higher for the contract nurses and the hospital’s nurses do not revolt.  In this case, the labor costs are the $25 million for the hospital’s 500 nurses and another $6 million for the contract nurses, pushing costs up to only $31 million instead of $36 million, or by 24%, not much more than the increase in nurses.

This past Saturday I, along with some colleagues and a student of mine from Nicholls, attended the Louisiana Political Science Association meeting at the Grambling State campus.  The meeting was helpful and very cordial, even though many of us strongly disagreed with one another.

There was a panel of undergraduate papers with two papers from Centenary students (my student and I presented a joint paper with Dr. Sanders in another session).  There was another panel of graduate student papers.  Both of these undergraduate papers were very interesting.  Allison Saylor an undergraduate student at Centenary had a nicely done paper titled ““The Bush Administration, Private Military Contractors, and the War on Terrorism,” in which she examined the substantial growth in the use of military contractors in the war in Iraq.  She posed a very useful question, “why would the war in Iraq require so many more contractors than we saw in previous wars?” (Quote marks are used here for my interpretation of her paper rather than a quote from her.)

During the discussion period after her presentation, I think the presenters, discussant, session chair and the audience arrived at a reason for this large expansion of contractors.  The last protracted war that the U.S. was involved in was Vietnam, and soldiers could be drafted then.  Any “desired” expansion (by the Administration) was met by increases in the number drafted. To expand under a voluntary force, we need to either attract more soldiers by increasing their benefits or by outsourcing non-combat roles to civilians.

The latter solution, outsourcing to private contractors, is likely to be less costly for two reasons.  Many of the non-combat requirements of a military force are things that many private sector companies are already doing and things where they have particular expertise, such as warehousing and goods distribution, food services, accounting services and construction.  Soldiers are no better at doing these activities and are probably worse than trained civilians at these sorts of  activities.  While this was also true during earlier wars, these activities in those days could be manned with soldiers who were drafted and forced to work below their opportunity cost or their voluntary wage rate.

The other reason for outsourcing certain tasks often performed by soldiers is exactly analogous to the nursing monopsony story told above.  The market for warriors is a monopsony market with the Department of Defense just about the only buyer in the market.

How can the higher pay be limited to just those new soldiers without paying more to the existing soldiers?  The contractors fill certain non-combat roles, while the military personnel perform the combat roles.    The pay is higher for the contractors, and the combat troops do not revolt.

While it might have been the case that certain contractors got sweetheart deals, no-bid contracts or cost-plus contracts, it is likely that troop increases with a voluntary force may have to increase pay to all rather substantially to get only a few more warriors.

I should point out that the return to the draft is not a solution to this high incremental cost of troop expansion, because the real opportunity cost of a draft is that some people are forced to do military jobs, often giving up positions where they are far more valuable to the country than as soldiers.  This social cost of the draft is hidden from presidents, congressmen, taxpayers and voters and they often do not consider such costs in their decisions.

Finally,it is almost ironic that those who kill and those who heal face the same sort of labor market issues, and those who hire them face similar incentives to price or wage discriminate.

-MC

We are told by politicians that the way to reduce health care costs is by getting more people covered with health care insurance and getting more preventative care. Maybe. Maybe not.  When we look at the numbers, we have to conclude that the problem is that demand is shifting up faster than supply.  The only thing that will bring health care prices down is if we are able to get supply to increase faster than demand.

Recently, the White House hosted a Health Care Summit. C-SPAN had some good coverage on it that you see at their website. The links to the events are:

Summit Opening Remarks, Breakout Session, Obama and Kennedy: Closing Remarks on Healthcare Summit, BilyTauzin Interview on Pharmaceuticals.

Most of the discussion centered on health care coverage–insurance. I would suggest that the problem that most Americans face is not whether or not they are covered, but the high cost of coverage.  Premiums are very expensive. A lot of the productivity gains of the American worker in the last 20 years has been paid to the employee, not in wages, but in the employer’s share of health care premiums.

