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incomplete guide to free market regulation

I’ve spent the past week or so struggling with how best to write a post on the proper role of regulation in market design. This a difficult topic to synthesize, since each market poses a different set of challenges for regulators; and I do not intend to catalog every regulation that exists and explain why I believe it to be useful or destructive.

That said, the current financial crisis has incited a chorus of criticism of the deregulation movement of the past thirty years. This deregulation has transformed numerous industries: air, bus, shipping, telecommunications, and, yes, finance. Now that there’s been a financial meltdown, in the mind’s of many, deregulation has been completely invalidated (of course, most of these folks felt this way five years ago).

I’m less than impressed by this mode of argument, as I believe that deregulation is necessary in many instances to reduce distortions in the market. But unlike some caricatures of the free-market position, I don’t advocate deregulation to the point of anarchy. I’d like to remove many regulations, keep many others, and selectively add a few as well.

Regulation is tricky business, and I am interested in arriving at a principled differentiation between regulation as appropriate market design versus regulation as nefarious market meddling. I’ve emailed a few highly-regarded bloggers, but in lieu of an appropriate response by these bloggers, I thought I would take a shot.

It’s appropriate to begin with a discussion of what I mean by market design versus market meddling. Market design is the set of formal and informal rules that shape and limit participation in the market: market design rules separate a market from anarchy. Market productivity is indeed enhanced by rules to govern market behavior. Thefts indeed reduce market exchange. Beyond security, consumer confidence is essential: forgeries will quickly empty a market place. The purpose of market design is to maximize voluntary exchange between willing parties.

Here’s my (incomplete) theoretical check list for a free market:

* No single buyer/seller should exert significant influence over prices or output (e.g., monopoly, collusion, unions)
* No asymmetric/incomplete information: participants must be straightforward in what they are buying/selling (e.g., used car market)
* No unpriced externalities (e.g., cost of toxic chemicals released into local lake)
* No threats to property (e.g., theft)
* No restrictions on who can buy/sell goods (e.g., licensing)
* No restrictions on prices at which goods can be bought/sold (e.g., minimum wage)
* No restrictions on the quality of the goods exchange (e.g., FDA approval)

Many will point out that by this check list, no market is completely free. This is truism akin to the observable fact that no human being is truly free. Still, just as I’d prefer to be “more free” even if I’m not completely free, I’d prefer to participate in markets that are “more free.”

Indeed many of these concerns will be mitigated by the market participants themselves. Two-faced scumbags will be left without a trading partner, while fair-dealing will be rewarded with more business. You probably don’t inspect the newspaper you buy in the morning before you hand over your money. But there is no law against selling newspapers with pages missing.

Still, few markets of import are self-regulating in all aspects. Formal legal laws and informal rules are necessary to advance the free-market agenda listed above. This post has served to reestablish the principles of the free market, which has been perverted by critics of the deregulation movement in their zeal to win the political blame game currently taking place.

The next post will be a bit more practical in looking at the issues of regulation, including regulatory arbitrage and capture, specifically in the context of our faltering financial system. It’s easy to say we need the “right” regulation (which obviously was lacking). It’s even relatively easy to state the principles by which this regulation should abide. It’s much harder to explain which, if any, rule-making institution (e.g, Congress?) is likely to produce regulation that improves the sustainability and productivity of the market.

But let’s try.

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Filed under: Economic Policy

skills to pay the bills – the college years

We’ve covered the importance of education, and the problems with our current public school education policy. Next up is the university level.

To begin, our universities truly are the envy of the world. That said, we aren’t perfect. There are a few low-cost options: community colleges, online degree programs, and technical schools. But these alternatives are generally considered to be “second class” education with a very firm ceiling that rules out many well-paying careers.

In response, progressives have fixated on making it possible for every high school graduate to go full-time to a four-year college.

On one level this makes sense, even marginal college students can expect at least a 7% wage premium per year of college. This is because the bachelor’s degree has achieved a majestical stature for students and for employers, signaling (at the least) a basic capacity to be trained (and eventually perform) in a high-value, well-paying profession.

There is nothing inherently wrong with a degree acting as a signaling device; we depend on just such signals for societal trust and exchange.

The problem is that the bachelor’s degree is a very expensive signal, and there is reason to believe a very wasteful signal. And while it’s not a societal problem if rich people want to spend their money on extravagant signalling, it is a societal problem when our anti-poverty program depends on subsidizing the poor’s purchasing of this overpriced signal.

(This is what $60,000 apparently buys you! Apparently, they didn’t budget for a decent sense of humor.)

