DRI-131 for week of 8-16-15: Hillary on CEO Short-Termism: Three Views

An Access Advertising EconBrief:

Is the Purpose of Government to Eliminate All Sources of Discontent?

If we took every action taken by government at face value, we would be forced to conclude that its central purpose is to eliminate all sources of discontent. And that is exactly the goal set for it by a long-forgotten Labor Party parliamentarian in early 20th-century Great Britain. Is that really what motivates politicians and bureaucrats? Should it be?

Actions taken by state-government regulators in New York raise these questions. Earlier this month, state Attorney General Eric Schneiderman announced that retailer Abercrombie and Fitch was the most prominent of 13 companies to end a work practice known as “on-call scheduling.” The Attorney General (hereinafter, AG) cited pressure by his office as the motivating force behind the change. The practice requires workers to be “on-call” for work in the sense that they must be prepared to show up or stay home on very short notice of as little as one hour. As noted in The Wall Street Journal (“Abercrombie Agrees to End On-Call Scheduling,” 8/7/2015, by Lauren Weber), “workers whose shifts are canceled don’t receive pay, even if they had blocked out that time and made child-care  or other arrangements.”

Abercrombie’s general counsel, Robert Bostrom, described the company’s capitulation by stating that workers will henceforth receive their schedules one week in advance and can choose to receive word about additional shifts that become available on short notice. The new policy, intended to “create as stable and predictable a work environment as possible” for Abercrombie’s employees, will become effective in September in New York and eventually be phased in nationwide.

Why did the Attorney General of New York state choose to intervene in the work-scheduling policies of a baker’s dozen retailers? “Unpredictable work schedules take a toll on all employees, especially those in low wage sectors,” commented Schneiderman, adding that other companies should follow Abercrombie’s “important step.” In April, the AG had claimed that Abercrombie’s policy “potentially” broke a New York law. That law states that staffers who report for scheduled work must receive at least four hours’ pay at minimum wage even if sent home. (Several other states have similar laws.) As the Journal points out, the law was passed before the advent of text messaging and e-mail made it easy to reach most people on short notice. Despite its change of policy, Abercrombie admitted no violation of law.

To an economist, the regulatory action taken by the New York Attorney General’s office and the explanations accompanying it seem utterly inexplicable – unless we are willing to believe that the inherent purpose of government is to eliminate all sources of human discontent.

Why Oppose – That Is, Regulate – On-Call Scheduling?

AG Schneiderman has chosen to regulate on-call scheduling by issuing an unfavorable opinion of this particular work practice, then pressuring firms behind the scenes to drop it. The question is: Why?

According to the Journal, “a number of current and former Abercrombie store associates nationwide left complaints about the scheduling policy on the employer-review site “Glassdoor….” (Parenthetically, we should note that the ghastly use of “a number of” could denote anything from one to infinity and is the kind of elementary error that freshman journalism students are taught to avoid.) Let us stipulate that some workers find the practice of on-call scheduling objectionable. So what? Is the purpose of government to act as a sort of all-purpose complaint department? Or is there something unique, perhaps, about the situation of retail employees – or human labor in general – that requires complaints to be addressed by government rather than directed to management?

As a matter of fact, why don’t workers who find the practice of on-call scheduling objectionable adopt the great American solution open to all workers in a free society; namely, quit and find a different job with working conditions more to their liking?

The Great Fried-Chicken Dilemma

To clarify this problem, consider a much easier problem posed in a much more familiar context.

Consider the problem of consumers confronted with a product they don’t like. Suppose a diner visits a fried chicken restaurant and finds the main course unpalatable. Should the diner complain to management? Well, many restaurants encourage this; it may or may not produce a refund for the diner. Conceivably, it might even result in alteration of the restaurant’s recipe or staff. But chances are that the diner will simply shrug and go somewhere else. After all, there are untold numbers of competing fried-chicken restaurants.

