The Becker-Posner Blog

President Obama’s Plan for College Reform—Posner

Several days ago the President proposed that the federal government create a rating system ("scorecards”) beginning in 2015 to rank colleges by such metrics as tuition, percentage of low-income
students, graduation rates, alumni earnings, and debt of graduates. Federal financial aid to students, currently running at $150 billion a year, would be allocated on the basis of the ratings, though this part of the proposal would require legislation; the other parts the President can effectuate without congressional action. For a good summary of the program, see Dylan Matthews, “Everything You Need to Know About Obama’s Higher Ed Plan,” Wonkblog, Aug. 22, 2013, www.washingtonpost.com/blogs/wonkblog/wp/2013/08/22/everything-you-need-to-know-about-obamas-higher-ed-plan/. 

There are of course college rating systems already, such as that of U.S. News & World Report. A federal rating system would probably have somewhat greater credibility; and if it became the basis for allocation of federal financial aid, the system would have far greater effect on college choice, given that more than 80 percent of college students receive federal financial aid. 

Multi-factor rating systems have an obvious, and very serious, problem: weighting. It is almost certainly the case that the factors in the proposed “scorecard” don’t have the same importance to an intelligent choice of which colleges to apply to. Worse, there is unlikely to be agreement on which factors are the most important and so should be given the greatest weight—and how much more weight than the other factors. That won’t matter a great deal as long as the ratings just guide college
choice, for then parents and their kids will give whatever weight they want to the various factors. But the ratings will matter greatly—and influence that choice—if Congress allows them to be used to govern the allocation of federal financial aid to students. 

To evaluate the President’s proposal, we need to step back and consider what ails our higher-education system. It is helpful to note the affinity between its rather doleful situation and that of our health care system. The top institutions in both systems provide world-class quality of service, mainly to children of the affluent and nearaffluent—the top tier of American universities and colleges is generally considered tops in the world. Both systems provide indifferent quality at the bottom, the bottom-tier universities and colleges being worse than the bottom-tier hospitals and clinics. Both systems are very expensive, with much of the tab picked up by the taxpayer—both are very expensive in part because of poor quality control by the federal government. The government is not a very competent financier, in major part because it is buffeted by interest groups wielding formidable political power. 

The Administration’s Affordable Care Act (“Obamacare”) is an enormously ambitious, almost incomprehensibly complex, effort to improve medical care and at the same time reduce the rate of growth of the nation’s medical expenditures. The President’s new higher-education proposal is much less ambitious, especially if one sets to one side the part that requires congressional approval—the part about keying federal financial aid to universities and colleges to how well they perform on the “scorecard.” It is worth analysis, of course, but can be relegated to secondary concern on the pragmatic ground that congressional approval appears to lie far in the future. 

The Presidente’s proposed ratings do identify characteristics of colleges and universities that parents and their high-school children should consider in deciding whether (and where) to apply to college. True, most of the information is available already, but not (so far as I know) in a compact, readily readable and comprehensible form, amd of course missing the imprimatur of the federal government. The Wall Street Journal in an editorial yesterday (August 24) scoffed at the supposition that the government can pick “winners.” But that isn’t the purpose of the ratings. The purpose is to provide accurate, readable information for the relevant consuming public, and so understood seems perfectly appropriate. The “picking winners” criticism will become more apt if and when Congress authorizes the allocation of federal financial aid on the basis of the ratings. 

But I do think the scorecard even when viewed purely as an information device can be criticized. For example, while I can see why the percentage of low-income students in a college would be an appropriate factor to consider in allocating federal aid, I don’t see its relevance to the choice of a college by would-be applicants. Tuition, on the other hand, is a relevant factor, obviously, but is disclosed up front by any college or university to which one applies. Alumni earnings sound relevant, but the problem is that they necessarily are backward looking. They are the record of experiences of previous students, and may reflect characteristics of the college or of the job market that have changed since those generations of students graduated. The amount of debt of graduates is similarly an ambiguous signal to a prospective applicant. If the debt of graduates of a particular institution is above average, this may reflect career choices or excessive optimism, things for which the college may bear only limited, if any, responsibility. The factor is included in the scorecard I assume because of a belief that some colleges lure students by obfuscating the financial obligations that a student who applies for financial aid will be taking on. I think this belief is correct but I don’t know how much
of the indebtedness of graduates it is responsible for. 