In theory, this problem should resolve itself as firms exploit this opportunity by hiring and training smart high school graduates themselves for less than they would pay the college grads. That is indeed what has happened in India: at least one software company is thriving by hiring young professionals whom others disregard. They don’t look at colleges, degrees or grades, because not everyone in India is able to go to a top-ranked engineering school, but many are smart. The firm goes to poor high schools, and hires kids who are bright but are not going to college due to pressure to start making money right away. They train them, and in nine months, they produce at the level of college grads.

This is not occuring in the US, primarily because of a coordination problem.

Good future workers know they need to go to college to signal their ability to firms and firms know that they have a much higher chance of finding good future workers in the college group. Furthermore, employers are much less likely to have their competence called into question if a hire with a degree doesn’t work out than if they hire a worker without a degree (because of the correct perception of the low likelihood of that hire being a wise choise).

The question is how to credibly signal to good future workers that a four-year college degree isn’t necessary to be considered as a candidate and to convince firms that there are enough good future workers without a four-year college degree to make it a wise investment to include them in their employee search.

The challenge is to develop viable alternatives to the bachelor’s degree that don’t confer a ‘second-class’ status. I’d like to see the proliferation of shorter, no-frills academic programs that focus on teaching professional skills and testing relevant capacity (take a lesson from master’s programs). In addition, I do believe that CPA-like exams for different professions (or areas of competency) will allow for a more fair and open competition.

There can be great value-added by a four-year liberal arts program, just as there can be value-added by a PHD or masters program; the problem is that the bachelors degree hasn’t become an option for those so inclined, but a requirement for a well-paying job – and an expensive requirement at that.

It would be wonderful if we could afford to send every child to a four-year sleepaway camp, where they could sleepwalk through four years of classes (if they so chose) and receive a magic ticket to a well-paying job — but that isn’t the case.

There is a lot of fat to be cut and changes in educational philosophy to be made. Perhaps rethinking the well-manicured campuses and live lectures, for instance. The academic lecture, by the way, has its roots in the medieval training of theologians in a time when one-book-a-course for four years of schooling would cost about $1.6M in book outlays. Back then, it made economic sense to have a lecturer (from latin lector – reader) read from a single book aloud to a hall filled with students. Yet despite the fact that nowadays students could read the contents of a lecture in an instant at virtually no marginal cost, or even watch a video of the lecture — the lecture remains at the foundation of university teaching.

Everyone in every occupation starts as an apprentice. This is as true of history professors and business executives as of chefs and welders.

The challenge is to make both our advanced schooling and our advanced signaling more efficient and thereby, more accessible. A proper long-term strategy is not to subsidize students’ purchasing a $160,000 education, but to support the establishment of alternative means, be it CPA testing or shorter, low-cost advanced degree programs for students to prove their merit to potential employers.

Filed under: Education

no skills to pay the bills, pt. 1

I’m sure if you asked Barack Obama or John McCain directly about the importance of schools, they’d give you a rousing sermon (or at least a few firm talking points). Yet education reform has been notably absent from our political debate. The candidates love riling up voters’ economic nationalism, whether it’s talk of foreign oil, foreign cars, China (everyone’s favorite boogeyman), outsourcing, globalization, immigrants, or any other buzzword that places blame for American worker woes far from the doorstep of the American government and people.

Yet it’s not globalization or immigration or computers that have widen inequality and slowed wage growth for many Americans. It’s the skills gap.

And while there are plenty of expensive plans to alleviate American poverty to varying degrees, tax-and-redistribution will never provide the economic opportunity and security that we wish for all Americans.

Education should be the primary program to cure our social ills as the key to sustainable high compensation. It is both the key to advancing the welfare of the American poor, and also the means of securing America’s economic growth.

This post will focus on primary/secondary education, with a post to follow on college education. Some of the prettier lines from this post I’ve lifted either from my summaries (linked below) or the original articles (also linked below), but I’ve spent a bit more time for the sake of flow and coherency to reformulate these ideas.

First, let’s recount why education is more important than ever.

The labor market has expanded dramatically in the past 50 years — undoubtedly for the better of Americans and all mankind. That said, unskilled Americans have had a much, much, much smaller share of the bounty than their fellow citizens.

The problem is that employing unskilled American labor isn’t much more profitable than buying a simple machine or employing unskilled labor in a third-world country, yet many unskilled Americans will only accept wages that are much higher than a third-world laborer will accept or a machine will cost.

The value of unskilled labor is low. This sounds like a truism, but it wasn’t always the case. Before the machines took over the world and the cost of doing business far from market plummeted, an unskilled laborer simply giving you a few hours time could get a decent wage (of course, that is relative to his peers; relative to his 21st century counterpart his life would be shorter and more brutish). What’s more, the American laborer with a high school education likely still had an advantage over his global competition – that advantage has since disappeared.

