Tuesday, May 29, 2007

The Income Gap and Education

The gap between the incomes of the richest and poorest Americans has been widening since the 1970s. According to a recent New York Times column by Tyler Cowen, the widening gap reflects the difference in earnings growth between high-skilled and low-skilled workers—the earnings of high-school graduates grew more slowly than those of college graduates. A recent paper by Harvard economists Claudia Goldin and Lawrence Katz suggests that immigration accounts for only a small part of the relatively slow earnings growth among high-school graduates.

According to Goldin and Katz, developments in the market for high-skilled labor better explain the growing income gap than developments (such as illegal immigration) in the market for low-skilled labor. Technological improvement typically leads to rising demand for the high-skilled workers capable of using the new technology. Over the past few decades, technological change has increased demand for highly skilled workers, but the supply of such workers has remained stagnant. Strong demand growth coupled with weak supply growth has led to unusually high wage gains for high-skilled workers (as illustrated in the graph above). Read Cowen's column to learn more.

Discussion Questions

1. According to Cowen, how does the educational attainment of the current generation compare to that of their parents?

2. Why has the supply of high-skilled labor increased so slowly? What policies does Katz recommend to remove the bottlenecks that keep Americans from obtaining more education?

3. Will a more educated population guarantee a decrease the income gap between the richest and poorest Americans? What is the rather unpredictable role of technological change in determining the size of the income gap?

Economist Joel Waldfogel's latest Slate piece focuses on an alternative approach to promoting educational attainment among low-income groups. Recent research by Nobel-winning economist James Heckman and University of Michigan economist Dimitriy Masterov suggests that government spending on preschool education offers bigger returns than spending on other parts of the education spectrum (like GED programs or efforts to reduce high-school class sizes). Compared to disadvantaged kids without preschool exposure, disadvantaged kids who received preschool education tended to perform better later in life—higher grades, more likely to graduate, more likely to be employed, less likely to commit crime, and less likely to be on public assistance. Read Waldfogel's column to find out more.

4. Could diverting education spending to intensive preschool programs reduce the income gap between rich and poor Americans? How do differences in cognitive development at kindergarten age feed into differences in earnings potential later in life?

5. Positive externalities occur when we do things that are good for us, but also inadvertently good for others. Preschool provides private benefits directly to families and kids, but it also provides social benefits to the rest of us—social benefits that the parents of young children do not account for when deciding whether to pay for preschool education. What are the social benefits of preschool? Why might government intervention lead to a more efficient preschool outcome?

Here's another Aplia perspective on the disparate wages of low-skilled and high-skilled workers.

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Monday, May 21, 2007

A Chinese Dilemma

The People's Bank of China announced on May 18 that it would allow the yuan to float within a 0.5% band around a government-imposed exchange rate. For example, if the government-imposed rate were 7.6938 yuan per U.S. dollar, the central bank would allow the exchange rate to fluctuate between 7.6553 and 7.7323 yuan per U.S. dollar. Due to a soaring economy and a widening trade surplus with the United States, the yuan closed at a record high of 7.6686 yuan per U.S. dollar on the first day of the new exchange rate policy. In other words, after the announcement, the yuan strengthened against the U.S. dollar.

A "stronger yuan" means that 1 yuan can purchase more U.S. dollars than before. If the exchange rate were 1 yuan per U.S. dollar, yuan holders could obtain $1 for each yuan exchanged. If the exchange rate fell to 0.5 yuan per U.S. dollar, yuan holders could obtain $2 for each yuan exchanged. Hence, the yuan gets stronger as its exchange rate falls, and is stronger at 7.6686 than at 7.7323 yuan per U.S. dollar.

The stronger yuan makes Chinese products more expensive for Americans, reducing net exports and therefore lowering China's real GDP growth rate. Why would the People's Bank of China want to destroy jobs in its exports sector by favoring a stronger yuan? One popular explanation is that the Chinese government is giving in to U.S. political pressure to strengthen the yuan. A stronger yuan would reduce the U.S. trade deficit with China, boosting American goodwill towards China and avoiding the passage of U.S. restrictions on Chinese imports.

