The Becker-Posner Blog

The Crisis in Microfinance—Posner

On October 29, 2006, shortly after the award of the Nobel Peace Prize to Muhammad Yunus and his Grameen Bank of Bangladesh, Becker and I blogged about microfinance, which Yunus and his bank had pioneered. The term “microfinance” (or “microlending”) refers to the making of tiny loans to small farmers, shopkeepers, artisans, and other minute commercial enterprises in underdeveloped countries such as India and Bangladesh at high interest rates—sometimes as high as 20 percent a day. In my blog posting, I called microfinance a worthy experiment,  superior to philanthropy because the high interest rates that the microfinanciers charge should induce self-selection by the borrowers: a borrower has to have confidence in the project for which he is seeking microcredit in order to be willing to assume the burden of servicing his debt. But I sounded a skeptical note. I said that the “success [of microfinance] has yet to be demonstrated despite glowing appraisals by Kofi Annan and others. It may simply be the latest development fad…The evidence for the efficacy of microfinance in stimulating production and alleviating poverty is so far anecdotal rather than systematic. The idea of borrowing one's way out of poverty is passing strange. And I am unaware of any historical examples of nations that climbed out of poverty on the backs of small entrepreneurs financed by credit.” I noted that the Grameen Bank had a surprisingly low default rate and pointed out that it “does not have written loan agreements and does not sue defaulters or invoke other legal remedies against them. The natural inference to draw is that the bank is extremely selective in its choice of persons to whom it is willing to lend, and such selectivity, if imitated by other microfinanciers, must greatly limit the scope and impact of microfinance.” I concluded by “suggest[ing], albeit tentatively, that there may be a good deal less to microfinance than its boosters claim.” 

Microfinance has continued to expand since 2006. The number of microloans made in India rose from 10 million in March 2007 to 26.7 million in March 2010. By the end of 2009 total microloans stood at $70 billion, half of them in India and Bangladesh. But a series of suicides by microborrowers in the fall of 2010 in the Indian state of Andhra Pradesh, the site of more than 25 percent of Indian microlending, led to charges that the microlenders, which are commercial rather than eleemosynary enterprises (though, as we’ll see, the Grameen Bank seems to straddle the two types of enteprise), were charging exorbitant interest rates and coercing people into taking out loans they could not afford to repay. Politicians urged borrowers not to repay their microloans; and repayment rates, previously as high as 98 percent, plummeted to 10 to 20 percent. The government of Andhra Pradesh has imposed strict limitations on microlending, and the Reserve Bank of India (India’s central bank) has proposed that similar controls be established throughout India—controls including a ceiling on interest rates and loan amounts and limiting eligibility to borrowers having an income above a specified level. In December 2010 the prime minister of Bangladesh declared that microlenders were “sucking blood from the poor in the name of poverty alleviation” and ordered an investigation of Grameen Bank. Similar reactions to microlending have taken place in Nicaragua, another country that had embraced microlending with enthusiasm. 

And then just a week ago, in a short article in the New York Times entitled “Sacrificing Microcredit for Megaprofits,” www.nytimes.com/2011/01/15/opinion/15yunus.html?_r=2&scp=2&sq=microfinance&st=cse,Yunus himself wrote: “when I began working…on what would eventually be called ‘microcredit,’ one of my goals was to eliminate the presence of loan sharks who grow rich by preying on the poor. In 1983, I founded Grameen Bank to provide small loans that people, especially poor women, could use to bring themselves out of poverty. At that time, I never imagined that one day microcredit would give rise to its own breed of loan sharks. But it has.” He writes that the problem “began around 2005, when many lenders started looking for ways to make a profit on the loans by shifting from their status as nonprofit organizations to commercial enterprises. In 2007, Compartamos, a Mexican bank, became Latin America’s first microcredit bank to go public. And this past August [2010], SKS Microfinance, the largest bank of its kind in India, raised $358 million in an initial public offering.”

It seems rather an odd point for Yunus to make, because the Grameen Bank is itself a stock corporation, not a nonprofit. See www.grameen-info.org/index.php?option=com_content&task=view&id=179&Itemid=145. Yunus says in the Times article that all the bank’s profits are returned to the borrowers in the form of dividends, but if so I don’t understand how the bank attracts equity capital. He contends that his is the best model for microlending, explaining that “commercialization has been a terrible wrong turn for microfinance, and it indicates a worrying ‘mission drift’ in the motivation of those lending to the poor. Poverty should be eradicated, not seen as a money-making opportunity… Instead of creating wholesale funds dedicated to lending money to microfinance institutions, as Bangladesh has done, these commercial organizations raise larger sums in volatile international financial markets, and then transmit financial risks to the poor…Some advocates of commercialization say it’s the only way to attract the money that’s needed to expand the availability of microcredit and to ‘liberate’ the system from dependence on foundations and other charitable donors. But it is possible to harness investment in microcredit—and even make a profit—without working through either charities or global financial markets.” The phrase I’ve italicized is strange, because Yunus claims that his bank does not make a profit, but instead distributes any surplus of income over expenses to the borrowers, and urges that as the model for the microfinance industry.

The recent uproar in microlending puts one in mind of our own controversies over payday lending, title lending (borrowing at high interest rates with one’s car as security), credit-card lending, and subprime mortgage lending—all examples of loans at very high interest rates, made largely to unsophisticated consumers. There is an inconclusive literature on the net social benefits of these forms of credit (sometimes lumped together in the term “fringe banking”). The basic difference between our fringe banking and microfinance is that fringe banking is primarily consumer rather than commercial lending, but the small farmers and shopkeepers who take out microloans probably are even less sophisticated on average than the American customers for fringe banking. Moreover, although what critics of fringe banking call “predatory lending” is not highly regulated in the United States and as a result fraud and other exploitive conduct may well abound, regulatory protections are undoubtedly far weaker in countries like India and Bangladesh. 