Most American colleges and universities are nonprofit, but that just means that are don’t have shareholders; profit residuals are dissipated in generous salaries for administrators and faculty, student amenities designed to attract rich kids and thus increase (along with high-powered sports programs) future donations, and lavish building programs. The colleges compete with each other with Darwinian ferocity. Federal financial aid has them to increase tuition at an astonishing rate, which has funded the competitive extravagances. The nonprofit colleges and universities seem just a tad less avaricious than the profit-making ones. 

The competition has greatly increased the number of college graduates—to the point where many cannot find a job requiring a college education. IQ is a limiting factor in the value of a college education in the job market. 

So below the very top tier of institutions, the picture of American higher education has become rather depressing. The President’s newly announced program seems unikely to work any significant improvement.

Information About Colleges and Student Loans-Becker

Colleges in the United States, and in most other countries as well, vary enormously in the quality of education provided, their cost, and their overall efficiency. The over 3000 American colleges compete fiercely for students in terms of tuition, quality of faculty and student bodies, athletic programs, student loans, student grants, and in many other ways. Even though many academics complain about the distortions of business advertisements, the catalogues and other “information” provided by many colleges and universities make lots of advertising look like models of accuracy and probity.

Therefore, to better assess different colleges, high school students, especially those from more educated and financially better off families, spend considerable time and effort in gathering information about colleges. All potential college students can use good information about courses offered, performance of the student body on standardized tests and other information about the students who have attended, the availability of student aid, and the earnings of graduates.

The market has responded to this interest in knowing about colleges by providing guides, rating system, and other school information. These include the well-known US News and Washington Monthly’s rankings, and many lesser known surveys and rankings that range from the frivolous to the informative.

The federal government has a role to play in making readily available many kinds of information useful to students applying to colleges. The government also could help, at least up to a point, by requiring colleges to release relevant information that they may try to keep hidden, such as default rates on student loans, earnings of graduates, dropout rates, and the like. This and other information would be particularly valuable to students from poorer families since recent studies show that these students, even those with very good school records and high scores on achievement tests, are not well informed about different colleges, partly because they put relatively little time into their college choices.

I do not see any good role for the federal government in providing rankings of colleges, as proposed by President Obama, and discussed by Posner. Competition among private market providers of ranking and other college information is far more likely to give students what they want in making their choices. To be sure, market-driven information tends to neglect information that students are not interested in knowing, even when the information might be helpful in their college choices.  But the federal government is unlikely to be efficient in discovering this information, and presumably students will give it little weight in making their school decisions.

Student debt has grown rapidly during the past 25 years, due to the rapid increase in school tuition during this time period, the significant subsidy to most loans, and the growth in high school graduates who attend college. Even though many in the media and elsewhere are complaining about this expansion in student loans, the average student loan of about $26,000 is not large relative to the average income of college graduates of about $70,000. Young families often take on mortgage debt that is twice or even a larger fraction of their earnings.

There is a legitimate concern about those persons with much larger student debt, and about those who make much less than the average college graduate, such as students who drop out of college, or who attended proprietary schools. The federal law that excludes student loans from personal bankruptcies makes the burden for these students still much harder to manage.

The president addresses this problem by proposed various changes in the student loan program, including a move toward a more universal income-contingent repayment system. I have supported income contingent loan programs because returns on investments in a college education are risky. Risky business investments are generally financed by equities rather than debt, and an income-contingent repayment system is more like equity than debt financing of student investments.

Income contingent loans appeal least to students who expect to earn a good income, such as graduates of medical, business, or engineering schools, because the repayment “taxes” on their earnings would be higher. This is why in order to get a balanced demand for such loans from both high and low earners, repayment rates should begin to decline after earnings exceed a certain level.

