The war in Iraq is intensely unpopular, disfavored by a strong majority of Americans, and fiercely opposed by the far Left. The President is also highly unpopular. The situation thus resembles the situation with respect to the Vietnam war in 1968 after the Tet Offensive. So why are there no violent protests, as there were in 1968 and indeed until the United States withdrew its troops from Vietnam?
The obvious answer is that there is no longer a draft; all the U.S. soldiers in Iraq are volunteers. But I do not consider that a sufficient answer, apart from the facts that only about a third of the persons drafted during the period of the Vietnam war served in Vietnam and, more important, that there were abundant escape hatches for persons of draft age who wanted to avoid military service altogether. Most of these involved continued education, and protesters were drawn disproportionately from the educated class. What is more, many of the protesters were either women or too old for the draft.
Still another source of doubt that the draft was solely responsible for the scale and virulence of the Vietnam protests is that, partly because all our soldiers today are volunteers, they are more popular than soldiers in the Vietnam era were, and casualties among them therefore arouse even greater sympathy. Indeed the military as a whole is one of the most respected institutions in America tpdau, which was not true in the 1960s. Another puzzle is that although Lyndon Johnson was intensely unpopular with the Left, it was only on account of the war; he was a liberal in domestic policy. George Bush is unpopular with the Left in all respects, not just the war, and so one might think him a more attractive target for protesters.
Another possible explanation for the difference in public reaction is that U.S. casualties in Iraq are far lower than they were in Vietnam. Almost 15,000 U.S. troops were killed in action in Vietnam in 1968, whereas the annual death toll of U.S. troops in Iraq is currently only about 1,000 a year. However, there is much greater sensitivity to casualties now than there was in the earlier era. The very low U.S. death rates in the invasion of Afghanistan and in the two invasions of Iraq make the slightly more than 3,000 U.S. deaths in Iraq since the completion of the 2003 invasion seem shockingly high by comparison.
I believe that five factors are as or more important than the end of the draft or the lower casualties in explaining the absence of violent protests against the Iraq war. The first is that the opponents of the war in Iraq have the support of one of the two political parties. Lyndon Johnson was of course a Democrat, and the Republican Party did not oppose the war (the Democrats were divided). The Left knows that violent protests against the war would weaken Democratic Party opposition and the likelihood of a Democratic President's being elected in 2008. Moreover, they have less need to protest because they are aligned with a powerful political force. Stated differently, protests would have a modest incremental effect on ending our military involvement in Iraq, and perhaps even a negative effect.
Second, the opportunity costs of time are higher today than they were in the 1960s and early 1970s for potential protesters. This is partly because of higher wages, especially for educated people, and the fact that a higher percentage of women are employed. The greater competitiveness of the economy discourages people from taking risks with their careers by protesting. It discourages college students as well as the employed, because someone who gets the reputation in college of being a violent protester, or is suspended or simply gets very low grades because of the distraction of engaging in protest activities, will see his opportunities for a good job diminish.
Third, the great expansion of the electronic media, including the advent of blogs, gives people outlets to blow off steam that are much cheaper, in cost of time, than street demonstrations or acts of violence. The electronic media enable a message to be communicated to far more people than street demonstrations do, and at lower cost, so one expects substitution in favor of the media.
Fourth is a learning factor. The violent protests against the Vietnam war probably did not shorten the war, but instead helped Nixon become President.
All together, these four factors suggest that the costs of violent protests have risen, and the benefits fallen, since the 1960s; hence the lower level of protest today, despite the parallels between the protracted, seemingly stalemated, Iraq and Vietnam wars.
But there is a fifth factors, cultural rather than economic or easily expressed in economic terms: For many of the Vietnam war protesters, the war was a symbol of what they believed to be deeper and broader problems with the United States and the entire Western world. They thought the "system" rotten and entertained Utopian hopes of overthrowing it and substituting a socialist or anarchist paradise. This belief gave the war more resonance as a target. Partly because of the collapse of communism, partly because of greater prosperity, few Americans are hostile to the American system. Most blame the Iraq war on the incompetence of the Bush Administration rather than on some more pervasive social or political pathology. This tempers their anger and their willingness to take career risks by engaging in protests against the war.
To me, the absence of a military draft is the most important factor behind the minimal number of violent protests against the increasingly unpopular war in Iraq. Explicit riots over the draft already occurred in New York City during the Civil War soon after the North instituted the draft in 1863. These riots were mainly by young working class men who could not afford to buy a substitute, a system in effect at that time. So it is no stretch to claim that violent riots have occurred in the United States when unpopular wars are combined with a draft.
Recall that President Nixon and many other politicians during the Vietnam War felt that the drafting of young men to serve in the armed forces was partly responsible for the violent protests against the war. As a result, Nixon in 1969 set up the 15 members Commission on an All-Volunteer armed Force (Gates Commission) to look into whether an all-volunteer armed forces should replace the draft. Milton Friedman, Alan Greenspan, and General William Westmoreland, who had commanded military forces in Vietnam until mid-1968, were all members of the Commission. Apparently largely due to the persuasive powers of Friedman, the Commission, while initially evenly divided between those in favor of and those opposed to the draft, came out in 1970 with a unanimous recommendation to end the draft. The draft was abolished in 1973, and protests largely vanished, although the war did not end until 1975.
Representative Charles Rangel of New York has proposed to reinstate the draft. He has claimed that President Bush would not have invaded Iraq had a universal draft been in place. I do not believe he is right, but I do believe the pressure to withdraw earlier would have been far greater if young men were being drafted in large numbers.
