February 27, 2005

The Summers Controversy and University Governance

We return this week to the Larry Summers controversy, not to rehash the points in the earlier postings and comments, but to consider the larger issues of university governance that the controversy raises. On these larger issues, Becker and I have some significant disagreements.

The “case” against Summers made by his faculty critics is a four-legged stool: he had the temerity to challenge the absenteeism of a prominent faculty member, Cornel West, who as a result resigned in a huff; he is peremptory, perhaps even rude and boorish, in his dealings with faculty; he refuses to consult faculty on administrative matters, such as the expansion of the campus into Alston, across the Charles River from the traditional campus; and, most notoriously, he challenged the conventional left-liberal view that any underrepresentation of a group in a prestigious activity (e.g., women on the science faculties of Harvard) must be due to discrimination rather than to preferences or capabilities.

For these actions, Summers—the most exciting and dynamic president that Harvard has had since James Conant—has been (or at least has felt) compelled to undergo a humiliating course of communist-style “reeducation,” involving repeated and increasingly abject confessions, self-criticism, and promises to reform. He has been paraded in a metaphoric dunce cap.

Why has he consented to participate in this ritual of self-abasement? Why has he refused to face down his critics? To appreciate the sheer strangeness of his situation, imagine the reaction of the CEO of a business firm, and his board of directors, if after the CEO criticized one of the firm’s executives for absenteeism, ascribed the underrepresentation of women in the firm’s executive ranks to preferences rather than discrimination, dealt in peremptory fashion with the firm’s employees, and refused to share decision-making powers with them, was threatened with a vote of no confidence by the employees. He and his board would tell them to go jump in the lake. But of course there would be no danger that the employees would stage a vote of no confidence, because every employee would take for granted that a CEO can be brusque, can chew out underperforming employees, can delegate as much or as little authority to his subordinates as he deems good for the firm, and can deny accusations of discrimination.

If, however, for employees we substitute shareholders, the situation changes drastically. The shareholders are the owners, the principals; the CEO is their agent. He is deferential to them. Evidently the Harvard faculty considers itself the owners of the institution; Summers appears to agree, as does Becker.

I disagree. The economic literature on worker cooperatives identifies objections to that form of organization that are pertinent to university governance. The workers have a shorter horizon than the institution. Their interest is to get as much from the institution as they can before they retire; what happens afterwards has no direct effect on them unless their pensions are dependent on the institution’s continued prosperity. That consideration aside (it has no application to most professors' pensions), their incentive is to play a short-run game, to the disadvantage of the institution—and for the further reason that while the faculty as a group might be able to destroy the institution and if so hurt themselves, an individual professor who slacks off or otherwise acts against the best interests of the institution is unlikely to have much effect.

All this is true of Harvard. The faculty are interested primarily in their own careers, and what is good for their careers and what is good for Harvard are only tenuously connected. The individual faculty member who denounces Summers knows that his denunciation is unlikely to bring about Summers’s departure, and even if it was decisive, and even if Summers is the best president that Harvard could find, an inferior replacement would be unlikely to do so much harm to Harvard as to have a discernible impact on the career of the denunciator. What is more, that replacement might be more inclined to kow-tow to faculty, enhancing their careers at the expense of the long-run health of the institution.

Apart from the misalignment of faculty and university interests, faculty at research universities, like intellectuals generally, tend not to be responsible participants in collective action, such as university governance. The academy does not select for people who have interpersonal skills, because most academic research is either solitary or conducted in groups of two or three, though there are exceptions, primarily in the hard sciences. In addition, faculty are highly specialized, many in fields wholly unrelated to the financial and other practical questions that loom large in a university as large and affluent as Harvard.

Universities are increasingly complex enterprises. Harvard has a multibillion-dollar annual budget. It is ludicrous for English professors to think they have a useful contribution to make to decisions involving budgetary allocations, building programs, government relations, patent policy, investment decisions, and other key dimensions of modern university governance. They are in no position to balance Summers’s strengths in these areas with what they consider his weaknesses in relations with faculties, or his ideological views that they find offensive.

Because universities are organized as nonprofit entities, there are no shareholders, and hence no owners in the conventional sense. As a practical matter, the university’s trustees are the owners; they control the endowment and the other assets of the university and they appoint the president, who in turn appoints the administrative staff of the university. The trustees’ interests are better aligned with the university’s interests than the faculty’s are. The trustees do not have a personal financial stake in the university’s success, but the position of a trustee of a major university is prestigious and even visible, and trustees who botch their job will experience embarrassment and loss of reputation.

Of course, as part timers and outsiders to academia, the trustees cannot actually manage the university. Nor do they try. Their principal function, besides general supervision and assistance in fund raising, is to hire a president, and to fire him if he performs badly. (So they are much like the board of directors of a business firm.) That is a limited function which a board of trustees should be able to discharge competently. The president is the CEO and he has both a reputational and a financial stake in the success of the institution. The president and his administrative staff, not the trustees—and not the faculty—should manage the university. The role of the faculty should be teaching, research, and appointments (subject to override by the president or provost) within their field of academic specialization.

So I would like to see faculty think of themselves as employees and leave governance to the university’s president. (Another reason for this conclusion is that preoccupation with governance is a distraction from teaching and scholarship, and so reduces faculty output. In doing so it compounds the bad effects of academic tenure, an institution that reduces the productivity of many academics.) Isaac Rabi, whom Becker quotes in his comment, not only was far above the mean of academics, but was also a person of great practical sense. If our universities were composed of Rabis, I would be happy with faculty goverance. They are not.

Against this Becker argues, first, that competition among universities will assure good performance regardless of the governance structure and, second, that a comparison of American with foreign universities shows that our universities must be doing something, or rather a lot of things, right, because our universities are the world’s best. Competition is indeed a powerful force for efficiency, but interuniversity competition is blunted by a variety of factors, including the lack of a profit incentive and the difficulty of evaluating a university’s output.

I agree that our universities are the best in the world, but comparisons of this sort are invitations to complacency. (If the Harvard trustees were complacent, they wouldn’t have appointed Summers president!) When the United States had monopolistic regulation of the telephone industry, as it did until the breakup of AT&T, we had the best telephone system in the world. When we lost the war in Vietnam, we had the best armed forces in the world. When the Civil Aeronautics Board administered an airline cartel, we had the best airlines in the world. We have the best universities, but I believe that they would be even better if they were governed differently. My belief is supported by the fact that American universities are evolving in the direction of greater conformity to the principles on which private businesses are run. The time has come to retire the faculty slogan “we are the university.”

Posted by posner at 6:11 PM | Comments (62) | TrackBack

Comment on University Governance-BECKER

I discussed earlier the factors determining why far fewer women than men are highly successful in science and other fields. At that time, Larry Summers’ controversial statement on this topic was not yet publicly available. It is now, and it is an excellent and balanced statement that should not cause offense to any thinking person, even though some might legitimately disagree. As in my blog discussion, he gives greatest priority to the time commitments necessary to be highly successful. Since women with children have much less time available to concentrate intensely and for prolonged stretches on their work, a disproportionate number of highly successful women do not have children. He also notes that universities and companies have a competitive advantage if they do not discriminate against able women.

As Harvard’s president, Summers has shown vision, enormous ability, and strength, qualities typically lacking in university presidents, with the exceptions of Edward Levi at Chicago, Gerhard Casper at Stanford, and a few others. If allowed to persist in his endeavors, he will go down as one of the great university presidents of recent decades.

Although I wanted to get these comments off my chest, they are also relevant to university governance, our topic this week. Posner argues against the view that faculties should be running universities. He points out several problems with such a system, including that professors pursue their own narrow interests instead of the universities long-term goals, that professors are not selected for interpersonal skills, and that universities have become too complex to be run by a faculty collective. Strangely, he comes down in favor of university trustees as having interests that are better aligned with those of universities. Yet my experience is that trustees typically know little about, and generally do not have much interest in, the universities they oversee, they are intimidated by professors, are not very brave in their trustees’ role, generally go along with whatever is presented to them by university administrations, and very seldom force a university president to quit.