Yunus’s mysterious nonprofit-profit model of microfinance cannot attract substantial capital, but commercialized microfinance seems increasingly unlikely to have substantial social benefits—and this with or without regulatory controls designed to protect unsophisticated borrowers. Without the controls, there will undoubtedly be a good deal of fraud, and improvident borrowing without fraud. With the controls, the amount of lending will be curtailed. But with or without controls, the amount of lending will be limited by the very high default rates that can be anticipated unless there is very careful screening of would-be borrowers. Interest rates will remain very high and will strangle many of the businesses that rely on microfinance. Microfinance may turn out to be a niche service, with little overall impact.

Overselling of Microfinance-Becker

 

Some enthusiasts for microfinance have sold it as an important component of the solution to poverty in developing countries. It often does help lower poverty, especially of poor women, but it cannot ever make more than a small contribution to overcoming poverty. As I said on October 29^th 2006 when we posted on microfinance, “Economic growth requires secure property rights, encouragement of private enterprise, openness to international trade, stimulation of education, limited and sensible regulations, and reasonably honest government. Microfinance makes only a small direct contribution to any of those variables”. Others may subtract some of the variables I mention, and add different ones, but no serious development economist would suggest that microfinance would have a major role in the economic development of poor economies.

Nor did microfinance invent small-scale loans to poor farmers and others. Local moneylenders in India and elsewhere have been doing that for centuries. However, the Grameen Bank founded in 1983 by Muhammad Yunus discovered several rather new ways to lend to the poor. This bank loaned primarily to poor women, usually Moslem women. Local moneylenders generally ignored Moslem women, either out of prejudice against women managing their own (small) businesses, or for other reasons.

The Grameen Bank also encouraged the formation of credit groups of a few women, about five members typically, that guaranteed repayment of the loans made to each woman in the group. Members of a group pressured other members to repay since they all might suffer if any member defaulted. With these guarantees, a group did not have to put up any collateral for the loans made to its members, a big advantage to poor women.

Although microfinance has had only a small impact on overall poverty in any country or region, studies suggest it has helped the Moslem women who received small loans. Families in which Moslem women have received microfinance improved the education of their children, especially the education of daughters, spent more on medicines, and accumulated more gold, which is usually the primary asset of Moslem women in Asia.

Yunus and many others have criticized the participation of for-profit lenders in microfinance. Yet in fact, for-profit lenders have always participated, although on much smaller individual scales than the companies Posner mentions (Compartamos and SKS Microfinance) that have hundreds of millions of dollars of capital. For-profit lenders have charged ”high” interest rates, but they have usually been flexible in allowing borrowers to take longer to repay if they were experiencing temporary financial difficulties. One would expect these lenders to adapt some of the lending innovations pioneered by the Grameen Bank and other microfinance lenders if the innovations improved repayments or helped in other ways to raise profits.

Although examples have been given of excessively high interest rates and other questionable terms changed by some for-profit micro lenders, it is not apparent that such behavior has been common. Poor farmers are accustomed to the borrowing process because they need to borrow in order to finance their outlays on seed and other farm inputs that occur months before they harvest rice or other crops to sell. Unscrupulous lenders could not easily fool these borrowers.

Even with well-informed borrowers, commercial interest rates will be high to borrowers with poor collateral, and to borrowers whose incomes fluctuate greatly due to the weather and other factors. Government-imposed ceilings on interest rates and other lending restrictions are likely to prevent such borrowers from gaining access to funds, unless governments or NGOs provide subsidized lending. This is why ceilings on interest rates and most other lending restrictions recently introduced or proposed will end up doing more harm than good.

After the financial crisis began, similar claims about exploitation of ignorant consumers were levied against providers of credit cards and mortgages. These claims motivated the consumer “protection” and other parts of The Dodd-Frank Wall Street Reform and Consumer Protection Act passed in July 2010. Yet little evidence suggests that borrowers were widely fooled by small print on borrowing contracts, by how interest rates were calculated, or by other claims about consumer exploitation (see my post on July 11, 2010). The consumer protection provisions of this Act will do little good, and will raise borrowing costs to the consumers who can least afford it.

Governments in countries with substantial microfinance should be mainly concerned about increasing the degree of competition among micro lenders in more remote rural areas. For monopolies do charge excessively high interest rates, and require borrowers to satisfy other onerous terms. Non-profits and other lenders should be encouraged to operate in localities where risk-adjusted interest rates are high, and anti-monopoly agencies should investigate possible collusion among lenders in these localities. Such policies would be more effective than trying to discourage for-profit lenders from making microloans.

The Case for Tuition Increases at Public Universities-Becker

 

 

The fiscal crisis in many states of the United States has led these states to cut their funding of public colleges and universities. The newly elected governor of California, Jerry Brown, has proposed to significantly cut state funding to California public colleges and universities, the most extensive and prestigious public system of higher education in the United States. To compensate at least in part for the cuts in public funding, tuition at American public institutions of higher learning is increasing significantly.

Something similar is going on in countries where cash-strapped central governments finance most university expenses. The newly elected British coalition government of Conservatives and Liberal Democrats last month approved a contentious bill that allows universities beginning in the fall of 2012 to raise tuition to a maximum of more than $14,000 a year compared to present levels of about $5000. Note that the average tuition and fees at American four-year public institutions was about $7,500 for in-state students, and it was over $12,000 for out-of–state students. Students at different British universities opposed the proposal to raise tuition by occupying university buildings, picketing the British Parliament building, and engaging in various acts of violence, but the bill passed anyway (by a close vote).

