Category: Equitablog

What explains the rise in college tuition in the United States?

Posted on by Nick Bunker

Bemoan the high price of college tuition these days and someone might remind you that you’re probably talking about the gross price of tuition. Once you include financial aid, such as student loans, the net price of tuition isn’t as high. Harvard University economist Greg Mankiw, for example, cites data showing a 70 percent increase in gross tuition turns into a smaller 32 percent increase in the net price for the student.

It’s clear that financial aid and student loans may ameliorate the sticker shock of college tuition. But what if the student loans—one of the tools to decrease net tuition—were actually increasing the gross price in the first place? A growing body of research is showing just that.

The idea that increased access to student loans pushes up the price of tuition is not new. The former U.S. Secretary of Education under President Reagan, William J. Bennett, first floated this notion back in 1987. In short, Bennett found that if consumers are less price-sensitive when choosing which college or university to attend, the school will use this inattention to cost to increase prices. If the amount of credit available to the student increases, so will the tuition.

Now almost 30 years later, a new paper by economists Grey Gordon of Indiana University and Aaron Hedlund of the University of Missouri seconds Bennett’s findings, pinning the vast majority of the increase in net tuition on the increase in student loans. In fact, the authors calculate that it’s responsible for 102 percent of the net tuition increase from 1987 to 2010. The other major factor is the increase in the college wage premium, which is responsible for a 24 percent increase in net tuition. Baumol’s cost disease, however, doesn’t seem to be a major contributor to the increase.

It’s also interesting that the increased credit supply doesn’t seem to increase school attendance. It’s unclear why that isn’t happening, but perhaps some students realize they wouldn’t get a great return on investment.

Gordon and Hedlund’s finding echoes a paper earlier this year from David Lucca, Taylor Nadauld, and Karen Shen at the Federal Reserve Bank of New York. The three economists find that increases in credit supply boost tuition, while grants—straight cash transfers to the student that don’t have to be paid back—don’t have any effect on tuition. Mike Konczal, a fellow at the Roosevelt Institute, interprets this result as saying that efforts to “complete” the student credit market would actually increase the net tuition students have to pay.

Not only does higher net tuition bite into the pockets of students attending school, but student loans are clearly not a well-targeted policy. The providers of higher education capture a large portion of student loan subsidy, and students get saddled with debt instead. Of course, the students who end up defaulting are more often those with smaller burdens. But large debt burdens in the name of an inefficient program seem to be a problem in and of itself. Policymakers and researchers should start thinking about other ways to make higher education more affordable without negative unintended consequences.

credit: Photo from Savannah College of Art and Design Fall Commencement, November 22, 2014. (by Richard Burkhart/AP Images for Savannah College of Art and Design)

The melting away of North Atlantic social democracy

Posted on by Brad DeLong

Over at Talking Points Memo: The Melting Away of North Atlantic Social Democracy: Hotshot French economist Thomas Piketty, of the Paris School of Economics, looked at the major democracies with North Atlantic coastlines over the past couple of centuries. He saw five striking facts:

  • First, ownership of private wealth—with its power to command resources, dictate where and how people would work, and shape politics—was always highly concentrated.
  • Second, 150 years—six generations—ago, the ratio of a country’s total private wealth to its total annual income was about six.
  • Third, 50 years—two generations—ago, that capital-income ratio was about three.
  • Fourth, over the past two generations that capital-income ratio has been rising rapidly.
  • Fifth, the flow of income to the owner of the dollar capital did not rise when capital was relatively scarce, but plodded along at a typical net rate of profit of about 5% per year generation after generation.