Still, I believe the only satisfactory way to evaluate how universities (or businesses) are run is by their success or lack of it in the long run. Although there is no simple way, like profitability, to judge universities, there is an effective way to judge a university system. The American college and university system is widely accepted as the strongest in the world. This is why American universities are filled with students from abroad, including those from rich nations with a long history of higher education, like Germany and France.

I conclude from this that the American university system must be doing many things right, at least relative to the other systems. And what is right about this system is rather obvious: several thousand public and private colleges and universities compete hard for faculty, students, and funds. That the American system of higher education is the most competitive anywhere is the crucial ingredient in its success.

Competition tends to weed out the inefficient and the ineffective, regardless of whether competing enterprises are private profit –maximizers, as are most business firms, private non-profits, as are many American universities, or public non-profits, as are the majority of universities. In any industry, including the education industry, many different approaches are tried, as in the Robert Hutchins great books approach to undergraduate education at the University of Chicago. Many of these approaches fail, as the great books approach failed because it turned out to be a poor way to teach science, economics, and many other subjects.

The basic effect of competition is that only the successes tend to survive in the long run. What survives in a competitive environment is not perfect evidence, but it is much better evidence on what is effective than attempts to evaluate the internal structure of organizations. This is true whether the competition applies to steel, education, or even the market for ideas. In particular, this is the main reason why I favor education vouchers, for it is one significant way to bring greater competition into the k-12 education system.

Posner rightly notes that professors typically run American universities. I may have told the story in an earlier comment about Dwight Eisenhower, then the newly installed president of Columbia University, who gathered its faculty together. He indicated that he wanted to meet the employees of Columbia. Isaac Rabi, the great Columbia University physicist, is said to have corrected Eisenhower: ”Mr. President, we are not the employees of this university, we are Columbia University”.

Given the effectiveness of the American higher education system, its governance, including the role of faculty, is probably on the whole along the right lines. Some literature has even shown that an industry composed of workers cooperatives, Posner’s analogy to faculty-run universities, in a competitive environment tends toward efficiency because these cooperatives have to bid against each other, and against other industries, for labor and capital. Much of that literature would apply to universities run by professors, and to other aspects of the structure of American universities.

Yet enterprises in even the most competitive industry often appear to be inefficient when looked at under a microscope. This is why the many best sellers every year on how to improve the management of American companies before long pass into the market for shredded paper. Similarly, the reaction of some faculty at Harvard to Summers’ remarks at the labor conference on women is foolish, but that should not be used to judge the efficiency of the system of American higher education.

I am dubious about proposals to improve a competitive system that is working. The American university system is competitive and it is working well, at least judged by its ability to continue to attract the best students from abroad, that few Americans go abroad for advanced degrees, and by the current efforts to imitate the American system of higher education in many other countries. We should not be complacent, but that is pretty effective evidence in its favor, including the approach to governance.

Posted by becker at 4:14 PM | Comments (19) | TrackBack

February 26, 2005

Immigration Reform--Posner's Response to Comments

This was, as usual, a stimulating set of comments. I cannot respond to all of them, but I will try to respond to some and in so doing clarify my original proposal. It is apparent that a number of the commenters misunderstand my proposal. I accept responsibility for not having explained it adequately; in addition, I modify it slightly in this response, in light of the comments.

A number of comments suggest that Becker's and my proposals are anti-immigrant or anti-poor. That is incorrect. As Becker explains in his response, his proposal would facilitate immigration by unskilled workers--as would mine, had it not been for my reference to IQ, which I retract below! Both of us contemplate that our proposals would lead to greater immigration. That in turn would tend to redistribute wealth from rich to poor, because the vast majority of immigrants (other than some asylum seekers) raise their standard of living by coming to the United States. This, by the way, was surely true of the people who were able to immigrate to America in the eighteenth century solely by virtue of the institution of indentured servitude. Indentured servitude (which must not be confused with slavery) is a method of commitment that, like a mortgage, enables a person to obtain an economic advantage that he could not obtain otherwise. Unfortunately this is a point that is very difficult for people not steeped in economic thinking to grasp. But try!

One comment misdescribes my proposal as one "to sell immigration rights." The only sale component concerns immigration slots auctioned to rich people who, because of age or health, would be unlikely to be productive citizens; the auction price would compensate the rest of us for supporting them in their sickness and old age.

I realize that I created the impression that I wanted immigration officials to assess whether each individual prospective immigrant would be likely to make a net contribution to the American economy, or to American society more broadly, as a condition of permitting him to immigrate. That was error; it would be an excessively costly, perhaps indeed a completely infeasible, undertaking. What I should have said is that the government should adopt a few simple criteria, perhaps limited to age, health, and criminal history, which could in most cases be readily determined, to screen would-be immigrants, and couple that with a residency requirement for welfare benefits (see below). I should not have mentioned IQ, since as Becker points out we need additional unskilled as well as skilled workers and since it is difficult to design IQ tests that will yield comparable results for persons of different linguistic, cultural, and socio-economic background. Congestion and pollution externalities are potentially strong objections to high levels of immigration, but they should affect policy at the level of deciding whether to place some overall limit on the annual immigration rate; they cannot be used to screen individual applicants.

Employability is important, but age and health are proxies for it; and disentitling new immigrants to social services for a limited period of time (probably no more than a year or two) is a way of discouraging immigration by workers who may be young and healthy and have a clean criminal record yet who for one reason or another are not attractive to U.S. employers. The purpose of this temporary residency requirement for entitlement to social benefits is not, as one comment asserts, to curb immigration because of the welfare state; it is to discourage free-rider immigrants. To repeat, the overall effect of our proposals would be to increase the amount of immigration. Moreover, even though the present patchwork of immigration laws is inefficient, I believe that the net effects of immigration, today as in the past, legal and illegal, on American society are positive, consistent with the study by Smith and Edmonston cited in one of the comments.

Speaking of the immigration law patchwork: an excellent comment, diffidently offered by an undergraduate, asks what features of the present system of immigration rights is my proposal intended to replace? All of them? No; I said that I thought we should continue to grant asylum to victims of persecution. But I did not comment on the other grounds on which people are allowed to immigrate under existing law, such as national quotas, family reunification, lottery, and special skills. Although family reunification has obvious appeal, I cannot think of a good reason to specify immigration quotas by nation. A lottery would make sense only if the number of people who passed the screening test that I have proposed exceeded some overall ceiling on immigration derived from concern with congestion or pollution externalities; in that event, a lottery would be a cheap way of equilibrating applications to openings. A special-skills exception would be superfluous (and is costly to administer) if the screening approach were adopted, because almost everyone who had special skills would pass the test.

One comment contains an intriguing hint that might be elaborated as follows: illegal immigration, being costly, tends to filter out would-be immigrants who are either faint of heart or don't have a really strong desire to live in the United States, while letting in would-be immigrants who are daring, ingenious, and optimistic about their chances for success in the U.S., albeit who also may have a below-average commitment to legality. On balance, illegal immigrants may constitute a desirable class of immigrants. If this is correct, it supports the Bush Administration's amnesty proposal.

Posted by posner at 2:29 PM | Comments (17) | TrackBack

February 25, 2005

Response on Sale of Rights to Immigrate-BECKER

A lot of comments, and many are of high quality, including some that disagreed. I had expected the clear majority to be opposed, and on this at least I proved right! Once again some of the discussion cleared up various issues, but some points need to be highlighted.

We now have severe restrictions on the number of immigrants allowed in legally. Although my $50,000 figure was just an illustration, I believe that more, not fewer, immigrants would be coming even with this price than under the present system since ALL applicants who met certain simple criteria would be accepted. Economic analysis proves that there certainly exists a positive price (and I believe a significant one) that would have a larger number of immigrants than under the present quota system.

Some of you complained about the red-tape involved now in immigrating to the US. I believe the immigration service is one of the most arrogant of all government agencies. They have the power to say “take it or leave it” since they are rationing a valuable asset, entry permits. Unlimited entry at a fixed price will not only raise the number of immigrants-if the price is not too high-but would drastically cut all the time-consuming and annoying hassle involved in immigrating. And it might even make immigration agents a little pleasant since immigrants would be paying for the right to come.

Some of you missed my stress on overcoming the financial difficulties of paying a high fee by encouraging loans to immigrants from private banks. They would be encouraged not by government insurance, but by giving them the many of the other privileges now available to those collecting on student loans, such as that immigration loans would not be dischargeable by bankruptcy, and that earnings could be garnished if some immigrants are in arrears.