The war in Iraq is being fought only with volunteers for military and civilian service, although some members of the armed forces and the reserves would not have joined if they anticipated the war when they enlisted. The reliance solely on military volunteers means that "taxes" to fight the war are spread over all taxpayers, and are not concentrated on young people. Moreover, draftees are more costly in terms of the resources lost to other activities, and they are on the average less dedicated to the military than are volunteers.
When draftees, and those who volunteer mainly to escape the draft, make up a significant fraction of military personnel, much of the burden of a war falls on them, not on the average taxpayer. Even those who volunteered during the current war have shifted some of the burden of their service to taxpayers by demanding and receiving higher pay. Since most of those involved in violent protests in general, and wars in particular, are usually young males, is it any surprise that they are protesting much less during this war when they are paying a much smaller share of the cost than young men did during Vietnam?
I agree with Posner that the many fewer deaths from the Iraq war than from the Vietnam War have weakened the impetus to protest violently, despite the war's unpopularity, although the slightly over 3000 deaths have to be augmented by the many more serious injuries to military personnel to get a full measure of the personal cost of the war in Iraq (see my discussion of the cost of the Iraq war in the post on March 19, 2006). Still, I believe violent opposition to the war would have been far greater if many of those killed or seriously wounded had been draftees, .
My emphasis on the importance of the draft in sparking unrest during the Vietnam War may seem misplaced since most young men who took part in violent protests were college students. Until 1969 students usually had their military service deferred. However, students could anticipate being drafted when their education ended. Studies have shown that the number of students in colleges and universities expanded during the Vietnam War beyond the numbers expected in peacetime because some persons continued with their education only in order to escape, or delay, being drafted. Even if college students ended up avoiding the draft, they were being indirectly taxed if they only stayed in college to avoid that. They would have been attracted to protests in recognition of the indirect costs they were paying as a result of the draft.
An additional factor that encouraged protests by college students during the Vietnam era is that the returns to college were not high and were declining then for the typical student, not only for those in college to avoid the draft. The major change in this regard during the past 30 years has been the unprecedented increase in the monetary and other benefits of a college education (see my post on April 22). Since the 1970's, real earnings of young high school graduates hardly increased, if they did at all, while real earnings of high school graduates increased slowly. The only explosion in earnings has been among college graduates, especially of younger ones. With no risks of being drafted, and with a potentially large cost from reduced job opportunities if arrested for participating in violent protests, college students could lose a lot more now than during the Vietnam era by joining such protests.
In my recent post on health care reform, I mistakenly suggested that all poor people are eligible for Medicaid. In fact, only about a third of uninsured adults are eligible, as eligibility is largely limited to (poor) parents, children, and the elderly.
The Pacific Research Institute takes issue with my criticism of its calculation of the costs of the U.S. tort system, and has asked me to give the link to its point by point response,which is at http://www.pacificresearch.org/press/opd/2007/opd_07-04-23lm.html, and also to its concise response (which I believe is less informative), which is at http://www.pacificresearch.org/press/opd/2007/opd_07-04-20lm.html.
An article by James Altucher, a columnist of the Financial Times, this past week essentially asserted that college and university education is a waste of time, that students would be better off by working rather than attending classes, or by using the money that went to tuition to travel instead. ("A mind is a terrible thing to waste but so is all the money that is being flushed down the toilet in the elitist quest for a good education. The best education is falling on the ground and getting a few scrapes. ‚Ä¶Just don't get robbed for four straight years [by going to college]"). Two days later a columnist of the Wall Street Journal, David Wessel, argued just the opposite, that the benefits of higher education have never been higher, at least in the United States, and that the puzzle is why more Americans do not finish high school and college. Who is right? The evidence is overwhelming that Wessel is right about the benefits of education, and that Altucher does not know the subject he is writing about.
It is well documented that the average earnings premium from a college education in the United States increased from about 40 percent in the late 1970's to about 80 percent at present. Not everyone does well financially from going to college, or badly by not going-Bill Gates is an obvious but extreme example of a college dropout- but the average person who does go has far better prospects for earnings, employment, and occupation than the average person who stops schooling after finishing high school. The economic benefits from completing high school also went up relative to those to high school dropouts, although they did not increase as much as the benefits from college. A similar picture holds for Great Britain and many other countries, although the changes elsewhere have been smaller than in the United States.
Nor is this all. Research increasingly demonstrates that education improves performance in virtually every aspect of life. Educated persons on the whole are healthier, are better at investing in their children, have more stable marriages, smoke much less and in general have much better habits, commit many fewer violent crimes, are better at managing their financial resources, and at adjusting to unexpected shocks, such as hurricane Katrina. It might be thought that these correlations between education and various benefits, including earnings and health but not only these, are the result of abler persons, such as those with higher IQ's, and healthier persons getting more schooling rather than the effects of schooling. More able and healthy persons do have greater amounts of schooling, but literally hundreds of studies have tried to correct for these differences. They find that even after making these and other corrections, the effects of education on various monetary and non-monetary benefits remain very large.
An additional finding is also important. Not only have the earnings benefits of education increased during the past 30 years, but so too have health benefits, the advantages of education in raising children, and the benefits of education in managing one's assets. The growing gains from education are pervasive and not limited to earnings, or to economic benefits narrowly conceived. This suggests that the forces producing the greater advantages are also broad and general rather than narrow and specific.