I plotted some health care data and came up with an interesting picture. I based this picture on two date sources: 1) National Health Expenditures 1960-2007 from the Centers for Medicare and Medicaid Services (http://www.cms.hhs.gov/nationalhealthexpenddata/ downloaded 3/10/2009) which provides estimates of the total expenditures in the US on health care and 2) the Consumer Price Index (CPI) subindex on health care (just like there is one on energy and another on food) which comes from the Bureau of Labor Statistics. I got a relative price of healthcare by dividing the Health Care CPI by the complete CPI (all goods and services). This tells us which is going up faster, general prices or health care prics and if HC is becoming more scarce (more in demand relative to what is going on with supply).

I divided the expenditure data by the Health Care CPI to get a quantity measure and then divided through by the population, to look at the quantity in per capita terms (more people means more buyers, but more suppliers too). Price and quantity combinations observed in the diagram below do not show a supply curve or a demand curve, but rather show where supply and demand intersect–the “equilibrium” values.

On the diagram above, the price is the Medical Care component of the Consumer Price Index (CPI) divided by the general (all goods and services) CPI, and multiplied by 100. 1983 is used as the base year (1983=100 for both all prices). The Quantity axis measures Health Care Expenditures per capita (Expenditures divided by the population) for that year and then divided by the Medical Care CPI, which gives us a measure of quantity for that year. Then, this quantity figure is “standardized” by 1983’s quantity (all years quantities divided by 1983’s quantity. The above should not be thought of as a demand or a supply curve, but showing the path of equilibrium prices and quantities for the years from 1960 (point furthest to the left) to 2007 (point furthest to the right). Think about how supply and demand must be shifting to give such numbers.

By the way, the 1960 point is at the lower left and the 2007 point is at the upper right. For things to look like this though, the demand must be growing or shifting out to the right faster than supply is increasing. And why has this occurred? Expanding health insurance coverage. The more someone else is paying our bills, the more we spend and the less attention we pay to our costs. Ever notice all those scooter store ads on TV, ads you never saw before Medicare started paying for scooter chairs? And all the ads say buy this and let Medicare pay for it (”If we approve it and Medicare turns you down, you get to keep the chair”), not a cent out of your pocket.

So, health care is way too expensive, because we have pushed up demand with all of our health insurance–and the politicians’ answer is more of the same, more HC insurance, more 3rd party payment, less individual responsibility. The folks at the Health Care Summit routinely avoid talking about doing anything on the supply side of the market–getting more doctors, more nurses more hospitals, more pharmaceuticals for the same prices (shifting supply out). Here are the questions we should be asking: How do we get the FDA to speed up its approval process? How do we get the med schools and nursing schools to open up their doors a bit wider? These are the things we need to get affordable health care, as universal health care increases demand without doing anything about supply.

-MC

A few weeks ago, PricewaterhouseCoopers (PWC) released its study, “Healthcare policy in an Obama administration: Delivering on the promise of universal coverage.” (You can read about PricewaterhouseCoopers here).

Obama’s plan is modeled after the Massachusetts healthcare system. His (near) universal coverage plan comes, not from a public takeover of the healthcare industry public ownership of the means of production in that industry-socialized medicine, but from subsidizing small firms’ healthcare coverage expenses and requiring businesses of all sizes to provide healthcare coverage for workers or face a hefty fine. What is substantially different about Obama’s plan from the Massachusetts system is Obama’s plan does not force individuals to purchase healthcare coverage. What we do have to keep in mind, however, is that it is unlikely that the healthcare reform that goes through Congress and is signed by Obama is the exact one that Obama recommended.

PWC estimates that the federal government’s cost for this expanded coverage, mostly from subsidizing small businesses, would amount to $75 billion a year, at least initially. As with all entitlement programs, initial estimates of future costs are underestimated and often overlooked. Real costs for Medicare and Medicaid were about 10 times what was originally estimated. Let’s hope that the estimates for Obama’s plan come closer to the mark. Here is what happens: as more people are covered, demand for health care expands greatly, pushing healthcare costs up dramatically. This results in calls for price controls, which create shortages, along with political civil wars to drop coverage for certain procedures and certain medications.

