December 30, 2007

The Liberal Skew in Higher Education--Posner

It is no secret that professors at American colleges and universities are much more liberal on average than the American people as a whole. A recent paper by two sociology professors contains a useful history of scholarship on the issue and, more important, reports the results of the most careful survey yet conducted of the ideology of American academics. See Neal Gross and Solon Simmons, “The Social and Political Views of American Professors,” Sept. 24, 2007, available at http://www.wjh.harvard.edu/~ngross/lounsbery_9-25.pdf (visited Dec. 29. 2007); and for a useful summary, with comments, including some by Larry Summers, see “The Liberal (and Moderating) Professoriate,” Inside Higher Ed, Oct. 8, 2007, available at www.insidehighered.com/news/2007/10/08/politics (visited Dec. 29. 2007).) More than 1,400 full-time professors at a wide variety of institutions of higher education, including community colleges, responded to the survey, representing a 51 percent response rate; and analysis of non-responders indicates that the responders were not a biased sample of the professors surveyed.

In the sample as a whole, 44 percent of professors are liberal, 46 percent moderate or centrist, and only 9 percent conservative. (These are self-descriptions.) The corresponding figures for the American population as a whole, according to public opinion polls, are 18 percent, 49 percent, and 33 percent, suggesting that professors are on average more than twice as liberal, and only half as conservative, as the average American. There are interesting differences within the professoriat, however. The most liberal disciplines are the humanities and the social sciences; only 6 percent of the social-science professors and 15 percent of the humanities professors in the survey voted for Bush in 2004. In contrast, business, medicine and other health sciences, and engineering are much less liberal, and the natural sciences somewhat less so, but they are still more liberal than the nation as a whole; only 32 percent of the business professors voted for Bush--though 52 percent of the health-sciences professors did. In the entire sample, 78 percent voted for Kerry and only 20 percent for Bush.

Liberal-arts colleges and elite universities are even more liberal than other types of institution of higher education. In liberal-arts colleges, the percentages liberal, conservative, and moderate are 62 percent, 4 percent, and 35 percent, respectively; and in elite universities the figures are 44 percent, 4 percent, and 52 percent. Professors in the 26 to 35 year-old age range are less liberal and more moderate (though not more conservative) than older professors, which I attribute to those youngsters' having reached maturity after the collapse of communism. It is thus no surprise that only 1 percent of the young professors describe themselves as "left radicals" or "left activists," compared to 17 percent of those aged 50 or older.

The summary in the Gross-Simmons paper of the previous literature on professorial political leanings finds that, at least since the 1950s, American college and university faculties have been more liberal than the nation as a whole, but that the liberal skew is more extreme today than it was in the 1950s. This is my experience. Between 1955 and 1962 I was a student at Yale College in the humanities and then at the Harvard Law School, and neither the humanities faculty at Yale nor the Harvard Law School faculty was noticeably liberal (the former was actually rather conservative), and I mean by the standards of that era, not by today’s standards. Today both institutions are notably liberal, though the present dean of the Harvard Law School has been attempting with considerable success to make her faculty politically more diverse. The Gross-Simmons study notes that the liberal skew is not limited to the United States, but is found in Canada, Britain, and much of Continental Europe, as well.

The survey results raise two questions: What is the explanation for the results? And what are the consequences? I address only the first question.

There is nothing mysterious about the fact that the members of a particular occupational group should have a different political profile from that of the population as a whole. A 1999 survey of U.S. military officers found that 64 percent were Republican, 8 percent Democratic, and 17 percent independent. In contrast, a 2002 study found that 40 percent of journalists are liberal and 25 percent conservative--a breakdown similar to but much less extreme than that of professors.

The conservatism of military officers is easy to understand--conservatives are much more favorable to the use of military force, and to the values of honor, personal courage, discipline, hardiness, and obedience, which are highly prized by the military, than liberals are. And the liberalism of journalists probably reflects the tastes of their readers; in my 2001 book Public Intellectuals: A Study of Decline, I found that the liberal-conservative split among public intellectuals (roughly 2 to 1) corresponded to the ratio of the circulation of liberal newspapers and magazines to the circulation of conservative ones.

It is tempting to conclude that the liberal bias of journalists and professors (especially in the humanities and social sciences) is the same phenomenon--the liberalism of the "intelligentsia," usefully defined by the Merriam-Webster Online Dictionary as "intellectuals who form an artistic, social, or political vanguard or elite." But that just pushes the question back one step: why should an intelligentsia be liberal? Because intellectuals are naturally critical of their society, which in the case of the United States is rather conservative, or at least not "liberal" as academic liberals understand the word? That is not a satisfactory explanation, because a society can be attacked from the Right just as easily as from the Left. Some of the most distinguished intellectuals of the twentieth century attacked social, cultural, political, or economic features of their societies from the Right--think of Martin Heidegger, William Butler Yeats, T. S. Eliot, Friedrich Hayek, and Milton Friedman. Today, in fields such as law, political theory, and economics, there is a vibrant conservative movment--the puzzle is why it is so distinctly a minority movement in the university world. Moreover, our college and university professors, especially those whose interests and background overlap most closely with those of the majority of journalists, appear to be markedly more liberal than journalists, the other major division of the intelligentsia.

One explanatory factor may be that colleges and universities select for people who are comfortable in a quasi-socialistic working environment. Virtually all colleges and universities in the United States are either public or nonprofit, there is usually salary compression within fields, tenure shields professors from the rigors of labor-market competition, and professorial compensation substitutes fringe benefits (such as tenure), leisure, and other nonpecuniary income for high salaries. The ablest academics generally have the highest opportunity costs--the brilliant chemist could get a high-paying job in the private sector, the brilliant law professor could make a lot of money as a practicing lawyer, and so forth--which suggests that the ablest academics attach especially great value to nonpecuniary relative to pecuniary income and hence are likely to feel especially alienated from a capitalist economy.

