The Becker-Posner Blog

Meritocracies and Intergeneration Mobility-Becker

Countries differ greatly in the influence of family background on the achievements of children. Family influence is measured through the degree of intergenerational mobility, or the relation between the achievements of parents and children. Intergenerational mobility is said to be stronger when the achievements of children are more weakly related to the achievements of their parents.

Intergenerational mobility in a country is often used as a measure of the importance of merit rather than prejudice, political influence, and other similar considerations in determining success and failure in that country. Although intergenerational mobility is related to the importance of merit in determining success, the connection is more complex than one might think.

Economists usually measure intergeneration mobility by the relation between the earnings (or education) of parents and children. If children’s (lifetime) earnings tend on average to increase by 4% when parents (lifetime) earnings increase by 10%, the degree of intergenerational mobility would be 60% (=(100-40)/100), while if children’s earnings tend to increase on average by only 1% when parental earnings increase by 10%, intergenerational mobility would be 90%. This measure of mobility ranges among countries from about 90% to less than 20%. The degree of mobility for the United States equals about 50%, while it seems to be over 80% for several Scandinavian countries, and only about 30% for Brazil.

Success in a meritocracy depends mainly on a person’s abilities and skills. The relation between intergenerational mobility and such a meritocracy is complex. Consider, for example, cognitive abilities, as measured say by IQ score. Genes are a major determinant of IQ, although early environmental experiences and the covariance between genes and environment are also important. The significant role of genes in IQ means that children of parents with high IQs also tend to have higher than average IQs in part because children inherit their genes from parents. If earnings depended to a large extent on IQs because the economy heavily rewarded this measure of “merit”, parents with high IQs would tend to have high earnings, and their children would also have relatively high earnings because the children would also have high IQs.

Therefore, to the extent that earnings depend on cognitive abilities, such a “meritocracy” would have a strong correlation between the earnings of parents and children. In other words, intergenerational mobility would be relatively low in such a merit-based economy. To be sure, intergeneration mobility would also be low if family position were automatically passed on from parents to children, independently of the abilities of children (or parents). Therefore, intergeneration mobility would be low at these two extreme models of the role of merit in determining earnings. By contrast, if earnings were basically randomly determined in each generation without regard to merit or any other considerations, there would be complete intergeneration mobility even though merit had no role in determining earnings.

The relation between intergeneration mobility and meritocracy becomes still more complex after we recognize that earnings in a meritocracy would depend not only on cognitive abilities, such as IQ. For it depends also on investments in education and other human capital, on getting to work on time, on being able to take criticism, and on many other psychological characteristics. Families that are more educated and have high earnings tend to invest a lot in their children’s human capital, and in various non-cognitive traits. In a merit-based economy where earnings depend on the totality of abilities and skills, children of high earning parents would also tend to be high earners because their parents would pass on both cognitive skills and investments in various forms of human capital.

Even after including parental investments in education, non-cognitive traits, and other human capital of children, an economy where success and failure are determined by merit would still have low intergeneration mobility. To be sure, investments in education and many other types of human capital are not only determined by parents, but also by government policies and by philanthropists. To the extent that governments and philanthropists invest more in the human capital of children with less successful parents (as appears to be the case for governments in Scandinavian countries), a merit-based economy could have relatively high intergenerational mobility since children from poorer and less educated families might have high levels of human capital investments.

Nevertheless, a big jump is still required to make inferences from the intergeneration mobility in a country to the role of merit in determining success and failure in that country. In particular, although the United States has considerably lower intergeneration mobility than many Western European countries, this does not imply that merit is a less important determinant of success in the American economy than in these other economies.

Merit-based economies use the human capital of individuals more efficiently than other economies, but a country might be willing to trade off less efficiency for greater intergeneration mobility. Good policies would recognize that there is such a tradeoff, and that policies that lead to much greater mobility across generations may make the allocation of human resources considerably less efficient.

 

 

 

Meritocracy, Social Mobility, Intergenerational Mobility—Posner

The three terms in my title are closely related. The first refers to a society in which people’s success is a function of their individual abilities rather than the wealth or position of their parents or other family members. The second, which is closely related, refers to the various social classes’ being permeable to entry by talented individuals from other classes. The third, a more technical social scientific term, refers to lack of correlation between parents’ and their children’s income or social status; the less positively correlated the parents’ income or social status is correlated with the income or social status of their children, the greater the intergenerational mobility in the society. 

If IQ were purely genetic and therefore only inherited, and if income were a linear function of IQ, children’s incomes would be very similar to their parents’ incomes and intergenerational mobility would be slight, with the important qualification, however, that social standing is not a function purely of income. There are scientists, highly regarded classical composers, distinguished poets, political leaders and other fficials, military heroes, priests, and others who have high social tatus but mediocre incomes. And notice that the correlation between parental nd child social standing or income would hold for any purely genetic trait hat was valued, such as athletic or musical potential, and not just for IQ. 

