Incentives matter. This is a fundamental tenet of economics: People respond to their incentives. If something in a market seems to be going wrong, it’s because the incentives have gotten screwed up.
Looking at the market for education, it’s hard not to think that there’s something wrong with the incentives. Tuition keeps going up and so does debt. The percentage of people who are not paying off that debt — either because they are in default, deferment, or an income-based repayment program — is staggering. Naturally, a lot of folks would like to get the government in there to start tweaking those incentives until the market stops being so crazy.
One issue involves the incentives that schools have to ensure that their graduates get value out of their degrees. At the moment, a school can enroll you in practically any program, and the government will lend you money for tuition and living expenses, whether or not that degree is likely to produce the means to repay the loan. Since schools are often in a better position to know the economic value of their degrees than naive potential students, that twists the incentives. Eventually, the student will pay, either with money or trashed credit. If the loan defaults, taxpayers will pay too. The school has the most information about the transaction and yet it has the least at stake. No wonder we have such high tuition, so many dubious degree programs and such a troubling rate of default.
Megan McArdle, “Don’t Make Colleges Pay for Student-Loan Defaults”, Bloomberg View, 2016-09-07.
July 17, 2018
QotD: The incentive problem for universities
July 2, 2018
QotD: Perverse incentives, death penalty edition
People cheered when, in the 1990s, Speaker of the House Newt Gingrich advocated mandatory executions for drug dealers. But economists wondered why Gingrich wanted to decrease the penalty for murder. How does the death penalty for drug dealers decrease the penalty for murder? Think about it this way: Suppose that Gingrich’s bill becomes law and the police bust into an apartment where three drug dealers have hidden their stash. What happens? The drug dealers know that if they give up, they will be put to death. So why not try to kill the police? If the dealers are lucky, they get away. If the dealers are unlucky, they are no worse off than if they didn’t fight because when drug dealing is a capital offense, drug dealers face no additional penalty for murder.
Tyler Cowen and Alex Tabarrok, Modern Principles: Microeconomics (3rd Edition), 2015.
May 28, 2018
QotD: Correcting mistakes in private and public enterprises
… government cannot do just one thing, and some of the repercussions of what it chooses to do will be, as it were, mistakes in the perspective of the public even if the initial action were not. But the public’s dissatisfaction with these adverse outcomes can make itself known only via the politically charged process of complaint to authorities, petition for redress of grievance, lobbying, payoffs to public officials, and all the rest of the endlessly complex apparatus for the operation of the government’s political and bureaucratic setup. One is lucky to get any constructive response at all from the government, whose effective control is apt to be in the hands of entrenched politicians, bureaucrats, and private-sector cronies in the various iron triangles that pervade the state at large. If one does succeed in getting a constructive response, it is likely to come forth only after years of expensive and time-consuming delays.
This lack of an effective feedback-incentive mechanism is among the greatest flaws of all government activities. Markets, in contrast, are certainly not perfect relative to the model criteria economists have devised to evaluate them, but they are undoubtedly superior in the operation of their feedback information and response to mistakes. To remove an activity from the market and place in under government control is to ensure that henceforth mistakes, whether they arise from bad judgement, corruption, or ignorance, will not elicit a proper or timely response. In the government realm, mistakes and the slow, counter-productive responses, like doomed lovers, sink together slowly in the quicksand of bad actions being made ever worse by ill-fated reactions.
Robert Higgs, “Dealing with Mistakes: Government Action versus Private Action”, The Beacon, 2016-08-17.
May 21, 2018
QotD: The key difference between private and public enterprise is effective feedback
State bureaucracies are notoriously inept in reacting constructively to their own mistakes. For example, they continuously seek to increase their budgets, staffs, and authority, even when their projects have proven counter-productive or disastrous. It’s almost as if they promote their institutional objectives best by fouling up their programs, then coming back to their funding sources to explain that they cannot succeed unless they receive more resources to do so. Thus do public agencies pour money and effort down the rat hole for years on end, wasting the public’s money every step of the way. The feedback system in this case is obviously perverse so far as serving the public interest is concerned.
