Paying Kids for Grades

Hey OPB listeners, check out what out erstwhile Central Oregon Bureau Chief, Ethan Lindsey, is doing these days: Freakonomics Radio!  Cool.

Alerted to this fact, I see that one of the first stories is on the idea of paying kids for grades to improve educational performance.  Sounds like a no brainer, right? Put the incentive right at the crux of the problem: learning is hard work so motivate kids to work harder.

Turns out this only sometimes works.  The reasons are still speculative but the most interesting theory is that only some kids 'know the production function.'  In other words, only some kids understand what they have to do to get better grades.  For them it is not just about effort but about learning how to learn.

Give lazy kids from educated middle class households money for As and it works great.  Give lower class kids from less-well educated households money and it often doesn't work out so well, because they don't understand what they need to do to get an A.

Sometimes money isn't the only answer.

A Lesson in Incentives

Incentives matter:

Sharp Rise in New-Home Sales in March

WASHINGTON (AP) — Sales of new homes surged 27 percent last month, topping expectations as better weather and government incentives helped sales.

The Commerce Department said Friday that new-home sales rose in March to a seasonally adjusted annual sales pace of 411,000. It was the strongest month since last July and the biggest monthly increase in 47 years.

...

The median sales price was $214,000, up more than 4 percent from a year earlier but down more than 3 percent from February.

The new-home sales report reflects signed contracts to purchase homes rather than completed sales and thus gives economists a feel for how many buyers were out shopping for new homes in a given month.

It is likely capturing consumers who are trying to qualify for federal tax credits that will expire at the end of this month. The government is offering an $8,000 credit for first-time buyers and $6,500 for current homeowners who buy and move into another property.

To qualify, buyers must have a signed contract complete by the end of next week and must complete the transaction by the end of June. Nearly 1.8 million households have used the credit at a cost of $12.6 billion, according to the Internal Revenue Service.

What Was the Failure of Economics?

Macroeconomists have been taking a lot of heat for the failure of the sub-discipline to forecast and/or forestall the crisis. This has often been enlarged to suggest that there is something wrong with the economics discipline as a whole.

This suggests an attitude that I am increasingly running into when I identify myself as a professor of economics: that somehow 'economists' run the economy. Ummm, no. The most important thing to understand is that the economy exists as a natural artifact of human interaction. We don't create it, pull the levers, etc. What we strive to do is understand it, and through this understanding, help governments manage it better.

And here there was a failure. However, I don't think it was with macroeconomics in general, but in the failure of the IO principal-agent and contracting folks to interact enough with the finance and macro types. In other words, there was a trust of the internal incentives of the firm (in this case banks) on the part of finance/macro types that was misplaced. It shouldn't have been: there is a lot of research on incentive problems in CEO compensation, in principal-agent contracts and the like. But macro-types that set policy ignored the lessons of this literature in pushing too far on bank deregulation, trusing the internal incentives to do the trick.

Alan Blinder says something similar in an op-ed in the Wall Street Journal but he blames the corporate boards. But again, we know the incentives were/are skewed there too. Still, his answer is along the same lines, get the incentives right through increased regulation.

Eco-nomics: The Streetcar and the Incentives of Fixed-Route Transit

[Photo Credit: Jamie Francis, The Oregonian]

The Oregonian reports that the Feds have approved $75 million for the east-side streetcar project.  This begs the question, why fixed-route surface transit?  It is no faster than busses, much more costly to implement, less flexible in terms of scheduling and cannot adapt its route to changing ridership patterns.  I suppose the best answer is that it is a commitment device that can spur development in areas in which such activity is considered desirable.  In so doing it can promote even more density, which is generally a good thing for local economies and the environment.  I suppose it might be more energy efficient, but I am a bit skeptical, especially relative to electric busses like those in SF that get power from overhead lines.  I am no expert or even much of a casual student of transit, so I am wondering why the feds are endorsing it so enthusiastically.  What have I missed or what should be added to the discussion?      