These examples underscore ecker’s point that a low level of intergenerational mobility is consistent ith meritocracy, even when as in the examples merit is a function of luck: hether your parents happen to have had a high IQ, and whether IQ is highly valued n the society you happen to have been born into. 

IQ is not entirely genetic (it’s enerally believed to be half genetic and half the result of other innate onditions, for example conditions during pregnancy and birth; early nvironmental conditions; and physical and mental health), but has a ubstantial genetic component, as just noted. And with the increased role of echnology in the economy and the expansion of the professions relative to other occupations, the financial and social status returns to IQ have risen. Increased assortative mating (likes with likes), attributable in part to a decline in discrimination and in part to the greater search for marital partners that is enabled by the Internet, will probably increase variance in IQ and thus increase the returns to the highest IQ strata, in the near future. 

That said, however, the United States is, at best, a highly imperfect meritocracy. The reason is the pattern of investment, both private and public, in children’s career and life prospects. Wealthy parents invest heavily in their children’s education by hiring tutors, paying the very high tuition charged by elite private schools and by colleges (public as well as private), making generous donations to such institutions, and financing extracurricular activities that impress college admissions
officers. Colleges compete for wealthy kids, seeing them as future generous alumni. Parents use personal contacts to land good jobs for their kids; sometimes hire them for the family business; and, of course, give, lend, and bequeath them money. Because public schools are financed mainly by local property taxes, the best public schools tend to be in high-income areas, and so wealthy kids that go to public schools rather than to private schools tend to go to the best public schools. Indeed, if there are no good public schools in a wealthy family’s neighborhood, the family will send its children to a private school. 

As a result of these factors, among the wealthy countries the level of intergenerational mobility is lower in the United States than in the four Scandinavian countries (which have the highest level of intergenerational mobility) and in Canada, Australia, New Zealand, Germany, Japan, France, and Spain, and slightly higher in the United States than in Italy and the United Kingdom. These rankings are highly correlated, as one would expect, with income inequality (the United  States is second-highest in inequality of income, after the United Kingdom, in the countries I just listed). Wealthy families that generously underwrite their children create more wealthy families in the next generation. 

Ideally, in order to maximize productivity, one would like the government to identify the high-IQ children in poor or lower middle class families and provide them with education and education-related services equivalent to those that wealthy families bestow on their usually high-IQ children. The need is acute in the United States because of our relatively quite low level of intergenerational mobility. Not much effort is being made to meet this need. The reasons probably are that children don’t vote (it is arguable that a parent should be given a bonus vote for every one of his or her children living with the parent), and that poor and lower middle-class parents have little political clout relative to old people, wealthy people, civil service pensioners, and other politically influential groups.

The Fiscal Cliff--Posner

The “fiscal cliff” refers to a federal law scheduled to take effect on January 1 that will rescind the Bush tax cuts and make other adjustments to federal tax laws, with the overall effect being to increase tax rates and at the same time slash discretionary federal spending, much of it defense spending, across the board. If the “fiscal cliff” takes effect and remains in effect, it is estimated that over a ten-year period it will increase federal tax revenues by about a trillion dollars and cut federal spending by approximately the same amount. 

This would do wonders for the federal deficit (the annual increase in the federal debt), slashing it in half (by $200 billion) in 2013 and presumably in each of the subsequent years as well—or would it? The increase in the deficit since the 2008 financial crash has been due mainly to the depression (as I insist on calling the “Great Recession”—its political consequences alone may turn out to be as great as those of the Great Depression of the 1930s). The depression has reduced federal income tax collections (because people’s incomes have fallen) and increased spending on unemployment
insurance and other depression-fighting spending measures (the “automatic stabilizers,” designed to smooth the business cycle by increasing tax revenue/reducing government spending in booms and increasing government spending/reducing tax revenue in busts). A substantial increase in taxes will
reduce private spending, and in turn the production of goods and services and therefore employment, while reducing government spending will reduce incomes and so increase the depressive effect on spending of higher taxes; both the tax increases and the spending decreases will reduce disposable income. The overall effect may be to offset the deficit reduction that would occur if the “fiscal
cliff” law would have no effect on disposable income and therefore on production and employment (and therefore on income and tax revenue). 

