Some thoughts on higher education

After healthcare, the biggest, growing expense that is dragging on every middle-class American’s well-being right now is probably the cost of higher education. Full tuition and expenses at top colleges in the U.S. is famously surpassing $60,000 a year. Newly-minted college graduates are taking five to six figures of debt into an economy with extremely high youth unemployment, in which a college degree is no longer a guarantee of a stable middle-class existence. New J.D.s are famously graduating from law school with six-figure debt loads and declining job prospects. American medicine is facing a shortage of general practitioners, at least partly because a lot of young M.D.s can’t bear the expense and work of medical school and internships if they’ll be condemned to a life making only (!) $300,000 a year, as non-specialists. These have a lot of serious, second-order, distributed costs that we don’t always think about: economically indebted young people are more risk-averse, less confident, more prone to depression and anxiety; the ever-growing costs of labor in services that employ credentialed professionals get passed on to all of us when we use their services; less savings ends up invested in other useful places in the economy; a kid whose parents grew up working class, but who are now middle-class and ineligible for financial aid, might choose to go to attend a state school instead of a prestigious Ivy League university, meaning that high college costs drag on social mobility even given generous financial-aid packages. But one cost that sticks out to me is that I think parents should be allowed to have a little fun and live large once their kids have graduated form high school. And many parents who fund their children’s educations are spending all of their savings — money which they could have put to a lot of other fun and worthy uses.

So it’s a big deal. What’s driving these rising costs? Economists who research this talk about a bunch of different things. First, since the 1970s, the “skills premium” in American wages has increased — that is, the differential between college-graduates’ and high-school graduates’ has grown. This, in turn, is explained by the fact that the U.S. has continued transitioning from a manufacturing-based economy to a services-based economy driven by information and knowledge. So as the financial returns to college education have increased, the purchase price that colleges can demand has naturally increased as well (particularly given that available spots at elite colleges have not kept pace with population growth). But colleges are non-profit — so where has all this extra money gone? One major rising cost is faculty salaries, and this has to do with a nifty economic concept called Baumol’s cost disease — since technology and globalization have increased the productivity of highly-educated professionals in other fields, such as law and finance, academe has had to raise its faculty salaries in order to compete with those industries for the highly educated, even though faculty productivity has not increased. Then, there are a lot of other assorted sources of growing costs: increases in administrative and non-faculty university staff (including yours truly!); all the indoor rock-climbing gyms and exorbitant athletic facilities and other frivolities designed to lure high-school seniors who do not know what money is.

These high costs and frivolities may be tolerable in a time of affluence. But since the recent recession, people have become increasingly upset. A spate of books have been written questioning whether college is still worth it. (For the record, in terms of financial returns, strictly, there’s no question that college is still ‘worth it’, in that the college wage-premium easily repays the cost of college, though there is a legitimate debate about the source of this advantage, i.e., whether it comes from real ‘value-add’ to graduates or mere signaling). In the startup community, it’s increasingly fashionable to advocate “hacking” your education, outside of prestigious brick-and-mortar universities.

Normatively, it’s very important to look for policies and innovations that can decrease the cost of providing higher education. Descriptively, colleges may face a much less compliant clientele unless they lower their prices (already, law-school applications have fallen of sharply). How could this happen? As in any other industry, decreases in costs will have to come from competition and technological advance. The major technological change that could impact higher education is the internet in general, especially Massive Online Open Courses (MOOCs), such as those being offered by edX and Coursera. The best argument for universities experimenting with employing MOOCs is that college costs are currently so unacceptably high that we should be open to almost any experiments to help control higher-education costs. But in the rest of this post, I want to consider MOOCs, and argue that they’re not just a valid experiment, but they’re likely to be a part of the right answer as well.

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What is the value of higher education? It might be most helpful to partition higher education into two parts. Part 1 is higher education’s instrumental value — i.e., it’s practical, it’s skill-acquisition, it’s relevant to jobs, it’s giving people abilities that will match them up with what the market is demanding. Part 2 is about education’s intrinsic value — i.e., finding yourself, inhabiting unusual and novel perspectives on life, learning to better understand and empathize with others, asking question that are just worth asking for their own sake, etc.. We probably get more of Part 1 in STEM classes and lab work. We probably get more of Part 2 in English and philosophy classes and in the conversations we have with our fellow bright young collegians. Now, this taxonomy is imperfect. It’s likely that things like “communication skills” and “teamwork” and “leadership” — all skills that employers look for — are things that we develop in late-night conversations and philosophy papers and extracurriculars. It’s also the case that computer science, cognitive science, and physics all are intrinsically meaningful and beautiful as well, and can even expand our curiosity and empathy. But this imperfect schema might help our thinking a bit as we move forward.