Three such broad forces have been identified. Probably most important is that the technological progress of the past 30 years has increased the demand for educated and other skilled persons. Examples include the growth of the Internet and the personal computer, developments in biotech, innovations in financial instruments, and rapid progress in technologies that improve the health of adults. Globalization and the economic development of countries like India and China is a second factor that raised the returns to skill, for global growth increased the worldwide demand for products and services that use highly educated and other more skilled inputs. A third general force is due to the decline in the cost of plant, equipment, and other physical capital, in part the result of lower real interest rates. Educated and other skilled manpower is complementary with physical and financial capital, whereas low skilled labor is a substitute for such capital. Hence a cheapening of physical and financial capital would raise the demand for educated inputs relative to the demand for the less educated.
Estimates indicate that in the United States the average rate of return on a college education in the form of higher earnings is about 10 percent. The average return is lower for students who fail to complete four years of college, and is higher for those who do graduate work. If the benefits of better health, better skills at raising children, better financial management, and so forth are added to the benefits of higher earnings, the total rate of return on college would rise to 15 percent or more. Should not such high returns have induced most persons who finish high school to go on for a college education, and encourage additional boys and girls to finish high school?
Up to a point they have, so it all depends on whether one looks at the glass as half empty or half fill. Since earnings and other benefits of a college education began to increase almost 30 years ago, the fraction of high school graduates who go to college has also increased greatly, and the increase has been pervasive among different genders and racial groups. Higher enrollments are found for white males and females, African American males and females, and Hispanic males and females. Over 60 per cent of high school graduates now get some higher education, one of the highest percents in any country. True, many of these college entrants, especially men, fail to finish college, but at least they show awareness of the advantages of a college education.
The real failure of the American education system compared to other countries is in the large numbers who drop out of high school. What is even worse from the perspective of equalizing opportunity is that the fraction dropping out of high school, some 20- 25 percent of high school students, is concentrated among African Americans and other minorities. Surprisingly, this fraction has not declined over time by very much, despite the huge increase in the returns from greater amounts of schooling. I do not have a good explanation for the lack of response in the high school graduation rate to the greater benefits of education, except that the American family started deteriorating rapidly only a little earlier than the returns to education began to rise rapidly. The reduced preparation for schooling, especially among boys in the many families without fathers, was offsetting the increased benefits from additional schooling.
How to better prepare students so that more of them want to complete high school and attend college, and benefit from their schooling experience? It would be important to help stabilize African American and other families. In an earlier post (March 12 of this year) I discussed a subsidy to couples if they get and stay married. That might be an option, especially if the subsidy to marriage was greater to lower income couples, although I give various arguments in that post why such a subsidy may not be desirable. Perhaps head start school programs for children from broken families would be a better approach. Legalizing drugs would contribute, so that students would not drop out of high school drawn by the (slim) prospects of making a lot of money through the sale of drugs. The quality of public schools attended by most minority students is low-although teachers at these schools face formidable obstacles- so school vouchers and other ways to increase competition among schools for students would be helpful.
Becker marshals convincing evidence that people who have more education have on average higher earnings and that the spread has been growing. But it is a bit of a leap to conclude that there are high (and increasing) returns to education. Correlation is not causation. Suppose what are increasing are not the returns to education but the returns to intelligence, and suppose that people with high IQs both enjoy education more than other people do and are more likely to be admitted to college or a graduate or professional school because teachers prefer teaching (and learning from!) them and because good students are more likely (because they are more intelligent, not because they are good students) to be affluent, and therefore generous, alumni.
Now if this is correct, one might expect many intelligent people to bypass college, because it is so costly; but few do. However, colleges and graduate (including professional) schools provide a screening and certifying function. Someone who graduates with good grades from a good college demonstrates intelligence more convincingly than if he simply tells a potential employer that he's smart; and he also demonstrates a degree of discipline and docility, valuable to employers, that a good performance on an IQ test would not demonstrate. (This is an important point; if all colleges did was separate the smart from the less smart, college would be an inefficient alternative to simple testing.) An apprentice system would be a substitute (and there is evidence that in Germany it is a highly efficient substitute), but employers naturally prefer to shift a portion of the cost of screening potential employees to colleges and universities. Because those institutions are supported by taxpayers and alumni as well as by students, employers do not bear the full cost of screening.
These points are consistent with higher education being a good private investment, but do not suggest that it is either a particularly good social investment (it does improve matching of employees to employers, but at great cost) or that its value has much to do with the institution's educational program.
Another good that higher (or for that matter lower) education provides is the creation of social networks, consisting of the students who get to know each other. They learn something from associating with other intelligent kids and they form friendships with them that may carry over into adult life and become business or professional relationships that enhance the graduate's income. Again that would be a benefit having little or no connection with the school's educational program. There may be little value added by the program to the contribution that attending college makes to a person‚Äôs income.
Orley Ashenfelter, Alan Krueger, and many other economists have worried about the possibility that the correlation between education and earnings is not causal and have tried a variety of ingenious methods for correcting for differences in ability, such as comparing the earnings of twins who have different amounts of education, on the theory that they have similar native ability, or comparing the earnings of people who have different years of schooling just as a function of the arbitrary age cutoffs that determine when one starts school, or seeing whether an increase in the age at which students are permitted to drop out is associated with an increase in the earnings of that cohort compared with its predecessors. Some studies correct for performance on standardized tests assumed to measure intelligence rather than knowledge. Most studies find that education has a substantial effect on earnings independent of native ability, and the convergence is impressive. However, the studies are convincing mainly about the benefits of precollege education.
I am skeptical that it should be a national priority, or perhaps any concern at all, to increase the number of people who attend or graduate from college. Presumably the college drop-outs, and the kids who don't go to college at all, do not expect further education to create benefits commensurate with the cost, including the foregone earnings from starting work earlier. This would be an entirely rational decision for someone who was not particularly intelligent and who did not anticipate network benefits from continued schooling because the students with whom he would associate would not form a valuable network of which he would be a part, either because he could not get into a good school, in the sense of one populated by highly promising students, or because if he did get into a good school the other students in the school would not consider him worth networking with.