This may be one reason why elite universities are more liberal than nonelite ones. (The greater liberalism of liberal-arts colleges may just reflect the fact that such colleges employ fewer scientists and engineers, who are less liberal on average than professors in the humanities and the social sciences.) In addition, there is the curious but well-documented fact that Jews are far more liberal than their socio-economic standing would predict; they are also disproportionately found in the faculties of elite colleges and universities. Furthermore, conservatism is associated in many people’s minds with religiosity, and faculty in nontechnical fields in elite universities are rarely religious. Catholics and evangelical Christians are underrepresented in such universities. Professors who are conservative in matters of economics, crime control, and national security but liberal with regard to social issues such as abortion rights, homosexual marriage, and separation of church and state would hesitate to describe themselves as conservatives, and many would not vote Republican.

Another factor that may explain the liberal skew in the academy is political discrimination. Academics pick their colleagues, so once a department or school is dominated by liberals, it may discriminate against conservatives and thus increase the percentage of liberals. There is a good deal of anecdotal evidence of such discrimination, but the best test (though hard to "grade" in soft fields) would be whether conservative academics are abler on average than liberal ones. If conservatives are disfavored, they need to be better than liberals to be hired. Political discrimination is less likely to be prevalent in fields in which there are objective performance criteria, which may be why there is a smaller preponderance of liberals in scientific and technical fields.

Related to discrimination is herd behavior, or conformism. Despite their formal commitment to open debate, academics, like other people, do not like to be criticized or otherwise challenged. The sciences, well aware of this tendency, have institutionalized practices, such as peer review, insistence that findings be replicated, and high standards of logical and empirical rigor, that are designed to foster healthy disagreement. These practices are much less common in the humanities and the soft social sciences.

One response to discrimination or herd behavior favoring liberals in academic has been the formation of conservative think tanks; if their professional staffs were added to college and university faculties, the liberal skew would be less extreme, though the difference would not be great.

A further point also related to both discrimination and conformity bias is that once a field acquires a political cast, it will tend henceforth to attract as graduate students and thus as future professors students who share its politics, as otherwise (as Louis Menand pointed out in a comment on the Gross-Simmons study) the students may have difficulty surviving graduate school, obtaining a good starting job, and finally obtaining tenure.

My last point is what might be called the institutionalization of liberal skew by virtue of affirmative action in college admissions. Affirmative action brings in its train political correctness, sensitivity training, multiculturalism, and other attitudes or practices that make a college an uncongenial environment for many conservatives.

For all these reasons, although the weakening of left extremism in college and university faculties can be expected to continue, the liberal skew is unlikely to disappear in the foreseeable future.

Posted by Richard Posner at 5:09 PM | Comments (46) | TrackBack

Events, Field, and the Liberal Skew in Higher Education-Becker

The study by Gross and Simmons discussed by Posner in part confirms what has been found in earlier studies about the greater liberalism of American professors than of the American population as a whole. Their study goes further than previous ones by having an apparently representative sample of professors in all types of colleges and universities, and by giving nuanced and detailed information about attitudes and voting of professors by field of expertise, age, gender, type of college or university, and other useful characteristics. I will try to add to Posner's valuable discussion by concentrating on the effects on academic political attitudes of events in the world, and of their fields of specialization. I also consider whether college teachers have long-lasting influences on the views of their students.

As Posner indicates, the type of persons who go into different fields varies by the characteristics of the field, so that students who become sociologists tend to be more liberal, while those who enter accounting tend to be more conservative-see Table 8 of the Gross-Simmons study on political identification of professors by field. It is also true, however, that the nature of the material analyzed in a field affects the political identification of persons in that field. The late eminent economist George J. Stigler claimed in an article many years ago that the study of economics tends to make the student more conservative because economics emphasizes that the hidden longer run effects of many government policies have much more negative consequences than the initial direct effects. Economists also show how decentralized competitive markets contribute to the general welfare. Similarly, the study of sociology emphasizes the oppressive effects of certain social forces on particular groups, like the less educated and minorities, which influence the attitudes of sociologists toward the prevailing capitalist economic system.

Admittedly, it is difficult to see the connection between the political attitudes of professors in various other fields and the nature of these fields. For example, why do less than 4 percent of historian, according to Gross and Simmons, consider themselves Republicans, whereas 23 percent of nurses do? Perhaps one important factor is that teachers in practical fields, like engineering, nursing, and medicine, see the limitations of what can be accomplished by various types of interventions, whereas those in theoretical fields, like mathematics and literature, can dream of more utopian solutions. Still, the dichotomy between the theoretical and the practical has trouble explaining why a field like history has such liberal academics since many historians deal with various disasters brought about by government ventures.

The differences in political views by age are informative. Generally, younger men and women are more liberal than older ones since age brings experience with the limitations of what can be achieved by grandiose programs. This is captured in the old adage that goes something like "if you are not a socialist when young you have no heart, but if you remain one when you get older you have no brains". Yet Table 15 in Gross and Simmons shows that academics aged 26-35 are significantly less liberal than those aged 50 and older. I suggest that events of the past 30 years are a major reason for this age-reversal on liberal tendencies. The collapse of communism, the growth of the Asian tigers that have emphasized private enterprise and export-oriented policies, the rapid development of China and India after abandoning communism and socialism, respectively, all reduced the attractiveness of Marxist, socialist, and communist ideologies. These events had less effect on the views of older academics since their views were largely determined when older academics were young, but these events had a great influence on attitudes of younger academics since their beliefs were formed while these transforming events were occurring.

Even economists, traditionally more conservative than those in other social sciences, are now much more market oriented and less sympathetic to various forms of government intervention than they were when I was a student many years ago. During the interim, not only did communism, etc collapse, but Keynesian interventionist attitudes also lost favor, and many more studies have shown the harmful effects of different attempts at government interventions in labor and other markets. The retreat among economists from interventionist policies is found not only among American academic economists, but also among younger economists in Europe and Asia, and also to some extent in Latin America. The reason is that the same forces affected economists elsewhere as affected American academic economists. I suspect, but do not have the evidence, that younger academics in other countries are also decidedly less liberal than older ones in other fields as well.