College is still a very good economic deal relative to their alternatives for the great majority of college graduates, including most of those with sizable loans. The returns from college are not so good for some students with lower abilities and poorer college preparation who come from poorer backgrounds, who do not attend colleges that help them much, and who take on too many loans. These students would benefit from better information about what different colleges have to offer, and from student loan systems that tie repayments to earnings.

Low Birth Rates: Causes, Consequences, and Remedies-Becker

Not long ago a vocal concern was about high fertility in the world and a rapidly growing population. Remember the currently quiet zero population growth (ZPG) movement? The tide has turned since the worry now is about too few births and a falling population.

The reason for this shift in attitude is that over 80 countries have fewer births than required to replace the number of individuals who die each year. They need a large flow of immigrants each year just to prevent their populations from peaking and then declining. These low birth countries contain over 40% of the world’s population, including every country in Western Europe, China, Japan, Russia, Poland, and Canada, to name just a few. Birth rates in many other countries, including the United States, Mexico, and Iran, are only a little above the level necessary to replace the number of deaths.

Scholars measure the level of fertility by the total fertility rate (TFR), which equals the average number of children born to women over their lifetimes. Countries with TFRs below the replacement level of about 2.1 fall into the low fertility camp. Essentially no countries were in this camp in 1970, but in each succeeding decade many additional countries fell below replacement levels. Moreover, and this is important, in not a single country has the TFR ever risen above replacement once it fell below.

As late as the beginning of this century, demographers and others were predicting a rapid growth in world population to over 11 billion by the year 2050. The rapid emergence of low fertility in so many countries has already made these forecasts obsolete. Populations forecasts now assume much lower future fertility levels, but even the present consensus that world population will be about 9 1/2 billion by mid-century may be too high as fertility continues to fall rapidly in poorer countries.

There is growing discussion in many low fertility countries about the negative consequences of having fewer young persons, and the prospects, already a reality in Germany, Japan, Russia, and a few other countries with low immigration levels, of declining populations. In richer countries, retirement incomes and medical care of the elderly are largely financed by taxes on the younger working population. Low birth rates eventually lead to fewer men and women of working ages, and hence a smaller tax base to finance social security payments, unless the fewer children born have sufficiently greater amounts invested in their education and other human capital.

Although potential difficulties in financing social security benefits are receiving the most attention, other negative effects of low birth rates may be of equal or greater importance. Low fertility reduces the rate of scientific and other innovations since innovations mainly come from younger individuals. Younger individuals are also generally more adaptable, which is why new industries, like high tech startups, generally attract younger workers who are not yet committed to older and declining industries.

The great majority of countries have had growing populations during the past 250 years as world population grew at unprecedented rates. Yet ever since Malthus wrote his great work on the harmful effects of population growth on incomes, group after group have opposed high fertility and growing populations as bad for the world’s food supply, standard of living, and environment, including local and global pollution.

However, these possible negative effects of larger populations have to be weighed against the sizable benefits from more people. These benefits include a larger number of young persons who, as mentioned earlier, are more likely to innovate, such as coming up with more efficient ways to grow food, and pay for the benefits to retired men and women. A bigger population also increases the demand for new drugs, software, social networking, and other innovations that have increasing returns to the scale of demand.

To be sure, if higher birth rates lead to lesser education and other human capital investments in each child, they may result in lower, not higher, per capita incomes. Malthus fear of lower per capita incomes explains his strong opposition to high birth rates. However, the rapid growth in world population during past 250 years has been accompanied by unprecedented high per capita incomes all over the world. Whatever the Malthusian negative effects of greater population, they have been dominated by factors that raised per capita incomes, including the benefits of increasing returns and other advantages from having a larger population.

China is seriously considering either greatly modifying or completely abandoning its “one child” policy because of its effects on the number of young persons, and population decline. France a while back instituted a generous and expensive system of financial support to families that have 2 or more births. Germany, Japan, South Korea, Russia, and other countries are discussing and sometimes implementing similar child support programs.