With such loans available, the unskilled will not be priced out of the immigration market. They would have to put together perhaps $5000 as a down payment, or about 1/3 of the gross earnings of an unskilled worker in the US. Many unskilled individuals could pool family resources to do that, as they did in earlier times when transportation costs to the US were so much larger than they are now. Recall that the cost of transportation in the 18th and 19th century to the US by boat from Europe was a significant fraction of the earnings during the first year in the US of the many low skilled immigrants who managed to come.

The term “payback period” is technical, and only is a way of describing how many years before the after-tax gain in earnings from immigrating covers the cost of immigrating. It does not mean they would have to pay the loans back in a few years; I agree that would be very difficult for low skilled individuals. My proposed loans would be longer term, as is the case with student loans.

I am confident that the absolute number of unskilled immigrants (as well as the total number of immigrants) who would enter under my fee system would exceed the number entering under the present system since unskilled applicants are discriminated against under the present quota system. So it is erroneous to call my proposal anti-immigration, or even anti unskilled immigration. I am certainly pro immigration, and I surely believe unskilled and other immigrants have contributed, and will continue to contribute, a lot to the American economy and society.

I also believe, however, that countries benefit more from having immigrants who make a commitment to stay, as 19th century immigrants to America did. My proposal works toward selecting more committed immigrants. Of course, they would still be free to return if they decide to do so, but the US gains more from their staying-if they are productive, etc- than it gains from whatever influence they bring back upon returning to the countries they come from.

Some of you complained that making immigrants pay is like bringing in indentured servants. Do you believe they are better off if they are not allowed in at all, which is the present system? Or do you believe students are “indentured” because many of them have large loans when they finish school? They surely are a lot better off than if limited financial resources prevented them from going to college at all!

Some of you doubt whether some immigrants come at least in good part to take advantage of medical, welfare, education, and other benefits. Although we need more evidence on this, there are a few studies showing that these entitlement –type benefits do affect immigration by poor individuals and families- see for example, an article by Terra McKinnish in the Winter 2005 issue of the Journal of Human Resources.

Auction or credit systems are in the same spirit as my proposal. In all cases, it is necessary to decide either the price to be charged immigrants, or the quantity to be auctioned or credited off. With full information about supply and demand curves, they are identical in terms of incidence, although credit systems allow other to capture the revenue. Why is that desirable?

Many of you raised a challenging question that I only briefly addressed: would my system increase or decrease the number of persons who would try to come illegally? On the one hand, they would escape paying the entry fee, so that would obviously be one force increasing the number entering illegally. But there is much more to the answer than that. Under the present system they do not have the right to come legally, so theyhave to try to come illegally if they want to come. I would give them a legal immigration alternative, and I believe many would choose that alternative since there are huge employment and other advantages of being here legally rather than working underground. Moreover, we would have the additional resources to add to patrols and others who are policing the numbers trying to cross illegally, or who overstay their visas.

In addition, I believe attitudes toward illegals would harden since, unlike the present system where they are excluded from coming, they could be coming legally. Some of you-not all!- confused the effect of charging an entry fee on the number of illegals in a system where they could have come freely, with the actual present system where the only way they can come is to come illegally. So I am pretty sure the number coming illegally would go down, but I agree that is not certain.

Much more could be said, but I believe I responded to the main points. My apologies that I did not have time to address all the relevant comments. Perhaps we will return to this topic in a future blog since our pieces stimulated so many good responses.

Posted by becker at 10:18 PM | Comments (32) | TrackBack

February 21, 2005

Sell the Right to Immigrate-BECKER

Rich nations are facing enormous pressure to increase the number of immigrants because of their sharp limits on the number of legal immigrants accepted, and the huge numbers who try to cross borders illegally. This immigration pressure stems in major part from the very large gap between the earnings of workers at all skill levels in the United States, Western Europe, and Japan compared to the rest of the world. In addition, low birth rates in the developed world create excellent opportunities for young persons from poorer nations, and travel between nations has become much cheaper.

The United States, the leading destination for immigrants, uses quotas that give preference to family members of persons already here legally, to applicants with greater skills, to persons who applied earlier, and some other criteria. Since I am a free-trader, readers might expect my preferred alternative to the present system to be 19th century-style unlimited immigration. I would support that if we lived in the 19th century world where government spending was tiny. But governments now spend huge amounts on medical care, retirement, education, and other benefits and entitlements. Experience demonstrates that in our political system, it is impossible to prevent immigrants, even those here illegally, to gain access to these benefits. I believe that with unlimited immigration, many would come mainly because they are attracted by these government benefits, and they would then be voting to influence future government spending and other public policies.

Given these realities of free immigration, the best alternative to the present quota system is an ancient way of allocating a scarce and popular good; namely, by charging a price that clears the market. That is why I believe countries should sell the right to immigrate, especially the United States that has so many persons waiting to immigrate. To illustrate how a price system would work, suppose the United States charges $50,000 for the right to immigrate, and agrees to accept all applicants willing to pay that price, subject to a few important qualifications. These qualifications would require that those accepted not have any serious diseases, or terrorist backgrounds, or criminal records.

Immigrants who are willing to pay a sizeable entrance fee would automatically have various characteristics that countries seek in their entrants, without special programs, point systems, or lengthy hearings. They would be younger since young adults would gain more from migrating because they would receive higher earnings over a relatively long time period. Skilled persons would generally be more willing to pay high entrance fees since they would increase their earnings more than unskilled immigrants would. More ambitious and hard working individuals would also be more eager to pay since the U.S. provides better opportunities than most other countries for these types.

Persons more committed to staying in the United States would also be more likely to pay since individuals who expect to return home after a few years would not be willing to pay a significant fee. Committed immigrants invest more in learning English, and American mores and customs, and become better-informed and more active citizens. For obvious reasons, political refugees and those persecuted in their own countries would be willing to pay a sizeable fee to gain admission to a free nation. So a fee system would automatically avoid time-consuming hearings about whether they are really in physical danger if they were forced to return home.

The pay-back period for most immigrants of a $50,000 or higher entrance fee would generally be short-less than the usual pay-back period of a typical university education. For example, if skilled individuals could earn $10 an hour in a country like India or China, and $40 an hour in the United States, by moving they would gain $60,000 a year (before taxes and assuming 2000 hours of work per year). The higher earnings from immigrating would cover a fee of $50,000 in about a year! It would take not much more than four years to earn this fee even for an unskilled person who earns $1 an hour in his native country, and could earn $8 an hour in the U.S.

These calculations might only indicate that $50,000 is too low an entrance price, and that an appropriate fee would be considerably higher. But with any significant fee, most potential immigrants would have great difficulty paying it from their own resources. An attractive way to overcome these difficulties would be to adopt a loan program to suit the needs of immigrants who have to finance entry.

One could follow the present policy toward student loans, and have the federal government guarantee loans to immigrants made by private banks. However, I objected to that program in a January 9th entry in this blog, and suggested instead removing the federal guarantees while retaining that education loans are not dischargeable through personal bankruptcy. The same approach would work for immigration loans since these are also investments in human capital. Of course, it would be difficult to collect from immigrants who return home, and that would lead to higher interest rates on these loans. But such forfeiture would be discouraged too if banks forced immigrants to make large enough down payments in order to get their loans.

Countries that charge a sizeable fee would have an incentive to raise the number of immigrants accepted because they would bring in tax revenue that cuts the tax burden on natives. For example, one million immigrants per year who each paid $50,000 would contribute government revenue of $50 billion per year. Moreover, immigrants who would enter under a fee system would generally make little use of welfare or unemployment benefits, would pay hefty taxes on their earnings, and would tend to be younger and healthier. So the overall direct economic benefits from larger numbers of immigrants would be much greater than under the present admission system. This would help quiet anti-immigration rhetoric as it induces countries to take more immigrants.

In addition, since anyone willing to pay the entry price could then legally immigrate, this approach should also cut down the number who enter illegally. Still, some persons will continue to try, especially if they want to avoid paying the fee, or only want to work for a short time in the United States. However, border and other immigration personnel would become more efficient in combating illegal entrants since they would have to deal with smaller numbers. It should become easier also to expel and even punish illegal entrants because they would get less sympathy from the American public than under the present system. After all, they usually could have entered legally, but tried to chisel out of paying.