Given the indisputable evidence that professors are liberal, how much influence does that have on the long run attitudes of college students? This is especially relevant since some of the most liberal academic disciplines, like the social sciences and English, have close contact with younger undergraduates. The evidence strongly indicates that whatever the short-term effects of college teachers on the opinions of their students, the long run influence appears to be modest. For example, college graduates, like the rest of the voting population, split their voting evenly between Bush and Kerry. The influence of high incomes (college graduates earn on average much more than others), the more conservative family backgrounds of the typical college student (but less conservative for students at elite colleges), and other life experiences far dominate the mainly forgotten influence of their college teachers.

This evidence does not mean that the liberal bias of professors is of no concern, but rather that professors are much less important in influencing opinions than they like to believe, or then is apparently believed by the many critics on the right of the liberality of professors.

Posted by becker at 4:42 PM | Comments (26) | TrackBack

December 23, 2007

The Subprime Housing Crisis -Becker

The vast majority of economists, including me, were surprised by the extent of the subprime mortgage crisis. This needs to be recognized when evaluating the numerous proposals about how to prevent the next housing crisis, and also about how to help those who are in danger of having their homes foreclosed.

Many economists and members of Congress have claimed that the housing crisis was greatly magnified because unqualified home buyers with limited incomes and assets were not fully aware of the terms of their mortgage loans, such as that the low initial (teaser) interest rates were only temporary. This belief in the beneficial effects of greater knowledge about mortgage terms is inconsistent with the evidence that the most sophisticated banks and investment companies, including Merrill Lynch, Citibank, and Morgan Stanley, have written down their housing investments by billions of dollars. No one can reasonably claim that these banks lacked the skills and knowledge to evaluate all the terms of, or the likelihood of repayment, on the subprime and other mortgages that they originated or held as assets. The losses to investors have been so large, and have so eroded their capital base, that some of the major investment companies have needed large infusions of capital from Middle Eastern and Asian Sovereign Funds (see our discussion of these funds on December 10th).

Although there was some fraud by mortgage lenders and by borrowers, fraud was not the main reason why so many subprime mortgages were issued. Otherwise savvy investors greatly undervalued the risks associated with many of the mortgage-backed securities that they held. They and borrowers alike did not fully appreciate that interest rates were likely to increase from their unusually low levels, and that many borrowers lacked the financial means to meet their mortgage repayment obligations at higher rates, and sometimes even at the low initial rates they had received.

Given the low interest rate lending atmosphere of the past few years, it is highly unlikely that borrowers would have turned down the mortgages they received if they had much better information about terms, or that lenders would have been more reluctant to originate or hold these mortgage assets if they had better information about the credit and other circumstances of borrowers. This is why I doubt that the rules proposed this week by the Federal Reserve to require lenders to get more information about borrowers, and to provide more information to borrowers about the terms of mortgage loans, would have been effective in warding off this crisis, or will be effective in preventing future crises.

Some have proposed that families should not be allowed to get mortgages if they do not meet minimum standards of income and assets, even if lenders would be willing to provide mortgages, and would-be borrowers still want a mortgage after being informed of the risks. This proposal is a dangerous form of paternalism that denies the rights of both borrowers and lenders to make their own decisions. Moreover, it is ironic that only a few years ago, banks were being investigated for "redlining"; that is, for avoiding lending to blacks and other residents of poor neighborhoods. The Fair Housing Act of 1968 prohibits discrimination in lending, and The Community Reinvestment Act of 1977 requires banks to use the same lending criteria in all communities, regardless of the living standards of residents. As a result of the present crisis, however, banks and other lenders are being criticized for equal opportunity lenient lending to all, including black residents of depressed neighborhoods.

The United States housing market is riddled with subsidies and regulations, including among many others, insurance by the Federal Housing authority of mortgages to first time and low income homeowners, tax deductibility of interest payments on mortgages –to families that itemize their deductions- and the quasi-governmental Fannie Mae and Fannie Mac Corporations that channel billions of dollars to the mortgage market. Nevertheless, both the White House and leading Congressional Democrats have proposed additional rules to help borrowers who may have difficulty avoiding foreclosure under present conditions. Treasury Secretary Paulson has been negotiating "voluntary" agreements with mortgage lenders to freeze the low introductory rates for five years on some subprime home loans, and to offer borrowers the right to refinance their loans into more affordable mortgages. The Democrats want to go much further than the administration, and have proposed, for example, to help homeowners renegotiate terms of their mortgages if forced into bankruptcy.

I am skeptical of additional government interventions into a housing market that already has too much. To be sure, homeowners who only temporarily have trouble meeting repayment schedules on their mortgages should not have to go into foreclosure. But lenders already have strong incentives to help these borrowers since lenders are also hurt by foreclosures, especially in the current weak housing market where it is not possible to sell repossessed homes at reasonable prices in poorer neighborhoods. Lenders also have much better evidence and experience than governments can ever have regarding which borrowers have a reasonable chance of handling their mortgages if given some temporary help, such as allowing selected borrowers to be in arrears on payments for a while, permitting some borrowers to renegotiate terms, and making other adjustments that raise the likelihood of eventual repayment. Lenders also are better informed about which borrowers are hopelessly in debt, and are better off going into bankruptcy rather than trying to sacrifice savings or consumption to meet their mortgage payments.

A counterargument to this skepticism is that the government should intervene further in the housing market because the Fed is partly responsible for the crisis by keeping interest rates artificially low. Perhaps the Fed did keep the federal funds rate too low for a couple of years preceding the onset of the crisis, but low interest rates were found worldwide. The main reason for the low rates was not the Fed, but the high savings rates in China and other rapidly developing nations that put pressure on interest rates all over the world.

Instead, the Fed, Treasury, and Congress should concentrate on using monetary and possibly taxl policies to help maintain the strength of the American economy that has so far done well despite the housing crisis. If these policies can help promote continued growth of GDP, probably for several months at a slower pace than during the past few years, with a robust labor market and low unemployment, borrowers in reasonably good economic shape will likely keep their homes as they navigate through the housing crisis.