Healthcare coverage for more people, while laudable, drives healthcare prices up for everyone and ignores consideration for how these more highly demanded services are to be delivered. Giving more people the ability to pay without increasing the number of healthcare providers merely puts more people into waiting rooms, without doing anything about actually getting people diagnosed and treated. We end up worse than the Canadians, with not only month-long waiting lists for specialties, but with month-long waiting lists to see primary care physicians. Massachusetts was able to handle this by getting more doctors and nurses from other states. This cannot be done so easily for the nation as a whole.

We often fail to see things from both sides. It is easy for us to put ourselves in the place of healthcare buyers, because most of us are. We have a difficult time seeing the big picture of both healthcare buyers and healthcare suppliers, but if we succeed in putting more people into waiting rooms without getting more doctors and nurses to into examining rooms and treatment rooms, we will see prices for healthcare take the express elevator through the roof. Then, political demands arise for a government takeover of the healthcare industry. As Steve Lieber, CEO of the health trade association Health Information and Management Systems Society (HIMSS), is quoted as saying: “Apply traditional economic principles. If you have an increase in demand, there should be some type of effort to address the supply side. It takes time to increase the number of physicians. As demand increases in that sense, it can be an economic incentive on the provider to become more efficient.” (p. 18)

However, the AMA and ANA control the accreditation of medical and nursing schools, and the licensing of doctors and nurses. There are several ways of increasing the supply of providers. Massachusetts, for instance, allows patients to designate a nurse practitioner or physician’s assistant as their primary care provider. They also required their medical schools to graduate a minimum number of primary care physicians. Of course, this does not keep these graduates from going out of state and obtaining more lucrative specialties.

Two things beyond the Massachusetts reforms are needed to really increase healthcare supply. First, is to require the medical schools and nursing schools to increase their graduation numbers. Second, with the political support from the AMA and the ANA and the current political frenzy over immigration, it is far too difficult for qualified doctors and nurses from overseas to come into the US and practice their professions—this needs to be reversed.

All-in-all, Obama’s plan is not the takeover of the healthcare industry that Hillary Clinton’s almost became. Still, without some rollback of the governmental regulations that provide unnecessary barriers to entry into the healthcare industry, his plan will cause prices to rise so substantially that the voters will demand a government takeover of the industry.

-MC

Responding to McCain’s sole zinger line in the final debate, “If you wanted to run against George Bush, you should have run for president four years ago,” Obama compared McCain’s voting record with the White House position and pointed out that McCain voted with the Bush White House 90 percent of the time. Then Obama repeated that old line “And if it walks like a duck….”

In a now well-known interview, Obama’s running mate, Joe Biden, laughed off a question about Obama being a socialist. Well, there are very few admitted socialists elected to office in this country. And to my knowledge, only one avowed socialist elected to any national office in the last 30 years, Bernie Sanders from the state of Vermont (see this article in the New York Times Magazine from January 21, 2007 by Mark Leibovich). Sanders calls himself a social democrat but has officially run as an Independent over the years.

I started to wonder how close Obama’s voting record was to Senator Sanders, since the closeness of McCain’s vote turned him into George W. So I went to the website of the U.S. Senate and found the Senate roll call votes here. Both Obama and Sanders are freshmen Senators in the 110^th Congress, so it makes their voting records easy to compare.

In one crucial respect, their voting records are quite different. Senator Sanders missed only 6 out of 655 votes held in the Senate in the 110^th Congress, voting over 99% of the time. Obama, on the other hand, had voted only 36% of the time in 2008 and slightly less than 54% of the time in the 110^th Congress (2007 and 2008 combined). Of course, Obama ran for president and Sanders did not. Still, by August 3, 2007, Obama had already missed more votes in the U.S. Senate than Sanders had by October of this year. And there weren’t any primaries to run for before that August date.

