Cost Increases in Higher-Ed

Marginal Revolution and Matt Yglesias both take swipes at the reason behind huge cost increases in higher education, and what can be done about it. I agree with Matt that a big part of the problem is the so-called Baumol effect, in which teaching a 90 minute lecture has, at least historically, not really been subject to any large productivity gains at least since the chalkboard -- it still takes 90 minutes. It might turn out that there could be future productivity gains here -- if Paul Krugman decides to offer his lectures, via webinar, to students at universities all over the US, and then to test the students electronically (or via local TAs), there could be some cost reductions. However, I don't see this type of thing catching on in any big way anytime soon, although Brad DeLong has/is reportedly trying something similar at the UCs, in part because most college faculty have a vested interest in seeing that this does not happen. Yglesias' idea of credentialing sounds like a really good one to me. I remember when I was first considering applying to Econ Phd programs, I really needed to take lots of math classes as quickly as I could. I probably should have considered University of Phoenix, but instead I was just forced in to taking a bunch of math classes one semester (since there were few offered in the summer), but was severely limited in how many courses i could take by the fact that the finals for these courses were limited to a five-day finals period. With 3-4 days to prepare for each final, I might have been able to take 7 or 8 courses over a six month period, but instead what happened was that I had to take three finals in a 24 hour sequence, got really exhausted midway, and didn't do as well I might have had I had more time. Obviously, this is inefficient. However, once gain, it's not clear that changing this state of affairs would be a good idea for most universities. If students can take more classes per semester, they could then graduate sooner, pay less tuition, and feel less of a bond to the school.

One under-rated factor in the cost of college tuition, especially at the higher end of the market, is that students tend to be fairly insensitive to prices, and there is no perfect competition among schools. There is only one Harvard, and thus it has market power to charge more than Yale. At the higher end, this cost insensitivity must arise in part due to trends in inequality in America. The sons and daughters of hedge fund managers will just choose the "best" university they can get in to, and it will be an investment that will be worth it, largely due to the signalling value. Hence, it would now likely make sense for most prestigious public schools such as UC Berkeley, to simply raise their tuition in order to compete for better faculty, better athletic coaches, and better facilities in order to rival Stanford. And given the state of inequality and the American quest for status, top universities could probably raise their tuition substantially before having to worry about reduced enrollment. At some point, of course, students will go to cheaper options (especially in a recession), but I'm quite curious what the data say about what happens to enrollment when tuition rises. I suspect schools find that raising tuition almost always raises revenue, and on a 1 for 1 basis (schools like Berkeley are going to fill their enrollments...)... Until this ceases to be the case, there will likely continue to be rapid appreciation in the cost of higher-ed, and no real productivity gains. What's more, due to the signalling value, ever more Americans will spend huge chunks of money to collect even more MBAs and other degrees of dubious value.

It's a prisoner's dilemma scenario, and the only solutions are likely to be heavy-handed centralized intervention. On the positive side, education, when done well, really is priceless, and so an ever-increasing share of GDP spent on it is not exactly the world's greatest evil.

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Budget Craziness...

OK, Mr. President, I think that proposing budget cuts in advance of the Republican onslaught, given the sheer craziness of our media and given the unfortunate state of public opinion, was likely shrewd and necessary political posturing. However, you should be aware of how wrong it is on the merits.

First, let's consider the factors which generally go into determining what the marginal cost of public funds are. Because taxing the populace engenders disutility and discourages work (although not as much as you might think), raising $1 of revenue "costs" society more like $1.05 to $1.10. (This needn't be the case, if policymakers got serious about shifting taxes to gasoline and carbon rather than work or savings, this could be substantially reduced.) Secondly, spending, at the margin, is borrowed. This usually means that the actual cost is even higher. Yet, now the government floats 5-year Treasuries at 2% interest -- an historically low borrowing rate. Meanwhile the Fed predicts nominal GDP growth at 5% over the next few years. Hence, any money the government borrows now will simply be easier to pay back down the road, as a percentage of GDP. This should lead us to discount the marginal cost of government spending at present.