Tuition and other fees at public colleges and universities generally are much less than the cost of providing the education. To be sure, tuition and fees at private nonprofit institutions are also generally considerably less than education costs. The crucial difference, however, between public and private institutions is that the gap between costs and tuition revenue of private schools is mainly covered through voluntary contributions from alumni, private foundations, and others, whereas a sizable fraction of the gap at state-run schools is paid out of taxes imposed on state residents.

The case for higher tuition for students at state-run institutions of higher learning is powerful. A compelling reason to raise tuition at the present time is that many states have serious fiscal problems because their overall spending increased during the past decade at unsustainable rates. They are searching for various ways to cut their spending, and there is little reason why public spending on universities should be exempt from this fiscal pressure.

The average college graduate earns much more than the average individual who does not go to college. As a result, college graduates earn a lot more on average than does the typical taxpayer. It is a questionable system of regressive taxation when taxes are spent on subsidizing individuals who will earn more than those paying the taxes.

To be sure, without offsetting subsidies, high tuition discourages poorer students from attending college. These students should not be priced out of higher education, but it is not sensible to insure that these students can attend by charging low tuition to everyone, including students from higher income backgrounds. Rather, poor students alone should be directly subsidized with grants, and/or extensive loan programs could enable all students to borrow to finance their education. They would then repay any loans from their higher earnings after they finish school. Perhaps individuals who earn less would have to repay a smaller fraction of their loans. The British bill that raised tuition does not require students to pay any tuition upfront since they could borrow all their tuition from the government, and then pay back gradually after they finish school. The US federal government also has an extensive program that makes loans to students at both private and public colleges and universities.

Another argument commonly made against further increases in tuition is that tuition already rose substantially during the past decades, even after adjusting for increases in the price level. For example, tuition and fees at the University of Illinois, Urbana increased from $4770 in the academic year 2000 to $13, 508 in the 2011 academic year. However, the growth in tuition was mainly a response to the large increase in the earnings of college graduates compared to individuals who never went to college. Salaries and other benefits paid to professors are the main cost of providing a college education, and these benefits went up by a lot because earnings of college graduates increased by so much since 1980. The growth in earnings of college graduates, and of persons with a post-graduate education, made a college education a very good deal, despite the increases in tuition, because the gains from going to college increased by much more than the costs of going.

A quite different argument often made in support of subsidizing students is that individuals with higher education produce large benefits to others in their country or region (positive “externalities”) as well as to themselves. Yet while individuals with advanced degrees who do research and development work sometimes produce important innovations that confer benefits on society as a whole, the US and many other governments already subsidize R&D spending. Similarly, governments subsidize college-educated (and other) individuals who make films, write books, and produce artwork.

Perhaps these subsidies should be increased, but that is distinct from subsidizing all college students with low tuition. For if society benefits from having college-educated persons engaged in particular activities, such as research, it is better directly to subsidize spending on these activities (perhaps more generously than at present) than to subsidize all college students, including, for example, salesmen, bankers, and lawyers.

Raising Public-College Tuition—Posner

A number of states are in quite desperate financial straits. They have huge debt, and like members of the eurozone, cannot lighten their debt load by inflating their currency or by improving their trade balance by devaluation. It is natural that they should be raising fees, such as college tuition. Whether this is the best way to reduce debt is a separate question, but probably an academic one; the pattern of revenue enhancement and cost reduction that a state embraces depends on the political balance in the state, rather than on what is efficient or otherwise in the public interest.

As Becker points out, there are external benefits to higher education. In the narrowest terms, college-educated persons (especially college graduates) have significantly higher incomes than the non-college-educated population, and those higher incomes generate higher tax revenues, which finance government expenditures that are used to finance government programs that largely benefit other people. The amount of the external benefits cannot actually be measured, however, because the decision to attend college is not random; generally, it is the intellectually abler who attend college, and their higher incomes are the combined result of their personal characteristics and the increased skills that college imparts to them. Nevertheless there is little doubt that college does generate external benefits, which creates a case for subsidy. 

Whether it is a good case is a separate question. Because college contributes to higher earnings, which are not taxed until earned (that is, the asset, consisting of future expected earnings, that is obtained by attending college is not taxed), attending college is attractive to anyone who has sufficient intelligence and discipline to benefit from it, and he or she can borrow to finance tuition and living expenses.

In any event, there is no case at all from an overall social standpoint for subsidizing students who would pay full college tuition, without the inducement of a subsidy; the subsidy does not induce students to obtain a college education who otherwise would not because they could not afford to; it is a windfall to their families. Private colleges recognize this. They charge very high tuition (though not high enough to cover all their costs—but they have other sources of funds, such as alumni donations), but grant scholarships or loans to students whose families can’t afford the tuition. Charging low tuition to everyone, as public colleges do for residents of the state in which the college or university is located), does not make economic sense; it merely as I said provides windfalls to families willing and able to pay the full tuition. As Becker points out, this results in regressive redistribution of income,  because families that can pay full tuition are wealthier than the average taxpayer, who pays for the costs of public colleges that tuition doesn’t cover.

This situation presents a case for a virtuous tax increase (raising a fee for a public service is the equivalent of a tax): the increase helps to close the state’s fiscal gap; the burden of the increased tax is borne entirely by the well-to-do; and some of the higher revenue can be used to subsidize students unable to afford the higher tuition.