Whether a subsidy is justified depends on whether the benefits from more births and a larger population, including the benefits to the families having children, exceed the cost of encouraging births, such as the budgetary costs to governments of a child support program, potentially greater environmental damage, and the like. Even if, as I firmly believe, that on the whole greater population in the modern world has more benefits than costs, one has to recognize that programs to stimulate births are expensive, aside from simply ending birth suppression policies, as in China’s one child regulatory policy,

For example, to cut the gap in half between Germany’s actual TFR of about 1.4 and a replacement level of fertility of 2.1 requires a 25% increase in the number of births. Yet such a large increase in fertility has not been achieved by any past fertility subsidy programs, even expensive ones, presumably because children are so costly to raise in the money, time, and energy of parents. A more modest 10-15 percent growth in fertility might be achievable with generous and expensive programs, as in France. Perhaps a full benefit cost analysis would show that such a program is warranted, but the jury on this is still out.

Does the World Need More People? Posner

To answer my own question: I am dubious. 

It is true that a country can get into economic trouble if the number of elderly people, who invariably impose heavy costs on a country’s health care system, becomes very large relative to the number of persons of working age, because then the financial burden on the working population can become extremely heavy. The reverse, however, is also true: too high a ratio of young to old can be destabilizing. The experience of many of the poor nations of the world has been that a large youth population creates severe unemployment problems and can lead to violent unrest, as in a number of Middle Eastern countries in the last few years—the naively heralded “Arab Spring” having quickly become a nightmare of violence, political disorder, and regional instability. 

It’s amazing that a poor, largely arid country like Egypt should have a population of 84 million. That cannot be a good thing. Much of Egypt’s current problems stem from inability to grow enough food to feed its population, and insufficient productivity to buy abroad all the food its huge population needs.

A growing population implies a growing number of children—not just persons of working age—and children impose heavy opportunity costs on parents (unless child labor is permitted, which however is likely to prevent children from becoming educated) and are costly to educate. A fast-rising population can not only create heavy youth unemployment but also strain public services (such as public educational institutions). And all this is in addition to the environmental impact of increased population, for example on global warming, species extinctions, and traffic congestion. 

If children were a “superior” good in the economist’s sense—that is, a good that is purchased in greater quantity when people’s incomes rise—one would expect the birthrate in wealthy countries to be high and rising, but the opposite in most such countries is true. Maybe children are actually an “inferior” good, valued most by poor people either because the children of the poor work to augment family income or because the family lacks the resources for such child substitutes as expensive cars, clothes, homes, entertainment, and travel. Increasingly in the wealthy countries both spouses work, increasing the opportunity costs to both parents of raising children. 

A better and certainly cheaper answer to the problem of declining population in countries like Germany and Japan—wealthy countries (though not all countries with declining populations are wealthy—Russia is not, for example)—is immigration. There are some two and a half billion people in China, India, and South Korea alone. Their average IQ seems similar to (maybe even higher than) that of the inhabitants of the United States and the other wealthy countries, including those wealthy countries whose populations are declining (a category that excludes the United States). This implies a very large number of East Asians with IQs well above 100. (Assuming that IQ is normally distributed, an average IQ of 100 means that 2.5 percent of the population has an IQ of at least 130—and 2.5 percent of 2.5 billion is 62.5 million.)  Obviously not all want to emigrate, but many are quite open to the possibility. The problem is that few wealthy countries, other than the United States and the other English-speaking countries, are welcoming to immigrants. They have immigrants—Germany for example has many citizens of Turkish origin; Japan has many Koreans. But these countries tend to be insular, ethnocentric, downright hostile to immigrants, and their immigrant populations—not just the first generation, either—have difficulty assimilating, unlike immigrants to the United States, which still really is a melting pot. If those countries can’t solve the assimilation problem, thereby making themselves more attractive to high-quality immigrants, their populations will continue to decline, because the countries probably can’t afford the subsidies necessary to halt the decline. 