After excluding the many votes that Obama did not cast and the few that Sanders could not cast, there were 348 votes where both voted. Of these 348 votes, Obama voted with Sanders 320 times, or 92% of the time.

Certainly, Obama’s redistribution policies and his proposed takeover of the U.S. health care system, his agreement (like McCain and Bush) to take over banks and help out the auto industry, his plan to take away the secret ballot from workers for union representation elections and his proposal to lift the minimum wage to one that compares to what the French have (which has led to widespread minority youth unemployment and riots there), all show that

Obama has the socialist walk and quack down pat.

With a voting record that matches the voting record of an avowed socialist, how can Obama deny being a socialist? Bernie Sanders doesn’t.

-MC

In 1944, an Austrian economist, Frederick Hayek wrote the book, The Road to Serfdom. His book was later shortened and released by Reader’s Digest, and even came out in comic book format and distributed by General Motors. Hayek dedicated his book to socialists of all parties. The central idea of the book is that socialism or collectivism has the same result, whether it is the sort we see in the old Soviet Union and China, and now in North Korea and Cuba, or Fascism of the sort we have seen in Hitler’s Nazi Germany, Il Duce’s Fascist Italy. Hayek’s thesis was that collectivism leads down the same road to tyrannical dictatorships by tyrannical dictators, and he has a very intriguing chapter on “why the worst get on top” in socialism. That very same road, of socialism or collectivism, whether the communist or fascist variety, where people surrender their freedom for the good of the country or the good of the universe, and fall under the spell of the idea that somehow something can be good for the country without being good for any particular person in that country.

Hayek put Fascism and the Naziism in the same category of the Marxism of the Russians, incensing political leaders and academicians in the U.S. as well as with our allies.

Why? The Russians were our allies and the Nazis our enemies. Also, many academicians, even academic economists, were taken in by the ideas of the Marxists. Their societies could not possibly be two sides of the same coin. Or could they?

Well, as my title suggests, we are not only on a road to serfdom, but we are speeding down it as fast as we can go, with little to slow us down.

It is not just that we are about to elect a radical left progressive to the White House. It is also not that both houses of our legislature are also going to have heavy progressive majorities.

No, we are not about to get on the autobahn to serfdom, we have been traveling on it awhile. Certainly policies passed under FDR’s New Deal got us on that road. And that was about the time that the real Autobahn in Germany was being built. It was started before Hitler came to power, but much progress was made on the roads under Herr Hitler, and much of it, fittingly, with slave labor.

The lanes widened with LBJ’s “War on Poverty,” a war that we should all agree did nothing to alleviate poverty, but perhaps only entrenched it and made it more durable, more systemic.

The highway was then super-sized, going from four to eight lanes, and all headed in the same direction, with banking of the curves added to keep us from crashing, but only encouraging us to go faster still. This was accomplished this past month with Bush’s gigantic bailouts with equity positions taken in banks worldwide.

Here are a few signposts along this “Autobahn to Serfdom:”

1. Abolition of property in land and application of all rents of land to public purposes.
2. A heavy progressive or graduated income tax.
3. Abolition of all rights of inheritance.
4. Confiscation of the property of all emigrants and rebels.
5. Centralization of credit in the banks of the state, by means of a national bank with state capital and an exclusive monopoly.
6. Centralization of the means of communication and transport in the hands of the state.

Notice that # 5 was pretty much taken care of in the U.S. and abroad with the giant bailouts. Both #2 and #3 seem to be well on their way with the next president and the next congress. You should note that these signposts are taken from Marx’s own Communist Manifesto.

Zoom, zoom, zoom!

-MC

I’ve felt kind of left out discussing the bailout.

Dr. Michel does research on fiscal policy – particularly taxes – and financial economics, and thus this is right up his alley. Dr. Coats does research on public choice – government spending, pork, attempting to get reelected – again, right up his alley.