Meanwhile, unskilled laborers have watched the skyrocketing wages of skilled laborers,. This shift in labor value has been jarring for many Americans, who are ill-prepared to compete for wages based on value-added by their labor, rather than simply time spent at work. And let’s be clear, the days of factories full of high-paying manufacturing jobs are gone forever.

Most means of fighting this growing inequality carry large costs that reduce the size of the economic pie (e.g., taxes on capital gains, rent control, large welfare programs). By contrast, investing in human capital encourages work and offers the potential for permanent increases in earnings.

It is no surprise we are seeing a divergence in income when the most valuable skills (soft) are only being attained by a minority of students who graduate college and high-school graduates lack both hard and soft skills.

The skill-wage hierarchy will always exist. Education -increasing skills- is the lone hope for the poor to actually improve their condition.

The wage premium for a high school degree has all but disappeared. There is little point in recounting the soul-crushing underperformance of American public schools, so let us instead look abroad to high-performing examples.

Two of the best primary/secondary schooling examples to learn from reside in Sweden and Finland. The Fins explain the key to their success is to develop excellent initial training for teachers (only ~10% of applicants are accepted for teacher training), start education late and gently (Fins start at 7), and don’t waste resources on national testing. The Fins’ biggest problem? Getting rid of bad teachers- even with alcohol problems.

While the Fins are more focused on testing achievement (…just not national testing), the Swedes are more interested in developing well-rounded thinkers, evidenced by their varieties of schools and competition, forcing schools to think more pointedly about quality as they risk losing 70k kronor if an unhappy student goes elsewhere.

Swedish reforms in 1994 allowed nearly anyone who satisfies basic standards to open a new school and take in children at the state’s expense. Schools can’t admit based on religion or entrance exams and nothing additional beyond the set payment by the state can be charged for – but making a profit is fine. Since the reforms, the share of Swedish children educated privately has risen significantly, leading to the proliferation of many “chain” schools.

In these chains, teachers update material on websites, utilize tutors, student-specific syllabi, and weekly student progress reports, and received performance monitoring and bonuses as personal tutors and subject teachers. There are no large school-owned facilities.

The schools are profitable despite only getting a fixed $8-12 thousand per student rate from the locality. The average returns on capital are 5-7% per year thanks to the adept, no-frills, IKEA-style management. I imagine its hard for Americans to imagine so little money can get you student-specific syllabi and tutors – but it can.

Back in the US, efforts to reform public education have centered completely on one thing: money. (One exception is the widely panned NCLB… Why is it panned? Big reason is lack of funding!)

Yet there is scant to any literature that shows increased spending leading to improved results, despite many court decisions mandating increased spending on the premise it is responsible for achievement gaps. That is not to say that less books are as good as more books, but it is to say that spending is not the binding constraint on academic achievement, and that dramatic increases in funding will not lead to the academic gains we’d like to see.

I believe that the public school organizational structure is incompatible with the flexibility and experimentation needed to attain the efficiency and productivity found in Sweden or Finland. Yet until recently, experimentation with other types of schooling has been verbotten. Thankfully, the crumbling public school empire couldn’t hold off the barbarians at the gate forever.

Free-market types have managed to carve out a few nooks and crannies for educational experimentation in the US, and we are beginning to see the first efforts to sprout out of these charter-school reservations.

The nation’s largest laboratory can be found in New Orleans, where 55% of public school students attend charter schools, by far the highest percentage of any city in the country. Dayton, Ohio and Washington, D.C. are second and third in charter-school market share.

It is still too early to draw firm conclusions on the New Orleans charter system, but there has been demonstrable achievement improvement in what was an entirely stagnant district. Classes are smaller, principals have been reshuffled or removed, school-hours remedial programs have been intensified, and after-school programs to help students increased. Much of the gains are attributed to the quality of instructors.

It would appear that government would be able to accomplish these aims, but it has not. New Orleans charter schools have capitalized on their flexibility to try different programs, allocate resources differently – to innovate. Surely, there will be success and failure in this process; the belief is that the successes will survive and reproduce, while the failures will whither away from disuse.

Top-down government management is ill-suited to support this process.

Meanwhile, in NY, charter schools are experimenting with increased principal autonomy, higher teacher salaries (with cutbacks elsewhere), and other education philosophies. In Washington D.C., there is a pilot program that will pay middle school students that meet academic and behavioral goals.

Are any of these ideas answer? Maybe, maybe not. But whether they work or not, the path to progress in education lies in entrepreneurial districts not national standards, empowered teachers not accredited teachers, and education markets not education mandates. Progressives are often quick to suggest we take notes from top performers around the world. I would love to see us take a page out of the Swedish playbook.

Next, we will look at what’s holding back America’s university system from reaching its potential.

Filed under: Education

SNL nails the financial rescue

Hat tip to Mankiw.
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Filed under: Economic Policy