There is also an economic explanation for China's new exchange rate policy. Along with China's recent double-digit economic growth comes the prospect of high inflation and economic instability. The standard monetary policy remedy for an overheating economy is higher interest rates. Raising the cost of borrowing reduces overzealous consumption and runaway investment spending. Furthermore, higher interest rates attract more foreign investors, raising foreign demand for Chinese currency, which strengthens the value of the yuan. At the same time, higher interest rates encourage Chinese investors to keep more of their yuan in Chinese assets, leading to a reduction in the supply of yuan, which adds additional upward pressure on the value of the yuan.

Therefore, the People's Bank of China faces an economic dilemma. If it wants to tame the roaring economy, it must allow the yuan to strengthen. But if it wants to maintain a fixed exchange rate, it would need to keep the interest rate unchanged. Today, the central bank has chosen economic stability over exchange rate stability.

Discussion Questions

1. The central bank coupled the exchange rate announcement with a Q&A document for the public. In what ways is the central bank's explanation for widening the exchange rate band similar to our analysis? In what ways is it different?

2. Why would the central bank hesitate to allow the yuan to float freely? In other words, what are the drawbacks of immediately eliminating exchange rate controls?

3. For some time, U.S. policymakers have complained about China's exchange rate policy. How would a weaker U.S. dollar affect American consumers of Chinese products? How would a weaker dollar affect American producers who compete with Chinese producers? How would a weaker dollar affect Chinese consumers of American products and American firms that export goods to China?

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Friday, May 18, 2007

The Economics of Nudging

A few months ago, Aplia was acquired by Thomson Learning. Looking over my first Thomson pay stub, I noticed that the company had automatically diverted some of my earnings to their 401(k) retirement plan. Though enrolled by default, I was free to opt out. Satisfied with my enrollment, I did nothing and stayed in. Like most well-intentioned people, I want to save a sensible portion of my earnings. The trouble is, when we are left to opt in to retirement plans on our own, there's a good chance we'll never get around to it. People want to save more, but many of us never do. With automatic enrollment, our employers nudge us toward the desirable outcome.

Thomson's default enrollment policy is possible because of legislation passed by Congress and the president in 2006. This new federal law preempts state laws that don't allow companies to withhold wages without employee consent. Notice that the law doesn't take away my 401(k) choices, it just allows Thomson to present them in a different way. Rather than deciding to opt in to my company's retirement plan, I have to decide whether to opt out. I still exercise the final say.

As New York Times columnist David Leonhardt has pointed out in two recent columns, appropriately placed nudges can do more than encourage retirement saving. Leonhardt applies the economics of nudging to dieting, education, and healthcare. Read his columns to find out more (one here, and another here).

Discussion Questions

1. According to Cornell marketing professor Brian Wansink, how does the size of your plate affect the size of your appetite? How do the contents and organization of your kitchen give you cues about what and how much to eat?

2. How might antique dinnerware help people cut down on calories? In what other ways can people design and stock their kitchens to provide a nudge toward healthier decisions?

3. How did Dr. Michael Gropper's rule about the default position of hospital beds lead to a big reduction in ventilator-associated pneumonia at his San Francisco hospital?

4. How did Yale economist Justine Hastings' experiment simplify the school choice application process for parents in the Charlotte-Mecklenburg School District of North Carolina? What problems do the Medicare Part D program and the State Children's Health Insurance Program share with the school choice program in Charlotte?

5. A cue in your kitchen that nudges you toward healthier choices is one thing. State-sponsored nudges are a bit different. A program in Missouri allows compulsive gamblers to sign a blacklist that bans them from casinos. If they're caught gambling, they face arrest and confiscation of winnings. The program helps keep addicts out of casinos, but it involves state coercion. Is this type of nudge really "libertarian paternalism"?

For more on the economics of nudging and libertarian paternalism, check out Jim Holt's article in the New York Times.


Friday, May 11, 2007

Can Economics Take the Guilt out of Conspicuous Consumption?

Looking at the world through economic lenses can often take the emotional charge out of otherwise controversial decisions. Take the environmental consequences of gasoline consumption. Instead of feeling guilty about driving a big SUV or thinking ill of those who do, why not take the approach suggested by this Time magazine article on carbon budgeting?