Should we demand that the Federal Trade Commission monitor consumer websites for customer complaints and “crack down” on restaurants that sell “inferior” fried chicken? No, there are huge flaws with this approach to the problem of maintaining restaurant quality. One drawback is that consumer tastes in fried chicken differ; one man’s inferior chicken is another man’s delight. Requiring government to enforce a quality standard in fried chicken will inevitably result in the production of “government quality” fried chicken; that is, one kind of fried chicken that diners of all tastes will have to eat or else. In this case, “or else” means they will have to prepare their own fried chicken. Since they previously had that alternative but rejected it in favor of dining out, this clearly makes them worse off than they would be if they could find a fried chicken to their taste. Of course, we could pretend to solve this problem by having government set up a different quality standard for each different flavor of fried chicken – one for extra crispy, one for spicy, and so on. But this would only create a host of new problems. And it assumes that government is just as responsive to consumer desires as producers are in free markets, whereas our experience tells us that government is quite insensitive to the desires of constituents and tends to impose a “one-size-fits-all” standard on the public whenever it can.

Another obvious drawback is the vast number of fried-chicken restaurants and diners, which would force government to employ huge numbers of people and spend ungodly amounts of time checking out complaints. (Lack of resources also argues against having government set up multiple quality standards for fried chicken, since it would hardly have sufficient time and manpower to enforce one standard, let alone multiple ones.)

Still another drawback would be the inducement sellers would have to file complaints against their competitors. Not only would this tie up government resources in investigating bogus complaints, it would also imperil the workings of competitive markets. If sellers could use government as a tool in falsely branding their competitors’ products as inferior, this would vitiate the very purpose that regulation is intended to serve.

Just think about all the problems we don’t have because we don’t force government to regulate fried-chicken quality in free markets. We don’t have to worry about how many different flavors of fried chicken to allow – are regular, extra-crispy, spicy, and Cajun-style enough, too many or insufficient to satisfy us? Should the number vary in different cities? Counties? States? Regions? Should it change over time, and if so how often? We don’t worry about any of these things. In fact, we take the answers to these questions completely for granted without ever realizing that they might be a problem in the first place. The market takes care of the answers without any of us ever giving the matter a moment’s thought.

Upon consideration, we realize that the mere fact that somebody doesn’t like fried chicken at a restaurant doesn’t necessarily mean that a market failure calling for government regulation has occurred. It might simply mean that the consumer has tasted fried chicken prepared in one of the various ways that don’t suit him; he needs to visit a restaurant better suited to his tastes. Of course, this could be styled a failure of information, but it is certainly not clear that government regulation could have prevented it or could solve it for other consumers. Markets, not governments, are collators and transmitters of information.

If we tried hard enough, we might envision a role for government in such a situation. Maybe the consumer didn’t like the chicken because it was tainted by salmonella. But we have government regulation of health standards in restaurants and preparation standards in chicken plants – and salmonella cases still happen. In reality, markets solve the problem of food poisoning in restaurants by turning restaurants that serve tainted food into commercial pariahs – a disincentive that exceeds any penalty government offers.

The Great Fried-Chicken Dilemma offers vast insight into the problems of labor markets in general and the regulation of on-call scheduling in particular.

The Potential Efficiency Benefits of On-Call Scheduling

Neither Wall Street Journal article nor Attorney General Schneiderman – nor, for that matter, Abercrombie itself – said anything to suggest that the practice of on-call scheduling might actually be beneficial for retail sellers, for consumers and for workers themselves. That omission is startling. There was a reason why Abercrombie and 12 other retail businesses employed this business practice.

Every consumer has patronized a retail seller and knows that these businesses are sometimes bustling with business and sometimes nearly empty. At some point, every consumer has experienced the frustration of seeking a sales clerk in vain. Businesses strive to keep exactly the right number of staff on the floor – not too many, not too few. Depending on the particular good(s) sold, human labor may be the most expensive cost incurred by the business, so it behooves managers to manipulate their “inventory” of sales staff to best advantage.

Just as businesses want to manage their inventory of sales staff optimally, so they also want to keep just the right amount inventory of goods on their shelves. For centuries, this was one of the biggest headaches facing the average business. Economists even identified the phenomenon called an “inventory recession,” caused by too many businesses simultaneously overestimating the need for future inventories and producing far more goods than were needed – only to find shelves and warehouses full to overflowing when consumer demand did not keep pace with expectations. Recent technological innovations in transportation, logistics and computers have allowed business to employ an inventory scheduling practice called “just in time” inventory management. This allowed businesses to postpone restocking until the last minute, letting them gauge demand much more accurately and avoiding the necessity for accurate long-distance forecasting of inventory needs.