There is still an argument against the tuition increase, which resembles the economic argument for the moratorium on increasing the federal income tax rate even on taxpayers who have very high incomes—even incomes of a million dollars or more a year (a proposal for eliminating the Bush tax cuts for those taxpayers was made by liberals but rejected by Congress). The argument is that any tax increase will reduce private spending (consumption and investment) unless the tax revenues are used to increase such spending; and given the still very shaky state of the U.S. economy, any measure that reduces such spending is suspect. Well-off families will have to allocate more of their income to their children’s education, and so will reduce their other spending. The revenue from the higher tuition will flow into the state’s coffers, but the question is whether the effect of that flow in stimulating investment and consumption will be greater than the decline in personal spending by persons paying the higher tuition. Conceivably, increasing tuition could retard economic recovery, though it is nevertheless a sensible long-term measure of fiscal reform because there is no reason to subsidize tuition of persons able and willing to pay it without subsidy.

I said earlier that the combination of tax (or fee) increases and spending cuts that states are adopting in an effort to alleviate their debt burden depends on the balance of politically effective interest groups. Well-to-do families will fight efforts to increase college tuition across the board. So of course will the state universities and other public colleges. Low tuition, made up for by public subsidies, helps state and city colleges and universities attract students who would otherwise go to private colleges and universities. Increasing tuition may increase state college revenues, assuming that demand is inelastic (meaning that the percentage fall in demand because of the higher price is less than the proportionate increase in price, so that revenue rises) within the range of the increase, but it will reduce the quality of the student body. 

The proposed tuition increases raise the broader question whether states should be in the position of providing higher education, rather than leaving it to the market to private. In fact state universities have been weaning themselves from state support. At prestitgious public universities such as the University of Michigan, state subsidies now account for only about 10 percent of the university’s budget. The fact that a state legislature can raise state university tuition at will, or stated otherwise reduce subsidy at will, creates the kind of financial uncertainty that has brought English universities low. Universities supported by diverse financial sources are more stable, which is the main reason for the trend toward public universities’ seeking private support. The recession-driven tuition increases will accelerate this trend. That would be a good thing.

Can Bookstores Survive? Prospects and Consequences—Posner

Two of the largest bookstore chains—Barnes & Noble and Borders—are in danger of being forced into bankruptcy; their plight raises the broader question of whether bookstores will survive in any significant number, and, if not, what the consequences will be.

There are two clear threats, both Internet-related, to the bookstore. The newest is the e-book, in which the contents of a book are transmitted over the Internet to an electronic reader owned by the book’s buyer. No bookstore is involved. Slightly older is the sale, as opposed to the delivery, of a book online; Amazon is the principal seller in this market. No bookstore is involved unless Amazon doesn’t have the book in inventory; in that event the customer is referred by Amazon to a bookstore that has the book and will sell it online and deliver it to the buyer; the purchase is made through Amazon. Most of the books that Amazon and the other online booksellers don’t carry in stock are out of print, and bookstores that stock such books tend to be small (though there are some exceptions), because the market for such books is tiny. 

A possible third threat is diminished appetite for books. I haven’t been able to find good statistics on annual sales of books in the United States (and anyway “books” is an extremely heterogeneous product category), but it would seem that the amount of entertainment and instruction available online is so great that online substitution for reading books must have reduced the demand for them. At the same time, however, the demand for books should be stimulated by the fall in cost when books are bought online, cutting out the middleman—the bookstore—a point to which I’ll return shortly. 

It seems inevitable that the number of books sold through bookstores will plummet. Books bought through bookstores are more costly not only in price (to cover the costs of the bookstore), but also in customers’ time—the time required to travel to and from the bookstore, find the book one wants to buy, and complete the purchase (which takes more time than an online purchase). The only offsetting advantages of the bookstore are the opportunity it provides for browsing and the fact that the customer can see and handle the book before buying it. But these advantages are offset to a considerable extent (doubtless more than offset, for many customers) by the use by online sellers of artificial-intelligence programs to recommend books to their customers, by the much vaster inventory of an online seller like Amazon, by ease of search, by the reader reviews that the seller presents, and by the seller’s ability to allow customers to look inside the online book before ordering it, much as if he were leafing through a printed book in a bookstore. 

It is true that Amazon’s book-recommendation program is primitive, and is no substitute for browsing in a well-stocked bookstore, but it will improve; one can foresee the day when customers will furnish (and Amazon store) comprehensive information about their age, sex, education, occupation, and reading tastes, which Amazon will use to create an initial list of recommended purchases, which it will refine as it receives orders from the customer plus supplementary information from the customer as the customer’s tastes and interests change. 

At present fewer than 30 percent of all books are bought online (either in hard copy or as an e-book), but I have seen an estimate that this figure will grow to 75 percent within a few years. Very few bookstores will have enough customers to survive if bookstore sales fall from 70 percent to 25 percent of all book sales, except those bookstores specializing in out of print books—whose customers will largely be online. In time, moreover, with more and more publishing electronic, there will be fewer and fewer “out of print” books. 

The substitution of online for bookstore distribution of books will provide a substantial social saving and, as I said, increase the demand for books by reducing their retail price. As for the effect on publishers and authors of books, there is concern that it will be adverse, but that seems unlikely. A seller tries to minimize his cost of distribution, just as he tries to minimize his other costs; the publisher is the ultimate seller, and the bookstore part of the chain of distribution. But there is an important, and potentially relevant, exception, and that is where a distributor provides point-of-sale services that increase the demand for the product. This is the rationale for resale price maintenance: manufacturers of some goods place a floor under the retail price of the goods, thus deliberately increasing the retailers’ margin, but hoping by doing so to induce them to engage in nonprice competition that will increase the demand for the goods. Bookstore staffs, by decisions they make concerning choice and display of books to carry, and by making purchasing suggestions to customers, can, in principle, increase the demand for books. But these services cannot guarantee the survival of many bookstores, because unless the services are valued by a greater margin than seems realistic to expect, there will be too few customers to defray the bookstore’s fixed costs at acceptable prices. 