In particular, I think there’s little controversy that MOOCs could be extremely useful in at least contributing to the provision of Part 1 of higher education. Indeed, MOOCs might be able to take over the majority of the work for many classes in this category. This past year, I took an introductory computer science course in my free time and never once attended the lecture in person. I sometimes watched a live feed of the lectures from my office — I usually watched them after the fact. But it wasn’t clear to me why the professor was still lecturing in person — few people attended class in person anyways, and  he’s been giving the same intro course for many years now. Tellingly, when a Monday class was cancelled due to the Boston marathon bombing, the professor simply had us watch his lecture from the previous year. In these courses, I also didn’t get much individual attention from my overworked, grad-student Teaching Assistants. I benefited more from online fora where I could exchange questions and tips with other students. And my problem sets probably could have been graded by a computer instead of these TAs — professors can easily write programs that, in a few seconds, throw thousands of different potential inputs into a program to make sure that the programs output the correct answer.

So I think it’s a no-brainer that universities should broadcast and offer credit for MOOC-based intro CS courses and other similar introductory STEM courses. For intro chem and bio classes, universities would likely employ mixed model, where students would watch lectures online, but attend lab in person. This would free professors up from intro teaching duties that they generally don’t enjoy. And by allowing students to choose from a variety of MOOC courses to use toward their college credit, students can be matched up with professors whose teaching styles fit them best, whatever university they’re situated at. This choice could also (once professors receive compensation for the MOOC use of their courses) bring competitive pressures to bear on professors’ teaching efforts.

For more advanced classes across the STEM category, I imagine mixed models would prevail. For a higher level course on, e.g., the theory of efficient algorithms, professors might want students to watch some lectures, write some programs, and master some content via MOOC-style recorded content, and automatically-graded problem sets, but the professor might want the students to then attend some seminar discussions on the much trickier theoretical stuff. Or a university might offer calculus, linear algebra, differential equations, real analysis, and mathematical logic, as MOOCs, while expecting math majors to attend seminars on the later, pure math theory courses in the curriculum, in person.

But the coolest thing about MOOCs is how they might provide more freedom and flexibility to people in seeking necessary job credentials. If you were, say, a successful engineer in Pakistan, but you moved your family to the U.S. (out of fear of religious persecution, or a desire to provide a brighter future for your grandkids), your lack of U.S.-based academic credentials might prevent you from landing a job in the U.S. that could fully employ your talents. Or if you’re a 25-year old mother stuck in a mid-level job, you might feel that your kids’ existence will preclude you from going back to school for a law degree or a CS masters degree. If these people could attend classes online at night, and get credit for their actual knowledge, however they attained it, and then get matched to jobs that are appropriate for their talent levels, that would our economy a lot more fair and efficient.

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Can MOOCs also change the provision of Part 2 of higher education? I have a couple of thoughts about this. First,  “asking deep, meaningful, philosophical questions for their own sake” sounds really nice — and it’s something I sincerely believe in in the abstract — but it’s probably not of much interest to the vast majority of people and is probably, in fact, a luxury that disproportionately appeals to that class of people who write about ideas and run universities for a living. The idea that a good education should not concern itself with utility is a luxury of those who will never need to really worry about unemployment.

Second, it’s hard to say how MOOCs will contribute to Part 2 of higher education, because it’s really hard to define what exactly Part 2 is, and how we measure it in the first place. We say that the liberal arts should make us more empathetic people and open our minds. So what do we make of the value of the liberal arts education of a recent cultural studies BA who gives no money to charity, spends no time interacting with people who lack his cultural markers and affiliations, and is completely intellectually incurious about non-Marxist veins of economic thought and aggressive towards those who are? Did this person fail at his liberal-arts education in the same way that, say, a computer science major who couldn’t build an app did?