And I, at least according to my vita, am but a lowly labor economist.

Labor economists can’t claim to have domain (over other types of economists) about incentives. At its heart, all of economics is really a study of the incentives people have and the constraints they have. However, there are some labor economics issues that are floating around in the background of this financial mess that I think are not getting lip service, at least not on this blog.

I’d wanted to post about the incentives that various players have had in the housing market for a while, hence the post. Then I came across an article, linked here, to a short commentary on the housing market mess written by John Quigley, an economist at UC-Berkeley.

Quigley suggests a large part of what got us into this mess was a really simply problem with labor market incentives – the way the people were compensated. I couldn’t agree more.

Not all people are paid on hourly pay or even salaries – some people’s compensation is structured differently. These different compensation structures give people different incentives. They are done with a reason – to solve one problem – but all forms of compensation schemes have drawbacks.

Back to the housing market mess. You’ll have to go to the link above, and then download the article (there is a download button on the upper right part of the page), but it is free, and only 3 pages long.

Here’s the background, lifted from the article:

The incentive structure that arose for firms in this specialized industry set the stage for the collapse. The incomes and fees generated are all transactions-based, that is, payments are made at the time the transaction is recorded. The originator of the loan, typically a mortgage broker, is paid at the time the contract is signed. Brokerage fees have varied between 0.5 and 3.0 percent. The mortgage lender earns a fee, between 0.5 and 2.5 percent, upon sale of the mortgage. The bond issuer is paid a fee, typically between 0.2 and 1.5 percent, when the bond is issued. On top of this, the rating agency is paid its fee by the bond issuer at the time the security is issued. All these fees are earned and paid in full within six to eight months after the mortgage contract is signed by the borrower.

And now the punchline, at least of the labor econ stuff:

Thus, no party to the mortgage transaction has any economic stake in the performance of the underlying loan. In fact the mortgage broker is paid a larger percentage, termed a “yield spread premium,” if he convinces his clients to accept a higher and more default-prone interest rate. With this structure of incentives, it is not hard to understand why many risky loans were originated, financed, sold, and securitized, especially during the period of rapidly rising house prices from 1999 through 2006.

Read that first sentence again.

Thus, no party to the mortgage transaction has any economic stake in the performance of the underlying loan.

That, folks, is a big problem.

And for the record, Quigley goes on to make some suggestions about how the system could be changed to make things better. Read it!

For my next trick, what labor economics has to do with this whole ACORN voting registration mess…

–CT

So, I’m in the middle of researching for another post on the financial crisis when I come across a new Barney Frank story. At first, I thought I had simply stayed up too late.

But Frank really does say this: “There should be a moratorium on bonuses.” “They have a negative incentive effect because they are the ones that say if you take a risk and it pays off you get a big bonus…and if it causes losses…you don’t lose anything.” (A little aside: apparently, he’s not just talking about bonuses for top-executives of financial companies.)

This is econ-incentives 101: Bonuses provide helpful incentives precisely because they reward only productive behavior. Did this guy ever have a job before going into public office?

NM

From the time we were young, we were told that the key to a good job is to get a good education. Is this right? I am sure we all know people who dropped out of school and were quite successful, and others who have Ph.D.s and cannot hold a job. Both of these types of exceptions to the general rule of better jobs with better education occur time and again. But these are exceptions. Getting a good job without finishing high school is betting against the odds. And that is a sucker bet.

The U.S. Current Population Report for 2002 found that on average, high school graduates made 50% higher incomes than did high school dropouts, and those with 4-year college degrees made almost twice what those who finished high school without additional education. The average doctoral earner made more than 3 times what the average high school only worker made. Also, high school dropouts make only about half of the average income for all those over 18.

More education is clearly related to higher incomes. Higher education gives people more options. If age or experience is taken into account, education becomes even more important.