The President has proposed to avert the fiscal cliff by replacing the fiscal cliff law with a new law, the main provision of which would be to rescind the Bush tax cuts for anyone earning less than $250,000 a year. This is opposed by conservative Republicans on the ground that the President is proposing a tax increase for everyone earning $250,000 or more. That is incorrect. Their taxes will rise beginning on January 1 if the fiscal cliff is not averted; the President’s proposal therefore does not alter their tax liability, as the law would go into effect the same day that the fiscal cliff (if not replaced by his proposed law) would raise everyone’s taxes. 

The Republicans are concerned about the deficit, and, being unwilling to reduce it by increasing tax rates even just relative to the low rates adopted early in the Bush Administration (when the deficit was small), want heavy cuts in spending but not in defense spending. The amount of nondefense discretionary spending is small, however, so the Republicans want the cuts to be concentrated in entitlement programs, mainly Social Security, Medicare, and Medicaid. Obama resists these cuts, because the entitlement programs are immensely popular, particularly though not only among Democrats; and though he is willing to make some cuts (mainly by adjusting the formula for raising
social security benefits to keep pace with inflation) in exchange for rescinding the Bush tax cuts, he is unwilling to make the kind of cuts the Republicans want. At this writing, so many Republican Congressmen are adamant against any action on the existing (pre-cliff) tax rates that no compromise is possible unless the Speaker of the House is willing to advocate a compromise that will attract enough Democrats and Republicans to create a majority. 

It ought to be easy for the Republicans to agree to some variant of the Obama proposal. The tax “increases” would affect only 2 percent of the population, and they are modest increases; the negative effect of such increases on spending and investing would probably be small, and perhaps
completely offset by the effect, modest as it would be, of the higher tax revenues in reducing the deficit. And remember that the tax “increases” proposed by Obama are not really increases, but merely reductions in the Bush tax cuts and in the “fiscal cliff” taxes now scheduled to go into effect on January 1. Before Bush’s tax cuts there was very little sense that Americans are overtaxed, especially Americans with high incomes. 

The conservative Republicans find themselves in a difficult position: they want to reduce the deficit, but they don’t want to raise any tax rates. They are open to tax reforms that would generate additional tax revenues, but such reforms, mainly reducing tax deductions, are very difficult to achieve politically because the main deductions—mortgage interest, charity, and state taxes—are extremely popular. The Republicans advocate spending cuts, but draw the line at cutting defense spending, and so cannot achieve substantial deficit reduction without big cuts in entitlement spending, but as I said the principal entitlement programs are very popular—even Medicaid, which supplements social security benefits for many people, and is already underfunded. 

During the election campaign, Romney was criticized for wanting to deal with the deficit solely through capping deductions and reducing nondefense spending, without specifying the deductions that would be capped or the size of the caps, and without specifying what major entitlement programs would be cut and if so by how much. He seemed to have taken Medicare off the table. It remains unclear what specific, feasible, and substantial measures the Republicans propose for reducing the deficit. 

Realistically, the best we can hope for at the present time is a modest increase in tax revenues along the lines proposed by the President, some modest cuts in discretionary and entitlement spending—tax and spending measures that will reduce the deficit, albeit not dramatically, without interrupting the
gradual recovery of the economy from its doldrums—and the prospect that continuing economic recovery will reduce the deficit quite apart from changes in tax revenues or spending.

Spending, Taxation, and the Fiscal Cliff-Becker

A front page article today in the New York Times points out that around 1990 the Republican Party shifted away from an emphasis on balancing the federal budget to an emphasis on the level of taxes. I believe that this shift was in the right direction, and it is highly relevant in understanding the Republicans’ position on what to do to prevent the so-called “fiscal cliff” in 2013.

Supporters of a balanced budget approach to fiscal policy want federal spending and revenue to be about equal to each other in the long run. This means that any long-term growth in the deficit and in the public debt should be less than the growth in GDP. By contrast, the level of taxation approach emphasizes that the levels of federal spending and taxation are the primary determinants of the effects of the federal government on the economy, including incentives to work hard, invest, and start businesses.

The level of taxation ultimately determines the size of government since no government can continue to spend substantially more than its revenues. Greater government spending may help stimulate an economy coming out of a major recession, although the absence of any clear stimulus to the economy from the Obama stimulus package raises serious questions about the ease of stimulating an economy with fiscal policy. However, the level of federal government spending also has major direct effects on an economy, such as through spending on medical care, defense, and subsidizing the production of ethanol. Greater government spending also tends to crowd out spending by the private sector on consumption and investments.

Concern about the size of federal spending is particularly relevant at this juncture since federal spending has grown substantially during the past 10 years, especially rapidly during the past four years. In 2007, federal spending was under 20% of GDP, while it rose to over 24% of GDP in 2012. Less than half of this increased spending has been due to the growth in government spending on medical care, social security, and defense, while the rest is the result of increased spending on many other programs. Since greater government spending is also the cause of most of the growth in budget deficits, even those who target budget deficits, let alone those who target total taxation and spending, might well expect most of the reduction in deficits would come from spending cuts (spread out over time) rather than from higher tax rates.