Third, every other Yale College graduate I talk to says the same thing, that the most meaningful aspect of their time at Yale was their constant conversations with each other — i.e., the philosophy and political theory that happened outside of the classroom. Right now, people tend to have these excellent transformative experiences at college. But in principle, it’s not clear why that has to be the case — and it’s also not clear how much of Yale’s $200,000 tuition expenses are necessary to facilitate those experiences.

So how will MOOCs transform Part 2 of education? The conventional wisdom is that they’ll only slightly change it, as part of a blended model — i.e., that  students may watch recorded lectures from great teachers, will still attending seminars in person and having their essays graded by people. But I think it would be interesting to see how far we could pushing using digital technologies for Part 2. Professor Gregory Nagy, a professor of Greek at Harvard, has made a compelling case that automated multiple-choice grading in Humanities courses can be useful, when well-designed:

A little later, Nagy read me some questions that the team had devised for CB22x’s first multiple-choice test: “ ‘What is the will of Zeus?’ It says, ‘a) To send the souls of heroes to Hades’ ”—Nagy rippled into laughter—“ ‘b) To cause the Iliad,’ and ‘c) To cause the Trojan War.’ I love this. The best answer is ‘b) To cause the Iliad’—Zeus’ will encompasses the whole of the poem through to its end, or telos.”

He went on, “And then—this is where people really read into the text!—‘Why will Achilles sit the war out in his shelter?’ Because ‘a) He has hurt feelings,’ ‘b) He is angry at Agamemnon,’ and ‘c) A goddess advised him to do so.’ No one will get this.”

The answer is c). In Nagy’s “brick-and-mortar” class, students write essays. But multiple-choice questions are almost as good as essays, Nagy said, because they spot-check participants’ deeper comprehension of the text. The online testing mechanism explains the right response when students miss an answer. And it lets them see the reasoning behind the correct choice when they’re right. “Even in a multiple-choice or a yes-and-no situation, you can actually induce learners to read out of the text, not into the text,” Nagy explained

But there’s another possibility. Everything I’ve discussed so far has centered on simply complementing or replacing some of the features of current universities, within the structure of universities as they exist today. But the most truly “disruptive” proposal for online education is currently coming from the Minerva Project. The Minerva Project intends to have a highly-selective admissions process (it aims to get ‘Ivy-League quality students’) and then house them at different dormitories, on a rotating basis, over the four years of their education. Meanwhile, they’ll watch recorded lectures from top scholars online (meaning–the top scholars only need to be involved in the production of course material once), while they’ll interact with, and be graded by, newly-minted PhDs who are currently out of jobs. Minerva claims that by cutting out the expenses of university infrastructure, athletic fields, etc., it will be able to charge half the tuition of most top-tier universities today. And by housing elite students together, they’ll maintain the benefits of late-night dorm-room conversations, etc.. By moving them around the world, from Paris to Sao Paulo, etc., every few months, they’ll make them more cosmopolitan citizens of the world.

Will it work? It’s not clear. But we need to try.

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Inflation basics [Econ for poets]

I recently had a conversation with a smart acquaintance about monetary policy, and we discussed the new Bank of Japan’s governors’ promises to push for higher inflation in the country. I tried to argue that we had good reasons to believe that such an inflationary policy could boost the real economy, while my friend argued against me. But eventually, I realized that the friend and I were doing a bad job articulating what, exactly, drives inflation, and this was a drag on our conversation. I suspect that there are a lot of us who know how to use all the words we see associated with inflation in magazines (“money supply,” “loose monetary policy,” “inflation expectations,” etc. etc.), who may even remember a mathematical formula from Intro Macro (MV = PQ), but who, when we dig a little deeper, have to admit we don’t have a clear grasp on what’s going on. So I thought I could do the blog world a favor by writing a very back-to-basic post (in English words) on what inflation is exactly and how it happens.

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What is inflation? It is a rise in the prices of goods and services. What causes inflation? Most people would say that  inflation is driven by an increase in the amount of currency or money in the economy — the “money supply.” The intuition here is that if an economy produces the exact same amount of goods in year 1 as in year 2, but there is twice as much money in circulation in year 2, then prices will have to double in order to sort of “soak up” the extra money. I think that’s the implicit metaphor most of us have for how it works: The monetary price of real goods is determined by the amount of money in circulation relative to the amount of real goods; and inflation (and deflation) is driven by increases (and decreases) in the money supply. Now, the interesting thing about this is that it is mostly true in practice but not entirely true in theory. To get a much better grasp  on this, we need to go back to very basic theory, to make sure we’re clear on things, and then we need to clarify exactly what we mean by the “money supply.”