This assumes that enticing the unwilling or the unmotivated to attend or complete college would not confer social benefits in excess of the private benefits (which I suggested in the preceding paragraph would probably exceed the private costs). But the marginal students are unlikely to be kids who, with a little more education, would make the kind of contribution to society that a worker is unable to capture in his wage. Nor are these marginal students likely to be educated into an interest in political and societal matters that will make them more conscientious voters or otherwise better citizens.
The early Presidential campaigning season is replete with complaints, discussions, and proposals concerning the health care system, widely regarded as broken. Democratic candidate John Edwards has proposed a comprehensive reform that he calls "Universal Health Care through Shared Responsibility," http://johnedwards.com/about/issues/health-care-overview.pdf.
Although the Edwards plan is commendable for its detail and clarity, there is an element of fantasy in Presidential candidates' proposing detailed, specific reforms, on any complex issue, so far before the election; for the feasibility of reform depends on economic and political conditions, including the political makeup of Congress, when the President takes office.
But, passing that point, the current concern about the health system, which generates plans such as the Edwards plan, may be misplaced. It is true that health costs are rising faster than the inflation rate. But rising costs, even of "essential" products and services, such as food, health care, and national defense, do not necessarily demonstrate the existence of a problem. Costs may be rising because quality is rising, which is true of health care (new and better therapies and diagnostic tools), or because demand is rising (and average cost is not flat or declining), which is also true; as people live longer, their demand for health care rises because more health care is required to keep people alive and healthy the older they are. In addition, much health care is in fact discretionary (cosmetic surgery is only one example; others are treatment for mild depression and other mild emotional or cognitive problems and treatments designed to enhance athletic ability), and demand for it can be expected to rise if quality rises relative to price.
It is also true that Americans spend much more on health care on average than the people in other wealthy countries do, without greater longevity to show for these expenditures. But health care does much more than extend life; it alleviates pain, discomfort, disfigurement, limited mobility, visual and hearing impairments, and mental suffering, and it is not clear that foreign health systems, which also involve considerable costs in queuing, do these things as well. In addition, the better a nation's health care is, the riskier the population's life style is likely to be, because the cost of obesity and other risk factors for disease is less.
Also misplaced is concern that the United States is becoming less competitive because employers pay for their employees' health insurance, rather than the government. Employers do not really pay for their employees' health insurance; employees (and the taxpayer, who subsidizes employee health insurance) do, because by raising labor costs employee health insurance reduces the wages that employers are willing to pay. Employers who committed themselves to assuming open-ended obligations for employees' (including retired employees') health costs have only themselves to blame for having assumed a risk that has materialized because of the rapid growth in those costs.
Nor is it a scandal, or even a serious inefficiency, that many millions of workers do not have health insurance. Their health care is paid for my Medicaid if they cannot afford to buy health insurance whether directly or as part of an employee group health insurance plan. Those that can afford health insurance but forgo it either are young and healthy or are risk preferrers, gambling that they will avoid illnesses requiring expensive treatment. If their gamble fails, they will have to pay out of their pockets, and when their pockets are empty (their assets depleted) go onto Medicaid, where their care will be subsidized. Although there is no reason why people who can afford health insurance should be treated at the taxpayer's expense, the effect on the aggregate cost of health care may be neutral or even negative, because Medicaid patients receive less pricey treatment on average than patients who have health insurance. If the young and healthy who today choose to go without health insurance were forced to buy health insurance, there would be two potentially offsetting effects: the average cost of health insurance would fall because the insurance pool was getting an influx of people with below-average expected health costs (though this assumes that the insurance companies wouldn't be permitted to charge lower rates on the basis of age and health, in which event the influx of young and healthy would not affect the rates charged the existing members of the insurance pool); at the same time the average cost of insurance would be rising because aggregate demand was rising, since being forced to have health insurance the newly insured would consume more health care in order to get their money‚Äôs worth.
Some people are uninsured because of lack of "portability." Suppose a person insured under his employer's group policy leaves the job, and cannot find another one; or suppose that while working for that employer he had contracted a serious chronic illness. In either case, he may find it impossible to buy health insurance at a rate that he can afford. But the idea that such experiences demonstrate a market failure comes from a misunderstanding of the economic function of insurance. The economic basis of insurance is declining marginal utility of income: the more money we have, the less utility (pleasure, happiness) an additional dollar would confer. Suppose your life savings is $2 million, and you are asked to flip a coin: heads you win $3 million, tails you lose your $2 million. The expected value of the bet is $500,000 ($3 million x .5 ‚Äì $2 million x .5), and thus is positive; but most people would refuse the bet, because the pain of losing their entire savings of $2 million would exceed the pleasure of winning $3 million. The implication for health insurance is that such insurance should be limited to catastrophic long-term illnesses that would drain an individual's or a family's resources and thus be equivalent in the example to losing $2 million. Such cases are rare, and therefore such insurance would be cheap, especially for young people, who would be unlikely to encounter such a catastrophe for many years, during which the insurance company would be earning interest on the premiums paid by the insured; so the premiums would be low. Someone who purchased such insurance at the outset of adulthood would not have to worry much about the lack of portability of an employer's group health insurance because he would have his catastrophic coverage even if he switched jobs or had no job.