Concentration on the level and nature of taxation implies support for widening the tax base through cutbacks in various unjustified exemptions and deductions from taxable incomes. Many special treatments of particular incomes should just be eliminated. The two most important deductions from taxable income are interest on mortgages and charitable contributions. Deductions of interest on mortgages are hard to justify from an efficiency standpoint, while the case for deductions for charitable contributions is stronger. Still,probably a cap on total deductions would be the best way politically to limit deductions. Such a cap would mainly hit higher income persons, and would raise the effective marginal tax rate for some taxpayers, but it would generally improve efficiency in the economy’s use of resources.

Many commentators have questioned how Republican members of the House could fail to support Representative John Boehner’s “Plan B” that would raise tax rates only on incomes over $1 million. I agree that the suggested tax increase on such a small fraction of taxpayers is unlikely to have much of a negative effect on the economy. But by the same token, President Obama’s compromise suggestion to raise tax rates only on incomes above $400,000 will also raise little additional tax revenue. This explains why the president also wants to raise taxes on dividends, capital gains, and estates, and reduce deductions.

The president is clearly in the political driver’s seat after winning reelection in a major victory. In the end he will probably get something much closer to what he wants than what Republicans in Congress want to offer. However, this does not mean that a position that wants major cutbacks in government spending and opposes increases in taxation that are not due to tax reforms, is a sign of intransigence rather than a thought-through opposition to larger government and bigger taxes.

 

 

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The Unemployment Rate and Central Bank Policy-Becker

Low inflation and “full” employment have been statutory goals of the Federal Reserve for the past 35 years. Often, however, inflation received the most attention, as when former Fed chairman Paul Volcker in the early 1980s sharply raised interest rates and put the economy in recession in order to wring inflationary expectations out of the system.

On December 12th, Ben Bernanke, the chairman of the Fed, indicated that the Fed would pursue what one might think is simply a variant of the full employment target by keeping nominal interest rates close to zero until the US unemployment rate dips below 6.5%-it is currently 7.7%- or until inflation is forecast to exceed 2.5%. The challenge facing this proposal is that while an unemployment rate target may seem to be just the flip side of the full employment target, unemployment can be nudged by other government policies in ways that have little effect on employment.

The present high level of unemployment in the US in good measure reflects the slow rate of recovery of real GDP and employment from its recession levels. According to "Okun’s Law”, the recovery in employment from a recession is simply related to the recovery in real GDP (see the discussion of Okun’s Law in my blog post on 11/4/2012). Okun’s Law implies that a central bank can use the recovery in real GDP as a proxy for the recovery in employment toward a full employment goal.

If the change in the unemployment rate were simply the mirror image of the change in the employment rate, ”low” unemployment would be as good a target as full employment. That would imply that Okun’s Law could be stated as a relation between the decline in unemployment from recession levels and the recovery in real GDP from recession levels. Then the recovery in unemployment to its “full employment” level could meet the Fed’s goal of maintaining full employment (along with controlling inflation), as in Bernanke’s recent announced goal of no more than 6.5% unemployment.

The complication is that changes in unemployment rates during business cycles are not just mirror images of changes in employment rates. This has been especially the case during the Great Recession. By definition, the unemployed equals the difference between the number of persons in the labor force and the number of persons working. The unemployment rate is then defined as the number of individuals who are unemployed as a fraction of the labor force. It follows from the definition of unemployment that the unemployment rate equals one minus the employment rate (the ratio of the number of persons employed to the number of persons in the labor force). This relation shows that changes in the unemployment rate would be equal to but opposite in sign to changes in the employment rate only as long as the labor force remained fixed.

During business cycles, the employment rate and the unemployment rate do move in opposite directions, but the relation is far from one to one, especially during severe recessions. The reason is that the labor force also changes over the course of a business cycle. Especially during severe recessions, some workers get discouraged about finding jobs and leave the labor force. This would tend artificially to reduce the unemployment rate even when both employment and unemployment did not change. This is why the official unemployment rate is usually supplemented with measures of the “total” unemployment rate that include both individuals who got discouraged and withdraw from the labor force, as well as those working part time because they could not find full time jobs. This total unemployment rate now stands at 14.4%, much above the 7.7% official rate.

The official unemployment rate is also affected by public policies that encourage individuals to either leave the labor force or work only part time. These are partly policies that increase eligibility for means tested welfare programs, such as food stamps, subsidies on mortgage payments, and Medicaid benefits. These and other means-tested programs greatly expanded during the past four years (for a good discussion of the evidence on this, see Casey Mulligan’s recent book “The Redistribution Recession: How Labor Market Distortions Contracted the Economy”).