Who sets prices? Theory: In a market economy, everybody sets prices. That is, the price of anything in a market economy is the price at which sellers choose to sell their goods, provided that they can find buyers. So any full explanation of inflation has to answer the question: Why, exactly, did sellers choose to raise their prices and why did buyers go along with it? So let’s start with an incredibly simple model: Adam and Barbara are stranded on a desert island and they have their own economy. Adam grows peaches on his peach tree; every day, he harvests a bushel, eats a peach for himself, and sells the rest to Barbara; Barbara then eats a peach, turns the rest into peach juice, drinks some of it, and sells the rest back to Adam; Adam drinks some of the peach juice and uses the rest to water/fertilize the soil of his peach tree. One day, a $10 bill falls from the sky. Adam and Barbara decide to use this for their transactions: First, Barbara gives Adam the $10 bill in exchange for his peaches; then Adam gives Barbara the $10 back for her peach juice.

Now, suppose that two more $10 bill falls from the sky, one into Adam’s hand and another into Barbara’s. What will happen? Will prices triple? Well, that’s up to Adam and Barbara. They might just decide to save their new $10 bills and continue trading one day’s worth of peaches and one day’s worth of juice for $10, every single day — the only thing that would have changed from before would be their “savings.” But it also is possible that prices could increase. Maybe one day Adam gets greedy for dollar bills, and decides to demand $20 from Barbara for his peaches — he knows she has the money, and since he’s her only supplier, she has to consent. At that point, since Barbara now expects she’ll have to pay $20 for future supplies of peaches, she’ll start charging $20 for a day’s worth of peach juice in order to maintain her living standard. So suddenly prices double, just like that. And it’s also possible — this is the really interesting part — that prices could more than triple. Perhaps Adam gets really greedy and starts to charge $40 for his peaches — more than all the currency in the economy — and Barbara responds by charging $40 for her peach juice as well. One way this could work is that, first Barbara buys half a day’s supply of peaches for $20, makes half a day’s supply of peach juice and sells it for $20, and then uses that $20 to buy the next half-day’s supply, etc. Another way they could do this would be to use the magic of credit —  Adam or Barbara hands over $20 for the full amount of peaches/peach juice and also a promise to pay another $20 that night. At the end of the day, after their two transactions, each is $20 in debt to the other, but each earned $20 in cash from that day’s transaction, so they simply swap $20 to settle up.

Now, notably, this simple model is not a good a good one, because it leaves out (1) the reason money is useful and influences our behavior in the first place, namely that is completely fungible and usable across a broad array of transactions that would otherwise be complicated by barter and (2) competition, which is the major thing that stabilizes prices in the first place. But the point of this model has been to get us beyond our implicit metaphor that prices have to “soak up” the supply of money. Adam and Barbara — the market — are in charge of the prices they set, and they do so according to their own purposes. They could randomly double or halve their prices at their whims. And what’s true for Adam and Barbara is also theoretically true for all of us. If every single person in the world were to wake up in the morning and decide to double the prices they pay and charge for absolutely everything (including doubling, e.g. the amount of credit they demand from and extend from others), then this could work without a hitch — every numerical representation of the value of every good would change, and nothing else would.

The above is just a verbal expression of the familiar “Equation of Exchange” that we see in Econ 101, MV = PQ. In this equation, P represents the price level and Q represents the total quantity of real goods sold — multiplied together, PQ thus simply represents the nominal value of all real goods sold in a given time period. So in the second iteration of our fictional desert-island economy above (where Adam and Barbara were each charging $20), PQ = $40 per day. What about the other side of the equation? M represents the supply of money (a total of $20 in that part of the thought experiment). And V is stands for velocity of money, or the number of times any given unit of that money changes hands in a transaction, per time period; in our thought experiment, since $40 worth of goods changed hands a day, and the amount of money was only $30, then the velocity of money was 1.333 transactions per day (($40 of transactions/day) / $30). If you think carefully about this, you can see that MV = PQ is an axiomatic mathematical identity: The total monetary value of all transactions taking place in a given period of time must necessarily be equal to the amount of money there is times the number of times the average unit of money changed hands in a transaction. If prices suddenly double, while everything else stays the same, it must necessarily be the case that money is changing hands twice as fast, doubling V.

