Thursday, September 6, 2012

Presidential Decision Making and Subsidizing Higher Education

This is a continuation of the previous post.

The second thing that stood out to me last night about the DNC speeches other than comments about Obamacare, was this explanation from the First Lady on how the President makes decisions:
And as President, you can get all kinds of advice from all kinds of people.
But at the end of the day, when it comes time to make that decision, as President, all you have to guide you are your values, and your vision, and the life experiences that make you who you are.
And later, an example:
And believe it or not, when we were first married, our combined monthly student loan bills were actually higher than our mortgage.
We were so young, so in love, and so in debt.
That's why Barack has fought so hard to increase student aid and keep interest rates down, because he wants every young person to fulfill their promise and be able to attend college without a mountain of debt.
So in the end, for Barack, these issues aren't political – they're personal.
His decisions are based on personal experience rather than evidence and logic -- and that's the problem. Economic decisions based exclusively on personal experience are almost surely going to lead to bad policies. As individuals, we have a really bad "feel" for how the economy as a whole really works, and as just one cog in a larger machine too often fail to appreciate how policies that look great if applied just to one of us look silly and can lead to disastrous outcomes if applied to everyone.


A simple example: If you were to win $1,000,000 a year from the lottery, you would be thrilled. So why not make it government policy that everyone gets $1,000,000 check from the government every year? Wouldn't everyone be equally thrilled? I hope you didn't just blindly agree with that policy proposal. With a little thinking, you should realize that the government would either have to raise taxes or acquire debt to pay it out or print money. Any way you slice it, you know that if everyone wins, you won't get $1,000,000 a year forever in consumption like you would if you were the only winner. If you think a little harder, you realize the reason for this is that prices must rise or some other sorting mechanism must come into place to allocate scarce goods -- everyone can't have everything they want. In fact, overall, things could even be worse for you than if no one had gotten the money in the first place. The intention behind the policy is good: "I want everyone to feel great and have it a little easier." In reality, the policy itself does not achieve that end. Good intentions are not good enough to make good policy.

Let's go back to the First Lady's example. She notes that Barack had this line of thought: "Going to college was the right choice for me, and it would have been better if I had not had as much debt. There are two ways my debt could have been lower: 1) a lower interest rate (which would lower the monthly payments) or 2) I could be given money directly (e.g. larger Pell grants). Because I'd be better off, if everyone got the same deal, everyone would be better off: more people could afford to go to college and those who went and took out loans would have an easier time of it."

But, let's think about the actual consequences of these two policies. Note that not everyone should go to college and not everyone should get the same level of schooling; for some people the opportunity cost of college is just too high. There is an efficient/optimal amount of schooling for each person. It is possible to have too much schooling or too little.

1) Lower interest rate on student loans from the government.

This is essentially a subsidy which needs to be funded by the government. The subsidy will lead to increased demand and higher tuition prices. In addition, the subsidy causes too many people to go to college or causes people to get too much schooling. In other words, there is deadweight loss from over consumption making people on average worse off.

It MAY BE possible to make the argument that there are significant positive externalities to higher education (One might be better aggregate decision making in elections from being better informed on a broad range of topics; another might be knowledge spillovers from general research made by over-educated individuals) and thus justify subsidizing higher education. But this is NOT the argument being made by the First Lady nor the President. 

2) Increased grants.

Similar to above. The key question is: What fraction of an increase in grant money actually is retained by students and what fraction is captured by Universities from higher tuition bills? From recent empirical work, it turns out that an increase in the Pell Grant is almost entirely captured by Universities in the form of higher tuition. For instance, Singell and Stone (2007) find that increases in Pell grants appear to be matched nearly one for one by increases in list (and net) tuition for private schools and out-of-state student pricing at public schools.

Don't forget, Pell grants have to be funded by distorting taxes, too. 

Applied to just himself, lower interest rates and increased grants would have lowered the cost of college for Barack Obama, but when applied to everyone as government policy, it leads to higher tuition, higher tax bills, and inefficient amounts of schooling consumed. 

Good intentions are not good enough to make good policy.

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