In summary, charging a fee to immigrate would raise tax revenue, increase the number of immigrants accepted, and also raise the quality of those accepted. It is a win-win situation for countries accepting immigrants, and for the vast majority of persons who would like to immigrate.

Posted by becker at 8:56 PM | Comments (86) | TrackBack

Immigration Reform--Posner Comment

I approach the issue of immigration reform (theoretical reform—neither Becker nor I are considering the political obstacles to radical changes in immigration law) somewhat differently. I begin by asking: why restrict immigration at all? The only answer I consider fully compatible with a market-oriented approach to social issues is that the immigrant might reduce the net social welfare of the United States, if for example he was unemployable or on the verge of retirement, or was a criminal, or was likely to require highly expensive medical treatment, or if he would impose greater costs in congestion or pollution than he would confer benefits, with benefits measured (crudely) by his income before taxes and by any consumer surplus that he might create. I assume that the welfare of foreigners as such does not enter into the U.S. social welfare function; but immigrants who create net benefits in the sense just indicated contribute to the strength and prosperity of the nation.

The problem of the “undesirable” immigrant—the immigrant who wants to free ride on the services and amenities that the United States provides its citizens—could be solved by means of a two-stage process. In the first stage, the prospective immigrant would be screened for age, health, IQ, criminal record, English language capability, etc.; the screening need not be elaborate. If the would-be immigrant “passed” in the sense that he seemed likely to add more to U.S. welfare than he would take out, he would be admitted without charge. If he flunked the screening test, an estimate would be made of the net cost (discounted to present value) that he would be likely to impose on the U.S. if he lived here and he would be charged that amount for permission to immigrate.

An alternative, less revolutionary, approach to screening out free-rider immigrants would be, first, to deny immigrants access to Medicaid and other welfare programs until they had lived in the United States for a significant period of time, and, second, to auction off a certain number of immigrant visas to the highest bidders. Immigrants willing to take their chances without access to welfare programs (not that all access could be denied—no one could be refused emergency medical treatment on a charity basis), and immigrants willing to bid high prices in an immigration auction, would be likely to be productive citizens, in the first case, and to cover any costs they would impose on the nation’s health or other welfare systems, in the second case.

Either the more or the less revolutionary alternative would impose significant transition costs, but that would be true of any radical change in immigration policy. The obvious cost (though not really a cost, rather a redistribution of income) would be that by increasing the supply of labor, an immigration policy that made it easy for employable workers to enter the U.S. labor force would reduce wages in the labor markets that the immigrants entered. A closely related but subtler consequence is that the downward effect of large-scale immigration on wages (a short-run effect, in all likelihood) would complicate the process of determining the correct fee to prevent free riding: an immigrant who might be able to pay his way at the existing wage level might be unable to do so if the wage level fell as a result of massive immigration. Similarly, congestion and pollution externalities might increase at an increasing rate with massive immigration, requiring a further adjustment in the fee charged the “undesirables.”

Either approach seems to me preferable to a flat fee for all would-be immigrants. A flat fee would not do away with the need to screen, since some would-be immigrants might impose net costs on the U.S. that were greater than the fee; that is why Becker’s approach includes screening. The flat fee would exclude two types of immigrant that should, in a market-oriented approach, be admitted. One type would be “undesirables” willing and able to compensate the United States for the expected costs that they would impose--and so they would not be free riders after all; a very wealthy person on the verge of retirement would be an example of such an “undesirable.” The second type would be highly promising would-be immigrants (for example, persons with a high IQ) who for some reason—perhaps because they reside in extremely poor countries—simply could not pay the down payment on the fee.

The fee would, it is true, increase government revenues, which may seem a plus. But it would do so at the usual cost of distorting the allocation of resources, in this case by excluding immigrants in the second class.

I note two complications. First, it may be desirable to adhere to the current policy of granting asylum to foreigners who are escaping persecution, even if they do not seem likely to be able to pay or to earn enough to cover the costs they’ll impose on this country. My reason is not sentiment, but the fact that people who are persecuted tend to be either nonconformists or members of particularly successful minorities, and in either case they, or at least their children, are likely to be productive citizens even if their U.S. employment prospects are dim. Second, the United States in formulating immigration policy may have to worry about “brain drain,” and, what may be more important, “leadership drain,” from poor or unstable countries. For example, it would be highly unfortunate if all the Iraqis who have the ability and motivation to build a democratic, free-market society fled to the United States. Thus it may sometimes be in our national interest to exclude persons who would otherwise be highly desirable immigrants, in order to shore up forces or tendencies in their own countries that promote U.S. interests. However, I do not know how to mesh this concern with either my or Becker’s proposals.

Posted by posner at 8:51 PM | Comments (68) | TrackBack

February 19, 2005

Medicare--Posner's Response to Comments

There were, as usual, many very interesting comments. Let me try to respond to a few. One interesting suggestion is that an increase in demand for drugs, brought about by the Medicare prescription-drug benefit, will not, as I suggested, reduce average price by enabling the drug companies' heavy fixed investment in R&D to be spread over a greater output; the companies' patent monopolies will enable them to charge higher prices. This is possible but not certain. If average cost is not rising in output, an increase in demand will not lead to a higher price. If, however, the demand curve facing a monopolist becomes less elastic (meaning that a small increase in price will have a less depressing effect on output), then the monopolist will raise his price (unless, perhaps, his average costs are falling). That is a possible effect of the prescription-drug benefit: the benefit will slow the output reaction to a higher price. However, this effect will be offset to some and perhaps a great extent by the fact that many patented drugs have good substitutes (for example, the different antidepressants and painkillers), since different molecules having the same therapeutic effect are separately patentable. However, I grant that there may indeed be a price effect from the new benefit; one possible (and unlikely!) response would be to shorten the patent term for pharmaceutical drugs.

Some comments suggest that compulsory health insurance and socialized medicine are, contrary to what I argued in my posting, the same thing. That is not so. Compare automobile liability insurance. It is compulsory in most (maybe, by now, in all) states, but since the insurance is written by private companies, it is hardly an example of socialized insurance. Similarly, one could have compulsory education laws but no private schools, and one would then not speak of socialized education.

The analogy of medical to auto insurance was criticized in some of the comments on the ground that there is no upper limit to how much medical treatment one may need. But, similarly, there is no upper limit to the amount of damage you can do driving carelessly, yet it is possible to buy essentially unlimited liability insurance. The real difference is that medical insurance is more expensive--and would be much more expensive were it not for Medicare--than automobile liability insurance is because many more people require expensive medical treatment, especially toward the end of their lives, than cause serious auto accidents. Many comments suggest that medical insurance would be so expensive if it weren't subsidized by the taxpayer through Medicare that it would be unaffordable. But this is obviously wrong. Here the analogy is to life insurance. One can buy a very large life insurance policy cheaply at a young age because the insurance company invests the premiums and earns a return on the investment for many years before it has to pay out. Similarly, medical expenses tend to rise with age. Of course, young people have less disposable income than older--but one implication is that many older people, having high incomes, can afford to buy health insurance even though their premiums will be higher than if they had bought a lifetime policy when they were wrong.

It is true that some, and probably many, people will not be able to afford health insurance, and I agree that, as a practical matter, they cannot be denied treatment just because they can't pay for it. So there will always be medical subsidies, just as there will always be subsidized pensions (social security). But why not make those who can buy health insurance, including health insurance for their old age, do so? One attractive method of subsidy, which I borrow from the automobile insurance example, is to require each insurance company to insure, at premiums only moderately above the market level, the individuals who because of poor health cannot afford to buy health insurance at market rates.

The suggestion that you cannot deny, medical treatment to someone who refuses to buy health insurance is also true, but you can punish him for not buying it, just as we punish people for not paying taxes.

I like the suggestion that low deductibles in health insurance policies are actually cost savers because they encourage people to visit the doctor at the first sign of trouble, when the problem can probably be corrected at less cost than if they delay. However, this reasoning does not justify the low deductibles in the prescription-drug plan. They will just encourage pill popping.