If we view a retail business’s roster of employees as its staffing “inventory,” it is clear that on-call scheduling is a kind of “just-in-time” program for staffing. It allows retail managers to postpone determination of their final staffing schedule until the point when they can gauge the demand for retail staffing much more accurately. This allows them to avoid paying superfluous clerks when the store is virtually empty while having extra clerks on hand when demand is unexpectedly strong. It is crystal clear that on-call scheduling is potentially very beneficial for a retail business.

Moreover, it should be equally clear that on-call scheduling benefits consumers, too. This is a case where the interests of consumers and those of the business are directly aligned. Consumers want to have extra clerks on hand at busy times but don’t benefit much, if at all, from the presence of superfluous clerks in slack times. In the long run, competition between retail businesses will insure that the benefits of lower costs are passed along to consumers in the form of lower prices, so the efficiency gains from on-call scheduling really go to consumers, even though we associate the concept of business efficiency with productive advantage and gains to business owners.

What obviously failed to occur to AG Schneiderman, the Wall Street Journal and (from outward appearances) even Abercrombie and its spokesman is that on-call scheduling is also a potential source of benefits to retail employees. Just as consumers in our fried-chicken example derive benefits from product differentiation, so also may workers derive benefits from different terms of employment and work environments. Retail sales work is generally viewed as a form of low-skilled labor. Economists treat low-skilled labor as homogeneous; that is, as indistinguishable. But on-call scheduling allows workers the chance either to accept employment or, alternatively, earn a higher wage by competing on the basis of willingness to work – or forego work – on short notice. Since the decision to work for a particular employer is voluntary, nobody is forced to take this offer – just as no consumer is forced to eat fried chicken they don’t like. There are countless retail sellers, so workers who don’t relish the practice of on-call scheduling can work for a business that doesn’t follow the practice – just as consumers who don’t like one variety of fried chicken can patronize one of the many other competing brands extant.

So Why Regulate On-Call Scheduling?

On-call scheduling offers potential benefits to retail businesses, consumers and even to retail workers – just as different types of products offer potential benefits to consumers. Nobody is forced to endure on-call scheduling if they don’t like it, since the large number of retail businesses competing for workers gives workers a wide choice of employment – just as consumers have wide choices of different products and aren’t forced to put up with a particular brand. If it would be incredibly wasteful and a huge mistake to regulate brand variety and quality of consumer goods – and it would – wouldn’t it be just as big a mistake to regulate the practice of on-call scheduling for analogous reasons?

The answer is yes. There is no earthly reason for government at any level – municipal, state or federal – to regulate the practice of on-call scheduling. Only bad can come of it. The implication of AG Schneiderman’s actions is that government has a duty to prevent human beings within its jurisdiction from experiencing even momentary discontent. The AG must consider workers to be either too stupid to act in their own interest or too helpless to do so even if they had the wit to perceive it. Left unspecified, however, is how or where the AG acquired the superior wisdom and knowledge to substitute his judgment for those of the workers whose interests he claims to represent.

Free Markets vs. Regulation

We have shown that various ways of producing goods and services (such as utilizing on-call scheduling to staff retailing establishments) and various types of goods (such as different varieties and flavors of fried chicken) offer potential benefits to consumers. How is that potential actuated; that is, how do we cross the bridge from “potential” to “actual?”

Apparently, there are two ways. We can give the processes and products a trial in the free market and see how they work, keeping the ones that succeed and discarding the ones that fail. The failures will lose money for sellers because consumers will reject them, either because they do not like them or because they are too expensive. That makes it easy for producers to discard them. Alternatively, regulators can accept or reject them on an a priori basis. In order for this method to succeed, regulators must know as much about technology and costs as the producers of the affected goods and services do. Regulators also must know as much about consumers’ tastes and preferences as the consumers themselves do – as well as knowing what is “good” for consumers to consume in a physiological and moral sense. In other words, regulators must be well-nigh omniscient. (Where input markets are directly affected, as in this case, we can treat workers as the “consumers” of the relevant process.)

Put in this way, the choice is as clear as two-way glass. Free markets work vastly better and are less expensive than regulation. Given this, why do governments leap to regulate at every opportunity?