Posted by becker at 4:24 PM | Comments (25) | TrackBack

The Subprime Mortgage Mess--Posner's Comment

The turmoil in the housing finance market raises fascinating questions. I shall offer some brief thoughts on the principal ones.

1. Surprise. I have been preoccupied in recent years with the subject of intelligence failures, about which I have written several books. The subprime mortgage "crisis" follows a classic pattern that should help us to understand the inevitability of intelligence failures (Pearl Harbor, the Tet Offensive, the Egyptian-Syrian surprise attack on Israel in October 1973, 9/11, and so on ad nauseam). These failures typically are not due to lack of essential information or absence of warning signs or signals, but to lack of precise information concerning time and place, without which effective response is impossible except at prohibitive cost. Alarms over risky mortgage practices had been sounded for years, and ignored for years. Someone, whether a home buyer or an investment bank buying home mortgages, who had heeded the warnings when they were first made, or indeed until years later, would have left a good deal of money on the table.

2. Bubbles. There were two bubbles: a housing bubble, and an investment bubble. The bubble phenomenon is related analytically to the phenomenon of surprise just discussed. A bubble begins when prices, in this case of housing, begin rising at a rate that seems inexplicable in relation to demand. No one knows how high they will rise. In conditions of uncertainty, there is a tendency to base expectations on simple extrapolation: if prices are rising, they are expected to continue to rise--for a time, but no one knows for how long a time. There is a reluctance to act as if they will not continue rising, for by doing so one is leaving money on the table. As a bubble expands, the rational response is to reduce risk, without forgoing profit, by getting in and out of the market as quickly as possible. The increased trading may keep the bubble expanding.

3. Ignorance. It has been argued that the people who took out subprime mortgages with adjustable interest rates did not understand the risks they were assuming, and that the banks that bought mortgage-backed securities did not understand the risks they were assuming. I am skeptical. Suppose you have a low income, you'd like to own a house, and a mortgage broker offers to arrange a mortgage that will cover 100 percent of the price of the house. What do you have to lose by accepting such a deal? Since you haven't put up any capital, you have no capital to lose if you lose the house because you cannot make your monthly mortgage payments. As for the banks, they rode the bubble for too long; but, to repeat, had they got out too early, they would have left a lot of money on the table.

4. Asymmetry of Risk. Bubbles are more likely to occur when downside risk is less than upside risk. My example of the asset-less home buyer illustrates the point. The savings and loan "crisis" of the 1980s was exacerbated, or perhaps even created, by the fact that federal deposit insurance was not experience-rated: savings and loan associations paid the same rates regardless of the riskiness of the loans that they made with the depositors' money. Since the potential loss to depositors was truncated, there was an incentive to take excessive risks. CEOs of banks, as of other large, publicly owned firms, face asymmetrical risk too. If the bank is profitable, the CEO's compensation soars. If his investment gambles fail, he may be fired, but he will be consoled by receiving tens or even hundreds of millions of dollars in deferred income, stock options, or severance pay. This may have been a factor in the decision of many banks to try to ride the bubble to the top.

5. Psychology. Economists have become increasingly sensitive to the findings of cognitive psychology, which teaches that emotions and cognitive quirks afflict all of us and lead to behavior that often deviates from simple models of rational choice, important as those models are. Among the psychological tendencies that are relevant to an understanding of bubbles are the following: optimism bias, and a related belief in luck (there is no such thing--some people are lucky, but that is a product of randomness, not of a thing--"luck"--that people possess in different proportions); herd behavior; excessive discounting of future costs; and difficulty in thinking sensibly about probabilities.

6. What Is to Be Done? In my opinion, nothing. There have always been bubbles. There will always be bubbles because of the factors that I have been discussing. The Federal Reserve Board, though ably led and staffed, missed the mortgage bubble just as it missed the tech-stock bubble that exploded in 2000. The proposals now on the table for resolving the subprime mortgage "crisis" or preventing future such fiascos include, first, requiring that more information be given to prospective borrowers and, second, that mortgage interest adjustments be frozen or other measures taken to reduce foreclosures. Information is not the problem, as I have argued; and bailing out the borrowers, which is to say truncating downside risk, will set the stage for a future housing bubble. Nor is it a good excuse for the second class of measures that we must at all costs avoid a recession. A major depression, such as we last experienced in the 1930s, imposes immense social costs in the form of lost output. A recession involving some temporary unemployment may impose lower social costs than governmental interventions designed to head it off.

Posted by Richard Posner at 3:30 PM | Comments (22) | TrackBack

December 15, 2007

The UN's Human Development Index: A Critique--Posner

When nations are ranked by gross national income per capita, the United States comes in sixth, after Luxembourg, Norway, Switzerland, Denmark, and Iceland, confirming one's general impression that the United States is the wealthiest large country; none of the countries ranked ahead of the U.S. have more than a fortieth of the U.S. population (Switzerland, the most populous of the group, has a population of 7.5 million). But when countries are ranked by the United Nations' Human Development Index, which rates 177 of the world’s 193 countries, the United States falls to 12, Denmark to 14, and Luxembourg to 18; and among the nations promoted above the United States are Australia, Canada, Sweden, Japan, the Netherlands, France, Finland, and Spain (in that order).

The composition of the Index reflects dissatisfaction with income as a measure of well-being. And of course it is a limited measure; income is not the only argument in a person's utility function. The Human Development Index is an attempt to develop a better measure of well-being. It is a composite of three indexes: GDP per capita (computed on a purchasing power parity basis, to correct for distortions introduced by using currency exchange rates); life expectancy at birth; and a combination of the adult literacy rate and the combined primary, secondary, and college/university enrollment rate, with the adult literacy rate being weighted twice as heavily as the enrollment rate. For each component index, the value of 0 is assigned to the minimum level of the development indicator (income, life expectancy, and enrollment) and 1 to the maximum, and each country's score is the percentage of the maximum level that it achieves. A country's Human Development score is the simple average of its scores on the three indexes.