Posted by posner at 10:10 PM | Comments (15) | TrackBack

February 13, 2005

Prescription Drugs and Medicare Reform--Posner

In 2003 Congress created a prescription-drug benefit program for persons enrolled in Medicare. It was estimated at the time that the program would cost the government $40 billion a year; a recent re-estimation, adding $30 billion a year, New York Times, has elicited proposals to curtail the benefit.

Given Medicare, I do not think that there is a principled objection to including a prescription-drug benefit in it. Suppose Medicare were limited to hospital treatment. Then critics would say, that’s absurd—it will only impel people to get hospital treatment that would cost society (though not the patient) less in a non-hospital setting. It is similarly questionable to exclude prescription drugs from Medicare coverage. Drugs are substitutes for other forms of medical treatment in many situations; therefore excluding them from coverage will induce people to seek other forms of treatment that may cost society more to provide. This means, by the way, that in calculating the net social cost of the prescription-drug benefit, the cost of other treatments for which drugs, with their cost to the patient reduced by the Medicare subsidy, will substitute should be subtracted. Concern has been expressed that increased demand for drugs may increase their price. That is unlikely. The principal cost of drugs is R&D. The manufacturing cost is slight; and therefore an increase in output brought about by increased demand should, if anything, reduce average cost and hence, given competition, price.

The real issue is not the prescription-drug benefit but the overall cost of Medicare; currently (that is, without the prescription-drug benefit) that cost is running at almost $300 billion a year, which is about 3 percent of GDP. As a matter of economic principle (and I think social justice as well), Medicare should be abolished. Then the principal government medical-payment program would be Medicaid, a means-based system of social insurance that is part of the safety net for the indigent. Were Medicare abolished, the nonpoor would finance health care in their old age by buying health insurance when they were young. Insurance companies would sell policies with generous deductible and copayment provisions in order to discourage frivolous expenditures on health care and induce careful shopping among health-care providers. The nonpoor could be required to purchase health insurance in order to prevent them from free riding on family or charitable institutions in the event they needed a medical treatment that they could not afford to pay for. People who had chronic illnesses or other conditions that would deter medical insurers from writing insurance for them at affordable rates might be placed in “assigned risk” pools, as in the case of high-risk drivers, and allowed to buy insurance at rates only moderately higher than those charged healthy people; this would amount to a modest subsidy of the unhealthy by the healthy.

Economists are puzzled by the very low deductibles in Medicare (including the prescription-drug benefit—the annual deductible is only $250). Almost everyone can pay the first few hundred dollars of a medical bill; it is the huge bills that people need insurance against in order to preserve their standard of living in the face of such a bill. But government will not tolerate high deductibles when it is paying for medical care, because the higher the deductible the fewer the claims, and the fewer the claims the less sense people have that they are benefiting from the system. They pay in taxes and premiums but rarely get a return and so rarely are reminded of the government’s generosity to them. People are quite happy to pay fire-insurance premiums their whole life without ever filing a claim, but politicians believe that the public will not support a government insurance program—and be grateful to the politicians for it—unless the program produces frequent payouts. If Medicare were abolished, the insurance that replaced it would be cheaper because it probably would feature higher deductibles; it is true that low deductibles are common in many forms of private insurance, such as automobile collision insurance, but I think it would be different in the case of health insurance simply because private health insurance for the elderly, with no Medicare crutch, would be very costly. The premiums would be much lower with high deductibles.

I do not think, however, that total expenditures on medical care would decline markedly if Medicare were abolished. The reason is the enormous value that the vast majority of people place on longevity, good health, and freedom from pain and other physical discomfort. (And, given this value, why shouldn’t people who can afford to pay for it be required to do so rather than be subsidized by the taxpayer?) Pursuing a theme in my posting on social security, young people may be unwilling to pay for health insurance that will cover their expenses generously when they are old. But when they reach old age they will demand treatment whether they have insurance or not, and no one who has a serious medical condition is refused treatment in this country although he or she may have to settle for less-than-cutting-edge treatment in a public hospital. To prevent this free riding, a scheme of compulsory health insurance would have to require generous coverage in old age; and so aggregate health costs might not be much lower than under the present system, although with higher deductibles and copayments there would be some reduction.

The explanation usually offered for the fact that a substantial fraction of the population has no health insurance is that these are unfortunate people who cannot afford health insurance. A better explanation is free riding. A person who has no assets lacks a compelling reason to buy medical insurance; he will be able to obtain medical treatment free of charge, as a charity patient. A person who does have assets but is young and healthy may prefer to gamble on not incurring large medical bills, rather than to subsidize the older and less healthy by being placed in the same insurance pool with them. However, these temptations to free ride provide an argument for compulsory health insurance rather than, as often argued, for socialized medicine.

The cost of Medicare (or private substitutes) will continue to rise in relative as well as absolute terms. The reason is that advances in medicine increase longevity and with it the number of years in which a person is likely to require expensive medical treatment. It would thus be desirable from a cost standpoint if medical research could be reoriented from extending the lifespan of the elderly to making the elderly healthier. It would incidentally reduce the cost of social security, because workers who become totally disabled before they reach retirement age become immediately entitled to social security. This will become an increasing problem as the normal age of social security entitlement rises from 65 to 67 pursuant to legislation passed by Congress in 1983.

But of course benefits must be considered as well as costs. If people value additional years of elderly life at more than the cost of the extension, the cost may be worthwhile, though it doesn’t follow that it should be subsidized.

Young people find it strange that such a large fraction of overall medical expenses is incurred in the last few months of life—that is, by people who are dying. (Last-year-of-life medical care accounts for 26 percent of Medicare expenditures and 22 percent of all medical expenditures. PubMed. ) Having nothing to look forward to, why are they willing to spend so much on a meager extension of life? There are several reasons. One is that a good deal of end-of-life medical care is devoted to reducing suffering rather than to extending life. Another reason is uncertainty as to whether one is really dying. Another is that the (private) cost of care, however extensive, is negligible for persons who are covered by both Medicare and private “medigap” insurance that pays for the copayments that Medicare requires. Still another reason for the heavy loading of medical expenses at the end of life is that for people who do not have a strong bequest motive, the opportunity cost of money spent in their last period of life is negligible because they will not be able to spend any money saved during that period.

Posted by posner at 10:08 PM | Comments (53) | TrackBack

Comments on Medicare Reform-BECKER

Total medical costs are about 15 per cent of GDP, and are continuing to rise. Medicare is some 20 per cent of this total, and its share will grow significantly in the coming decades as the population ages, and as new medical technologies develop. Many people are under the misperception that aging of the population is the main driver of the growth in medical expenses, but health economists have demonstrated that this is false. The more important reason is greatly increased medical spending at each age, especially at older ages. Expensive treatments and drugs have been developed to treat heart conditions, cancers, and other diseases, to replace and repair hips and other parts of the body, and simply to keep people alive.

A reasonable question would be why complain since the value placed on advances in both the quantity and quality of life at older (and younger) ages have far exceeded the increased spending on medical care- my colleagues Kevin Murphy and Robert Topel have demonstrated this in important studies. But the system can be made much better, as long as changes bolster the weak parts of the American medical system, and do not tear down the many strong parts.

I concentrate these brief comments on one problem only, the excessive use of hospitalization and expensive surgeries under both private and public systems of payment. One major reason for this excessive use depends on “political” considerations, while the other depends on economic reasons.

Politically, it is very difficult to prevent expensive treatments from being used by persons who gain little. To take one of many examples, removal of the prostate after detection of prostate cancer may be the best treatment for a younger person, but makes little sense for someone in his late ‘70’s or 80’s. Yet it is usually impossible to force patients who want that surgery to take instead much cheaper and more appropriate options, such as hormonal deprivation therapy, or doing nothing (“watchful waiting”).

Given that the U.S. is unlikely to be able to prevent excessive use of expensive options, we should try to find more approaches that are relatively cheap to use to treat additional patients, even when those patients are better treated in other ways. New drugs and improved understanding of the medical value of proper nutrition may both have high development costs, but they are cheap to extend to additional users, especially after patents expire and cheap generics enter. By contrast, hospitals have relatively constant costs of adding additional patients.