There is no necessary connection between population and economic growth. The sharp decline of Europe’s population because of the Black Death is thought to have increased per capita incomes significantly by reducing the ratio of people to arable land, resulting in improved nutrition. A larger population can, as Becker points out, increase the rate of technological progress by increasing the number of geniuses and other very creative people. But so can assortative mating, which has become much more common in the advanced countries as a result of falling discrimination and Internet dating search. At some point there may be diminishing returns to the increasing number of computer engineers.  

Paying people to have children sounds odd though it can be defended on economic grounds if the additional children yield a net economic benefit. (So for that matter could paying elderly people to forgo end of life medical expenses likewise be defended on economic grounds, depending on how large the subsidy would have to be and how it would be financed.) I am skeptical that such a defense can be established. Too little is known about the economic effects of continued growth of a world population that has now surpassed seven billion.

Poverty and Near-Poverty in the United States--Posner

Two recent articles—Hope Yen, “80 Percent of U.S. Adults Face Near Poverty, Unemployment: Survey,” July 2, 2013, www.huffingtonpost.com/2013/07/28/poverty-unemployment-rates_n_3666594.html, and Ron Nixon, “House Plan on Food Stamps Would Cut 5 Million From Program,” NY Times, July 31, 2013www.nytimes.com/2013/07/31/us/politics/house-plan-on-food-stamps-would-cut-5-million-from-program.html?_r=013----invite attention to the problem of poverty in the United States today. 

Yen’s article points out that while “only” 15 percent of American households have annual incomes below the poverty line (actually the figure is 16 percent)—$23,000 for a family of four—a much larger number can expect to be poor at some time during their lives; many fear sinking into poverty; and many people above the poverty level struggle to make ends meet. 

I believe the poverty line is a useless statistic. For one thing it omits government benefits such as food stamps, social security retirement and disability benefits, Medicare, and Medicaid, along with private charity. For another, “poverty” is not well defined. And for another, the notion of a “line” that separates poverty from non-poverty is ridiculous. If $23,000 is the line for a family of four, does that mean that a family of four with an income of $23,500 is not poor? 

A very small percentage of Americans is actually destitute; but a very large percentage do not have a sufficient income to be comfortable. In fact I am guessing that half the population is in that fix. The median household income in the United States is only $50,000. That is, half the households have less. These households have very little in the way of savings, often cannot afford to live in school districts that have good schools, and cannot afford health insurance (for which Medicaid is a poor substitute). Because of their meager savings, they are highly subject to economic vicissitudes, and are often dependent on usurious loans and often on—or over—the brink of bankruptcy. Partly as a consequence and partly as a cause of low income, they often are in poor health. They cannot pay for their children’s college tuition; the children must go deeply into debt to attend college. 

The number of Americans in households with income below the median must be close to 150 million (the exact number would depend on the average number of persons per household having less than the median household income). Obviously the significance of the number depends on the median income. But that income is modest, an important fact that has to be assessed. One question that needs to be examined is the cause; another is the effect; and a third is what if anything could be done to raise the median income significantly. 

I accept that the main cause of economic inequality in the United States, and thus of poverty and near poverty, is that the United States uses a more or less free market to allocate resources, and hence household income is mainly the result of the demand for and supply of labor. In recent decades, rapid advances in technology have increased the demand for highly educated, high IQ persons and (along with increased imports of manufactured goods from low-wage countries) reduced the demand for persons who do manual labor, notably in factories, or more generally for persons whose jobs can be done more cheaply by machines. At the top of the income distribution, the growth of global markets, notably in finance, has enabled successful entrepreneurs and investors to obtain unprecedently large profits. Low tax rates have been a factor as well.  