The unemployment rate is also affected by policies that affect eligibility for unemployment compensation, such as the extension of unemployment benefits during this recession to 99 weeks. Such an extension increases unemployment because it encourages individuals to become or remain unemployed in order to collect unemployment benefits for a longer time. The net effect of extensions in unemployment benefits is to increase the unemployment rate differently from any decline in the employment rate.

This discussion implies that a shift by the Fed from a full employment target to an unemployment target could lead to some shift in the Fed’s goals. In addition, and most important, some of the causes of changes in the unemployment rate are not amenable to manipulation by the Fed through very low interest rates and the purchase of bonds or other assets. Unemployment rates will remain higher than in the past, regardless of Fed policies, as long as the extensions of various means-tested programs and of unemployment benefits during the past few years remain in effect.

A major risk of trying to implement an unemployment target through present Fed policies is that the inflation rate could increase in a futile attempt to bring down further the unemployment rate to a targeted rate, as happened in the 1970s. To its credit, the Fed protected against this possibility by setting its target at a relatively high unemployment rate of 6.5%, even though the rate prior to the onset of the recession in 2007 was well under 5%. The Fed also directly faced the risk of creating excessive inflation by setting its target as no more than 6.5% unemployment only as long as the inflation rate does not rise about 2.5%, a modest rate of inflation.

 

 

Unemployment, Inflation, and the Fed—Posner

As Becker points out, the unemployment rate is a misleading figure because it ignores discouraged workers, who have left the labor force (the denominator in calculating the unemployment rate, where the numerator is the number of full-time employed), and workers involuntarily working part time. But that is to say that the Fed’s choice of 6.5 percent unemployment as the level below which the Fed will stop flooding the economy with money is conservative, in the sense that at that rate the underutilization of the labor force is considerable and warrants extraordinary measures. Similarly, an inflation rate of 2.5 percent is low, suggesting that the Fed will stop flooding the economy with money well before inflation reaches a dangerous level. 

I am not a macroeconomist, but my sense is that macroeconomics is so complex, in the sense of involving so many interactive forces, that no one understands it fully. For example, it may seem obvious that “hand outs,” such as unemployment insurance, food stamps, and Medicaid, increase unemployment by reducing the financial pressure on an unemployed person to seek work. On this ground, Casey Mulligan, whom Becker cites, has argued that the hand-outs have prevented poverty from increasing during the current depression, and that this is a bad thing because poverty makes unemployed people search harder for jobs. The other side of this coin, however, is that the hand-outs increase the amount of money that people have and can spend on consumption, and consumption drives production, which in turn drives employment. If there are no jobs to be had, searching for a job has no payoff. Of course there may be methods of increasing consumer incomes that do not involve making work less attractive, such as Keynesian public projects that increase employment directly, or income tax reductions. Those are fiscal measures impeded by the dysfunctional character of our political system, from which the Federal Reserve is largely immune; and so the burden of speeding the economy’s recovery has fallen on the Fed. 

The Federal Reserve’s easy money policy, adopted expressly to speed recovery, keeps interest rates very low, which reduces both the burden of debt and the cost of borrowing and therefore stimulates consumption and therefore production and so employment. Inflation, which is stimulated by an increase in the ratio of money to goods, also reduces the cost of debt. As debt falls, people save less and spend more. 

It makes sense, therefore, for the Federal Reserve to increase the supply of money when employment (however measured) is abnormally high and inflation very low, which is what it is doing. And by not only doing these things but committing to continue doing them (until the 6.5 percent and 2.5 percent trigger points are reached), which is a departure from the traditional taciturnity of central bankers, the Federal Reserve is reducing uncertainty. This is important because economic uncertainty tends to impede action, whether it is hiring people or buying consumer goods. Freezing is a common and rational reaction to uncertainty—one freezes in the hope that the uncertainty will soon dissipate and then one can act with greater certitude about the consequences of one’s actions. 

The Federal Reserve expands the money supply basically by buying government securities for cash. Should inflation loom, the Fed would try to reduce it by selling government securities for cash, and retiring the cash it received, thus reducing the money supply. The danger is that by reducing the money supply and thus forcing up interest rates, the Fed’s action in response to inflation could cause a recession. But today the continued weakness of the economy, given the large deficit, seems a more urgent concern, justifying the Fed’s action.

