Month: June 2009

My talk on economics for university administrators

Thank you all for the advice; in my talk I promoted the following ideas:

1. Many mid-level schools do not yet apply rigorous quantitative analysis in reviewing their fundraising techniques; this should change.

2. Norms will shift toward a greater inequality of rewards for lower-level staff.  Yet any single administrator who tries to bulldoze through a business-like, highly-incentivized solution does so at his or her peril.  The shift of norms will take a long time.

3. Community colleges are in many cases turning out to be stronger competitors than are for-profits.

4. The higher education bubble has burst.  The expiration of stimulus funds in 2011 will be a crushing event for many public sector universities.

5. Faculty governance is essential for tenure and curriculum decisions.  But faculty governance for setting university priorities is a big mistake.

6. The value of face-to-face classroom time (discussed in Create Your Own Economy, by the way) will prove robust.  But the very best teachers of the future will take on an increasing role as editors, collage creators, and DJs.  A brilliant scientist who doesn't understand YouTube will be crippled as a teacher.  Adjuncts may lead the wave of innovation here.

7. The way to be fiscally responsible is to refuse luxury projects in good times.  If bad times have come it is already too late.

8. Current administrators are using stimulus funds to buy off the old interest groups, under the view that these are temporary bad times.  Relative to what will come, these are "good times," and much of that surplus ought to be put in reserve funds.  That is not happening.

9. Many mid-level schools underinvest in making incremental improvements to their strong, core departments, because nobody gets much credit for that.

10. Being a good university administrator requires the right mix of idealism and cynicism and that is hard to come by.

Should banks be allowed to repay TARP funds?

Here is a new NYT symposium, including a contribution by yours truly, opening like this:

The sooner banks can get out of TARP the better. People have differing opinions on which of the bailouts were good ideas and which not, but we can all agree that the entire episode has been a national nightmare. We should not turn down a chance to put parts of that nightmare behind us.

Matt Yglesias had a good blog post on this same topic.

The public health insurance plan

Here is comment from Ezra Klein, who distinguishes different versions of the public plan idea and also links to further reading.  Matt Yglesias comments in favor of the idea.  Here is a Paul Krugman column.  Arnold Kling is skeptical.  Those are good introductions to the debate.  On the economics, Ezra writes:

Rather, the theory here is simple: If you can't replace them, convert
them. If the public plan works, then private insurance will work better
as well. In this telling, the simple existence of the public plan
forces a more honest insurance market: Private insurers need to offer
premiums closer to their marginal cost, and they have to cut
administrative costs, and they have to work on their reputation for
cruelty and capriciousness. The existence of another option changes the
market. Individuals will have access to private insurers, but they'll
no longer be stuck with them.

I believe Ezra is assuming no direct cash subsidy to the public plan, lower marginal and average costs for the public plan, and some mix of market power and X-inefficiency in the private insurance companies.  The existence of the public plan then "contests the market," which eventually lowers MC in the private plan and leads to lower prices and better service.

My question is what the equilibrium looks like.  Say the public plan has a cost advantage (both MC and AC), as plan proponents suggest.  If public and private plans are to coexist, the public plan must be attracting the higher-cost customers, namely the higher medical risks.  (I am also assuming that the political equilibrium does not allow the public plan to reject these customers outright.)  There is then market segmentation and it is not obvious that there are significant positive competitive pressures on private insurance companies.

Oddly, I believe in some models the public insurer constrains the private companies more tightly when the public insurer does not have an apparent cost advantage.  Even here, the properties of the monopolistically competitive equilibrium would be very tricky.

You might wonder why the public plan does not attract all the low-risk customers and take over the whole market.  I would say that either a) it does, or b) it is tailored toward the high-risk customers.  Since public plan advocates sincerely and correctly claim the policy is not just a back door to single-payer, we are left with b).

Another question: is the "cruelty and capriciousness" of the private plans — cited by Ezra — driven by profit maximization?  Presumably it is and again assume the government plan will not do the same.  Why then would public sector competition force a private firm to throw out a profit-maximizing strategy?  In fact "cruelty and capriciousness" would be a comparative advantage of the private companies and maybe it would be milked more strongly in a more competitive environment. 

Another possibility is that the public company has a bigger cost advantage on AC than MC.  For instance maybe it has a "head start" on the fixed costs, because everyone has heard of it, but its cost advantage for additional service dwindles at some point.  The successive accretion of high-risk customers then threatens to put the public plan under (especially if there are lots of previously uninsured and they are high risks) and the public plan requires a subsidy simply to break even.  I consider this equilibrium to be not totally unlikely.