In my home state of Louisiana, we have natural resource wealth in many forms and in great quantities. Oil, natural gas, farmland, water, timber, fish and wildlife are abundant in this state. A few years ago, I discovered that my own lot was above 3 of 4 natural gas formations below my subdivision. But in Louisiana, amid great natural resource wealth, our rates of poverty are among the highest in the country. Why is this? It is because Louisiana has among the lowest rates of high school completion in the country, with less that 75% of our above 25 population having completed high school, compared to high school completion rates in the upper 80s in states such as Iowa, Vermont, and Minnesota.

The wealth that states such as Louisiana and Mississippi lack is something economists call “human capital.” Human capital is the knowledge, education, skills, training, and experience that a person has that enables them to be more productive. Good health is also a form of human capital, as healthier people have more work days. What economists find time and time again is that more productive people earn more. And people who are able to produce things that people will pay a lot for get paid more. Along these same lines, education that is easy to come by, such as a degree purchased that requires little or no study is of very little value.

Adam Smith, the father of modern economics, noted over two hundred years ago that areas where education was highly subsidized, such as theology, had far greater supplies and far lower pay than areas where there were few scholarships.

In a study I did with Gohkan Karahan for Applied Research in Economic Development, we found that states with more high school completers and college completers had substantially higher levels of income, even when controlling for factors such as the percent of those under 18 (kids who don’t work much) and those over 65 (seniors who don’t work much) and for those in the latter years of their work lives.

Another factor to consider that makes it less likely that high school dropouts will make dropping out even more costly: high school dropouts are much more likely than high school completers to land in jail with more than 50% of African-American male dropouts and more than 10% of white male dropouts getting prison records before they turned 30.

Does more education guarantee someone a better job? No, but it sure makes better jobs easier to get and unemployment much less likely. Is all poverty due to a lack of education? Certainly not, poverty has many causes. But people who are not able to complete high school for some reason or other start off with two strikes against them and must face the next pitch with a blindfold on.

Want to fight poverty? Help a child stay in school.

-MC

In class, one point that I wanted to make on the last day I forgot to make.  Here is the theory framing the point.  As a worker’s wage rises, the substitution effect of the higher wage, a higher opportunity cost of not working at a market job (as opposed to a job in the home, or even leisure), means that workers will demand less time off of work and substitute time at work for time off.  However, there is another force going on, what we called the income effect.  With higher wages, a worker’s income rises, and by being richer as a result, can now afford to take more time off of work, which is usually taken to mean more time for leisure.

However, when economists look at men and women and their labor decisions, we see that as wages rise for men and rise high enough, after some high level of hours worked per day, male workers who earn very high wage rates begin to “buy” more leisure or time off of work, giving up the wage rage for each hour taken off.  However, working women are not observed “buying” more time off as their wages rise at any level of wages or hours worked. The question that should be raised is “why are women different from men in this behavior?”

Ah, the title I have provided is based on an old English poem by that name that you can find at this site  and here are a few appropriate lines:

“As I was wandering on the way,
I heard a married woman say
That she had lived a solid life [grave, serious]
Ever since the time that she was made a wife.
“For why,” quoth she, “my labor is hard,
And all my pleasures are debarred:
Both morning, evening, night and noon,
I’m sure a woman’s work is never done.”

So now do you see?  For most men, time off means fishing, golf, some time for themselves, so that time off is really a “normal good” one that people buy more when their incomes rise.

For women, the story is not quite the same.  A working woman goes home after working all day, and what does she do?  Fix supper, help kids with homework, clean a bathroom, put on a load of clothes, and when she stops at 11pm or so, she falls to sleep rather exhausted.  For her, a rise in wages at any level does not induce a choice of more time off and less work offered.  And the reason is that the time off of work is nothing special, nothing to lose time at work over, because the time off is not spent at real leisure, not spent playing golf or tennis, but all too often, working at home instead of working at the office.  The big difference is getting paid well in one place and not getting paid in the other.

Have a good summer.  Relax, unless of course, you are a working, married woman.

-MC