Incentives and Life

It is not without a certain level of embarrassment that I will admit that the house I owned in Corvallis was a new house in a new development that was almost 3000 square feet.  My wife and I never felt entirely comfortable there, neither of us really felt at home in a new neighborhood and we missed the character of older houses. Still, it was bought at a time when alternatives were very few and because we knew there was a reasonable chance we would make the move to Portland and it seemed a safe investment (it was).  Sure we have two kids, but we always felt the house was just too big for us.

Now, for a time, we are installed in a old 1000 square foot bungalow and the transition has been quite interesting for this economic naturalist.  You see, economics is all about how rational people respond to incentives, and in moving from 3000 to 1000 square feet, the incentives have sure changed.  In 3000 square feet there is no incentive to choose, to limit yourself, you never have to dispose, donate or never acquire in the first place.  This is especially true with the kids stuff.  Many old gifts that are now long forgotten and no longer played with remained stuffed all around the house.  Now, at 1000 square feet, every thing has to be carefully selected - so the toys have diminished considerably and guess what - the kids couldn't care less.  

So the cost of having stuff has gone way up and the incentive to have less stuff is now much stronger. Low and behold, it turns out we really don't need much stuff.  But I guess the real story is how just 2 years in a big house led to a massive increase in the amount of stuff - a fairly quick response to the lower cost of storage.  And we are not big consumers, its just that we never got rid of anything like infant clothes and supplies (e.g. a crib we hadn't used in a year).

So the point of all of this is that I don't think that your life determines what size house is right for you, I think its more that the house determines how you live.  Its the incentives once in a dwelling that kick in and define and guide your subsequent choices.  At 1000 square feet we are doing just fine and it is good to be reminded of what is really necessary and what is surplus to requirements. We haven't changed through the house changes and I thought that the big house would just remain pretty empty, but nope, the incentives were just too pervasive. Anyone in the market for old toys?...

Prescription Drugs and Oregon

On December 7, 2006, the voters of Oregon passed Measure 44 by a 78% majority. The passage of this measure means that all Oregonians without prescription drug coverage can join the Oregon Prescription Drug Program which is a state-run program that buys prescription drugs in bulk and negotiates for lower prices using volume as leverage. I do not question the reasonableness of this measure or program - given the inadequate access to health insurance in the U.S. and Oregon it is incumbent for states to try and find reasonable solutions in the absence of sound federal policy. But it does raise a question that I think is important in how the government provides incentives to pharmaceutical companies and the perverse incentives programs such as the OPDP might provide.

The fact that the OPDP exists is evidence of the extremely high cost of prescription drugs. Why do drugs cost so much? Partly it is a function of the cost of research, development, trials and manufacturing, and partly it is a function of the fact that for most newer drugs the companies have a monopoly on the market. This monopoly power is granted to companies by the U.S. government in the form of patent protection precisely to incent these firms to invest in research on new drugs so that medical care and treatment can be ever improved. But what do profit maximizing drug companies focus on when exploring new drugs? Drugs for which they anticipate huge markets. These markets are where there are a lot of potential users of a drug and who have money or insurance to buy it. This means that the drugs that are important to the companies themselves (e.g. Viagra) may not be the ones that society might deem most valuable in term of, say, how many lives can be saved or extended (e.g. Anti-Malarial drugs).

So the question that seems important to ask is what drugs are the most commonly sought after drugs in the OPDP? I doubt, for example, that Viagra is one of them (though I would probably be surprised). I think the most commonly sought after drugs are those that treat diseases and illnesses that are more common among lower income individuals like, for example, heart disease. Are there others? Maybe ones that treat diseases associated with common income related illnesses like obesity and diabetes, liver disease, etc. I am not a health economist and I don't have the answers to these specific questions but here is the rub. If programs such as the OPDP lower the margin drug companies receive on these types of drugs it provides further incentives to devote even more resources to finding the next Viagra or drug that deals with health complications associated with aging. So, in a nutshell plans such as OPDP may lower the cost of these drugs but may also stunt the progress on finding better more effective drugs.

This is, of course, no reason to stop the OPDP, rather it is a reason to again think about how we may benefit from one comprehensive health care solution for all Americans rather than a patchwork of state and federal programs. Perhaps it is also time for the federal government to be more proactive in sponsoring research into drugs to combat less-profitable illnesses.