He wondered what these facts predicted for the shape of the major North Atlantic economies in the 21st century. And so he wrote a big book, Capital in the Twenty-First Century **READ MOAR at Talking Points Memo

Version with annotations, references, and deleted scenes: https://fold.cm/read/delong/the-melting-away-of-north-atlantic-social-democracy-Fdf2BEBZ

Photo of Thomas Piketty in Sweden, June 30, 2014. (AP Photo/Janerik Henriksson)

Must-reads: December 22, 2015

Posted on by Brad DeLong

Must-read: Jeffrey Sparshott: “Where the Jobless Rate Is 2.3%, Here’s What Happened to Wages”

Posted on by Brad DeLong

Must-Read: Jeffrey Sparshott: Where the Jobless Rate Is 2.3%, Here’s What Happened to Wages: “In Lincoln, Neb., average hourly earnings were stagnant until the unemployment rate crossed below 2.5% in the fall of 2014…

…Then, wages took off. Since last October, they gained as much as 10.9% from a  year earlier. The jobless rate in October: 2.3%…. ‘I continue to judge that there remains slack in the economy, margins of slack that are not reflected in the standard unemployment rate, and in particular I’ve pointed to the depressed level of labor-force participation, and also the somewhat abnormally high level of part-time employment,’ Federal Reserve Chairwoman Janet Yellen said this week…

Fed officials’ median projection for the normal long-run unemployment rate was 4.9% as of December. But economists don’t agree on a specific number, or even whether the economy has already reached full employment. In October and November, the unemployment rate was 5% and wages showed signs of firming…. ‘While most indicators have been trending in the right direction, nominal wage growth and the prime-age employment-to-population ratio remain far outside of target ranges, and provide ample evidence that the economy has a way to go before reaching full employment,’ said Elise Gould, an economist at the left-leaning Economic Policy Institute….

Private-sector wages across Nebraska have been growing faster than the national average. The state bumped its minimum wage to $8 an hour from $7.25 at the start of 2015 and will raise it to $9 at the start of 2016, but many firms are moving beyond that. One of the state’s biggest private employers, Bryan Health, in November moved its starting minimum wage to $11 an hour from $8.45….

But to highlight the fine line between apparent full employment and signs of slack, one only need look as far as Omaha. The larger city is only about an hour away from Lincoln and, with the unemployment rate at 2.9%, many companies there also worry about finding enough workers. But wages haven’t taken off. Indeed, for the first time on record, average hourly earnings in the Lincoln metro area surpassed those of Omaha earlier this year.

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Must-read: Danny Yagan: “Capital Tax Reform and the Real Economy: The Effects of the 2003 Dividend Tax Cut”

Posted on by Brad DeLong

Must-Read: Danny Yagan: Capital Tax Reform and the Real Economy: The Effects of the 2003 Dividend Tax Cut: “This paper tests whether the 2003 dividend tax cut…

…stimulated corporate investment and increased labor earnings, using a quasi-experimental design and US corporate tax returns from years 1996–2008. I estimate that the tax cut caused zero change in corporate investment and employee compensation…. The statistical precision challenges leading estimates of the cost-of-capital elasticity of investment, or undermines models in which dividend tax reforms affect the cost of capital…

Must-read: Paul Krugman (2014): “The Limits of Purely Monetary Policies”

Posted on by Brad DeLong

Must-Read: The arguments for quantitative-easing-as-stimulus were always twofold: (1) Taking duration risk off of private-sector balance sheets is a thing, even if a small thing. (2) It is unreasonable for markets to believe and for liquidity injections this large to be completely unwound at the end of the day when the long-run comes and the sea is calm and flat again. (1) appears to be small. And (2) appears to be false. But is (2) false because markets expect quantitative easing to be totally unwound? Or is it because markets don’t have “expectations” of anything the way we economists think they do? Moreover, I had an argument (3)–that the liquidity trap only emerged because financial disruption destroyed the risk-bearing capacity of the market, and that quantitative easing would (a) provide some of that risk-bearing capacity directly via the government, and (b) lure private-sector risk-bearing back into the marketplace. Why is it wrong?