The question then becomes whether the loss of point-of-sale services that bookstores provide will hurt publishers (and therefore authors, whose prosperity is linked to that of publishers) more than it will help them by reducing their distribution costs. That too is doubtful. As technology continues its forward march, online booksellers will find it increasingly feasible to duplicate and indeed improve on the point-of-sale services that bookstores offer. Bookstores will decline, and perhaps vanish when the current older generation, consisting of people habituated to printed books (as to printed newspapers), dies off. Yet this may well represent genuine economic progress, just as department stores and supermarkets represent progress though they cause the demise of countless small retailers.

 

Traditional Bookstores are Doomed-Becker

 

 

The traditional bookstore is doomed by e-readers and online sales of hard copy books. I use the word “doomed” in the same sense that online digital sales of movies and music have doomed movie rental stores, movie theatres, and stores that sell albums of music. Doomed does not mean that these stores will quickly, or ever fully, disappear, but that they have received deadly blows from Internet competition.

Joseph Schumpeter, an outstanding economist in the first half of the 20^th century, originated the term “creative destruction” to describe new technologies and other forms of new competition that wreak havoc on older and established industries. The process is creative because it provides consumers and producers with more effective ways of satisfying their wants. The process is at the same time destructive because it greatly reduces the value of services and products provided by older industries.

Extreme examples of creative destruction from the 20^th century include the complete substitution of cars for horses and buggies, movies with speaking for silent movies, and computers for typewriters. Less extreme are the large reduction in clerical and secretarial staffs caused by the development of computers and the Web, and the sizable reduction in demand for milk and eggs induced by better information on the health value of low cholesterol diets.

A similar creative destruction process began for bookstores with Amazon’s development of online book sales that offered huge inventories of books, convenience of purchase, speedy deliveries, online reviews of books, and various other services that made it more efficient and often cheaper to buy books online rather than in bookstores. Sales of books online started slowly, but they have accelerated as consumers became more familiar with the process of buying books (and other goods) online. I first started using Amazon at my summer home since it is not near any bookstore. Discovering the convenience of buying books online, I now buy online all year, although I still enjoy visiting bookstores.

Effective online readers, like Amazon’s Kindle, and Apple’s iPad, are only a few years old, but they have become big hits since they can be used both to purchase books online, and to read books in digital form. Hundreds of books can be stored digitally in a single Reader that weighs less than a couple of pounds. They are especially valuable when traveling, but are useful when reading in bed or eating, and also with traditional reading when seated on a comfortable chair. They are particularly useful for individuals with weak eyesight since print size can be easily adjusted. This is why digital readers will appeal eventually even more to older persons than to others, although mainly younger persons are the ones who so far have bought digital readers because old persons are less familiar with digitalization.

I do not expect bookstores to rapidly disappear the way the production of silent movies virtually ceased once talking movies were created. However, I do expect an accelerating decline in the number of bookstores as many close down due to bankruptcy and excessive losses. Some bookstores will continue to exist to cater to men and women who like to browse among physical copies of books, and because some owners of bookstores get great pleasure out of selling and being surrounded by books. Many bookstores that survive are likely to combine selling hard copy books with that of other products. For example, university bookstores usually also sell clothing that have the university logo, computers, greeting cards, snacks and coffee, and other goods that cater to students and faculty. Other surviving bookstores might combine selling of hard copy books in physical facilities with online sales of hard copy books, and online sales of digital books.

The decline of bookstores, theatres, laundries, and other retail industries with physical facilities illustrates a trend that runs counter to older ideas about the effects of economic development. The process of development has been presumed to cause a substitution of market activities for home production. For example, households in poor rural societies have not only grown their own food, but also made much of their clothing, washed their clothes, baked their bread, and cooked from scratch their other food. As countries underwent economic growth, many of these productive activities left the home and migrated to the marketplace. Factory-made clothing was substituted for clothing made at home, and bakeries and laundries developed to make bread and sweets, and to wash, clean, and dry clothes.

Further technological developments,however, such as small motors used in home washing and drying machines, and small machines that cooked bread easily at home, shifted many activities back into the home, and thereby saved on time and energy spent in the shopping process. The online digital revolution is a further major step in this trend of returning activities to the home. Time and effort are saved, for example, when instead of going to movie theatres, consumers both order and download films online to be viewed at “home”, either on television sets, or increasingly on computers.

From this perspective, what is happening to bookstores is not unusual. “Books” are still read at “home”, but increasingly they are also purchased at home, and not only in hard copy form. Digital books are a true revolution, but their effects on bookstores are only a small part of a broader technological development that has brought important activities into the home.

 

 

Implications of International Comparisons of Student Performance-Becker

 

 

Results on standardized tests are becoming a common way to evaluate student performance in different school systems, such as in different states of the United States. These tests are especially important in international comparisons of student performance since school systems differ so much across countries. International tests in mathematics, science, and reading have been given to high school students in different countries every few years since about 50 years ago. The well-know PISA tests started in 2000, and the number of countries included has been expanded by 2009 to over 60.

Scores on standardized tests have many well-discussed problems from the viewpoint of measuring how much students learn. For example, teachers may concentrate on materials that are likely to be on a test rather than on other possibly more important knowledge- this is called “teaching to the test”. Still, standardized tests are a much better way to compare achievements among students, and especially among students in different countries, than are various measures of average years of schooling- the most commonly used measures in international comparisons.