So I agree with Posner for this reason mainly, but also for the reasons he gives, that medicare and other medical systems should include drug coverage. The potential of drugs to reduce the total cost of treatment is provided by the evidence on costs of the antidepressants developed during the 1990’s. A recent study in the Journal of Clinical Psychiatry shows that spending on anti-depressants increased from about $400 per depressed person in 1990 to about $1399 in 2000, but total spending per depressed person declined because expensive hospital stays fell by a lot. Moreover, antidepressants also allow many formerly depressed persons to lead reasonably normal lives.

Unfortunately, the 2003 Act that introduces drug coverage under medicare has serious flaws that needlessly increase its cost to the very high levels recently revealed by a government recalculation. For persons who elect this coverage, it pays fully up to the first $250 per year of drug expenses, then has no coverage-the famous “donut”- for additional drug expenses in the middle range, and finally it has insufficient coverage at the very high end. The total cost of this program could be significantly cut while eliminating the “donut” and raising high-end coverage by adding a sizeable deductible, perhaps as large as $1000. Incidentally, a not very well understood puzzle is why both private and public systems of medical payments, and also other types of insurance, generally have foolishly low deductibles.

Another way to cut excessive use of medical care is to end the free riding by the approximately 40 million uninsured individuals who receive cheap care at emergency rooms of all hospitals, and as in-patients in public hospitals. To prevent that, everyone should be required to buy at young ages private catastrophic medical insurance that can be automatically extended. Medicaid would cover the poor who cannot afford to pay for this insurance (I cannot address the many problems of Medicaid here). Catastrophic insurance provides people with protection against their greatest fear: diseases and disabilities that require expensive treatments which they cannot afford.

A third important change would be to encourage tax-free medical savings accounts that allow unused medical balances to be carried over from year to year. The advantages of medical saving accounts with carry over provisions is that they encourage economizing on non-catastrophic medical expenses, which would help take further waste out of the present system.

Once these three reforms are in place, we can then start to “privatize” the medicare system for the elderly, except for those elderly who are poor enough to qualify for a government program like Medicaid that pays for their medical needs. The privatization of medical coverage of the elderly would be the dual to my proposal last week to privatize retirement incomes.

While reform of pay as you go social security gathers most of the headlines, the value of the looming “crisis” in the medicare system for the elderly is much bigger. Privatizing medicare would prevent that crisis from developing if combined with a system of compulsory catastrophic medical coverage, medical savings accounts, and greater emphasis on treatment by drugs and nutrition rather than by hospitalization and surgery.

Posted by becker at 9:59 PM | Comments (6) | TrackBack

February 12, 2005

Social Security--Posner Response to Comments

Some of these excellent comments put me in mind of the following crude but suggestive way of stating the difference between liberals and conservatives: liberals think that the average person is good but dumb, conservatives that he or she is "bad" (in the sense of self-interested) but smart. Liberals trust the intellectual elite (because they are good) to guide the masses (because they cannot guide themselves); conservatives distrust the elite (because the elite are bad and therefore dangerous) and think the masses can guide themselves. So in the social security debate, liberals oppose private accounts because they do not think the average person competent to manage money for retirement but think government can be trusted to manage it; conservatives support private accounts because they give the opposite of the liberals' answers to the goodness and competence questions.

The basic contrast that I have suggested (something of a caricature, I admit) between the liberal and conservative world views has a further implication for the social security debate. Beleving that people are good and therefore never, or at least very rarely, deserve to be poor, liberals favor redistribution of wealth from rich to poor, which a self-financed retirement system would be incapable of bringing about because everyone would be paying for his own retirement rather than for the retirement of others. Conservatives recognize that people can be unlucky, and also (because in the conservative view people are "bad") that the elderly may free ride on their children, and on these grounds support public welfare for the indigent elderly.

Several comments take issue with my suggestion that social security is prone to politicization because the elderly vote disproportionately to their percentage of the population. The commenters argue that the young could vote more if they wanted to and if they don't, it suggests that they are content with the status quo. I disagree on two grounds. The first is that the cost of voting is greater for the young because they are more likely to be employed and therefore to have a high opportunity cost of time--not only time spent voting but also time spent studying the candidates and the issues. Second, children are disfranchised. This creates serious distortions in public policy. For example, it would make better sense to subsidize health care for children than for old people, because in the first case one would be adding to the stock of human capital. I have argued that each parent should be given an extra one-half vote for each of his or her children, in order to redress the arbitrary imbalance of political power in favor of the elderly.

I would like to underscore a point made by Becker. Compelling and providing are separable. There are good reasons to require people to save for their retirement just as there are good reasons to require children to be educated. But in neither case does it follow that the government should provide the required service. That decision should depend on the relative competence of the public and private sectors in producing particular products and services.

Posted by posner at 2:44 PM | Comments (21) | TrackBack

Response to Comments on Social Security Privatization-Becker

Plenty of comments and some quite good. Too many to answer in detail, so I pick out a few highlights.

I made political aspects of government behavior with regard to pay-as-you-go social security the cornerstone of my argument for privatization. I emphasized the substantial lowering of retirement ages in the U.S. and elsewhere-this is a fact not disputed by anyone who has studied the experiences of Europe, and North and South America-- the political determination of benefits that has little to do with a sensible welfare program for the elderly, and not the least, that governments tend to spend the “surplus” on social security accounts (and other tax revenues) rather than saving them for future generations.

Some comments suggest it would be easier to keep the present system and just get rid of these political defects. If only that were possible, governments could operate most industries very well! But I argued these “merely” political defects are intrinsic to a government operated social security system since they occur in pretty much every single pay-as-you-go system, including the European and South American ones.

The case for privatization of different industries throughout the world has always ultimately rested on similar “political” defects in government-run enterprises. As an example of government behavior, publicly owned banks in China continue to make capital available to government enterprises, even though these enterprises for the most part have no chance of ever repaying these “loans”.

Some government involvement in a private system is necessary, especially if, as in my system, there is a guarantee to all retirees of a minimum standard of living. I suggested the use of index funds for private retirement social security accounts as a way to keep government involvement in the new system to a minimum.

The index fund industry is easy to enter, and so is very competitive. Since it involves minimal buying and selling of stocks and bonds, and no research on picking “winners”, this industry has very low administrative charges. So private accounts under this system would most definitely not have high administrative management costs. Moreover, these funds still provide individuals with choice since they can and do vary the fraction of their assets allocated to bonds vs stocks. Those savers who are very risk averse could choose funds with high bond-stock ratios.

Moreover, one should not oversell the low cost of the present social security system. The government managed social security system until recently gave individuals little choice and information about their accounts, and still gives little updating of payments and expected benefits. The cost of promoting and selling cars would be greatly reduced too if they were all produced by the government and were all the same kind. That was the Soviet method, not one to be envied. Private funds would be more costly to operate, but they would give more choice and information as they compete for customers. Index funds, in particular, would still have very low administrative expenses, as exemplified by Vanguard.

It is inconsistent to complain about the low savings in U.S. and object to a system that is likely to increase savings, much of which would be invested in equities. Higher savings would reduce dependence on foreign investments in the country, and would make more domestic capital available to be invested. Is that bad?

Withdrawals upon retirement or reaching a fixed age would be either in a lump sum, or spread out on an actuarially-determined basis. Individuals who are “worried” (not a bad worry!) about living longer than average could save part of their withdrawals. To be sure, some persons might underestimate the amounts needed because they live longer than average, and some of them would fall below the minimum income guaranteed level. If that is considered a problem, the actuarial calculations could err on the conservative side.

Some of you were dubious about my argument that governments tend to spend any surplus. But that is not theory alone, it is also fact, as shown in a Journal of Law and Economics Article of October 2003 by my colleague Casey Mulligan and myself. We look at several types of evidence from different countries, and from US history. Not included in our discussion, but valuable additional evidence comes from the 1990’s. Federal spending was first kept down by deficits, but then both Federal and state government spending grew rapidly with the sharp increase in tax revenues during the boom years at the end of the century. This pattern indicates that the large current federal deficits will force a slowdown of government spending growth during the next several years. Privatization would significantly increase the pressure on spending by removing some personal retirement savings from government revenues.