There is nothing, or very little, that is sinister or pernicious in the growth of inequality of income and wealth under pressure of market forces. But the consequences are not altogether desirable. They include reduced upward mobility (upward mobility has declined in the United States and is now below that in most European and English-speaking countries; see Vasia Panousi et al., “Rising Inequality,” Brookings, March 13, 2013, www.brookings.edu/~/media/Projects/BPEA/Spring%202013/2013a_panousi.pdf; Scott Winship, “Mobility Impaired,” National Review Online, Nov. 14, 2011, http://www.nationalreview.com/articles/282292/mobility-impaired-scott-winship), as the wealthy use their wealth to assure the prosperity of their children and grandchildren, in part by buying the best education for them; greater distance between the income classes, so that the wealthy have diminished contact with lower-income people (some of Mitt Romney’s comments during the 2008 Presidential election campaign suggested little familiarity with the lives and problems of lower-income people); and increased dependence of politicians on campaign donations by wealthy companies and individuals. 

Americans seem singularly lacking in envy, and to be uniquely imbued with a culture of self-reliance, and as a result the growing inequality of income does not portend political instability. But it seems wasteful. Those 150 million or so members of households that have incomes below the median include
a very large actual and potential labor force that is not being utilized very productively. People who are poorly educated, unhealthy, brought up in broken families, exploited by unscrupulous sellers of goods and services, preoccupied with making ends meet, unable to afford labor-saving devices, in and out of bankruptcy, and constantly worrying about the household budget are unlikely to be productive workers; and the entire society suffers. They are also unlikely to be competent participants in the political process, as voters, because they lack both the leisure and the education to become even minimally informed about public matters. 

But what is to be done? Some conservatives believe that the social safety net—the food stamps, Medicaid, etc.—should be removed (see, for example, Ron Nixon’s article that I cited at the beginning of this post) in order to increase the incentives of the poor to work hard and improve themselves, and
that the near poor, ineligible for the safety net, should simply be left to struggle. Neither seems a realistic suggestion for improving the productivity and political sophistication of either group. 

More promising I think would be a large investment in early childhood education and nutrition, a shift in medical resources from the diseases of old people to the medical needs of children and pregnant women, a substantial expansion in Medicaid, and a modest expansion in public work projects involving services. A restructuring of the federal tax code and a modest increase in income tax rates in the higher brackets could finance such programs.

 

Education and the Growth of Poverty in United States-Becker

Inequality in the US has grown substantially since 1980. As a result, “poverty”, often defined as the fraction of families with incomes less than half the average income, has increased greatly. Similarly, “near poverty”, defined say as families with incomes between a half and three quarters of average income, has also grown by a lot. It is no surprise that greater income and wealth inequality has a big effect on the degree of poverty since it is a property of all distributions that more variability especially raises the fraction of observations at the tails of the distribution. In the income and wealth case, this means particularly rapid increases in the fractions of the poor and very wealthy as inequality increases.

The main causes of the growth in US earnings inequality are in order of importance: the large increase in returns to education and other skills, the rapid growth in households headed by unmarried mothers, the financial crisis and the resulting large expansion of unemployment, especially of lower income workers, and the big growth in some income maintenance programs that have induced some workers to leave the labor force.

Previous discussions on our blog and elsewhere have documented the rapid growth during past 40 years in the returns to college education, and to a lesser extent to high school graduation. The large expansion in the fraction of children living in households headed by a single parent increased to about 28% due to the boom in divorce rates and in the tendency of women to have children without being married. The recession that accompanied the financial crisis raised unemployment rates of high school dropouts from 7% in 2007 to more than 13% at its peak. This is still at a highly elevated rate. Finally, the recession lowered eligibility requirements for food stamps, Medicaid, mortgage reduction, and other welfare programs. This led to a decline in labor force participation among lower income workers in order to increase their prospects of qualifying for these benefits (see the evidence and discussion in Casey Mulligan’s “The Redistribution Recession”).

Many separate approaches are available to attack each of these causes of greater poverty rates, but improved education would significantly reduce the incidence of each one. The crucial education improvement would be in much lower dropout rates from high school and from four-year college programs. Lower dropout rates starting soon would take years to affect a large fraction of labor force, but the benefits would be enormous. First of all, the fraction of persons with very low incomes would decline greatly since high school dropouts and some high school graduates make up the bulk of the low-income population, although a boost in the fraction of the labor force who graduated high school and finished college would also lower the returns to education.