The US spends much more per student than any other country (with a few small exceptions). Yet from the very beginning, American students have generally performed below average compared to students from the richer countries that comprise the OECD countries. In 2009, the average American student did a little better on the PISA tests: they were much above students from the great majority of the 65 countries that participated, and were at, but no better than, the average level of OECD countries.

Another interesting case is that of Chile. Some critics have used Chile’s below average performance on the PISA tests to oppose Chile’s extensive use of school vouchers. Chile’s performance may be disappointing, but in 2009 Chile did the best of all Latin American countries (Chile was a little behind Uruguay in math), and much better than Brazil, Argentina, and Mexico (except again in math where Chile did about the same as Mexico), even though Argentina has a much longer tradition of emphasizing education.

Japan and other Asian countries typically place much greater emphasis on rote learning and memorization than does the United States and some European nations. South Korea, Japan, and Hong Kong rank high on the PISA tests, much higher than the US. However, America is the world leader in game-changing creativity and innovations, far above these other countries. Perhaps America’s lead is related in part to the emphasis that the American education system places on creative thinking rather than memorizing what famous people have said.

Russia provides another interesting example. Russia has produced many outstanding mathematicians and scientists, yet the Russian Federation ranks quite low on the PISA tests in mathematics and science.

Modern economies have enormous specialization by skill, type of industry, and various other characteristics. This implies that an economy can perform at a high level even though not everyone is well educated in mathematics, science, reading, or other fields. It is sufficient if enough young persons are prepared in these subjects to supply enough trained men and women for the jobs and other tasks that require specialized training. Such specialization implies that not only are the average scores for different countries relevant, but so too are measures of the distribution of scores among students within a country. Calculations by William Hubbard of the University of Chicago Law School for the 2003 PISA results do show that the US ranks somewhat higher relative to other countries when comparing the variances in scores among students in the same country than when comparing average scores.

That the distribution of scores is important does not deny that average scores may also matter a lot in modern economies that rely extensively on the labor force’s command of knowledge and information. to test this hypothesis, a few economists have related average scores on various international tests in math and science, along with average years of schooling and other variables, to subsequent growth in per capita incomes. Eric Hanushek of the Hoover Institution pioneered this approach, but the latest study I know of is by Appleton, Atherton, and Bleaney, “International Test Scores and Economic Growth”. They show that higher scores by different countries are followed in later years by moderately higher growth rates in GDP, holding constant initial per capita incomes, average years of schooling, and some other variables. Test scores are far more important than average years of schooling in predicting subsequent economic growth.

International comparisons are always somewhat suspect because differences across countries that are not observed by economists rather than the variables that are measured may be producing the results found. For this reasons, Appleton, Atherton, and Bleaney also relate changes over time in test scores within countries to subsequent changes in their economic growth rates. They find much weaker results in these within-country comparisons, which is not uncommon.

Despite all the qualifications, scores on standardized tests, like the PISA tests, are much more effective ways to compare student achievements in different countries than are average years of schooling and other measures of school years completed. As I indicated earlier, the mediocre performance of the average American student on the PISA and other tests may indicate only that the US school system emphasizes creativity and independent. However, I strongly believe that it is also evidence of the mediocre performance of many American schools. International test scores have been used for decades to push for improvements in the schools available to the lower third of American students through the spread of charter schools, school vouchers, and stronger incentive to teachers, students, and parents. The 2009 PISA test results indicate that some progress is being made in American schools, but considerable room for improvement still remains.

 

The PISA Rankings and the Role of Schools in Student Performance on Standardized Tests—Posner

International comparisons are tricky, as Becker points out, but the PISA (Programme for International Student Assessment), which tests 15-year-olds for proficiency in reading, math, and science by well designed standard tests conducted in thousands of schools all over the world, is a careful and responsible program, the results of which deserve to be taken seriously. The latest results (which are for 2009) reveal among other things that although the United States spends more money per student on secondary school education than any other country except Switzerland and Austria, Americans’ performance on the PISA tests is mediocre. In the latest tests Americans ranked 17 in reading, 24 in science, and 30 in math. 15-year-old kids in East Asian nations (including Australia and New Zealand), along with Finland, Switzerland, the Netherlands, Belgium, and Canada, outperform the United States in all three subjects. Since 2000, when the PISA tests were first given, the United States has fallen in rank in reading and science, and is unchanged in math.

The rankings tend to be interpreted as measures of the quality of a nation’s pre-collegiate school system (primary and secondary education, since primary education influences performance in secondary schools). But this may be a mistake. Schooling is only one, though doubtless an important, input into performance on the PISA tests. Another is IQ. There have been some efforts to compare IQ across countries, notably by Richard Lynn and Tatu Vanhanen; see their 2006 book IQ and Global Inequality. Their results cannot be regarded as definitive, given significant limitations in the data, but they are suggestive. The authors find that the East Asian countries, which generally rank highest on the PISA tests (including reading—not just math and sciene), have the highest average IQs; the average IQ of Americans is lower because of our large black and Hispanic populations, which have lower average IQs than whites and Asians.

IQ is understood to reflect both genetic endowment and environmental factors, particularly factors operative very early in a child’s life, including prenatal care, maternal health, the educational level of the parents, family stability, and poverty (all these are correlated, and could of course reflect low IQs of parents as well as causing low IQs in their children). The case for very early intervention in children’s development, powerfully urged by the distinguished University of Chicago economist James Heckman, can be understood as an effort to lift IQs in the black and Hispanic communities and by doing so improve the educational performance of black and Hispanic children, including performance on the PISA tests. It is true that Heckman emphasizes noncognitive skills that facilitate learning, but these skills could also increase performance on IQ tests, indicating a positive effect on IQ.