I do believe that one of the most important obligations of a decent government is to provide a safety net for individuals and families who, for one reason or other, are in bad economic circumstances. My proposal does take care of the elderly who fall into this category since I support a minimum income floor for all retirees. Contrary to comments that complain my proposal would not have a “progressive” structure, this floor does give the payout system a sizeable progressive element.

I conclude by emphasizing that privatizing any government activity, including social security programs as well as many others, does presume some confidence in the ability of the great majority of individuals and families to look out for their own interests, however they define them, in a market-oriented competitive environment. To be sure, people make mistakes, but the crucial issue is whether they can usually promote their own interests better than government officials and bureaucrats can do it for them. I have great confidence in the ability of even the poor and less educated to generally look out for themselves, however limited are the opportunities available to them. Judging from some but far from all the comments, many of you do not have that confidence in people.

Posted by becker at 12:12 PM | Comments (60) | TrackBack

February 6, 2005

Why I Support a Privatized Individual Account Social Security System-BECKER

Today both Republicans and Democrats are passionately arguing about the future of social security. Although there is merit in each side’s argument, neither side is portraying the situation accurately. In my view, movement toward a privatized individual account social security system offers the best option, where individuals save and accumulate assets to provide for their retirement.

It is true, as the critics correctly observe, that there is no magical gain in privatizing since all systems have to provide incomes for retired persons. But there is also no magical gain in privatizing a government steel plant since steel still has to be produced, yet there are good reasons to privatize steel. I also believe that there are excellent reasons to aim for a privatized individual account social security system.

Pay as you go social security started first in Europe as a relatively easy way to provide a minimum standard of living for the elderly. It was introduced in the United States during the 1930’s partly also to discourage the elderly from competing for jobs when unemployment of younger workers was staggeringly high. It was a cheap system then because there were more than 10 workers per retired person, so the social security tax could be small relative to the benefits received by retirees. Indeed, the first several generations of retirees earned very high returns in retirement income on their accumulated social security tax payments.

But as birth rates fell drastically, and the life expectancy at age 60 expanded enormously, fewer workers are now being forced to support more and more retirees. The result is a huge rise in social security taxes in every nation with a pay as you go system. The combined tax on employees and employers in the United States, excluding contributions to medicare, is now 12.4 per cent and rising, and that percentage is much higher in Japan and most Western European nations. The expectation of continuing growth in this tax rate explains why countries as different as Sweden and Great Britain have partially moved toward a privatized individual account system. It also helps understand why Hong Kong, Poland, and other countries with low birth rates that recently introduced social security have important components of individual accounts in their systems.

I do not believe that the main advantage of a private account system is that individuals can get a higher return on their old age savings by investing in stocks. There are no free lunches from such investments since the higher return on stocks is related to their greater risk and other trade offs between stocks and different assets. However, neither is there any special “transition” problem in moving to a fully funded privatized system since future generations in some way or another have to pay for the implicit debt due to commitments toward present and future retirees. But it is better to transit smoothly to fund this debt rather than require a sharp increases in taxes on later generations.

Retirees for whom social security income is not a major part of their retired assets will invest much of their own savings in stocks. Studies indicate that this is precisely what they generally do with their IRA’s in order to have a balanced portfolio between stocks and the implicit social security assets guaranteed them. Since lower income men and women accumulate few assets other than their social security assets, a fully funded system through personal savings would enable them to have more balanced portfolios between stocks and bonds.

If there is no obvious gain from allowing most individuals to invest in stocks to help cover their retirement, and if there is no fundamental transition problem, what, if any, are the advantages of a funded privatized system? I believe the advantages are mainly political, not “economic”, that privatization helps to separate saving for retirement from interest group politics, taxation, and government spending.

Pay as you go systems are in trouble throughout the world in good part because of changes in the number of workers per retiree, but also because of politically determined decisions that changed the system from saving for old age to an inefficient and complicated welfare system for some of the elderly. For example, despite the growing mental and physical health of older persons, political pressures in all nations with pay as you go systems forced a restructuring of social security payouts to encourage retirements at earlier ages than even the originally established age 65. In the United States many retirements occur age 62 or earlier, while Italians retire frequently while in their mid fifties, and very early retirement is not uncommon also in Germany, Belgium, and many other European countries.

In addition, the link between contributions and benefits has been separated, so that each additional dollar contributed in taxes pays on the average no more than about 40 cents in additional benefits. Hence, the social security system has evolved into two largely independent systems: a sizeable tax on wages, starting with the first dollar earned, and retirement benefits that are ‘guaranteed” by the government. There is only a modest link from an individual’s accumulated tax payments on his earnings to these “guarantees”.

Just as important are the political implications of Federal fiscal behavior. Tax revenue from social security taxes at present exceed payments to retirees. This excess is counted as part of the growing Social Security Trust Fund, but in fact also enters into the consolidated Federal budget account, and helps reduce the reported spending deficit. Reported deficits during the past decade would have been much larger if social security was not running a surplus during this whole time period.

Social security tax revenues are expected to fall below spending on retirees in about 20 years. If we simply raised social security taxes now-say by two percentage points- consolidated federal deficits would appear much smaller, and the federal government would be under less constraint to reduce spending. Both theory and evidence indicates that a good fraction of the additional revenue would indeed be spent. “Putting aside” assets for the future is very difficult for all governments, subject as they are to immense demands for spending now from various interest groups.

A good individual funded savings system would require people to save 4-6 per cent of income (President Bush suggests 4 per cent), and invest these savings in private individual accounts that would meet certain government established criterion. At the same time, social security taxes should be cut by a couple of percentage points from its present level to ease the burden on workers. These taxes could be cut since younger workers would then be contributing to their own retirement. Moreover, a tax cut would reduce the social security surplus, so the government would be less tempted by rapidly growing social security “reserves”.

These private accounts would accumulate tax-free until individuals decide to retire. The age of retirement within broad limits would be left to individual choices, but funds would continue to grow with savings for persons who retire at later ages because they like their work and are in good health-this basically is how IRAs work. At retirement, individuals would get access to their assets, either in a lump sum or as an annualized income, and they would then pay taxes on their withdrawals.

As in Chile and other countries with private retirement accounts, the government would guarantee every retiree a minimum income-similar to but larger than the minimum social security guaranteed income under the present United States system. Unfortunately, such guarantees create a “moral hazard”; that is, savers may want to make risky investments that give high payoffs if they succeed since the government partly bails them out if they fail. Or they may not save at all. The minimum required savings rate overcomes the latter incentive to “game” the system, and regulation of which types of investment accounts are approved takes care of the incentive to be overly risk-taking.

We should follow the President’s proposal, and only allow index funds for social security accounts- that is, funds that do not try to beat the market and invest in a balanced market portfolio of stocks and bonds. Individuals who are contributing more than the 4 per cent minimum could take greater risks if they want to since they do not pose any moral hazard from bad investments on these larger accounts. Index funds both reduce the overall risk of an account, and have very low management fees since it is quite cheap to run these funds, as shown, among others, by Vanguard and Barclays. High management fees is a common complaint about the Chilean system, although this system has yielded high returns to investors even net of these fees, and the fees have come down a lot in recent years.

There is no guarantee that government interference would not increase further in such a privatized system since the retired would continue to press for additional benefits. But experience shows that governments interfere less when an industry is privatized than when it is a public enterprise, especially in access to capital and financing of industry budget deficits.

So the really strong arguments for privatization are that they reduce the role of government in determining retirement ages and incomes, and improve government accounting of revenues and spending obligations. All the other issues are really diversions because neither advocates or opponents of privatization are asking the most meaningful question about privatizing social security: Is there as strong a political economy case for eliminating government management of the retirement industry as there is for eliminating their management of most other industries? My answer is “yes”.

Posted by becker at 10:42 PM | Comments (66) | TrackBack

Social Security Reform--Posner

One of the commonest objections to President Bush’s proposal for reform of social security is that there is no need to act now because there is no “crisis.” Yet the same people who say this are wont to say that a weakness of government is its failure to take the long view. Politicians have a short time horizon because they have limited terms of office and are therefore reluctant to address a problem that lies in the future even if the problem could be solved more easily before it assumes crisis proportions. The increasing burden of social security, owing to the declining ratio of workers to retirees, is a problem easier to solve now than when a continued decline in that ratio (it was 3.3 in 1996 and is expected to be only 2 by 2030) brings on a fiscal crisis necessitating either steep tax increases or drastic benefits cuts (one form of which would be raising the retirement age), or both. In 1983 Congress raised the retirement age for full social security benefits from 65 to 67, thus reducing liftetime benefits. But the legislation provided for phasing in the increase over a 22–year period beginning in 2003, which made the discounted present cost of the reduction in benefits negligible for prospective retirees.