The Professional versus the Business Model in Law and Medicine--Posner

The central focus of economic analysis of markets is the activity of profit-maximizing business firms in unregulated competitive markets; and such firms are indeed the central players on the supply side of markets in a free-market economy. Analysis of profit maximization is complicated by the fact that large business firms are complex organizations, and persons who compose such a firm, ranging from shareholders to rank and file workers, have conflicting incentives which can blunt profit maximization to an extent. Competition is itself a complex activity, and firms often find it more profitable to collude in price and concentrate on product competition instead. There are also nonprofit enterprises and government producers to complicate the picture. 

An important though it seems a diminishing example of a service provider that deviates from the standard model of a profit-maximizing competitive firm is a professional organization such as a law firm or a medical practice. Professionals include besides lawyers and doctors architects, nurses, teachers, engineers, clergy, and military officers (the list is not example), and they constitute an important segment of the economy; there are, for example, a million lawyers and more than 700,000 doctors. 

Law and medicine are the oldest professions (other than clergy), the most prestigious and highly remunerated, the most influential, and the most discussed, praised, and criticized. They are also changing at a rapid rate—and in fact changing from professions to businesses, although the change may be reversed in the case of medicine. (I can’t see that happening in law.) 

The traditional concept of the profession (the concept that is undergoing change) provides an interesting contrast to the concept of the profit-maximizing business firm. In the business model, the goal is profit maximization in a competitive environment that operates in a basically Darwinian fashion (survival of the fittest); risk is pervasive and both extraordinary profits and devastating losses are real possibilities. Employment and leadership in such an environment attract many and repel many. The people it attracts tend to be aggressive and daring. The ones it repel tend to be cautious and thoughtful. 

In the traditional professional model, risk both upside and downside is trimmed by a combination of regulation and ethics both aimed at muting competition. With muted competition the lawyer or doctor can realistically aspire to a safe upper-middle-class income, but he is unlikely to become wealthy. The result, in combination with requiring postgraduate education and qualifying exams for entry into the profession and subjecting members of it to professional discipline, is to attract a type of person quite different from the entrepreneurial type—the latter a type exemplified by such extraordinarily successful college drop-outs as Bill Gates, Steve Jobs, and Mark Zuckerberg. The professional model attracts a more studious, intellectual, risk-averse type of person. 

Why does society value such persons and create a comfortable niche for them? The answer is that some goods and services involve a degree of complexity that makes it very difficult for consumers to evaluate the quality of the goods and services. Legal services and medical treatment are important examples. Both involve considerable uncertainty (even the best lawyer loses some cases, even the best doctor fails to cure some patients). When a consumer is unable to determine the quality of a product or service, the provider has to be regulated, either directly as in the case of the regulation of the drug industry by the Food and Drug Administration or indirectly as in the professional model, in which the conditions for becoming a member of a profession encourage self-selection by persons likely to be trustworthy, responsible, and ethical because less inclined to cut corners in order to make a killing.  

The professional model in law began to wane in the 1970s, with the beginning of the deregulation movement, which loosened restrictions on competition in legal services. The trend continued in subsequent decades, and was marked by an increased spread in earnings within law firms, an increased dispersion in the size of law firms, and increased turnover—in particular, the tendency of successful lawyers to move from firm to firm (taking their clients with them) in quest of higher incomes. Today, law firms closely resemble business firms. I am speaking mainly of law firms that handle corporate business, not of criminal or tort lawyers, who tend to practice by themselves or in small firms.  

Corporate lawyers today don’t want just a comfortable upper-middle-class income; they want to be rich; and one reason is the increased risk they face. Few law firms (remember that I’m talking only about corporate-law firms) any more practice “lockstep” compensation, in which all partners of the same vintage in a firm are paid the same—a risk-minimizing method of compensation that used to be the norm in large law firms. Today a lawyer faces the risk, if his productivity declines, of seeing his income decline, or indeed of being pushed out of the firm altogether; and to cushion that risk, naturally he wants to earn as much as he can while he can. 

Once the legal and ethical limits on lawyer competition are relaxed, the underlying riskiness of law firm practice is unchained. That riskiness lies in the fact that, like banks though less dramatically, law firms’ capital is short term but their assets are long term. The principal capital is human capital—the most successful partners and their clients—and that capital is short term; a partner can leave the firm, clients in tow, with little or no notice. This can cause a run on the firm, as happened in the collapse of the previously very successful Dewey LeBoeuf firm, because its assets, including its accounts receivable and future clients (corresponding to a bank’s loans), cannot be liquidated at a moment’s notice to match the firm’s assets to its shrinking capital and its fixed debt. 