The 2009 PISA test scores reveal that in American schools in which only a small percentage (no more than 10 percent) of the students receive free lunches or reduced-cost lunches, which are benefits provided to students from poor families, the PISA reading test scores are the highest in the world. But in the many American schools in which 75 percent or more of the students are from poor families, the scores are the second lowest among the 34 countries of the OECD; and the OECD includes such countries as Mexico, Turkey, Portugal, and Slovakia.

If IQ is playing a significant role in America’s mediocre showing on the PISA tests, improvements in secondary school education are unlikely to have dramatic effects. The white and Asian kids in American schools are already doing fine, for the most part; the black and Hispanic kids may not do much better until their early childhood environment is improved to the point at which black and Hispanic IQs are raised significantly.

Analysis of the PISA results has revealed some other interesting facts. One is that higher teacher salaries dominate small class size as a factor in high PISA scores. This is a reassuring finding because it suggests that secondary school education can be improved at no net increase in cost, since higher teacher salaries are offset by larger classes—if class size is raised in proportion to increases in teacher salaries, there is no net increase in the school’s cost, and there should actually be a reduction in cost in the long term because a reduction in the number of classrooms reduces the size and therefore cost of a school even if each classroom is larger. Another reassuring finding, in light of all the agitation over charter schools and voucher systems, is that private schools on average do not outperform public schools after adjusting for the quality of students upon entrance and that competition for students does not seem to improve average performance either. Of course these are generalizations across many countries and America’s individualistic culture may not fit them.

This observation is especially pertinent to another finding in the PISA report, which is that poor kids do better in a school that has mostly middle-class kids. Our education system, both public and private, tends as a practical matter to be segregated according to family income and social class. This is a reflection of economic inequality, which is great in the United States and growing.

Becker points out that despite the imperfections of its educational system, America remains preeminent in innovation. This is important but it appears to be due in part to the nation’s attractiveness to immigrants. Many of our innovators are foreign born; increasingly they are Asian. The United States, as a result of generous immigration policies in the nineteenth and early twentieth centuries, also has the largest Jewish population in the world—larger than Israel’s, and a higher percentage of American Jews are Ashkenazi—that is, descendants of European Jewish immigrants. This is significant because Ashkenazi Jews have a significantly higher average IQ than other Americans, including (though the margin is small) East Asians, and, as important, a very strong cultural orientation toward high achievement in business, science, and intellectual fields generally. From the standpoint of innovation, a wide distribution of IQs is more important than the average IQ, because most innovations will come from persons with an above-average IQ, and in scientific and other technical fields from persons with a way-above-average IQ. Moreover, because of the bell shape (normal distribution) of IQ across persons, a higher average IQ translates into a much longer upper tail—the part of the distribution that contains the highest IQs.

If as I am speculating (and I emphasize that it is speculation), IQ is a major factor in school performance, we should hesitate to place too much weight on variance in educational investments, methods, etc. in explaining differences in that performance, relative to genetic and cultural factors and also (and importantly) to economic inequality.

The Tax and Spending Compromise-Becker

 

 

Both supporters and opponents of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 usually confuse its short term-stimulus effects on the economy, and its long-term effects on economic growth. I would give it a grade of C+ as a short-term stimulus to the economy, and a grade of B+ for its effects on longer-term growth.

The Act provides for a one-year two-percentage point reduction in employee contributions to social security taxes at an estimated cost in tax revenue of over $100 billion. This will add a significant amount to the budgetary deficit for the year going forward, while providing very little short-term stimulus. Even the most simplistic Keynesian analysis recognizes that a one-year tax reduction will be mainly saved in order to spread out the added consumption from this additional “wealth” of households over more than a single year. In economics terminology, a one-year tax relief would be considered a transitory increase in income rather than a permanent increase.

Evaluating the desirability of the extension of unemployment compensation to the long term unemployed (up to 99 weeks of unemployment) is more complicated. Although, like the social security rebate, this also is just a temporary windfall to these unemployed, they are likely to have exhausted their liquid assets during their long period of being unemployed. They would tend to become liquidity constrained, and hence would consume a large part of their unemployment benefits.

This extension of benefits to the long-term unemployed could have been made more or less revenue-neutral by reducing, or preferably eliminating, unemployment compensation to the men and women who have been unemployed for less than 3 months (they constitute about 40% of all unemployed). The great majority of the short-term unemployed are not liquidity constrained since they can finance their unemployment from savings, earnings of spouses, and borrowing from relatives and friends.

Unemployment benefits as insurance against the risks of becoming unemployed are best concentrated on the longer-term unemployed because they are more likely to have run out of assets. Just as with other insurance, the optimal unemployment insurance would have a sizable deductible-that is, little payment during the first several months of unemployment- and then significant insurance coverage for longer-term unemployment. Also, as with other insurance, a good program tries to protect against moral hazard; that is, against the unemployed not looking for jobs because they prefer to continue to collect unemployment checks. Such moral hazard considerations imply that payments should begin to fall, and eventually be eliminated, after say six months or so of unemployment. One exception would be during and shortly after severe recessions, as at present.

The largest component of this Tax Relief Act is the extension of the Bush-era tax cuts on incomes, dividends, capital gains, and estates. This extension will have some relatively short-term benefits to the economy by stimulating investments and the formation and expansion of small businesses, but the main case for extending these tax cuts is their effects on longer-term economic growth. The growth rate in per capita incomes is determined mainly by the rates of investments in human and physical capital, and by technological progress. Both these drivers of economic growth are in good part in turn determined by tax rates on personal and business incomes.