Nor finally should we think it a scandal that such a large percentage of the Gross Domestic Product (about $2 trillion out of a total of $14 trillion) goes for health care. One reason it is so large is that other expenses of living, such as food and clothing, have become such a small fraction of overall spending. The question should be not whether the percentage of spending that goes to health is increasing but whether there are better things to spend some of the $2 trillion on than health care. Notice that liberals' concern with the increasing percentage of expenditures on health parallels conservatives' concern with the increasing percentage of GDP that is spent on government services. In both cases the proper concern is not the percentage of overall spending that goes for a particular class of services but whether there are better uses for some of the money being spent for those services.
There are two ways to reduce the aggregate cost of health care, if this is considered a worthy objective, as I am inclined to doubt. One would be to ration demand. If the supply curve for health care is upward sloping, as undoubtedly it is, then capping demand would result in lower prices by forcing the market down the supply curve. But rationing demand would be fiercely resisted by patients, for obvious reasons. The second way to reduce aggregate health costs would be to force down the price of treatment by exercise of the government's potential monopsony power. Suppose all doctors were employed by the government. Then their wages would be low because if you wanted to be a doctor, as many people do, you would not have any alternative to accepting the government's wage. Of course the quality of care would decline. Or suppose (and this the tendency toward which some of the current proposals are tending) that the government bought all the drugs that are produced, having forbidden the drug companies to sell to any other purchaser. Then the price of drugs would be much lower than it is today, but so would be the quality, since the incentives for innovation would be diminished by the lower price.
We should be wary of proposals that if adopted would not reduce (and might increase) aggregate costs, but instead would shift the costs to another class of payees, such as taxpayers (the Edwards plan contemplates additional federal subsidies for health care, which are paid for out of taxes) or future consumers of drugs.
I will make three points: the United States system of health care may not be the most efficient but people here get good value for their large spending on health care, employer-based health insurance has the frequently overlooked major advantage of providing long term insurance, and catastrophic health coverage probably should be made compulsory.
Americans spend the largest amount of any country on health care, both in terms of dollar spending, and as a percent of income-the health sector in the United States takes about 1/7 of GDP, which is a far larger percent than any other country. Although this share of income has grown rapidly during the past 25 years, the benefits are also very large. Using the economists concept of how much people are willing to pay for improvements in their life expectancy- called the "statistical value of life"- Kevin Murphy and Robert Topel (see their ‚Äú"he Value of Life and Longevity", Journal of Political Economy, 2006, pp. 871-904) estimate that improvements in life expectancy in the United States from 1970-2000 is worth over $95 trillion (yes, trillion!). Even after netting out the $35 trillion dollar increase in medical spending over the same period, the net gain exceeds $60 trillion.
Of course, not all the increase in life expectancy is attributable to medical spending, as declines in smoking and other behavior changes made major contributions to longer life. On the other hand, the large improvements in the quality of life due to medical spending, including hip replacements, pacemakers, organ transplants, Viagra, and other advances should be added to the benefits of the increased medical spending. Other OECD countries, such as Europe and Japan, had comparable improvements in life expectancy with much smaller increases in medical spending. Perhaps that means they have more efficient health care delivery systems than the United States has, but these nations generally ration care, and are less generous in providing quality of life improvements, such as hip replacements and breast reconstruction after breast cancer. The United States is also the world's leader in medical research, and residents of other countries come to this country for advanced medical treatment of serious diseases and ailments.
I have argued in a previous post (January 29, 2007) that the tax advantage currently enjoyed by employer-provided health plans should be extended to individual and other group based plans in order to level the playing field among competing plans. All tax advantages should have a cap, however, so that "Cadillac" coverage is not deductible, and any extension to individuals and that other group plans of the tax advantage of employer plans would not raise the overall tax burden. Even with such changes, employer-based plans would continue to be important in competition against other group-based plans. A drawback of employer-based health coverage is that workers with existing medical conditions who are covered by such plans would be discouraged from changing jobs because their condition may discourage companies from taking them on. However, most job changes are by younger workers who have few serious medical conditions.
Employees who have been with the same company for a few years or longer are not likely to change jobs, although the propensity of senior workers to lose their jobs has risen a little in recent years. The advantage of employer-based medical insurance to employees who remain with the same employer for many years is that they effectively have long-term medical coverage against serious health problems that could arise in the future. The big problem in individual health insurance coverage is that it is on a year-by-year basis. Anyone who develops a serious health problem can lose his coverage or be forced to pay much higher rates, especially if he wants to change plans or insurance companies.
Long-term health insurance with individual plans is uncommon mainly because health insurance companies cannot force customers to make a long-term commitment. If a person has experienced good health, he may seek a cheaper plan with another company that would reward his additional years of good health, an experience that his original plan could not fully anticipate. Given such "adverse selection", health insurance companies are discouraged from offering long-term insurance.
Most individuals and families need a combination of health savings accounts that give them incentives to conserve on normal health spending, and protection against major health problems. President Bush's State of the Union address proposed an excellent extension of health saving accounts that would help handle more normal health spending (see my post on this on January 29, 2007). To avoid the risk that individuals and families would attempt to free ride on taxpayers and others by not contracting for catastrophic medical coverage, one can make such coverage compulsory for everyone, either through group plans, such as from employment, or through individual plans. As Posner indicates, poorer individuals and families are already covered through Medicaid, so no additional subsidy for lower income persons is needed to implement compulsory coverage of catastrophic health problems.
Recently Sam Zell, a leading Chicago businessman, arranged to buy the Tribune company, owner of the Chicago Tribune, Los Angeles Times, other newspapers, and many TV and radio stations. Aside from the low price that he paid, which reflected the rapidly declining fortunes of the print media and conventional TV stations, the most noteworthy aspect of the deal is that he plans to take the company private through the creation of an ESOP, or employee stock ownership plan.