I cannot myself see the value of the Human Development Index. Not that per capita income, life expectancy at birth, and level of education as proxied by adult literacy and school enrollments are unimportant; a ranking of each of these aspects of human development might be a good first step in identifying areas of weakness that a society might wish to devote additional resources to improving. It is the combining of the indexes and announcing that the combination offers a ranking of nations by the degree of their "human" as distinct from narrowly defined "economic" development that strikes me as dubious, and indeed as senseless. The obvious objection is to the equal weighting of the three indexes, and to the omission of a host of other important dimensions of development, such as housing quality, pollution, tax rates, adult life expectancy, crime rates, unemployment, inflation, quality and variety of goods and services, economic growth, and quality of education--though including them would exacerbate the weighting problem, and some involve serious measurement problems.

A less obvious objection, but a general problem with rankings, is that from a sensible evaluative standpoint the distance between ranks is more important than the number of ranks that separate two countries. The wealthiest nation has a per capita income twice as great as that of the 20th wealthiest nation. That is a big difference. But now consider life expectancy at birth. Japan is number 3 with a life expectancy at birth of 82 years; the United States is only number 44, with a life expectancy at birth of 78. A four-year difference in life expectancy is not trivial by any means; but compare it to the difference in per capita income between the third richest country, Switzerland, and the 44th, Palau: the Swiss income per capita is almost eight times as great as the per capita income of Palau.

If a country devotes resources to improving life expectancy, it has to give up some other good. It is hard to say that the United States is making a mistake in not spending more resources on extending life expectancy; many Americans think that we spend too much on health care already. One reason (though by no means the only one) that the United States ranks only 44th in life expectancy is that our large black population has an abnormally high death rate; the average life expectancy of black male Americans is only 69. This shockingly high death rate reflects deep-seated problems of American blacks that would probably cost an enormous amount of money to solve. The political will to expend those resources does not exist. This may be a misfortune, a tragedy, or even a sin, but to use it to push the United States down in an index of human development is a political judgment, rather than anything determined by neutral social science.

The Human Development Index is an example of ranking mania that has the United States tightly in its grip, so maybe Americans shouldn't complain about the Index. One cannot generalize about the value of rankings. There are pluses and minuses. The major plus is that a ranking is an economical method of presenting information. The related minus is that it often presents it in a misleading way--that is my earlier point that the distance between ranks is more important than the number of ranks that separates the persons (nations, etc.) being ranked. The more compressed a distribution--of ability, health, income, etc.--the less meaningful rank ordering is.

But the more serious problem with rank ordering is the arbitrariness of weighting different quality measures to come up with a composite ranking. It is well illustrated by the college, law school, and business school rankings done annually by U.S. News & World Report. Unlike the UN, the editors of that magazine do not rank the different measures they use (such as SAT or LSAT scores and ratio of applicants to admits) equally; but the weightings are just as arbitrary. They are worse in one respect than the Human Development Index: they are manipulable. A school can (and many schools do ) increase its ratio of applicants to admits by blurring its admission criteria or reducing its application fee, thus increasing the number of applicants without increasing the number of admits. It is unlikely that a nation would try to improve its ranking in the Human Development Index by reallocating resources to activities that influence the rankings.

Posted by Richard Posner at 7:06 PM | Comments (20) | TrackBack

How to Combine Income and Life Expectancy into an Index of Wellbeing-Becker

Modern national income accounts developed about 75 years. Although a sterling achievement that won Richard Stone a Nobel Prize in economics, even pioneers like Stone and Simon Kuznets recognized that these accounts had serious limitations as measures of wellbeing. Among the major oversights that remain to this day are that these accounts neglect the value of time spent in households at housework and other activities, they do not attempt to measure investments in human capital, they fail to adjust for the environmental damages due to pollution, and they take no account of improvements in the quantity and quality of life.

The UN's Human Development Index recognizes some of these defects in income accounts, and attempts to correct them by combining percentage changes (or percentage levels) in per capita incomes with percentage changes in life expectancy, and percentage changes in education levels. However, as Posner points out, the weights attached to these different changes (1/3 weight to each) are completely arbitrary. Moreover, there is substantial double counting since much of the value to increased education results from its effects on raising incomes and lower mortality, and these are counted separately.

The UN Index ignores modern research that provides a method that is well grounded in economic analysis to combine changes in national income with changes in various types of mortality risk. This method calculates the "statistical value of life", which essentially measures how much individuals are willing to pay for various improvements in mortality rates. To get a measure of the per capita change in what has been called "full" income, one simply adds the per capita change in real income to the value placed on the improvements (or deterioration, as in some African countries due to Aids) in mortality risks. One can divide this change by the initial level of per capita real income to obtain a measure of the percentage changes in full income. These full income measures combine changes in life expectancy and in ordinary income not in some arbitrary way, but by extending the willingness to pay concept that is used in national income accounting to valuations of changes in life expectancy.

Hundreds of estimates of statistical values of life have been made for different countries. They are derived from evidence on how consumers and workers value various types of risks to their life. The most common type of study determines how much individuals need to be paid to choose occupations, like construction, that involve relatively large risks of fatal accidents. Other studies use the speed of cars under different circumstances, recognizing that after a point greater speed raises the risk of a deadly accident. Still others examine the willingness of individuals to pay for expensive drugs that are believed to reduce the probability of dying from different major diseases.

There is a range of estimates even for a given country, but the central tendency of estimates for young Americans is that they require some $500 to take on a risk that adds about 1/10,000 to their annual risk of dying. So the statistical value of a typical young American life in this case would be $5,000,000=$500/1/10,000. Based on similar calculations for a number of countries, a rough approximation is that young persons in other countries would have statistical values of life that multiply the American value of life by the ratio of per capita income in that country to the American per capita income.

In a paper I published with Tomas Philipson and Rodrigo Soares in the American Economic Review, March 2005 called "The Quantity and Quality of Life and the Evolution of World Inequality", we apply this method to estimate the relative changes in full income from 1960-2000 in about 100 countries. A common finding on income growth is that the usual measures of per capita incomes grew only a little more rapidly during this period of time in poor and less developed countries than in richer countries. Even that slight degree of income convergence is found only when income changes in each country are weighted by its populations since the two largest countries with about 40 per cent of the world's population, China and India, experienced unusually rapid growth in per capita incomes.