I view the maintenance of the Bush tax cuts as only the first important move of the American tax code toward a more effective income tax structure. That structure would have a broad-based low rate flat tax on personal incomes, with little, if any, taxation of corporate incomes, and with dividends and capital gains taxed as ordinary income. As the majority report of the recent National Commission on Fiscal Responsibility and Reform proposed, the income base should be greatly broadened by eliminating the deductibility of interest on mortgages, and a variety of other special deductions that result from the political influence of various special interests.

I showed in a post last month (see 11/07/10) that even a one-half percent increase in the American long-term rate of economic growth would have a large effect in 20 years on both per capita incomes, and on the size of the US debt relative to its GDP, as long as the rate of growth in government spending was not allowed to increase along with the growth in incomes. Control over the rate of growth of spending is essential even with faster economic growth in order to try to prevent the debt to GDP ratio from becoming a major problem.

A broad-based flat income tax could have a relatively modest tax rate- perhaps about 25%- and still raise as much revenue as the tax structure that would exist if the Bush tax cuts were allow to lapse. A flat consumption tax would be even better than a flat income tax since such a consumption tax would not distort the incentive to save. However, this type of consumption tax is unlikely to be introduced as a substitute for the income tax. It could play a role as a supplement to the income tax if that combination were necessary to prevent a narrow-based progressive income tax system from being imposed.

 

 

The Tax Deal: A Second Stimulus?—Posner

The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, which President Obama signed into law on December 17, is being described as an $858 billion stimulus bill. But this is imprecise. 

The immensely complex Act is well summarized in “CCH Tax Briefing: The 2010 Tax Relief / Job Creation Act,” Dec. 20, 2010, http://tax.cchgroup.com/downloads/files/pdfs/legislation/bush-taxcuts.pdf (visited Dec. 25, 2010), which provides the following breakdown of the costs of the two-year program

 

Individual Tax Cuts .............$ 186 billion

AMT Relief ............................$ 136 billion

Payroll Tax Deduction ..............$ 111 billion

Estate/Gift Tax Relief .............$   68 billion

Capital Gains/

Dividend Cuts .......................$  53 billion

Bonus Depreciation/179

Expensing ............................$  21 billion

Other .................................$ 226 billion 

In addition to this $801 billion in tax relief, the Act authorizes a $57 billion extension of unemployment insurance benefits for a maximum of 99 weeks. 

All these are just estimates, since the amount of tax relief depends on incomes, the size of estates, and so forth, and the amount of unemployment benefits depends on the number of claims made. 

Most of the “costs” represent simply lost tax revenues; the Act extends tax cuts, made a decade ago, that would have expired at the end of this year—but the payroll (i.e., social security) tax deduction and extension of unemployment benefits, along with some of the other tax provisions, are new tax breaks. The benefits extension will probably expire at the end of the two years in which the new Act will be in effect, as unemployment falls. The other provisions of the Act are likely to be continued, given Republican hostility to any tax increases—and refusing to extend a temporary tax cut is rightly perceived as a tax increase. The Act illustrates the nature of compromise between the Democratic and Republican parties in the current political climate: each party seeks tax reductions for its constituents (the payroll tax deduction being the Democrats’ preferred form of tax break) and the Democrats in addition seek to increase spending (hence the extension of unemployment benefits). 

The aggregate federal deficit is about $14 trillion, and is increasing at a rate of about $400 billion a year. All other things unchanged, the Act, assuming permanence, will almost double the annual increase in the deficit, putting the country farther along the road to bankruptcy—unless, as the Administration argues, the Act will operate as a stimulus (Keynesian deficit spending in a depression or recession) that will bring down the deficit by accelerating economic growth. 

This would be unlikely if the tax breaks were new rather than for the most part merely continuations of the Bush tax cuts of a decade ago (I explain the significance of this qualification below).

The normal (not recessionary) rate of the nation’s economic growth is about 3 percent a year, but is usually much higher in the recovery period following a depression or recession. The economy is expected to grow by only about 3 to 4 percent in 2011; if the new Act added 2 percent to the higher figure, which I don’t think anyone expects, so that the Gross Domestic Product grew by about $800 billion (6 percent of our $14 trillion GDP), this would, it is true, reduce the rate of growth of the deficit. Suppose the additional $800 billion in GDP yielded $160 billion in additional federal tax revenues (20 percent). Then the 2011 deficit, instead of being roughly $800 billion, would be “only” $640 billion—we would still be on the road to bankruptcy. 

Moreover, the benefits in deficit reduction from the Act would soon peter out; there is no basis for thinking that the level of taxation in the Act, compared to the higher tax level in the 1990s, will produce a higher rate of economic growth than the normal 3 percent. 

It is nevertheless possible to defend the new Act on two grounds. The first, and I think less important, is that it indicates the possibility of compromise between the Obama Administration and the resurgent, and increasingly conservative and assertive, Republican Party, though compromise will be more difficult come January when the Republicans take control of the House of Representatives and significantly increase their representation in the Senate. Second, and more important, estimates that GDP would grow by at least 3 percent in 2011 were premised on the expectation that the bulk, at least, of the Bush tax cuts would be continued. Given the weakness of the economy, a sudden tax increase in 2011, which would have been the effect of allowing those cuts to expire, could easily have knocked one or two percentage points off the GDP growth rate. 

It would have been better to have just continued the tax breaks and not have cut the payroll tax and extended unemployment benefits. A small, and possibly (though not probably) temporary, tax cut is unlikely to stimulate much spending, and extending unemployment benefits can actually increase unemployment by making unemployed workers more picky in their search for a new job. These provisions of the Act are simply the Democratic quid pro quo for the tax breaks for the wealthy, favored by the Republicans.