Why Governments Almost Always Choose Regulation

The New York State Attorney General chose to regulate on-call scheduling for a reason. Based on our analysis, we might suppose him to be perverse – deliberately choosing a result that makes everybody worse off than before. But that is not so. Economics tells us that somebody has to be better off, and the first place to look for the beneficiary or beneficiaries would be the AG himself and his sponsors and constituents.

The AG is a bureaucrat, a denizen of state government. He benefits when his domain grows larger and his power over it increases. When the number of firms he regulates increases, the AG’s power increases and his budget increases or, more properly, his basis for demanding a budget and staffing increase strengthens. When the AG’s office regulates the processes employed by retail firms, preventing them from using innovative means to compete with other firms, state government is cartelizing what would otherwise be a competitive market. The result of this will be less output and higher prices in the retail-sales sector. This creates a constituency of business owners and managers who are beholden to the AG and state-government politicians. (In the broad sense, this is what happened for over four decades when the old Civil Aeronautics Board cartelized interstate airline travel in the United States between the 1930s and 1978.)

Notice that the list of beneficiaries from regulation of on-call scheduling is small compared to the roster of potential beneficiaries from unregulated on-call scheduling. Regulation benefits government bureaucrats, workers and politicians directed involved with the affected industry, along with business owners who gain from market cartelization. It harms everybody else, most notably the consumers of the good involved and (in this case) almost certainly the workers affected as well. The gains of business owners are probably temporary, but the gains accruing to government will last as long as government regulation continues.

The best way to visualize the actions of government vis a vis markets is by thinking of government as entrepreneurship in reverse. Politicians and bureaucrats are always alert for opportunities to expand their domain. But whereas the invisible hand of competition and voluntary exchange insures that free-market entrepreneurship creates broad, mutual benefits, the coercive, visible hand of government subtracts net value from almost all of its interchanges with markets.

Is the Purpose of Government to Eliminate All Sources of Discontent?

Now we understand the heretofore inexplicable contention that the purpose of government is to eliminate all sources of discontent. How could anybody be so naïve as to think that government has the ability to remedy all unhappiness? Doesn’t the speaker realize that his statement is a recipe for fiscal insolvency? Writing a blank check to government is a fruitless quest for a non-existent nirvana.

Alas, the author of those words didn’t particularly care whether government actually succeeded in eliminating any discontent or not. He was not striving for universal bliss. Rather he sought an unlimited warrant for government intrusion in order to benefit his own special interest. The more power government has, the larger it grows. The larger it grows, the more its servants prosper. And the more the servants of government prosper, the more the rest of us suffer.


DRI-128 for week of 12-28-14: The Student-Loan Bubble: Blackboard Economics Strikes Again

An Access Advertising EconBrief: 

The Student-Loan Bubble: Blackboard Economics Strikes Again

The subjugation of print and broadcast news media by the Internet has changed many aspects of the news business, but crisis mode still predominates. The financial crisis gave the Great Recession its headline stories, the biggest of which were the housing bubble and accompanying subprime-mortgage loan scandals. Ever since then the New Media have been beating the bushes for their next big crisis. The front-running nominee seems to be the impending student-loan debacle.

News outlets across the political spectrum have vied for shrillest note of alarm in detailing the deplorable state of the student-loan market. In fact, this use of the term “market” is highly stylized, similar to its use in government bonds, home mortgages and military-defense. Ever since 2010, the federal government has effectively monopolized the market for student loans obtained for purchase of higher education. This monopoly operates in a manner analogous to the federal monopoly on home mortgages enjoyed by Fannie Mae and Freddie Mac. And a popular consensus has formed around the idea that the student-loan result will duplicate that in home mortgages; namely, a bubble with disastrous economic consequences for the economy at large.

The Outlines of the Disaster in the Making

Why is everybody all het up? Here are the outlines of the disaster as the various sources see it coming:

Between the years 2003-2013 college tuition has risen by almost 80%. To put this rise in perspective, consider that it is roughly double the rise in the average cost of medical care over the same time period. That sounds bad, but a price increase is not a bad thing ipso facto. Marked increases in quality can account for a higher price, for example, by causing increases in demand. Demand can increase for other reasons, too. Might higher tuition derive from these causes?