That conclusion about little change in inequality among countries is altered quite significantly when changes in full incomes are compared. Since mortality declined more rapidly in poorer countries than richer ones, adding the value placed on declines in mortality to get measures of changes in full incomes affect the calculations for poor countries more than for rich countries. In fact, the percentage increases in full incomes are on the average much more rapid in poorer countries than in richer ones, which imply a sizable convergence in full incomes across nations during the past several decades. The main reason for this convergence was the transfer of antibiotics and other drugs and medical knowledge from rich to poor countries.

Posted by becker at 6:50 PM | Comments (8) | TrackBack

December 10, 2007

Why Sovereign Funds? Becker

The growth of large government managed funds during the past few years has been spectacular. These funds are estimated to manage between $2-3 trillion, and their assets are increasing rapidly. Sovereign funds have grown mainly because of the run-up in fossil fuel and other commodity prices, although China is creating a large fund with the capital earned from its trade surplus in goods. If present energy and commodity prices continue, sovereign funds could have over $10 trillion in assets within a few years. I do not believe that the scale of these funds is a healthy development for these countries.

The largest fund is that by The United Arab Emirates, which is thought to have assets of about $900 billion. Next in size are the funds from Singapore, Saudi Arabia, Norway, and China: each has capital of about $300 billion. Following these giant government funds are another 20 or so funds with much smaller amounts of capital. Oil producing countries have about two thirds of the capital of all sovereign funds. The aggregate assets of sovereign funds greatly exceed the approximately $1.5 billion invested in hedge funds.

During the past couple of years, sovereign funds have begun to invest more aggressively in international companies. For example, the Abu Dhabi Investment Authority recently gave cash infusion of $7.5 billion to Citigroup to help replace bank capital that had been depleted due to the credit crunch. China's State Foreign Exchange Investment Corp invested in the IPO of the large private equity company, Blackstone, and was embarrassed after the stock declined greatly from the issuing price. Sovereign funds have made other investments in private companies, and many more are expected.

With only a few exceptions, such as the fund of the Norwegian government, sovereign funds are secretive and not at all transparent. Lack of transparency is a major obstacle to citizens of countries with secretive sovereign funds in determining whether the money that automatically flows to the funds is being well spent. Even estimates of the total assets of most sovereign funds have to be arrived at through guesswork, and except for an occasional well-publicized transaction, their asset allocations are kept private. While private equity and hedge funds have also been criticized because they are little regulated- I do not share this criticism- they are paragons of voluntary disclosure and good governance compared to the vast majority of sovereign funds. Private equity and hedge funds voluntarily disclose information mainly because they compete vigorously for funds, whereas sovereign funds automatically get their resources because of government ownership of oil producing and other commodities.

Compounding the adverse effects of the extreme secrecy is that managers of these funds, being government employees on fixed salaries, have only limited financial incentives to try to achieve higher returns for given risk. Even when those in charge of sovereign funds hire private managers for some of their capital, there is still what economists call a principal-agent problem because government officials choose the managers. As a result, one would expect that the management of these funds would be excessively conservative to avoid investment blunders and bad publicity, or that managers would be tempted toward corruption by companies that want to attract investments from these funds. Or governments will use the funds for other government purposes, such as the just announced unwise decision by Brazil to create a sovereign fund to intervene in the foreign exchange market to shore up that country's currency. Given that little information is available, it is very difficult to discover whether a fund is managed too conservatively, or whether corruption affects investments in a significant way.

A major reason behind the growth of sovereign funds is the desire by oil producing and other countries to avoid what happened during previous booms in commodity prices. Vast revenues in the past were spent with little concrete results to show later on. Countries now recognize that the enormous boom in their export prices, such as oil close to $100 a barrel, is not likely to last. That makes it prudent to save rather than spend most of the revenue that is being collected. The desire to save the surplus is commendable, but that consideration alone does not imply that governments rather than households should do the saving.

Central banks and fiscal agencies should accumulate assets during years with high oil and other commodity prices, or what are in other ways unusually good times, in order to protect against the adverse effects of bad times on fiscal and foreign trade deficits. However, the Abu Dhabi fund and the other large funds, and many smaller ones, have far more assets than is necessary for cyclical management of government portfolios. Instead of government funds retaining the excess assets, they should be distributed as national dividends, or as reductions in taxes.

One advantage of distributing most of a funds' assets as dividends, or reduced taxes, is that since families at different stages of the life cycle have very different investment needs, they would invest such a dividend in ways that best suit their individual needs. Younger couples that are investing in children, and actively accumulating wealth, will spend their dividends on buying homes, cars, and other consumer durables, saving for the education of their children, and investing in mutual funds and other financial intermediaries. Since older persons with adult children already own their homes and other durables, they would spend their dividends mainly on conservative financial instruments.

To be sure, countries accumulating some of the largest funds are not at all democratic, so that any national dividend would only go to a relatively small fraction of the total population. But so too are any benefits from the investments of sovereign funds, so a national dividend would not be any worse in this dimension.

Posted by becker at 9:23 AM | Comments (18) | TrackBack

Sovereign-Wealth Funds--Posner's Comment

I shall focus my comment on the consequences of the sovereign-wealth funds for the United States; Becker's post focuses on the consequences for the nations that have such funds. Owned mainly by major oil-exporting nations, sovereign-wealth funds have today in the aggregate some $2.5 trillion in assets, and if oil prices remain sky-high this figure may grow to more than $20 trillion in a relatively short time. At that point the funds will be among the world's most important sources of investment capital. (The total debt and equity capital in the world is about $110 trillion, though of course it will be greater when the sovereign-wealth funds reach $20 trillion, if they ever do.)