What if everyone in the country received the same number of pollution credits regardless of whether they owned a car? The question of who gets to pollute is reduced to a matter of who is willing to incur the cost. And people who do not own cars or who seldom drive benefit from their ability to sell their credits to those who need or want them. The next time someone passed you in a Hummer, you'd know she paid a greener soul for the right to do it.

Discussion Questions

1. How would the pollution-credit scheme change the tradeoff between driving and alternative modes of transportation?

2. Harvard economist Greg Mankiw advocates a gasoline tax for a variety of reasons, including environmental considerations. How is a pollution-credit scheme different from enacting a stiffer tax on gas? How would government enforce pollution-credit usage? Which system would require fewer administrative costs?

3. Critics note that stiffer gasoline taxes would be regressive. That is, a relatively rich person with a gas-guzzling SUV would still devote a smaller share of his or her income to gas taxes than a poor person with a fuel-efficient compact. Would a pollution-credit system face similar concerns?

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Friday, May 04, 2007

Who Wants to Be a Harvard Grad?

It's getting tougher and tougher to get into Harvard. The admissions rate—that is, the fraction of applicants who are accepted—has been declining for decades. And you don't need an 800 on your math SATs to figure out why: the number of spots at Harvard has remained roughly the same, while the number of applicants has soared. But why has the number of applicants soared? And should it be soaring?

As with all economic questions, the answer comes down to costs and benefits. The social and economic benefits of attending Harvard are large. To spend four years among the "best of the best" (by some measures, anyway) is an exhilarating experience. And in what Robert Frank calls our "winner-take-all society," going to an elite school may be a necessary first step if you want to compete for the kind of positions (Supreme Court justice, CEO, Nobel Prize winner) that only a microscopic proportion of the human population ever obtain. But these benefits are roughly the same as they have always been: indeed, students can now choose from many more excellent colleges than they could in the past.

In the meantime, what has happened to the cost of getting into Harvard? Harvard alum Michael Winerip recently wrote an essay in the New York Times on how the young people applying to his alma mater now are, on paper at least, much more accomplished than he was at their age. But many of their accomplishments—from a string of 5's on AP tests to touring Europe with youth orchestras—are the result not of increased inner drive among college-bound students, but rather of a nascent industry designed to help students get into college. Winerip writes that, as an alumni interviewer, he interviewed a girl who worked at NASA doing research on weightlessness in mice; his project in high school, by contrast, was a shoebox with soil and bean sprouts. And while some of the students he has interviewed take 10 AP courses and get top scores on all of them, he took a single AP course and scored a 3. However, he writes,
Of course, evolution is not the same as progress. These kids have an AP history textbook that has been specially created to match the content of the AP test, as well as review books and tutors for those tests. We had no AP textbook; many of our readings came from primary documents, and there was no Princeton Review then. I was never tutored in anything and walked into the SATs without having seen a sample SAT question.

As for my bean sprouts project, as bad it was, I did it alone. I interview kids who describe how their schools provide a statistician to analyze their science project data.
Reading Winerip's essay, it may seem as though the costs of getting into Harvard have skyrocketed—but in fact, if one thinks about this like an economist, it quickly becomes clear that the opposite is true. The price of preparing any one element of one's résumé has in fact decreased: for example, one can now buy a textbook that is keyed to the AP test, whereas before, students didn't have access to those resources.

However, total expenditure on college preparatory activities has increased dramatically. This is because, as the law of demand would predict, the lowered cost of achieving specific goals leads to more people attaining those goals—and therefore drives up the number of people applying to Harvard. Furthermore, as more people do the things that used to get you into Harvard, students have to do more and more to set themselves apart from the rest of the crowd.

Discussion Questions

1. Winerip laments the fact that many of these driven students are missing out on the fun of childhood. Is it efficient (in the economic sense of the word) for so much effort to be devoted to getting into college? What are the costs and benefits of this kind of competition?

2. Use a supply-and-demand model to illustrate what has happened in the market for college preparatory activities (tutoring, mentoring, test prep). Note that the probability of getting into Harvard is both dependent on the outcome of that market and a determinant of demand in that market. How is an equilibrium reached that takes both of those factors into consideration?

3. What effect does increased competition for elite schools have on other schools? Is it easier or harder to get into a good state school because of all the competition to get into Harvard? What about the effect on tuition, both at elite schools and other schools?

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