Surveys have demonstrated that tenured professors now average between six and nine hours of teaching per week at public universities, compared to the former average of nine to twelve hours. A majority of courses are now taught by non-tenured faculty, consisting of full-time, non-tenured faculty members, part-time adjunct faculty and graduate students. In order to believe that students are now receiving higher-quality teaching, we must believe that this motley mix are better teachers than the older, better credentialed tenured faculty members.

On its face, that proposition seems wildly far-fetched. In fact, it is not at all unusual to observe younger, non-tenured faculty members winning teaching awards and popularity polls. But this still doesn’t make a case for higher-quality education, for if it were generally true then it would argue for the separation of teaching and research altogether. And indeed, this may well be the optimal organization of labor in higher education. We will never know until we deregulate the industry, cutting off all government funds and allowing markets to determine the question.

The real source of tuition increases is not an organic increase in demand for higher education. Since 1999, the total volume of student loans has grown by 511%. Thus, the felt, effective demand for higher education has increased dramatically because it is an artificial, subsidized demand.

This has led to about $1 trillion being allocated to student loans – more money than is currently tied up on consumer credit-card debt. The so-called average individual owes about $24,000. This form of personal debt is very tenacious. Unlike most forms of personal debt, it cannot be discharged in bankruptcy. Only death can extinguish it.

Not surprisingly, the high rate, volume and burden of student-loan debt have produced defaults on that debt. Some $146 billion worth of student-loan defaults have been recorded to date. The default rate stands at its highest level since 1996.

Where there is default, there are those seeking to deflect it. There is even a term used to describe this practice; it is called forbearance. A Wall Street Journal op-ed (“The Hidden Student-Debt Bomb,” by Jason Delisle, WSJ 12/31/14) describes the practice and its spread.

Forbearance is the generic term for various means of avoiding on-time payment of student loans. Of the total $1 trillion in student loan debt outstanding, the amount in forbearance is $125 billion and rising.

The standard forbearance benefit is usually granted by the company servicing the loan. The student calls the company and requests forbearance. Upon receipt, the student receives postponement of payments for as long as three years. Since this benefit is granted at the discretion of the company, there need be no qualifying criteria, although there are sometimes income qualifications.

Forbearance can also be used to cure a delinquency status. As author Delisle notes, this becomes rather quaint – accrued interest and principal accumulates on the loan so that the initial too-onerous-to-pay amount is now bulked up considerably by the time the next payment is due. Really, then, Delisle argues, forbearances should be treated as equivalent to delinquencies and defaults rather than as a treatment for them. Thus, their steady upward march in recent years (12.5% of repayments in 2006, 13.3% in 2013 and 16% of the $778 million in repayment today) is reason for alarm.

Another technique bases forbearance on ability to repay, or income. At an income of 150% of a poverty-level income or less, payment is zero. As income rises, payments rise on an ascending scale to between 1% and 15% of income. At some point – either 10, 20 or 25 years, depending on the precise details of the program – remaining debt is forgiven completely and taxpayers pick up the remaining tab. The interesting feature of income-based programs is their separation from standard amortization principles of debt repayment. For example, the most generous income-program cases do not even cover the accrued interest on the student loan! Thus, there is really no pretense that the loan will ever be repaid under these circumstances – the program just gives the student a thin layer of epidermis in the game. According to Delisle, “the Obama administration estimated in 2012 that the average amount forgiven in income-based repayment plans will be $41,000 per borrower” (!).

Since those loans represent expenditures financed by the federal government, that means that the money was acquired by the federal government in one of the three standard (and exclusive) ways: by taxing, borrowing and “printing” (e.g., creating). That means that taxpayers have already paid for it or will pay for it in the future. If students do not repay their loans, that means that taxpayers will bear the burden. Then again, even if students do repay the loans, the only form of “repayment” taxpayers get is reimbursement to the Treasury, which defrays future expenses on some other boondoggle. But even if you discount the dubious notion that taxpayers are repaid by students, it is clear that the practice of forbearance encourages students to take on heavy debt loads and later shed them at taxpayer expense.

One obvious paradox is that the overall U.S. economy has been improving recently while the pattern of delinquency, default and forbearance on student loans has been increasing. This makes no economic sense. That makes Delisle wonder whether the purpose of student loans is political rather than economic.