Paul Krugman (2014): The Limits of Purely Monetary Policies: “But, asks Evans-Pritchard, what if the central bank simply gives households money?…

…Well, that is, as he notes, really fiscal policy…. [And] central banks aren’t in the business of just giving money away… [but] of asset swap[s]…. Still, isn’t this just theory? Well, no. Huge increases in the monetary base in previous liquidity trap episodes had no visible effect…. I have supported QE in both Britain and the US, on the grounds that (a) central bank purchases of longer-term and riskier assets may help and can’t hurt, and (b) given political paralysis in the US and the dominance of bad macroeconomic thinking in the UK, it’s all we’ve got. But the view I used to hold before 1998–that central banks can always cause inflation if they really want to–just doesn’t hold up, theoretically or empirically.

Paul Krugman (2014): The Simple Analytics of Monetary Impotence: “If we have rational expectations and frictionless capital markets…

…which we don’t, but let’s see what would happen if we did… [plus] logarithmic utility… then…

C = C(P/P)/(1+r)…

an Euler equation that lets us read off current consumption from future consumption, current and future price levels, and the interest rate…. Now suppose that we’re in a New Keynesian world in which prices are temporarily sticky; so P is given. And… we’re at the zero lower bound, so r=0. Then there’s only one moving part here: the expected future price level. Anything you do–monetary or fiscal–affects current consumption to the extent, and only to the extent, that it moves the expected future price level. Full stop, end of story. An immediate implication is that the current money supply doesn’t matter…. Don’t talk to me about monetary neutrality, or how it stands to reason that money must matter, or helicopter money, or even money-financed deficits; we’ve taken all of that into account….

Now, if we let households be liquidity-constrained, giving them transfer payments can affect current spending; but that’s a fiscal point…. Another perhaps less immediate implication is that there is no crowding out from temporary fiscal expansion…. Notice that this is in an approach with full Ricardian equivalence; so every economist who claimed that Ricardian equivalence makes fiscal expansion ineffective has actually shown that he doesn’t understand the concept….

I’m not claiming that this Euler equation is The Truth. If you want to make arguments about policy that rely on… imperfect capital markets, fine. But that’s not what I hear in most of this discussion; what I hear instead are attempts to talk things through that end up being, unintentionally, word games… reason[ing] in terms of concepts like monetary neutrality that aren’t as well-defined as [people] think… fooling themselves into believing that they’ve demonstrated things they haven’t.

Now, one good exception is Brad DeLong’s argument that money does too work in a liquidity trap because such traps are always the result of disrupted financial markets. What I’d say is that they are sometimes caused by financial disruption. But is this one of those times?…. If you disagree, please try to put your argument in terms of what the people in your model are doing–not in terms of catchphrases.

Must-reads: December 21, 2015

Posted on by Brad DeLong
  • Simon Wren-Lewis: The Knowledge Transmission Mechanism and Austerity: “Central banks therefore played a crucial role in the failure of the K[nowledge ]T[ransmission ]M[echanism in 2010.” :: A good wrestle with a very tough intellectual problem by the truly excellent Simon Wren-Lewis
  • William McChesney Martin (1958): Discussion: “That would indeed be a great feather in its cap and ultimately its success would be great…” :: And if the Federal Reserve System were to adopt bad policies in the hope of preserving its political independence, its political independence is already lost…
  • Joshua M Brown: The Woes of the Asset Managers: “Goldman is going slash-and-burn for factor investing market share with a pricing structure that rivals what State Street, Schwab, Vanguard and BlackRock are charging for plain vanilla index exposure…” :: Passive diversified portfolios with an eye toward overweighting factors that have historically offered high returns is what nearly all investors *should be doing.*
  • Dean Baker: The Upward Redistribution of Income: Are Rents the Story?: “[My] argument on rents is important because… it means that there is nothing intrinsic to capitalism that led to this rapid rise in inequality…” :: I think Piketty would say that Baker is wrong here…

Must-Read: Simon Wren-Lewis: The Knowledge Transmission Mechanism and Austerity

Posted on by Brad DeLong

Must-Read: A good wrestle with a very tough intellectual problem by the truly excellent Simon Wren-Lewis:

Simon Wren-Lewis: The Knowledge Transmission Mechanism and Austerity: “How do economic policy mistakes happen?…

…Policy makers want to do the right thing (although they have political preferences), and the academic consensus is correct, but policy makers do not follow it because they rely on imperfect intermediaries….