Such perversity is practically guaranteed in government operations because government operates outside the realm of private property rights, the price system, and the profit-and-loss accounting that constitute a feedback system in the market realm. In the market, money-losing projects do not persist indefinitely. Their owners and managers eventually decide against throwing good money after bad and close the unprofitable operations. Owners who refuse to read and respond correctly to the clear message transmitted by profits and losses suffer reductions of their own wealth, which serves as a powerful incentive to act correctly and to rectify the mistakes they have made before even more wealth goes down the drain.
Robert Higgs, “Dealing with Mistakes: Government Action versus Private Action”, The Beacon, 2016-08-17.
April 25, 2018
March 19, 2018
QotD: Unintended consequences, recycling division
The hallmark of science is a commitment to follow arguments to their logical conclusions; the hallmark of certain kinds of religion is a slick appeal to logic followed by a hasty retreat if it points in an unexpected direction. Environmentalists can quote reams [!] of statistics on the importance of trees and then jump to the conclusion that recycling paper is a good idea. But the opposite conclusion makes equal sense. I am sure that if we found a way to recycle beef, the population of cattle would go down, not up. If you want ranchers to keep a lot of cattle, you should eat a lot of beef. Recycling paper eliminates the incentive for paper companies to plant more trees and can cause forests to shrink.
Steven Landsburg, The Armchair Economist, 1993.
February 14, 2018
Repost: “I, Rose” and “A Price is Signal Wrapped Up in an Incentive”
Published on 8 Feb 2015
How is it that people in snowy, chilly cities have access to beautiful, fresh roses every February on Valentine’s Day? The answer lies in how the invisible hand helps coordinate economic activity, Using the example of the rose market, this video explains how dispersed knowledge and self-interested actors lead to a global market for affordable roses.
Published on 8 Feb 2015
Join Professor Tabarrok in exploring the mystery and marvel of prices. We take a look at how oil prices signal the scarcity of oil and the value of its alternative uses. Following up on our previous video, “I, Rose,” we show how the price system allows for people with dispersed knowledge and information about rose production to coordinate global economic activity. This global production of roses reveals how the price system is emergent, and not the product of human design.
January 31, 2018
QotD: “Enhancing the user experience”
Once upon a time, computers weren’t all constantly connected to the intertubes. What we call “air-gapped” these days was the normal state of machines back in the desktop beige box days.
Back then, when you bought a program it came in a cardboard box on physical media. You would install it on your computer and it would work the same way from the day you installed it to the day you stopped using it. Nobody could rearrange the menus on WordPerfect or change the buttons in Secret Weapons of the Lufwaffe … Good times.
Nowadays, half the software you interact with doesn’t even reside on your PC. Further, there are whole departments at, say, Facebook or Blizzard or Google whose entire job is to “enhance the user experience”. If they’re not constantly dicking around, adding and removing features, changing what buttons do, moving things around … then they’re not doing their jobs.
We have incentivized instability.
Tamara Keel, “Tinkering for tinkering’s sake…”, View From The Porch, 2018-01-10.
December 22, 2017
QotD: Economic lessons from Christmas toy shortages
Toy marketing on this elite level — Canada should be proud! — creates enraged parents. Hatchimals disappeared from stores altogether many weeks ago, and the high prices commanded in the resale market have created an industry of colorful social-media abuse. Hatchimal hoarders (who can now command C$120-$140 on eBay for one egg) are alleged to be greedy monsters, ruining Christmas for single moms — that is, by making the toy available at a premium at a time when toy stores and the makers of the product are no longer any help. (If the toy had never been invented, or were otherwise unavailable at any price, there would be no cause for complaint.)
What we have here is the familiar operation of a strong human superstition: the belief in an illusory “just price” for a product. It is the same superstition that makes some music and sports fans angry at scalpers. But it is exacerbated in the Christmas-shopping milieu by the innate predicament of the parent, always an emotional hostage to their offspring.
The complainers know perfectly well their kids will survive if they have to wait a couple of months for a Hatchimal. They know they could buy many equally good (and equally ephemeral) toys for half what they might pay a Hatchimal hoarder. They probably even know, if I can play the obtuse childless know-it-all for a second, that an authoritative, confident parent could explain the situation to a child, and make them live with the explanation.
Parents always want Christmas to be just so, but in the people who are castigating Hatchimal resellers, you can hear the hints of desperation, maybe even bad conscience. The problem, angry moms and dads, is not the hoarders. They just saw the real problem coming, and it is you.