The rise of the sovereign-wealth funds may well be a positive development for the rest of the world, assuming that the alternative would be for these countries to increase domestic consumption or to invest in domestic infrastructure. The decision to invest on a global basis increases the global supply of capital, including therefore the supply of capital for investment in the United States. As Becker and I argued in our August 7, 2005, postings concerning opposition to the proposed acquisition of Unocal by an oil company owned by the Chinese government, the purchase of assets by foreign nations, even when they are hostile or potentially hostile to us, does not threaten U.S. welfare or security. The purchase of a company from its owners places money in the hands of those owners that they can invest for a higher return--if they did not think they could do this, they would not sell the company. So such a purchase is wealth-enhancing. It does not undermine our national security just because the purchaser is a foreign government, but on the contrary enhances our security because the investment is a hostage. It's as if to guarantee China's good behavior the president of China sent his family to live in the United States. But it is different if the purchase could create a security risk, as was argued to be the case with the proposed purchase by Dubai of a British company that serviced a number of U.S. ports (see my posting of March 13, 2006). The concern (which may have been overblown, however) was that Arabs employed by the Dubai company would obtain in the ordinary course of business information about the ports and might pass it on to Islamic terrorists. Notice that this was a concern about foreign companies whether or not government-owned.

One of the motivations for the creation of the sovereign-wealth funds is the concern of the oil-exporting nations with the value of their huge dollar surpluses; China has the same concern, though in its case its trade imbalance with the United States is not due to oil exports. As Becker points out, at least in the case of the oil-producing nations these surpluses are due to the fact that the governments of the nations are the producers, so they receive the export revenues; if the producers were private companies, the revenues would not go into government coffers. For political reasons, however, the governments are the recipients of the oil revenues, they are paid in dollars, and they want to put their dollars to work rather than just accumulate them or distribute them to their citizens. And rather than just purchase U.S. Treasury notes or other safe securities--which would not make economic sense, since as Becker points out the amount of money in the funds greatly exceeds the nations' liquidity needs--the governments are in effect operating giant hedge funds, investing in diverse assets all over the world. By doing this they are giving hostages to the nations in which they invest. We should welcome the fact that these investments are less liquid than the short-term securities in which governments conventionally invest their reserves. The less liquid an asset, the better a hostage it is; it can't be withdrawn as rapidly. In addition, excess liquidity in the world's financial system can lead to financial instability.

The concern being expressed in some quarters in this country about the rise of the sovereign-wealth funds is ironic in view of the fact that our government's policies have contributed significantly to the growth of these funds. Those policies include failure to exploit our Alaskan and offshore oil resources more vigorously, because of the opposition of environmentalists; our low tax rates, which facilitate consumption, including consumption of foreign goods, which in turn shifts dollars abroad; and, in particular, our very low taxes on oil and on oil products, such as gasoline and aviation fuel. A stiff tax on imported oil, by reducing consumption, would reduce the wealth of the oil-exporting nations and hence the size of their sovereign-wealth funds. Such a tax would have the not incidental further benefit of reducing emissions of carbon dioxide (though from that perspective a tax on carbon emissions is superior to a tax on oil and oil products) and of stimulating the search for alternatives to fossil fuels, a major culprit in global warming.

Posted by Richard Posner at 9:14 AM | Comments (21) | TrackBack

December 9, 2007

Notice

We will be posting tomorrow (Monday).

Posted by Richard Posner at 9:35 PM | Comments (3) | TrackBack

December 2, 2007

Carbon Offsets--Posner

A number of firms, such as TerraPass, sell "carbon offsets" to consumers worried about global warming. You give TerraPass information about your driving, flying, and the size of your house, and TerraPass computes your annual carbon dioxide emissions and offers for a price to offset some or all of them by investing the proceeds from your purchase in projects (for example, wind farms) for reducing carbon emissions. In principle, if you purchase offsets for your entire carbon emissions, your net contribution to global warming is zero.

The carbon-offset movement is an echo of the "cap and trade" approach to pollution control, which is used for example to limit emissions of sulfur dioxide. (The Kyoto Protocol creates such a system for carbon emissions, but the United States is not a signatory to the Protocol and has no cap and trade program for carbon.) In cap and trade, each polluter is given a permit to emit a certain quantity of a pollutant. The total amount permitted to all polluters will be less than the total pollution, because the aim is to reduce pollution. The key point is that the cost of compliance varies across polluters. Consider two polluters. One can eliminate a ton of emissions at a cost of $10, the other at a cost of $50. At any price between $10 and $50, both polluters are better off if number one sells the right to emit a ton of emissions to number two; society too is better off, because the trade frees up $40 to invest in other goods.

The problem with carbon offsets is that they are purely voluntary. You do not obtain a monetary benefit by reducing carbon emissions, as you would if you had an emissions permit that you could sell to big emitters, or if you would be punished for exceeding a permitted level of emissions. When you buy a carbon offset, you are making a charitable contribution to fighting global warming. Since charitable motivation is weak compared to self-interested motivation, carbon offsets are a poor substitute for a cap and trade system, quite apart from the doubts that have been raised about the efficacy of the projects in which the firms offering carbon offsets invest. At best, moreover, carbon-offset programs are severely limited because consumers are not the only emitters of carbon dioxide. A further problem is that the investments by the carbon-offset firms in reducing carbon emissions may to a great extent simply replace existing investments. (An estimate of the replacement effect should be reflected in the price that TerraPass charges for offsets.) There is commercial and governmental investment in wind and nuclear energy, reforestation, climate research, fossil-fuel efficiency, and so forth, and if now consumers through carbon-offset programs invest in such projects, the commercial and governmental investors may scale back.

But the most serious drawback of the carbon-offsets movement lies elsewhere--though not, as environmental radicals would have it, because it makes emitting carbon dioxide into the atmosphere respectable, whereas it ought to be thought sinful, like littering, or driving without a catalytic converter. Although carbon emissions pose a much greater danger to the environment than other pollutants, they differ because they confer benefits as well as impose costs, and indeed reducing them to zero would be a disaster because atmospheric carbon dioxide is essential to maintaining a temperate climate. There is nothing wrong with emitting carbon dioxide. The wrong lies in the quantity being emitted, which is excessive.