Educated persons have more stable marriages and are less likely to have children out of wedlock or out of stable non-married relations. This means that reducing high school and college dropouts would also reduce the incidence of the family structures that lead to low household incomes. Greater education may not reduce the incidence of serious recessions, but it would reduce the vulnerability of the labor force to these recessions. Finally, a more educated population would be less tempted to leave the labor force to take advantage of food stamps and other welfare programs because they would then have to give up too much in the way of earnings.

There is no magic way to improve the education of younger persons, especially given the vicious cycle between less educated and low-income parents, broken households, and low education and other poor performance of children. However, as argued in more detail in earlier blogs (see for example Sept. 2012 on “Good and Bad Teachers”), more charter schools and a greater use of school vouchers, teacher evaluations based on objective measures of their performance, much better pay for good teachers (such as teachers whose students perform better), and weaker tenure for bad teachers would go a considerable way toward reducing school dropouts and improving the overall education performance of American students.

Technological Change and Natural Resource Prices-Becker

Natural resource prices increased rapidly during the first decade of this century, mainly propelled by rapid increases in world GDP, especially of the US, China, Brazil, and other fast developing countries. These prices then stabilized and many declined due to the world recession brought on by the financial crisis in 2008.

Some examples illustrate the magnitude of the price movements. Nominal copper prices quadrupled from 2001, despite a sharp fall in 2008, peaked around 2010, and declined by about 25% since that peak. Oil prices increased from $20 a barrel in 2002 to more than $140 a barrel in 2008, and have been in the range $100-$120 since then. Natural gas prices in most of the world increased several fold since 2000, and have been flat for the past couple of years. At the same time, natural gas prices in the US have fallen by more than 2/3 since their peak a few years ago.

These higher prices encouraged companies and consumers to economize on resource use. In the short run, however, both the demand and supply of oil and many other natural resources are only mildly responsive to higher or lower prices.

The long run picture is very different, for then opportunities to substitute away from the resources rising most in price are much greater because users have more time to adjust. For example, more permanent higher prices of gasoline induce consumers eventually to shift toward smaller more fuel-efficient cars, and drive less with the cars they have. They carpool more, make greater use of public transportation, or even take jobs nearer their homes. Cars are smaller and more efficient in Europe and Japan than in the US in good part because gasoline prices have been much lower in US.

Longer run adjustments on the supply side are also much larger, and some of them are game-changers. Although the world stocks of natural resources in the ground cannot be augmented since they were created by millions of years of evolution on the earth, the cost of getting these stocks out of the ground vary enormously: from the cheap and easily accessible oil just below the surface in Saudi Arabia to the difficult to access resources very far below ocean surfaces. Higher prices of a natural resource encourage extraction of more costly deposits, which increases the supply of that resource.

High prices also encourage investments in technologies to lower the costs of accessing various deposits that make them worthwhile to develop commercially. The most important example in recent years is the improvement in fracking methods used to extract oil and natural gas hidden in shale rocks. Wildcatters in the United States, like the recently deceased George Mitchell, spent years and much money, sometimes assisted by government support, in developing fracking to the point where it became commercially viable at the oil and gas prices prevailing during recent decades.

The success of fracking has resulted in a huge increase in American oil and especially natural gas production that greatly increased the American supply of these fossil fuels to produce gasoline, substitute for coal in electric power plants, and for many other purposes. Due to this revolutionary technology, American oil imports are at their lowest level in more than a decade, and natural gas prices in the US are now a fraction of what they are in Europe, Japan, and other gas importing countries.

The price of oil in the US remains close to the world price since oil continues to be imported. American oil commands the world price because it competes against imported oil at that price. Natural gas prices differ greatly among regions of the world because these prices depend on whether pipelines and liquefied gas facilities allow gas to be imported or exported. As I mentioned earlier, the widespread use of fracking techniques in the US has produced a huge fall in the domestic price of gas in this country.