Regular readers of this space should already have reached that conclusion by this point. Before broaching this issue fully, we should pause to ponder the question: Exactly what is the economic purpose of student loans for higher education underwritten by the federal government?

The Orthodox Economic Case for Government Subsidies to Higher Education

The economic case for subsidies to higher education by government can be found in virtually every undergraduate economics textbook. It is cited as an example of a positive externality. Ordinarily, an economic transaction involves a buyer and a seller – the benefits of the good being purchased are confined to the buyer and the costs of production were incurred by the seller. Education, it is claimed, benefits everybody, not just the student. So, there are benefits “external” to the parties immediately involved in the purchase, making the externality a “positive” one. (The presence of external costs would be a negative externality; pollution flowing from a production site would be an example.) Because students take only their own future benefits into consideration when weighing an investment in their human capital, they will not purchase enough education. It is up to government to subsidize education to make up for this inherent flaw in the free market. True, you and I are forced to pay for the education of others, but that is justified by the benefits we receive from their education – better goods and services that they produce, better conversation that they make with us, better government that they give us and more.

Even the apostle of free markets and laissez-faire, Milton Friedman, gives lip service to this argument in his treatise Capitalism and Freedom. And just as Keynesians like Ben Bernanke cite Milton Friedman’s slightest obiter dictum as support for their loose-money policies, so have government spenders cited him in support of spending on higher education.

This is a classic case of what the late Nobel laureate Ronald Coase called “blackboard economics.” Teachers will develop an argument on the blackboard, “prove” it using the assumptions they assert under the terms of their model. Then – because they probably had a vested interest to promote in the first place – they proceed to promote policies that are based on its validity.

“Economic policy involves a choice among alternative social institutions, and these are created by the law or are dependent on it. The majority of economists do not see the problem in this way. They paint a picture of an ideal economic system and then, comparing it with what they observe (or think they observe), they prescribe what is necessary to reach this ideal state without much consideration for how this could be done. The analysis is carried out with great ingenuity but it floats in the air. It is, as I have phrased it, ‘blackboard economics.’ There is little investigation of how the economy actually operates, and in consequence it is hardly surprising that we find…that the factual examples given are often quite misleading.”

Coase cited two famous blunders by famous Nobel Prize-winning economists. Paul Samuelson, author of the all-time bestselling economics text, followed the precedent set by several generations of economists going back to John Stuart Mill in the 19th century by flatly stating that lighthouses were an example of a positive externality and could only be provided by government, never privately in a free market. In reality, private lighthouses flourished for centuries. James Meade declared that bee pollination of orchards could never be handled by free markets, blithely overlooking the fact that beekeeping in the U.S. had done just that for many decades at the time (the early 1950s) that he wrote. Ironically, despite his suggestive term, Coase never applied his logic to higher education itself.

Coase implies strongly that the problem with “blackboard economics” is a lack of empirical investigation. He was trained at the London School of Economics and taught for many years in the Law School at the University of Chicago. Thus, he was exposed to the influence of two famous philosophical positivists, John Neville Keynes (father of John Maynard Keynes) and Milton Friedman. Both men developed a school of economic logic and practice that was very widely taught and practiced within the profession. It preached that economists should not only develop hypotheses but test them empirically using formal statistical inference. Only those hypotheses that pass the tests – that is, the ones that are empirically sound – should be vetted for policy purposes.

This philosophy is purportedly based on the habits developed by the natural sciences – physics, biology, chemistry et al. It sounds – or, more precisely, sounded– attractive, which accounts for its onetime dominance of the profession. It now lies in ruins. Few theorists pretend to “test” economic hypotheses today, although everybody goes on mechanically employing statistical tools and looking for new ones. The concept of “statistical significance” today brings a blush to professional cheeks after its scandalous misuse by generations of social scientists.

Coase made a minor point, all right; economists were arrogant for not at least peeking out the windows of their ivory towers before applying the theories they formulated so carelessly. But the decisive point is theoretical, not empirical. The externalities argument is badly reasoned in the first instance. Coase himself proved this when he laid the groundwork for the so-called “Coase Theorem,” which shows that when transactions costs are disregarded, the existence of an externality does not make a case for government involvement. The two parties involved have an incentive to bargain their way to a solution.