The most serious drawback of the carbon-offsets movement is that it is likely to make the problem of excessive carbon emissions more rather than less serious, and this for three reasons. The first is that it creates the impression that modest reductions in the rate of annual increases in carbon emissions make a meaningful contribution to the fight against global warming. They do not. Given the limitations of the carbon-offsets movement that I have noted (its purely voluntary nature and the fact that only consumer emissions are affected), plus the fact that any reductions attributable to the movement are more than offset by continuing rapid increases in emissions by China, India, and other rapidly developing economies, the movement can at best limit only very slightly the rate of annual increase in carbon emissions, whereas the need is to reduce the level of those emissions. The reason is that, because atmospheric carbon dioxide is absorbed by the oceans only very gradually (and the ability of the ocean to act as a "carbon sink" apparently is declining), a high annual level of carbon emissions tends to have a cumulative effect, so that even if that level were steady (rather than increasing, as it is), the atmospheric concentration would rise.

Second, the movement encourages the belief that anyone who reduces his carbon "footprint" (that is, the emissions of carbon dioxide that he causes) to zero has done his bit to combat global warming. My wife and I have two cars, two houses, and fly a certain amount, but according to TerraPass's calculation, we can reduce our carbon footprint (roughly 32 tons of carbon dioxide a year) to zero at a cost of $282 a year. Then I will feel good about myself. But if a million American families having similar carbon footprints eliminate them at this rather modest price, the result--a reduction of 32 million tons of carbon dioxide emitted per year--will be microscopic, as the worldwide hourly emission of carbon dioxide is 16 million tons. A million American families would be roughly 1 percent of the U.S. population. Suppose the carbon-offsets movement, which is recent, and is getting a boost from the increasingly ominous evidence of global warming, grows beyond my expectations, to a point at which 10 percent of the U.S. population is paying TerraPass or other carbon-offset providers to offset an average of 32 tons per family. The effect would be to reduce annual worldwide carbon emissions by 20 hours' worth, or about one-quarter of 1 percent, and the reduction would be greatly offset by the worldwide growth of emissions, currently running at about 3 percent a year.

Third, and most serious, the carbon-offset movement, combined with well-publicized projects by Google and other companies to reduce carbon emissions, creates the false impression that global warming can be tamed by voluntary efforts, just as cleaning up after dogs has been achieved by voluntary efforts, without need for legal compulsion. Global warming cannot be tamed by voluntary efforts, because the costs of significantly reducing carbon emissions in order to reduce the atmospheric concentration of carbon dioxide (or at least stop it from increasing) are enormous. If people believe that voluntary efforts will suffice, there will be no political pressure to incur the heavy costs that will be necessary to avert the risk of catastrophic climate change.

Against this it can be argued that the carbon-offset movement is increasing the public awareness of the global warming problem, which may lead to other voluntary efforts to reduce carbon emissions, such as switching from SUVs to more fuel-efficient vehicles, or may exert pressure on politicians to support the regulation of carbon emissions. I am skeptical. I think very few Americans are prepared to incur substantial costs to deal with a problem that is so afflicted by uncertainty about its imminence and magnitude as global warming. They will avoid cognitive dissonance by exaggerating the practical efficacy of largely symbolic gestures, such as purchasing carbon offsets.

Posted by Richard Posner at 10:45 AM | Comments (39) | TrackBack

On Carbon Offsets-Becker

Posner's discussion of carbon offsets is thorough, so I will concentrate on only a few issues. The main obstacles to a large reduction in the aggregate emission of carbon dioxide from any offset system are that the system is likely to affect only a small number of persons and companies that produce carbon emissions, and also that many alleged "offsets" have only a small net effect on emissions.

It is an impressive testimony to the power of the "green" movement that many consumers, and some companies responding to consumer pressure, are voluntarily seeking offsets for the carbon emissions from their diverse activities. Nevertheless, the carbon-offset movement still has only a tiny fraction of all consumers and companies worldwide. Even if the movement doubles or trebles in size, and even if the alleged offsets are real offsets, its overall effect on carbon emissions will remain quite small.

Of course, the numbers involved would multiply greatly if offsets for emissions became compulsory rather than voluntary. But then the carbon-offset system would be fundamentally no different from a carbon emission trading system of the cap and trade variety. Cap and trade systems, and any compulsory offset system, presumably would apply only to companies since enforcement and management of the system is much easier for the relatively small numbers of firms than with the hundreds of millions of consumers in the US alone.

The natural link between an offset system, whether compulsory or voluntary, and an emission trading system does dispose of the criticism that offsets are not desirable because they are like the indulgence system of the Middle Ages, In that system, sinners could purchase forgiveness for some of their sins without either having to repent, or having to agree not to sin anymore. Yes, an offset system does essentially involve buying the rights to pollute, but buying such rights helps get polluting into the hands of those businesses and consumers who get the most value from these rights. That is why the world has gravitated toward a cap and trade system rather than merely a cap system.

Another major problem with any carbon-offset system is that activities producing the so-called "offsets" may have happened anyway. For example, an initial and still popular type of carbon offset is to pay for the planting of trees in a reforestation project, particularly in the tropics. Forests help cool the atmosphere by storing carbon. It is quite difficult to determine whether any particular tree-planting program makes a net contribution to planting, rather than simply displacing other tree plantings that would have occurred anyway.

As one example, a country located in the tropics may have planned on a reforestation project for several reasons, including a reduction in the degree and rapidity of water runoffs during rainstorms. If a carbon-offset project began to plant trees in that forest, the country may cut back on its own efforts since these would be replaced by the tree plantings that serve as carbon offsets. TerraPass, an important company that sells carbon offsets, was accused of selling offsets in a methane recapturing project that allegedly would have happened without the TerraPass offsets (the company denied this claim; see the discussion in the Wikipedia article on "Carbon Offset").

In our complicated and interdependent global economic system, opportunities to create carbon offsets can be readily produced by both companies and governments without any significant affect on the scale of emissions. Mainly for this reason, but also because of the reluctance of most individuals to voluntarily pay significant costs for acting "green", a cap and trade system, despite its many flaws, is a far preferable direction to develop in order to cut down on carbon emissions.

Posted by becker at 10:25 AM | Comments (11) | TrackBack