Of course, companies that extract natural gas from shale would like to export some of their production to other countries to take advantage of higher prices there. Since such exports would raise gas prices in the US and lower them in the recipient countries, domestic users of cheap natural gas have organized to oppose its export elsewhere. Restrictions on gas exports would be unwise because the value received from the higher prices in other countries would exceed the value created by the artificially induced increase in American industrial output. It is poor policy to encourage domestic American industry through costly and inefficient methods like export restrictions.

 

 

 

 

Commodity Price Fluctuations—Posner

Becker’s discussion of natural resource price fluctuations presents a compelling picture of the role of demand and technology in the price of oil and natural gas. Similar fluctuations, with varied causes (though reducible generally to demand and supply changes), affect other natural resources as well. The fluctuations in the natural resources that Becker describes are relatively benign, and though often steep, are kept within tolerable levels by the competing effects of increased demand, which pushes prices up, and technological advances, which pushes them down by increasing the practical availability of the resources. 

The fluctuations can however be socially or politically destabilizing, sometimes in unusual ways. A striking example is the rapid rise in gasoline prices (gasoline being itself a manufactured good, but the major component of its cost is of course oil) in the summer of 2008, peaking at $4.11 a gallon. The rise helped to blind the Federal Reserve to the impending financial crisis. Minutes of the Board’s open market committee that summer reveal a preoccupation with the threat of inflation, of which the gasoline price rise was thought symptomatic, when in fact the danger to the economy was a nascent financial crisis having nothing to do with commodity prices. 

But to understand the real danger to economic and political stability (and the economy and politics are closely entwined of course) that fluctuations in commodity prices can cause, we need to turn from natural resource commodities such as oil to agricultural commodities such as wheat. For the current instability in the Arab world, which has engulfed Tunisia, Egypt, Jordan, Lebanon, and Syria, appears to be traceable mainly to increases in the price of wheat and corn, though it is possible that those increases were triggers, affecting the timing of the political instability of those countries, rather than basic causes. 

The Middle Eastern countries are large importers of wheat and corn, and to a lesser extent other grains. The prices of those commodities fluctuate a great deal. Between 2006 and 2008, the prices of these two grains rose by 136 percent and 125 percent respectively; the price of rice rose by more than 200 percent and the price of soybeans by more than 100 percent. The prices dipped in 2009 and 2010, as a result of the global depression touched off by the financial collapse of September 2008, but they spiked again in 2010; and the “Arab Spring” (an odd term for what seems unmitigated region-wide political disaster) ensued. 

The cause of the price spikes that began in 2006 appears to have been a confluence of increased world population, increased per capita incomes in consuming nations, diversion of corn to the manufacture of ethanol, increased oil prices, and droughts. The effect on the Middle Eastern countries, where bread (made of course from grains) is the basic foodstuff, was dramatic. The governments of these countries subsidize bread, and had to increase the subsidies as the price of grains rose. But the governments have limited resources, so could not prevent the price to the consumer from rising, or shortgages if imports were reduced to save money. 

The price increase was the last straw for the citizens of these countries. They had much to complain of anyway. But the idea that the protests that led to riots and the overthrow of governments and the civil war in Syria resulted from a yearning for democracy or from religious antipathies appears to be incorrect; or in any event the spark that triggered the conflagration was not political or religious discord but economic desperation. (There is by the way considerable grounds for doubting that these countries are ready for democracy.) 

The irony is that agriculture is generally regarded as the poster child for the market allocation of goods, since agricultural commodities tend to be homogeneous and to be produced by very numerous independent producers, so that cartelization is infeasible and deception or confusion of consumers unlikely. Of course governments will not let well enough alone, so there is a great deal of regulation of agriculture; nevertheless the international market in agricultural commodities is highly competitive. But there does not seem to be any mechanism for smoothing price changes at the international level. In principle futures and forward contracts should enable prices of agricultural commodities to be smoothed over time, but these, though common in economically advanced countries, seem not to be employed by the nations that are most susceptible to political challenge—even to political disaster—as a result of fluctuations in the prices of agricultural commodities.