Colby Cosh, “How the Hatchimals Christmas craze got me to own up to my irrational baseball complex”, National Post, 2016-12-16.
September 10, 2017
QotD: Peak oil
Witness, brothers and sisters, witness. The oil, it’s going to run out. Peak production of the world’s oilfields has either passed or is about to pass; from here on out it’s rising oil prices forever. Now we wave our hands and pronounce that the energy-guzzling capitalist West (and especially Amerikka) is so addicted to cheap oil that its decadent empire will collapse, collapse I tell you. Barely concealed gloating follows.
There are so many mutually-reinforcing idiocies here that it’s hard to know where to start. As I was thinking of writing about this, one of my commenters pointed out that above $32 per barrel it becomes economical to build Fischer-Tropf plants and make your oil out of coal. This is old tech; the Germans did it during WWI. At slightly higher price points, MHD generators to burn garbage start to look good.
These are instances of a more general phenomenon: markets adapt to price shifts! To wreck an economy with oil-price rises, they’d have to spike so fast and so far that you somehow couldn’t run the cement trucks to build the Fischer-Tropf plants. Not gonna happen.
In fact, the long-term trend will be that the amount of oil invested per constant-dollar value of goods produced in the U.S. economy drops faster than the price of oil rises. This is a safe prediction not because manufacturers have all bought into Green ideology but because they want to make money. This means that they have a market incentive to use their inputs (including oil) a efficiently as possible, and to substitute less expensive inputs for more expensive ones. It’s called capitalism, and it works.
(And, by the way, the cheapest input of all is information. Buckminster Fuller pointed out forty years ago that as technologies mature, the products tend to get smaller and lighter and less energy-intensive and smarter. Your cellphone today weighs less than it used to, and costs less oil to produces than it used to, because its design is smarter. Information has replaced mass. This trend will continue and accelerate.)
The peak-oil collapse scenario is not credible for five minutes to anybody who understands market economics. But the sort of people who believe it are blinded by their own prejudices; fundamentally they think market economics is an invention of the Devil. They need to believe in the collapse, because they need to believe that the wickedness of Americans and capitalists and Republicans will be punished.
Eric S. Raymond, “Peak Oil — A Wish-Fulfillment Fantasy for Secular Idiots”, Armed and Dangerous, 2005-11-13.
September 1, 2017
The complex dance of supply, demand, scarcity, and price
Tim Worstall explains why laws against “price gouging” are denials of economic fact and actually work against getting urgently needed items to the people who require them:
Those little diagrams at the start of the Econ 101 class (supply, demand, price) are not optional extras to our universe, they are instead accurate descriptions of how we humans interact with it. If and when demand rises then price rises, this in turn encouraging an expansion of supply. Thus why we desire to have price flexibility in the face of either changes in supply or demand.
Consider Houston right now in the wake of Hurricane Harvey. It seems a good bet that the tapwater supply is disrupted — flooding has a tendency to do that. We would therefore assume the demand for bottled water has risen – the sensible who normally hydrate from that wondrous invention, the municipal water supply, will not be able to do so, thus increasing the demand for the bottled stuff. Equally, on the other side, there’s going to be a certain difficulty with supply at present — roads 5 feet underwater don’t exactly help trucking.
We thus desire to do two things simultaneously. We want to restrain demand to only the really important things and we want to incentivize greater supply.
Which is exactly what a price rise does for us.
With water at (just to make up a price) $99 a case, people are only going to buy it for drinking water, perhaps only in sippy cups. Which is excellent — we want whatever limited supply of potable water (we’ve really plenty of non-potable around, that’s the basic problem) there is in place to be used for that most valuable use, being potable. We’ve achieved one of our goals therefore, by allocating that scarce resource to its most valuable use: keeping people alive.
We also want to increase supply, though, and being able to sell in Houston for $99 something bought for $9.99 in Beaumont (again, just to invent an example) might well get a few boats carrying loads in – although quite possibly not from Beaumont. Thus, by allowing prices to rise, we’ve at least potentially increased supply.
Our price system, operating without constraint, is thus achieving the two things we desire, a curtailing of demand through rationing to only truly important uses, and a rise in supply.