In contrast to the 1930s, the key features of the current situation are explicable in terms of textbook macroeconomic theory. Governments are actively trying to reduce their budget deficits through fiscal austerity, and this is having a predictably negative impact on economic activity when monetary policy is unable to offset its effects. So the current macroeconomic crisis does not seem to be the result of lack of macroeconomic understanding….

[The] folk story… often told by policy makers [has basic problems. It is that] in response to the Great Recession… some countries had employed a limited fiscal stimulus… this intervention, the recession itself and earlier failures of governments to be fiscally prudent led to a debt-funding crisis. Economies realised that they too could become like Greece, and so were forced to embark on a sharp fiscal contraction, commonly called austerity…. [But] there is no clear evidence that there were serious fiscal problems [outside of Greece] before the financial crisis… debt increased… because of the impact of the recession itself… no evidence whatsoever of a debt-funding crisis outside the Eurozone… if anything a shortage of debt…. How can I blame the second Eurozone recession on fiscal austerity with such confidence?… First, it is what basic macroeconomics – the macroeconomics taught to every undergraduate and post-graduate around the world, including in Germany – tells us. Second, it is what every independent model based exercise that I have seen also tells us….

Things have gone wrong in the Eurozone not because of any inadequacies in macroeconomic theory, but because that theory was ignored by policymakers…. I think it is worth exploring [the] alternative: that policy has gone wrong because the knowledge transmission mechanism (KTM) has failed…. Why might [policymakers] have been getting the wrong advice? One response is that they asked the wrong people…. The expansionary austerity line… appeared to be the one that many policymakers adopted. If the KTM had been working, then this result could only have been a consequence of policy makers willfully choosing to adopt a minority academic point of view for political ends…. Political commentators… unlikely to be economists… relate to… financial bookkeeping. It is… easy… to tell stories about excessive borrowing, but rather more difficult to talk about multiplier effects and the ZLB…. There are also important interactions between economists working in the financial sector and the media…. There is a saying in financial markets: “bond economists never saw a fiscal tightening they didn’t like”….

Among the governors of the three major central banks, only Ben Bernanke seemed prepared to say publicly that a severe fiscal contraction would make his job much more difficult. Central banks also seem far too optimistic, at least when they talk publicly, about the impact of unconventional monetary policy measures…. It seems to me that the main reason why central banks failed to give good advice on fiscal consolidation is that, among their leaders at least, there is a deep seated fear of fiscal dominance. They fear that if deficits are large, then at some stage they will be asked (or required) to monetise those deficits and that inflation will increase as a result. As Mervyn King, Governor of the Bank of England in 2010, once said: “Central banks are often accused of being obsessed with inflation. This is untrue. If they are obsessed with anything, it is with fiscal policy.”… It possible to argue that King’s role in 2010 was actually quite pivotal…. Central banks therefore played a crucial role in the failure of the KTM in 2010. They were naturally seen as a source for macroeconomic received wisdom, and indeed they were, if those seeking advice had talked directly to those involved in modelling the business cycle. In practice, however, advice was received from central bank governors, and in most part that did not convey received macroeconomic wisdom…

But…

My memory of what the bulk of policy-oriented macroeconomists were saying in 2008-10 is:

  1. Central banks are not tapped out at the zero-lower bound.
  2. Even at the zero lower bound, fiscal multipliers are relatively low.
  3. Debt issued now will have to be refinanced later at high interest rates.
  4. Hence expansionary fiscal policy can be a temporary bridge, but is not a solution.
  5. North Atlantic economies recover robustly and rapidly from demand shocks on their own.