The number of American ESOPs has grown substantially during the past 30 years, and they are currently estimated to hold more than ¬Ω trillion dollars in assets and cover over 10 million workers. Probably the main reason for their growth is that ESOPs had during this period sizeable tax advantages that include deductibility from federal taxes not only of the interest payments but also of much of the principal used to finance creation of an ESOP. The argument made for these special privileges is that employee ownership is a good thing for workers that should be encouraged, but is that true?
In reality, the creation of an ESOP is often a management tool to fend off unfriendly takeover bids. This was certainly the case behind the pilot-led ESOP created by United Airlines, and may have played a role in the ESOP to be created at Tribune company. ESOPs that help keep poorly performing management in power would contradict the claim that this organizational form improves rather than contributes to poor performance.
Employee ownership is said to induce employees to work harder because they then have a financial stake in the company where they work. If that were true, owners would not need a tax advantage to create a sizable employee ownership since they would subsidize stock ownership by employees in order to improve productivity. Employees in a small closely held company with few workers may feel part of a family and work harder when they own an interest in the company. But in large companies with thousands of employees, such as Tribune company and other ESOPs like Science Applications International, ownership is not likely to be a strong motivating factor because hard working employees would then mainly benefit the many other employees and stockholders. Between 1995 and 2000 United Airlines was an ESOP with employee representatives on its board. Soon after 2000 the company entered bankruptcy with employees and management not known either for their great effort.
Careful studies that compare the productivity of employee-owned companies with those owned by general stockholders are limited in number and scope, and advocates of ESOPs often get quite emotional in reacting to criticisms of the concept. Still, there is little hard evidence indicating that ESOPs are better run than normal companies. Reputable studies of employee ownership in the United States and other countries generally indicate that both profits and productivity remained about the same after companies introduced employee ownership. This is not surprising since most ESOP-owned companies are not run by employees, and for the reasons I gave employee ownership does not usually better motivate workers of larger companies.
However, the most powerful argument against the view that employee ownership improves efficiency is that new firms would tend to take this form if it improved efficiency, and many older firms would convert to employee ownership on their own, even without tax advantages from doing so. Yet despite the competitive nature of American industry, with substantial rates of entry and exit of companies, less than 10 percent of employees in the United States work in firms that have ESOPs despite the considerable tax advantages to this organizational form. This more than all the highly imperfect comparisons between the performance of ESOPs and other companies is persuasive evidence that ESOPs would not usually be more efficient. Indeed, given the tax advantages, there would be many more ESOPs if they were equally efficient.
Various types of employee-ownership of enterprises are found in many other countries. Usually they are the result of legislation that either forces or encourages this form of ownership through regulations and tax advantages, sometimes when public enterprises are privatized. The evidence on their efficiency as determined by their spread and performance in these countries is similar to that for the United States: even with special privileges, employee ownership has not become the dominant organizational form of enterprises. This suggests again that employee-owned companies would tend to under perform more conventional ownership structures that have stockholders who either manage the enterprise, or are largely independent of both employees and managers.
The biggest and most obvious drawback of employee ownership from the perspective of the financial wellbeing of employees is that they hold their assets in one basket, the company where they work. Even without ownership of equity the wealth of experienced employees is still poorly diversified since it is largely in the form of human capital whose value depends on the success of the company that employs them. When the company does well, earnings from their human capital tend to rise more quickly, while the opposite occurs when the company does poorly. Ownership of shares in the company exacerbates the economic dependence on the company's performance since now the value of the financial assets of employees also rises and falls with the company's fortunes. The same problem arises with the many corporate pension plans that mainly hold bonds and stock that they have issued. When the company does poorly, the value of pension assets, and thus of the retirement incomes of employees, go down along with earnings, employment and profits of the company. Forcing top management to hold much of their financial assets in the stock of the companies they run through stock option and stock ownership plans reduces their financial diversification too, but that may be beneficial to the company's performance since the decisions of CEOs and others at the top do greatly impact company performance. As I indicated earlier, that is not the case for typical employees of large corporations.
The disadvantages of being poorly diversified is not simply hypothetical, but was sadly brought home to employees of companies like Enron and United that had substantial stock ownership by employees. After these companies went into bankruptcy, mainly due in Enron's case to mismanagement and corruption, many employees not only lost their jobs but employees lost much of their other wealth as well.
I share Becker's concerns with the favorable tax treatment of employee stock ownership plans. Such treatment would be justifiable only if such plans conferred benefits on society that could not be generated more cheaply by other means. Proponents of the law that authorized ESOPs and conferred favorable tax treatment on them argued that ESOPs would unlock a new source of capital‚Äînamely workers, who contribute capital to the corporations that employ them when they take part of their compensation in the form of participation in an ESOP. But there is no shortage of capital, so no justification for subsidizing investment in corporate stock. If anything, ESOPs can be criticized from an overall social-welfare standpoint as an antitakeover device that we do not need: workers are unlikely to vote for a takeover, as it might jeopardize their jobs.
As Becker points out, abolishing the favorable tax treatment of ESOPs would permit a market test of this form of corporate governance. (In confining my discussion to cases of governance, I focus on situations in which, as in United Air Lines before its bankruptcy, or the proposed reorganization of the Tribune Company, the ESOP owns all or a controlling amount of the common stock of the corporation.) I believe that it would usually flunk the market test. Granted, the ESOP has an advantage over the conventional worker-owned firm: the value of a firm's capital stock is the discounted present value of its expected future earnings, so that a worker who owns ESOP shares has, at least in his role as part owner, the same horizon as the corporation itself, rather than the truncated horizon of the worker in a conventional worker-controlled firm (a cooperative), who cannot benefit from anything the corporation does after he retires and who consequently has no financial stake in maximizing the corporation's present value.