Obviously I am missing some equilibria, but in many cases the public plan is mainly providing insurance to high-risk customers.  There's nothing wrong with that (and indeed it is a major policy goal), but the resulting equilibrium needn't much improve the performance of private health insurance.  I file this argument under "not yet established."

Why it’s worth defending rational expectations theory

RSuleiman, a commentator over at Ezra Klein, writes:

Having just finished reading the paper, it seems very much of a piece
with Professor Cowen's other post-crash writings, and yes, it does seem
to be designed as a defense of the rational markets hypothesis.

He is referring to my piece on the crash.  Suleiman's is a common response but it is neglecting why rational expectations (RE) models are so powerful and also, at least among economists, so popular.  Economists try to fit various phenomena into RE models to show that the mechanisms underlying those phenomena are general and not relying on some very specific set of assumptions about expectations.  The goal is not to convince everyone that expectations, or markets, are indeed rational.  They're not, at least not always. 

The goal of an RE model is to establish the universality (or lack thereof) of a specified problem. 

There are people who misuse rational expectations techniques, but don't let those mistakes mislead you.  Krugman and Stiglitz also have used RE a lot as a modeling device, although they are (properly) willing to abandon it as a descriptive assumption in many cases.  A market failure argument with RE is often more powerful than a market failure argument without RE.

Markets in everything

Hamas now has a matchmaking service:

"The applicants, who pay a fee of $10-$70, are divided into
categories according to their eligibility. Women under 25 are easiest
to marry off; more challenging are women over 30 and divorcees.

in a nod to Gaza's grinding poverty triumphing over its conservative
culture, there is a special file for women with jobs. Bringing home a
salary in Gaza can trump any other category, matchmakers say.

the women's application, they describe their ideal man. Most ask for a
devout Muslim with a job and his own apartment, a top find in crowded

"Women also must describe their appearance and answer a
killer question: 'Do you consider yourself pretty according to Gaza

I thank for the pointer.

The Black Swine

High-tech models developed by quants have, once again, greatly underestimated risk.  What will be the consequences?

In the waning days of April, as federal officials were declaring a public health emergency and the world seemed gripped by swine flu panic, two rival supercomputer teams made projections about the epidemic that were surprisingly similar – and surprisingly reassuring. By the end of May, they said, there would be only 2,000 to 2,500 cases in the United States.

May’s over. They were a bit off.

On May 15, the Centers for Disease Control and Prevention estimated that there were “upwards of 100,000” cases in the country,..

A Simple Theory of the Financial Crisis or, Why Fischer Black Still Matters

The key question about the current financial crisis is how so many
investors could have mispriced risk in the same way and at the same
time. This article looks at the work of Fischer Black for insight into
this problem. In particular, Black considered why the “law of large
numbers” does not always apply to expectations in a market setting.
Black’s hypothesis that a financial crisis can arise from extreme bad
luck is more plausible than is usually realized. In this view, such
factors as the real estate market are of secondary importance for
understanding the economic crisis, and the financial side of the crisis
may have roots in the real economy as a whole.

That's the abstract from an article by me, Financial Analysts Journal, Vol. 65, No. 3, 2009. I don't yet know of an on-line copy.

State-run health insurance plans

This article in The New York Times offers some detail on the government-run insurance plans at the state level.  I learned:

1. Three dozen state governments currently run such plans and they do not in general drive private insurance companies out of business.  In California, the largest such plan, two-thirds of all eligible people choose the privately-run health insurance plans.

2. The state-run plans are usually administered by a major private insurance company, which has authority to negotiate payment rates with doctors and hospitals.  In this regard the forthcoming Obama proposal might be quite different.

3. These plans are not especially effective at controlling costs.

4. The North Carolina plan now requires a significant bailout.

5. Some people (this is now my esoteric reading) view the state-run plan as a way of forcing private insurance companies to bargain down reimbursements much further than they have done.  It's a monopsonistic social means of opting for lower expenditures and lower returns for the medical sector.

Lunch with Felix Salmon, and then Gretchen Rubin

Or was it dinner?  He let me order and we ate at the excellent Sichuan Gourmet, on 39th between 5th and 6th.  Felix asked me who were the three greatest living contemporary artists.  Although we had never discussed this question before (and we had barely met before), we agreed immediately on picks #1 and #2 and required only a short while before settling the more difficult question of who should be #3.

Can you guess our picks?  I'll leave it to Felix to decide if and when to offer up our answers, whether on his blog or in the comments section here.

I also had an excellent lunch with Gretchen Rubin, covering the strengths and weaknesses of Judith Harris's The Nurture Assumption, people who have a "relentless" writing style, and what sells books and what doesn't. 

I have never once met a person whose blog I like and then been disappointed.  Never.