Bryan Caplan  

How Deep to Cut: A First-Pass Answer to Pearlstein's Challenge

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Towards the end of my debate with Steve Pearlstein, he posed an intriguing question.  My paraphrase: Suppose half of higher education really is pure waste.  What's the efficient government response?  Should government should cut its subsidy by 50%?  Or what?

Steve's asking a complex question, so let's start with a simple case: perfectly elastic (i.e. horizontal) supply of education.  In this scenario, subsidies have no effect on price.  To cut Q by 50%, then, you have to cut total spending by 50%, too.  Since total spending=private spending + subsidy, you simply have to ask two questions:

1. Was the subsidy initially more than 50% of total spending?  If so, the efficient subsidy is (.5*initial total spending-private spending). 

Numerical example: Initial spending=$500B, optimal spending=$250B, and initial subsidy=$350B.  Upshot: Cut the subsidy to $100B.  That way, private spending + subsidy=$250B, the efficient level.

2. Was the subsidy less than or equal to 50% of total spending?  If so, the efficient subsidy is 0

Numerical example: Initial spending=$500B, optimal spending=$250B, and initial subsidy=$200B.  Upshot: Cut the subsidy to $0B.  Private spending ($300B) still exceeds the efficient level of $250B, but unless the government can give negative subsidies (i.e. taxes), there's further better it can do.

Knowing Steve, he'll protest the unrealism of my key simplification.  After all, the supply of education isn't perfectly elastic in the real world, so cutting subsidies automatically cuts prices.  However, this plain fact just amplifies my austere conclusions. 

To see why, recall that total spending=price*quantity.  If we cut subsidies enough to halve quantity, and prices fall too, total spending falls by more than 50%.  And given the 50% waste premise, a greater than 50% fall in total spending is the efficient outcome!

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COMMENTS (5 to date)
Henry writes:

Does half of education being pure waste imply that cutting the supply of higher education in half eliminates all waste? I think not, unless what you're trying to say is that "there is twice as much higher education as is socially optimal".

Alan R writes:

This question reminds one of the numerous versions of the CEO/CFO quotes regarding their advertising budget - "I know that half of it is wasted, but I don't know which half." The proposition regarding advertising is an uncontroversial old chestnut, unlike the higher education version, so I wonder whether the economics profession had anything useful to say in response beyond "try harder to find out which half"? And if it did, the apparent total failure to influence the genuine profit-seekers spending the money (genuine compared to the constituencies in charge of education spending) suggests that this particular campaign may be quixotic even by Bryan's standards.

Robert Easton writes:

I don't see why any of this calculation is relevant. If higher education has a high negative externality from signaling and if nearly all the benefit is internalized, then clearly the net externality is negative. So it should be taxed or at least not subsidized. What else is there to calculate?

The issue is not what proportion is currently funded by government and what proportion is waste. The issue is does this thing have net positive or net negative externality.

Costard writes:

Attack his premise. Subsidies makes it impossible to determine the cost/benefit. Even if "pure waste" were a measurable or reasonable concept (it's neither), we couldn't begin to measure it.

The university system has been granted something like a monopoly on signaling. The competition is either uncompetitive (trade schools, on-the-job training) or illegal (apprenticeships). If a degree is the only option, then the benefit of it is indisputable. Value is conferred by the lack of alternatives, while the cost of a lack of competition is invisible.

Really the question isn't whether we need fewer degrees, but do we more of something else. If the intention is to get rid of inefficiency, or allow for the existence of alternatives, then the only "optimal" level of subsidies is zero.

An interesting, and entirely hypothetical question: to what extent has education-forcing in this country allowed industry to underinvest? Would the invention of the assembly line have been possible (or necessary) with a college-educated labor pool? Or would industry merely have become accustomed to, and dependent on, skilled labor?

Glen writes:

I second Henry and Alan's comments. Let me put it a different way. I assume the 50% waste assumption comes from the idea that, for a typical student, the value of a degree is 50% human capital and 50% signaling. Suppose that's true for all students. Cutting Q by one-half means half as many students go to college. Nevertheless, all those students continue to get 50% value from signaling. In which case the loss of subsidy will have cut the waste in half, but only by cutting the good stuff (building of human capital) in half as well.

Now, the assumption that all students are identical isn't really true, but I don't see any particular reason to think the students who don't go to college without the subsidy necessarily have the highest signaling-to-human-capital ratio.

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