But this advantage of the ESOP over the conventional worker-controlled form will usually be modest. A worker will trade off any long-term benefits to the corporation from a corporate action that would increase the value of his shares against whatever short-term benefits, in the form of a higher salary or greater fringe benefits or a lighter workload, an alternative course of action would confer on him; and usually the tradeoff will favor increased compensation for work over increased stock value.
It is true that to be entitled to the tax benefits of the ESOP form, the workers' shares must be placed in trust, and the trustee must vote them to maximize share value; he cannot trade a lower share value for higher employee compensation of the worker owners. (And so he cannot oppose a takeover that would maximize share value, even if it would do so by laying off many of the workers.) If the favorable tax treatment of ESOPs were abolished, there would be no requirement of placing ESOP shares in trust. But that would still be an attractive choice for the ESOP in order to reduce the misalignment of incentives in conventional worker-controlled firms.
But overcoming the problem of incentive incompatibility would not create an affirmative reason for a worker to own shares in the corporation that he happens to work for rather than in some other corporation, a mutual fund, etc. Becker rightly rejects the notion that having an ownership interest closely aligns a worker's incentives with those of the corporation. Unless the corporation is very small, which obviously is not the case with United Air Lines or the Tribune Company, the efforts of an individual worker will not have a significant effect on the market price of the corporation's shares and hence on the worker's wealth. Of course, some workers may not realize this (they may exaggerate the contribution that their working harder would make to the firm's bottom line); or they may, by virtue of being "owners," become altruistic toward "their" company; but such workers would be likely to buy shares in the company voluntarily (or take part of their compensation in the form of shares), without all the workers having to do so.
The ESOP has one genuine advantage over the conventional corporate form, an advantage that played a role in the decision to convert the ownership of United Air Lines to an ESOP. It can smooth labor relations by increasing the cost to workers of striking or otherwise pressuring the corporation to incur greater labor costs. Even though, as I have suggested, workers' work-compensation gains will usually exceed the losses in share value that will result from the corporation's greater labor costs, their demands will be moderated by the cost to them in lower share value. This depends however on the shares being held in trust, so that the workers' interest as workers is not reflected in how the shares are voted; otherwise workers may use control of management to increase rather than moderate their demands for employee compensation. But as I have said, the trust format could be retained even if it were no longer required.
Against the possible (tax-independent) advantages of the ESOP form stands the powerful disadvantage of underdiversification. The shares in their employer's ESOP are likely to be the principal financial asset of the workers. If they are risk averse, they will be bearing uncompensated risk by holding an underdiversified portfolio. The consequences were dramatically demonstrated by the United Air Lines bankruptcy. The trustee was sued for not having sold United stock before the collapse, but because the purpose of an ESOP is to hold stock in one company, namely the employer of the participants in the ESOP, an ESOP trustee does not have the usual trustee's duty of diversification; what exactly his duty is to protect the participants against excessive risk is unclear.
A further complication is presented by employee turnover. An employee who quits and goes to work for some other employer cannot remain a participant in his former employer's ESOP. His shares must be redeemed‚Äîbut at what price? If the ESOP owns all the common stock in the employer, the fixing of a redemption value will be awkward. If it is too low, this will reduce the value of the shares to other employees who anticipate quitting at some future time; if too high, it will reduce the value of the shares by diminishing the corporation's assets, out of which the price to redeem departing employees' shares is paid. Still another complication is reconciling the competing interests of different classes of ESOP shareholder, such as active and retired employees.
To summarize, were it not for the favorable tax treatment of ESOPs, one would not expect the device to be common except in small corporations (and perhaps not even there, since the partnership and the closely held corporation provide attractive alternative governance forms) and in some firms that have particularly troubled labor relations.
A study published last month, and favorably summarized in an op-ed in the Wall Street Journal, estimates that the American tort law system costs the nation $865 billion a year. The study, entitled Jackpot Justice: The Cost of America's Tort System, was written by Lawrence J. McQuillan and other members of the staff of the Pacific Research Institute, which published the study. (The study can be downloaded at www.pacificresearch.org.) How did the authors arrive at that figure, and is it meaningful?
They begin by estimating that the nominal (that is, dollar expenditures as distinct from social costs) annual cost of the tort system, consisting mainly of attorneys' fees and other costs of administering the system plus the amount of money paid to tort claimants in judgments and settlements, is $279 billion, of which $128 billion is the amount paid out to claimants. The estimate comes from a report (U.S. Tort Costs: 2003 Update) by Tillinghast-Towers Perrin, a consulting firm for the insurance industry, with the report's estimate updated to 2006. It is impossible to determine from Tillinghast-Towers Perrin‚Äôs report what the sources for most of its data are, and so the figures I have quoted must be taken with a grain of salt; indeed, so far as I can tell, they may be completely unreliable. They are almost certainly exaggerated, given the financial connection between the firm and the insurance industry.
The authors of Jackpot Justice know the difference between a cost, which in economic terms is a reduction in the amount of valuable resources, and a transfer of wealth from one person to another that doesn't reduce the total amount of resources but merely redistributes them. The $128 billion figure is a transfer, not a cost. But as the authors point out, the opportunity to obtain a wealth transfer can generate a cost--a cost incurred to obtain the transfer (incurring costs to obtain a wealth transfer, when socially unproductive, economists call "rent-seeking"). They assume, without analysis or evidence, that the entire $128 billion is translated into a cost.