The positive externality argument for government subsidies to higher education has an even bigger hole in it, one big enough to drive a truck holding $1 trillion through.

When Is An Investment Not An Investment?

When we stand back and view the positive externality argument and today’s reality of student-loan spending by government in some sort of perspective, it is blindingly obvious that something is missing. Something vital was overlooked all along in the mad rush to get money in the hands of students. What was it, exactly?

After Forbes Magazine published one of the cautionary articles referred to earlier, a young student sent in a dissenting response. His economic arguments were chillingly naïve: Since the loans are made and supported by the government, the private sector is “protected” against the fallout from default, unlike the case with the mortgage default on subprime loans; the loans are not securitized via derivative assets and thus have less potential for harm. But most telling of all is his closing comment that “after all, education is not a cost, it is an investment.”

Incredible as it seems, this is the same hazy-crazy-lazy blue-skies frame of mind with which economists themselves have approached the subject. Let us rectify this carefree, careless approach with some incisive thinking. Education is a good. The purchase of education by an individual is an investment that entails a cost. The cost is the highest-valued alternative foregone by that individual in the purchase as it is viewed BY THAT INDIVIDUAL. The benefit is the discounted present value of the future benefits expected to accrue from the human capital created as they are viewed BY THAT INDIVIDUAL. Nobody else’s views matter in evaluating this investment. Nobody else can evaluate the benefits because they are his or her benefits – nobody else’s. Nobody else can evaluate the cost because it is his or her cost – nobody else is foregoing the alternative(s).

Are there other people who gain in some way from that individual’s education? Fine – let them subsidize his or her education, if they want to. If they want to run the risk that he or she will purchase too little education, let them run it. If they don’t perceive sufficient benefit to them from his or her education to subsidize it, then the only sensible policy is to treat that external benefit as negligible. In practice, we see various people and institutions willing to subsidize the educations of others.

Now the shortcoming of the current system sticks out like the proverbial sore thumb. As it stands out now, the education decision is NOT an investment – because the individual making it considers only benefits, not costs. By manipulating the system, the student-borrower can slide out from under a very substantial proportion of the nominal cost.

And that’s not all. The investment decision is further distorted by the fact that, when the buyer perceives the cost to be zero or very low, the quantity demanded will be very high. Thus, the price – tuition – will be driven artificially high. Expansion of capacity – that is, supply – comes rather slowly because public funding to build more universities or expand existing ones comes from legislatures, while private universities are funded largely from endowments.

The Political Basis of the Current System

Delisle’s conjecture about the political basis of the current system is well-founded. Conservatives sometimes act as if sin originated with the election of Barack Obama in 2008, though, and iniquity in public education goes back over a century. The economists who formulated the positive externality theory worked for the government, as do most economists today. The 20th century saw education become a captive of the state. The subjection of students via student loans is only the latest foray by a marauding government.

The current design of student-loan programs is not the result of laxity or well-meaning over-generosity, but of political calculation. The concept of “predatory lending” has absolutely no meaning in a private, free-market economy because private, profit-seeking businesses have no incentive to write bad loans. But government does and the student-loan program is the locus classicus of predatory lending a la government. Its purpose is to entrap students in loans from which they have no alternative except to default. Government is both their benefactor – for “giving” them a college education – and their savior – for rescuing them from financial ruin and penury with forbearance. Thus, government has now created a built-in, guaranteed constituency. Moreover, this new constituency comes complete with an army of bureaucrats that also owe their jobs to government. Bureaucrats first of all to administer the loans in the first place – fill out the forms and check eligibility (as if!) and recruit new borrowers and keep the loans flowing; bureaucrats later on to administer the forbearance phase in which de-facto defaults are carefully managed and nurtured to their soft landings.

Both these new constituencies will vote for big government forever.

And “forever” lasts just as long as it takes for the money to run out and the ultimate financial debacle to take down the whole monetary and financial system.

Bust Up the Blackboard 

Most utter debacles come about in spite of economic theory and logic. This one was carefully engineered with the aid of economics and economists. We cannot fine-tune out way out of this disaster. The only way out is to privatize education at all levels. Severing the financial lifeline of these subsidies is the only way to kill this two-headed student-loan beast that devours our real income with each mouth.