With the social security “crisis” still in the future, it is possible to begin now to change the system in the direction of a genuine retirement program, that is, one in which people pay for their own retirement rather than having it paid for by current workers. With that shift, it would no longer matter what the ratio of workers to retirees was.

The shift is independently desirable. Having people pay through the tax system for other people’s retirement produces a capricious redistribution of income. The elderly have disproportionate voting power: a higher percentage of elderly than of other age groups vote, and they tend to focus laser-like on issues that affect their pocketbook.

The shift can be made painless to present and imminent retirees (anyone over 55, say) by keeping benefits at their current level. However, if younger workers are required to place a percentage of their income in a retirement fund, those who do not want to reduce their disposable income by that amount will perceive the requirement as an increase in their taxes, and will squawk. If to quiet them taxes are reduced, the federal deficit will grow because benefits are not being cut. Eventually, fiscal equilibrium will be restored, but until then, the political price paid for the reform may be high.

Deficit spending, financed by government borrowing, may be economically superior to higher taxes or inflation, but to the extent that the lenders are foreign, the payment of interest on the loans will transfer wealth from Americans to foreigners.

The issue of compulsory pensions should be decoupled from that of welfare. Some people cannot save enough to be able to retire on; the government should guarantee them a decent retirement income. Those are the only people whose retirement should be financed by other people, that is, by taxpayers. All others should be required to finance their own retirement. This applies to health costs as well as to other expenses of retirement. Just as social security should be for people who can’t save enough to retire on, so medicare should be for people who can’t save enough to buy health insurance for their old age. It is ridiculous that people with Becker’s income or my income should be receiving social security and medicare benefits, except insofar as those benefits have actually been financed by our payments of social security taxes rather than by taxes on workers.

Extreme libertarians will challenge the assumption that people should be compelled to save for their retirement. They will say that people should be allowed to allocate their income over their life span as they choose; if they choose to allocate nothing to their old age, then let them starve. I do not agree with this position, and for two reasons. First, I believe it is plausible to model the individual as a succession of selves with different preferences. A young person may dislike the idea of growing old and may be inclined therefore to refuse to make provision for his old self. The old self—the self that will not emerge and “take over” the individual for many years—has no control over the decisions of the young self. Compulsory retirement saving gives the old self a “voice” in the decisions of the young self.

Second—and a point actually consistent with libertarian thinking—these improvident oldsters will in fact free ride on their children and grandchildren. This, however, suggests an argument (made in my book Aging and Old Age [1995]) for the existing pay-as-you-go system, as distinct from one in which people finance their own retirement. If by lifting the burden of elder care (or much of it, at least) from the shoulders of one’s children, social security confers a benefit on the children, they should be expected to pay for it. A distinct but related point is made by Becker in his book A Treatise on the Family (enlarged ed. 1991). He points out that parents’ payment of school taxes finances their children’s education (and hence earning power), and social security can be regarded as repayment to the parents in their old age. The larger the family, the greater the aggregate benefits to the children of a “free” public education, but also the greater social security taxes they pay (because there are more of them). The benefit to the children of shifting the elder-care responsibility is probably independent of family size, since parents’ need for such care is independent of the number of children they have.

But the matching of benefits and costs under the pay-as-you-go system is both very crude and highly politicized. Compulsory retirement saving would protect children from parental demands for old-age care; and education, like retirement, could be made self-financing, though with appropriate subsidies for children whose parents cannot afford to educate them.

Posted by posner at 10:12 PM | Comments (26) | TrackBack

February 4, 2005

The Summers Controversy--Posner's Response to Comments

As always, there were many illuminating comments. I shall try to respond to a few, but I want first to direct readers to the article in this morning's New York Times about the controversy. In it we learn that Summers has apologized not once, but "repeatedly," for having raised questions about women's innate scientific abilities, and that he has now appointed two task forces (comprising a total of 22 women and 5 men) to present proposals for increasing the number of women on the Harvard faculty. He has, in short, capitulated (and rather abjectly, it seems to me--why two task forces?). The response by his critics has been ungracious. They remain guarded and suspicious--he is on probation--and they will no doubt press him for further measures. He is now effectively committed to affirmative action for women scientists. Yet of all the nation's problems, and all the claims for affirmative action, the underrepresentation of women on the science faculties at Harvard must be among the least important.

Some of the comments suggest that the real significance of Summers's January 14 remarks was to demonstrate that universities are no longer citadels of free speech, though that cannot have been his intention. One comment compares his apology to the confessions of Stalin's purge victims: "Everyone should oppose a 'signal of discouragement to talented girls and women.' [That is a quotation from Summers's first apology.] But the truth is that such a signal, to the extent it occurred, resulted from deliberate, intense, and misleading responses to his remarks. That's classic totalitarian suppression of an unpopular view, with forced public acknowledgment of guilt and forced repudiation of the 'wrong.'" Another comment quoted: George Wills: "Forgive Larry Summers. He did not know where he was...He thought he was speaking in a place that encourages uncircumscribed intellectual explorations. He was not. He was on a university campus."

But no one who has spent much time around universities thinks they've ever "encourage[d] uncircumscribed intellectual explorations." The degree of self-censorship in universities, as in all institutions, is considerable. Today in the United States, most of the leading research universities are dominated by persons well to the left of Larry Summers, and they don't take kindly to having their ideology challenged, as Summers has now learned to his grief. There is nothing to be done about this, and thoughtful conservatives should actually be pleased. As John Stuart Mill pointed out in On Liberty, when one's ideas are not challenged, one's ability to defend them weakens. Not being pressed to come up with arguments or evidence to support them, one forgets the arguments and fails to obtain the evidence. One's position becomes increasingly flaccid, producing the paradox of thought that is at once rigid and flabby. And thus the academic left today.

One comment makes the interesting point that Summers's post-apology position implies indefinitely deferring any inquiry into possible innate differences in science abilities. The reason is the insistence that before those differences should be studied, every other possible cause--social, economic, psychological, political--for the differences in male and female career choices be studied and eliminated. But many will not be eliminated, not soon, at any rate; some, indeed, may be secondary to innate differences. A serious scholar does not order his or her research priorities by their political inoffensiveness.

Such an ordering reflects a methodological fallacy as well as an ideological commitment. It is the fallacy of mechanical extrapolation. In the past, differences between races, the sexes, groups defined by ethnicity, nationality, or even sexual orientation, were exaggerated, and as the exaggerations are identified and unmasked, discrimination declines; it has declined greatly. And now we have an animal rights movement that claims (with some justice, I might add) that differences in cognitive capacity between human beings and other animals have been exaggerated; and there are even proposals afoot to give some of our fellow primates human rights. So it is natural, but it is also fallacious, to assume that eventually all differences (well, almost all), certainly including different career patterns, that are correlated with immutable (or near-immutable) characteristics, such as sex, will disappear; and so let us jump on the bandwagon of history and speed the process. But not only are the costs of trying to speed up history ignored; there is no reason to expect the trend toward less and less differentiation of careers by race, sex, etc. to continue. It could stop at any time. In 1950, looking back at the enormous strides made by labor unions to organize the American workforce, one might have expected that by now 100 percent of the workforce would be unionized. In fact the percentage of unionized workers has fallen precipitately and is now about where it was in 1900.

One further note: several comments point out that genetic factors can influence preferences as well as capabilities. Even if women are just as capable of doing science at the Harvard faculty level as men, it is possible that fewer women than men find a career in science congenial. This might or might not reflect innate differences. One notes the enormously greater percentage of men than of women who are in prison. Could not this "discrimination" reflect innate differences in attitudes toward violence, risk, and transgression?

And a final, slightly technical note: yes, another way to express increased variance and therefore longer tails in one distribution than in another is to say that the standard deviation is greater.

Posted by posner at 3:07 PM | Comments (44) | TrackBack