They further assume that 28 percent of the $128 billion transfer represents a deadweight cost, that is, a loss of value. They base this assumption on a study which found that increasing the corporate tax rate by $1 generates 28 cents in deadweight costs. The basis of that finding was that a tax, like a monopoly markup, causes the taxpayer, like a consumer, to substitute for the taxed item or activity something that may cost society more to provide but looks cheaper because it's untaxed, or taxed at a lower rate. The authors of Jackpot Justice do not explain why a tort transfer would have the same effect. Of course the threat of tort liability might well alter the behavior of potential injurers--indeed, it is intended to do so--but it might alter that behavior in the direction of greater efficiency, by making potential injurers internalize accident costs. That is the objective of tort law, though imperfectly achieved. Without tort liability, firms would have weak incentives to invest in safety measures to benefit potential victims of the firms‚Äô activities, unless the victims were either their employees or their customers.
With the addition of 28 percent of $128 billion ($36 billion) to $128 billion in assumed rent-seeking expenditures, the authors jack up their estimate of the annual social cost of the tort system to $164 billion. To this they add another $36 billion, on the assumption (it seems---this part of the report is none too clear) that efforts to avoid the deadweight cost will cost that amount. This appears to be double counting, based on the assumption that $36 billion is spent every year in a futile effort to avoid a $36 billion cost. It is possible, however, that some--maybe considerable--costs are being incurred to prevent that deadweight loss from rising from $36 billion to some higher level‚Äîfor example, legal-counseling costs (not included in the attorneys' fees incurred in actual litigation) or costs in curtailed new-product development (see below). But there is no basis for supposing that the sum of such costs would equal $36 billion; nor do the authors make any effort to defend the figure or estimate the actual costs.
They add to their new total of $200 billion the $128 billion transfer, for a grand total of $328 billion. The addition is improper, since the transfer is not a cost. They are adding apples and oranges.
They borrow from another study an estimate that tort liability generates some 2,000 accidental deaths a year by discouraging the introduction of risk-reducing products and services. But they fail to offset against that figure (and its monetization) the number of accidental deaths that are prevented by the deterrent effect of tort liability. In the absence of liability, potential injurers would spend less on safety, at least with regard to potential victims with whom the injurers lack actual or potential contractual relations.
The authors of Jackpot Justice cite a respectable economic study by Daniel Kessler and Mark McClellan which finds that malpractice liability increases hospital costs by 5 to 9 percent; and they treat the entire amount as social waste. But as I said earlier, the aim of liability is to induce potential injurers to spend more on safety, and so the fact that they do spend more cannot be adjudged a failure to improve social welfare. Medical-malpractice law is in its administration rife with inefficiency, but it would be surprising if eliminating it entirely would be all social benefit and no social cost (nor in fact do the authors argue for eliminating it, as we‚Äôll see).
The authors argue that products-liability law is responsible for the loss of $359 billion in new products. They base this on a study by the economists Kip Viscusi and Michael Moore which found that when the ratio of liability costs to sales revenues exceeds 5 percent, firms reduce their investment in R & D. The authors of Jackpot Justice identify product markets such as power tools, fireworks, and cigarette lighters where they believe (relying however on the questionable data in the Tillinghast-Tower Perrin reports) that this ratio is exceeded. Then, using Viscusi and Moore's estimate that 6 percent of the products of the industries that the two economists studied are new products, Jackpot Justice multiplies the output of these markets by 6 percent; with certain other adjustments, this calculation produces the estimate of $359 billion in lost sales.
This is not, however, as the authors believe, a social cost. The social cost is the consumer surplus that the sales of the new products would have produced. Suppose that a product costs $10 and is sold in a competitive market for $10, but that consumers would pay $12 for it if it were priced at $12. Then if the product is not produced, there is a loss of consumer surplus of $2. That, not the $10 in lost sales revenue, is the social cost of not producing the product.
The sum of $328 billion and $359 billion is $687 billion, which is almost $200 billion short of the authors' grand total of $865 billion. The excess malpractice costs and accidental-death costs they estimate at less than $50 billion, so there is still a big gap. I can't figure out how they fill it.
So far in the report, there is nothing about the benefits of the tort system. To estimate those benefits, the authors compare the percentage of U.S. GDP that is accounted for by our tort system with the percentage of GDP accounted for by the tort systems of other developed countries. They base all these percentages on the dubious Tillinghast-Towers Perrin report. The U.S. percentage is estimated at 2.2 percent, twice Germany's and roughly three times Japan's and the United Kingdom's. The average for the foreign countries in the comparison is 0.9 percent, so the authors of Jackpot Justice conclude that the benefits of the U.S. tort system are equal to only 0.9 percent of our GDP. The possibility that our more costly system might generate greater benefits (though not necessarily equal to the greater costs) is ignored. But a more serious weakness is the implicit assumption that a tort system generates benefits exactly equal to its costs. It might generate much greater benefits. Politics, which the authors assume lead to greater than optimal liability, might instead lead, in the countries they compare to the United States, to less than optimal liability. And even if investment in the U.S. tort system has been carried to the point at which the last dollar spent on the system generates exactly one dollar (no more) in benefits, the total costs may be far below the total benefits because average cost may be much lower than marginal cost. This is apart from the possibility that politics may have prevented our investing enough in the tort system to equate benefits and costs at the margin.
The authors' estimate of the benefits (= costs) of the average foreign tort system, when subtracted from the $865 billion "cost" of our system, results (with some further adjustments) in an estimate of an annual excess of costs over benefits of almost $600 billion. The figure, however--the authors' estimate of the net social loss created by our tort system--is, as I have tried to show, fictitious.