Lastly, and most importantly, are the Macro implications of spending. An additional dollar of government spending is expansionary, and therefore increases inflationary pressure. This raises interest rates, and it also is likely to engender a reaction from the Federal Reserve, who would respond by raising interest rates/keeping rates higher than they otherwise would, in order to keep inflation under control. Hence, there is no effect on overall output, although government spending "crowds out" private investment. In normal times, this is another factor for why we should want the government to be as small as possible. However, now short-term treasuries, the Fed's usual mechanism for controlling interest rates, is stuck at the zero lower bound. Given that core inflation is now at 1.0% for the past 12 months, and expected to be roughly 1.3% for 2011, and given that unemployment is at 9.0%, the Fed would "normally" respond by cutting interest the interest rates, which in this case are unfortunately pegged at zero. The current Fed has been very slow to change course or respond to events, and have largely taken a very passive, wait-and-see attitude to the current economic malaise. During the "we're all gonna die" phase in the wake of the Lehmann collapse, the Fed pumped $1.5 trillion into the economy. Over the following two years, on net, the Fed has done roughly nothing, while inflation has, predictably, stayed at bay and unemployment, predictably, has stayed high. Hence, every additional dollar the government spends now is not likely to be offset by the Federal Reserve -- at least not completely. Not only that, the money that the government spends will increase employment, and will be spent in turn. The CEA formerly used a fiscal multiplier of 1.5, but in a depressed economy, this is likely to be quite conservative. A multiplier of 2 is likely to be more realistic.

Hence, in normal times, $1 of government spending might "cost" $1.20 or so, now we should discount this marginal cost by two factors. The first by the degree to which repaying debt becomes easier in the future, and the second to which that spending increases the size of the economy. Hence, MB - MC = $2 - $1.20*(.97^5) => spend money now! This implies that the marginal cost of public funds, at present, is at an historic low and certainly less than the marginal benefit of government spending, even when we assume that said government spending has no inherent intrinsic benefit, and so cutting spending now makes less sense than at any time in US history since 1937.

But no one in the media apparently understands this, and so it is too much to ask that you stand up for more spending. But what you should keep in mind is that, if you agree to a budget cut of some sort, that it will hurt the economy -- aside from the bad created by cutting government programs and freezing the salaries of federal workers, who are already underpaid and who will stand to lose more talent to Wall Street as a result. And since there will be negative consequences for the economy, it is absolutely imperative that you attach two sensible Fed appointments to whatever compromise you reach.

If not, and despite a rash of good economic news in recent months, our Japan-style economic malaise could well continue for another few years, just as China continues to get rich...

From the Mailbag...

Anonymous writes in: "I'm curious -- why do you think Obama's new gang will be any better?"

Simple, because Obama's new gang does not include Larry Summers! I think that really does imply that the new gang will at least be less-bad than before. One of the under-rated mistakes that the administration made was not changing course on the stimulus once it became as clear as day that it was just going to be too small. That was a Larry Summers-type mistake. I don't think there will be any major changes in policy however, and anyway, with a Republican House Gene Sperling and the new economic team is way more limited in what they can do to influence the economy than was Larry Summers and the old economic team.

The Torch Has Passed...

As everyone is well aware, as of last month, Larry Summers is no longer a part of this administration. Hence, the name of this blog had become a touch anachronistic. While the original mission of the blog -- to see to it that Larry Summers get to spend more time with his family -- has been accomplished, the overall vision of having a Democratic President who makes smart Economic Policies (or at least policies that aren't terrible), is unchanged. While the torch has been passed to a new set of Economic Advisers, the need to keep heat on these people persists. And so, this blog is now devoted to providing Economic Policy advice for President Obama, free of charge.

I plan to continue blogging both sporadically and in an unpredictable manner. The past year has been an interesting one both personally and professionally, and it is very difficult to judge in advance how much time I will actually be able to spend blogging. However, I will continue to hold forth on key issues as I see fit.

Special thanks to all of my advertisers and loyal fans, famous and infamous, who have written in over the years. 2011 is going to be a great year!

About those Fed Appointments...

So, as far as I can tell (disclaimer: I know nothing about how the Senate works), to get Peter Diamond confirmed Reid would need 60 votes to file cloture. I have this on good word from a bar conversation I had last night with a fit blonde Senate staffer (I'd recommend her for WH intern, btw). Her view was, some horse-trading could probably get him through -- come to think of it, you should have attached that to the tax cut.

And now your administration has another appointment to make with Kevin Warsh stepping down.

Your White House needs to move on both of these ASAP. There's an argument to be made that this is the single biggest thing you could do to help the economy in the next couple years, much less your own reelection prospects.