What are the factors behind high economic rents?

Posted on by Bridget Ansel

In research and debates about economic inequality in the United States, there’s been a resurgence this year in explanations for rising inequality that emphasize market power and market imperfections. In a recent piece for the New York Review of Books, Paul Krugman details how increasing market power seems to be a more attractive story of how inequality became so large in the United States. A paper that Krugman cites—by Jason Furman, Chairman of the Council of Economic Advisers, and Peter Orszag of Citigroup—emphasizes the role of “rents” in contributing to inequality and suggests increasing market power could be the reason for this trend. But an interesting new paper from Dean Baker, economist and co-director of the Center for Economic and Policy Research, proposes a very different reason for why those rents came about.

First, let’s define economic rents. In short, a rent is the extra return to an economic agent above what it would have been able to get under a different set of circumstances. If you’d be willing to do a job for $10 an hour and I pay you $15 an hour to do it instead, the extra $5 you’re earning could be considered a rent. You often hear the term “rent” used when discussing monopolies because those firms have lots of excess returns due to being the sole provider of a good.

It’s with this story that Baker lays out a key role for rents. Baker points to four areas where rents are pervasive in the U.S. economy: patents and copyrights, the financial sector, high pay for CEOs and executives, and high pay for professionals more broadly. What brings these areas together is that the institutional arrangements in these portions of the economy have not only created rents, but that these rents disproportionately go to those at the top of the income ladder. Getting rid of these rents would stop the “upward redistribution of income.”

The first area Baker highlights—patents and copyrights—is easiest to understand. Patents and copyrights are explicitly monopolies created by the government to reward producers of new research, pharmaceutical drugs, movies, and a number of other types of intellectual property. Baker argues that these schemes are providing rents to the intellectual property creators and that other setups could produce the same amount of research, for example, without producing these rents.

Baker has a similar argument about the financial sector: The industry is simply inefficient and takes in income well above its contribution to the rest of the economy, as other research has shown.

When it comes to the high pay of CEOs and professionals such as doctors, Baker’s argument is that institutions have been arranged so that these CEOs and professionals make more money than their productivity would necessarily predict. CEOs make much more money than they would if their pay was actually in line with their contribution to the success of their firm. And professionals would be paid less well if the government allowed more competition for those jobs in the form of more highly educated immigrants.

Altogether, these factors could have a big impact on the level of inequality. According to Baker’s calculations, the combined amount of rents from these four areas would be equal to between 6 percent and 8.5 percent of U.S. gross domestic product in 2014. That’s about the same size as the increase in the share of income going to the top 1 percent of income earners in the United States from 1979 to 2012.

What differentiates Baker’s argument from similar ones is that he is less persuaded that decreased competition among firms and firm consolidation is a major factor. Furman and Orszag mention patents as a potential cause of excess returns, but the emphasis seems to be more on market power as is the case with similar narratives of U.S. income inequality.

In short, Baker sees the story of rents less as capital versus labor and more about a fight within labor. His read of the data leads him to believe that the share of income going to labor has really only declined since the Great Recession, but of course that read is debatable. (Measurement is always important when it comes to rents.) So while rents might have broken through as a compelling story for why inequality has risen in the United States, the reason for high rents is still very much up for debate.

(Photo by Bartex Szewczk, veer.com)

Must-Read: William McChesney Martin (1958): “And If the Federal Reserve…

Posted on by Brad DeLong

Must-Read: And if the Federal Reserve System were to adopt bad policies in the hope of preserving its political independence, its political independence is already lost…

William McChesney Martin (1958): Discussion: “If the System should lose its independence in the process of fighting for sound money…

…that would indeed be a great feather in its cap and ultimately its success would be great…