The market response to the transition of the legal services industry from a profession to a business has been increased vigilance by corporate house counsel, who are expert monitors of legal services, and a related trend toward business firms’ bringing legal business in house, where direct supervision of the lawyers handling it is feasible. Are these adequate substitutes for the ethical and regulatory restraints that define a profession? And if not are the costs offset by increased competitiveness? I don’t know the answer to the first question, but I am skeptical with regard to the second. Even if the business model is more efficient, it is unclear that efficiency in corporate law is a public good. The reason is the adversary nature of corporate law, not only in litigation but also in negotiation of deals, structuring of transactions, and coping with regulation. If there are good lawyers on both sides of a case, the aggregate costs of litigation are higher, and the benefits to judge and jury of a more vigorous and informed adversary process generally quite modest. If private lawyers with a regulatory practice are abler, the regulatory agency needs to hire abler lawyers, and so the cost of regulation increases, though there may be a net gain in the quality of regulation. And do abler lawyer on both sides of a deal negotiate a better deal in a social sense, or simply increase the costs of negotiation? 

Turning briefly to medicine, about which I know less: When I was growing up in the 1950s, doctors constituted a highly respected profession, though their capabilities were distinctly inferior to what they are today, after more than half a a century of remarkable progress in medical technology. Like lawyers, doctors in the old could realistically aspire to a comfortable income but not to become wealthy. 

Opportunities for wealth developed, not because of significant changes in regulation, as far as I’m aware, but because of the rise of costly though effective specialized treatments and because of the increased availability and generosity of private and governmental health insurance. Most doctors in the old days were general practitioners, or at the higher end specialists in internal medicine, but really they were generalists too; like general practitioners they both diagnosed and treated. With increased specialization, treatment for the rare, complex, debilitating, or lethal diseases gravitated from general practitioners to specialists in particular fields of medicine. These specialists were understood to “deserve” higher incomes because of their more protracted medical education. Moreover, health insurers are more comfortable reimbursing procedures than visits to a general practitioner, because the optimal length of such a visit is impossible to gauge. 

As a result specialists now outnumber general practitioners and some specialists, if able through automation or staff to treat a large number of patients in a short span of time, have extremely high incomes. And yet, since medicine more than law has as a career a powerful appeal to a relatively large number of able people, including many foreigners who would be eager to relocate to the United States (in fact a significant fraction of our doctors are foreign-trained), one can imagine a medical system in which doctors were paid somewhat less than they are today yet would be content. This would be some form of “socialized medicine,” such as found in much of the developed world, and it may prove to be the direction of reform of our much-criticized health-care system. 

In sum, the professional model is giving way in corporate law to a business model, whether for good or ill, though quite possibly the latter. The professional model is endangered in medicine as well, but there it may actually be on the verge of renewed vitality.

Is the Business Model Worse Than the Professional Model? Becker

Posner has a good discussion of the shift in the organization of services in law and medicine from a traditional “professional” model to a more business-like model (especially in law). Have the higher incomes and apparently increased inequality of incomes in law and medicine during the past several decades, perhaps partly due to a shift toward a more business model, reduced the social value of the care provided to clients in these professions?

Medical patients and consumers of legal services may be badly served because the doctors and lawyers treating them are either incompetent or unethical. I believe that the low level of competence of many doctors and lawyers is the biggest source of bad medical care and legal representation. I will emphasize the changes in medical care since I am more familiar with the evidence in this field.

Many studies have shown sizable differences within the United States in the treatments provided for different forms of cancer, cardiovascular disease, and other diseases. Sometimes, differences in treatments are consistent with all the physicians and hospitals involved being competent, knowledgeable, and ethical because different approaches appear to have similar outcomes for patients. Often, however, some treatments are used even though quantitative studies show, and leaders in medicine indicate, that these treatments are unnecessary or decidedly inferior to best practice medical care.

Some of these incorrect or excessive treatments are motivated mainly by the monetary gain to doctors or hospitals, such as overuse of MRIs, or multiple use of triage facilities for a given patient on the same day. However, inferior or excessive treatments are often used because doctors misdiagnose a disease or condition, or because they are just not up to date on what are the best treatments for conditions they correctly diagnose.

The sharp growth during past several decades in the drugs and surgeries available to treat different diseases makes it harder than in the past for less competent doctors and hospitals to keep up with best practices. This is why one would expect the frequency of deviations from best medical practices to have grown over time, even when the distributions in the abilities and ethical standards of doctors and hospitals have not changed.

Have the deviations from best medical practice grown even faster than would be expected from the advancement in medical knowledge, perhaps because of a decline in ethical standards of doctors and hospitals, or the growth in medical specialization emphasized by Posner?  That is possible, although I do not know of evidence that assesses the changes over time in the ethics of doctors. Growth in medical specialization per se should reduce the degree of bad medical practice because specialists are more knowledgeable of advances in their field than are general practitioners. Specialization has increased over time mainly because of the growth in medical knowledge and the increased size of the medical market. This is why specialization has grown in all modern countries with very different ways of organizing the medical field, although its growth has been more extensive in the United States.