“But,” goes the cry, “this isn’t fair!”
Indeed it isn’t, and ain’t that a shame, fairness not being a notable feature of this universe we’re struggling to inhabit. All we can do is the best we can. Which is, again, why I insist that there should be variable prices, why there should be no laws against price-gouging. Because this really is a disaster, there really are significant shortages in Houston right now, we really do want to solve them. Which means that we should be using all of the tools at our disposal.
August 27, 2017
August 24, 2017
Words & Numbers: Child Labor Was Wiped Out by Markets, Not Government
Published on 23 Aug 2017
In 1938 the US government passed the Fair Labor Standards Act mandating a forty hour work week, establishing a minimum wage, and prohibiting child labor. Because of legislation like this, government is often credited for making the American work environment safer and more fair. Yet, as Antony Davies and James Harrigan demonstrate with historical data, market forces were already making things easier on the American worker long before the FLSA.
Learn More:
https://fee.org/articles/child_labor_was_wiped_out_by_markets_not_government
https://youtu.be/0zq-2cKENOchttps://fee.org/articles/child_labor_was_wiped_out_by_markets_not_government
Data:
http://www2.census.gov/prod2/statcomp/documents/CT1970p1-05.pdf
See page 170 for average weekly work hours.
See page 134 for child labor rates.
August 17, 2017
Words & Numbers: The Illusion of School Choice
Published on 16 Aug 2017
In private schools, as in private enterprise in general, poor performance drives funding away by driving paying customers away. Yet in public schools, poor performance is used as an excuse for increased funding. With incentives like these, is it any wonder that public schools are failing our children so badly? Isn’t it time to inject some competition into the system?
Education for all is a worthy wish. So is food for all. But we don’t force poor people to eat state-produced food. Even food stamp recipients get to choose where to shop. Why shouldn’t beneficiaries of public education spending get to choose where to send their kids?
Our hosts James R. Harrigan and Antony Davies want to know…
August 7, 2017
The Idea Equation
Published on 31 May 2016
Alex Tabarrok’s TED talk showed you that ideas can trump nearly every crisis. Now, since ideas are so important, we have to ask: is the future of ideas a bright one?
To answer that, we’ll look at something we call the Idea Equation.
It goes like this: Ideas = Population x Incentives x Ideas/per hour.
This equation is a useful way to lay out the factors affecting idea production. When we understand the factors behind production, then we can better predict how the future will go.
Now, the first factor in the equation, is population.
Population determines how many possible idea creators we can have. The good news is, not only is world population growing, but a larger percentage of that population is becoming part of the researcher pool. For instance, China now has 1 researcher per thousand people. This seems low, until you remember they had about half a researcher per thousand in the year 2000. This means they’ve doubled their researcher pool, in just about 10 years.
So, on the population front, we’re seeing progress.
But how about the incentives that encourage idea creation? What’s the state of those?
That’s factor 2 in the equation, and again, we have good news here.
See, for the most part, countries are now choosing better institutions. On balance, the world now has more dependable legal systems, and more honest governments. Previously closed-off nations are now opening their markets to competition and trade. Aside from that, the world is generally becoming more politically stable, and property rights are strengthening as well.
As a result of these better institutions, there are now more incentives to produce ideas. Not to mention, we’re still continuing to globalize world markets. Remember what the TED talk said? Larger markets incentivize more R&D, and we’re certainly seeing higher activity in this area.
For example, in 1990, only seven nations accounted for 92% of world research spending. Today, those same 7 countries only account for 56%. Countries like China, Korea, and Brazil have already joined the fray, sharing the burden of idea creation, which benefits us all.
That said, we do still have the third part of the Idea Equation. This is where things get hairy.
You see, the factor “ideas/per hour” is the most mysterious one. Yes, it measures the productivity of idea creators, but we’re still unsure how productive the future will be. For one, there’s evidence that idea creation is becoming more expensive in certain fields. But on the other hand, we’re also seeing new technology that makes idea creation easier—things like the Internet, AI, and online education.
As long as we continue to globalize markets, provide better incentives for idea production, and keep developing technology that makes idea creation easier, then there’s no reason to think that the future can’t be bright. The brightness may not be guaranteed, but at least there’s hope, which is what matters.