I will spend much less time on the legal profession because Posner has covered changes there very well. Lawyers involved in corporate or class action practices frequently earn a lot. That is not surprising since even slightly more competent lawyers can often make a large difference in the monetary gains from IPOs, mergers and acquisitions, and product liability suits.

Has the greater competition for lawyers by different law firms, the increased turnover of lawyers from the larger law firms, and other changes in the organization of the legal profession led to lower ethical standards by lawyers, or to a greater social waste of resources spent on lawyers? Any adversary system has “waste” in the sense that lawyers on one side of a dispute partly just offset the arguments put forward by lawyers on the other side. Perhaps that “waste” has grown over time as the stakes in corporate disputes have gotten bigger, and perhaps the adversary system is inferior to other types of approaches to resolution of legal disputes.

However, none of this implies that much of any growth in “waste” from legal disputes is due to the increased competition or greater turnover in the legal field.

Breakup of Countries: No Economic Disaster- Becker

The largest and some smaller political parties in Catalonia, one of the richest parts of Spain, want to have a referendum in that region on whether they should secede from the rest of Spain. This is despite the fact that during past several decades the central government of Spain has ceded considerable fiscal and other independence to Catalonia and other regional governments. Those supporting a breakup argue, among other things, that Catalonia is being heavily taxed to help support poorer and less hardworking regions of Spain. The opposition to a breakup both within and outside of Catalonia claims that secession would be illegal under the Spanish constitution, and that it would destroy Spain’s culture.

 Spain is not the only country that is experiencing pressure either to breakup, or to become much more decentralized politically. Major parties in Scotland want independence from the rest of the United Kingdom. As a result of this pressure, Scotland and other regions of the UK have received much more autonomy than they had in the past. The independence movement has quieted down in Quebec, but only after Canada established French on an equal footing with English, and after the province of Quebec received other special treatment from the rest of Canada.

 The Western and Russian-influenced part of the small country of Georgia is essentially independent in most respects from the rest of Georgia, while Georgia only became independent after the breakup of the Soviet Union into many independent countries. At the close of the nineteenth Taiwan, which had long been part of China, became a colony of Japan until World War II ended. Taiwan was returned to China at that time, but became an independent republic in 1949. China is pressing hard for Taiwan to once again become a province of China, probably with a large degree of autonomy. However, the great majority of Taiwanese prefer the status quo, in part because per capita incomes are so much higher in Taiwan than in Mainland China.

 Although emotions usually overflow on the subject of secession and forcible integration, I will not try to evaluate the significance of nationalistic feelings in a region or country. I will instead focus on the economic consequences of a country’s breakup into smaller and largely independent countries. Often stressed is that since larger countries have bigger domestic markets, companies in larger countries can utilize economies of scale in production.

 

The movement toward free trade agreements and globalization during the past 60 years has enormously reduced the economic advantages of having a larger domestic market to sell goods ands services. Small countries can sell their goods to other countries, both large and small, almost as easily as large countries can sell in their own domestic markets. For example, during the past 30 years the small country of Chile has had the fastest growing economy of Latin America, larger than Brazil and Mexico, the two largest nations of this region. This would not have been possible without the access of Chilean companies to markets in other countries, both in South America and elsewhere. As a result, Chile now exports around 40% of its GDP, compared to a ratio of exports to GDP in the United States of about 13%.

 To many in Czechoslovakia, the economic future seemed dim when Czechoslovakia voluntarily split in 1993 into the Czech Republic and the Republic of Slovakia. Similarly, emotions were strong after a destructive war forced Yugoslavia to split into six separate countries. Yet these separate nations are generally doing at least as well economically as did Czechoslovakia and Yugoslavia.

 Small countries can do well with small domestic markets by taking advantage of a globalized economy by selling large fractions of its production to consumers and companies in other countries. That is why smaller countries usually export a considerably larger fraction of its production, and import a much bigger share of its consumption, than do larger countries. Size of country was much more important in the past when many countries had high tariffs, and transportation costs were much more important.

 Political interest groups tend to be less able in smaller countries in distorting political decision in their favor. This is partly because smaller countries are more homogeneous, so it is harder for one group to exploit another group since the groups are similar. In addition, since smaller nations have less monopoly power in world markets, it is less efficent for them to subsidize domestic companies in order to give these companies an advantage over imports. The greater profits to domestic companies from these subsidies come at the expense of much larger declines in consumer well being.

 The growth in the competitiveness of small countries on the global market is in good part responsible at a deeper level for the remarkable growth in the number of countries since 1950 from a little over 100 to almost 200 countries now. And the number of independent countries is still growing.