So let’s now think about some of the things that happened in our thought experiment, in terms of this identity, PQ = MV. At first, there was $10 in the economy, and $20 worth of purchases, because the $10 bill changed hands twice a day. So PQ = $20 and MV = 2 * $10. It balances! Then $20 fell from the sky. In one scenario, Adam and Barbara didn’t change their prices, so PQ still was equal to $20. Since M was was now equal to $30, V must have fallen to 2/3rd. In other words, since they were still just doing the same transactions, at the same dollar value, even though there were two new $10 bills hanging around, the ‘velocity’ of any given $10 bill was now 1/3rd of what it had previously been — only 2 $10 bills changed hands per day, even though there were 3 of them in the economy. In the scenario after that, both Adam and Barbara raised prices to $40, meaning that PQ was now equal to $80. Because M was equal to $30, V was necessarily 8/3 transactions per day — that is, the average $10 bill changed hands more than twice, because of how Adam and Barbara transacted four times per day.

So going forward, let’s keep in mind this main theoretical takeaway: The only fundamental constraint on prices is the mathematical identity that PQ = MV. So, if the money supply, M, say doubles, that could cause prices to double, but it’s also possible that the extra money could get “soaked up” by a lower velocity of money, i.e., people choosing, for whatever reason, to hold on to any given dollar in their hands for longer before spending it (and it’s also possible that we could see a little bit of each, or that velocity could surprisingly increase, leading to more than double inflation, etc., etc., etc.)

What influences prices? Practice: In theory, the only certainty about the price level is the identity that MV = PQ — the velocity of money could double one day, and halve the next, making prices double and halve in turn. But in practice, things are much different. First, we don’t, in practice, all just wake up in the morning and all collectively decide to double or halve the velocity of money. If I own a shop and I double my prices one day, my competitors probably won’t, and so all my customers will leave me and buy from them. If I suddenly halve my prices, I’ll run out of goods real quick and won’t make a profit. So, because most firms (hopefully!) face real and prospective competitors and don’t like selling things at a loss, the velocity of money, V, doesn’t just randomly, wildly oscillate on its own. This means that if both the quantity of real goods an economy is producing, Q, and the money supply, M, are held relatively constant, then we won’t usually see wild fluctuations in the price level, P.

And second, in practice, changes in the supply of money do not usually get entirely absorbed/cancelled out by changes in the velocity of money. Just think about it: If you suddenly had an extra $100,000 would you hide it all under your mattress? Maybe you would hide some of it (you would probably save much — but these savings would be someone else’s credit, which we’ll get to later), but probably you would increase your spending at least somewhat. And if all of us suddenly got an extra $100,000 we would all probably start to spend a bit more. Since our increased spending would amount to an increase in nominal demand for goods, we would expect prices to rise. So the Econ 101 explanation here is that increases in money lead to an increase in nominal demand, which causes nominal prices to rise. If you prefer narrative to graphical style thinking, think of it this way: if we helicopter-dropped an extra $100,000 into everyone’s bedroom, workers would demand higher pay to work overtime (since they already have such great savings), people would take vacations and bid up the price of spots at restaurants and on airplanes, everyone would be willing to pay more for houses, bidding up prices, etc., etc. But people also would hold onto or save much of that $100,000, meaning that velocity of any given dollar would slow down at first, and so the extra money supply wouldn’t be immediately ploughed into higher prices. So usually the price level should correlate and moves with the money supply, but not immediately in a perfect, linear 1-to-1 relationship.

What is money? In the first few iterations of the desert-island thought experiment, “money” basically means “paper currency.” But in the modern world, most of what we call “money” is actually just debits and credits in bank accounts. For example, if you have accumulated $10,000 in cash at work, and you put that into a checking account, you still have $10,000 in “money” (because you can withdraw at any time) even though your bank is not keeping those $10,000 locked away in a vault. Your bank likely lent most of those $10,000 in cash out to somebody else, and so now there is $19,000+ in “money” resulting from your deposit, even though there was only $10,000 in cash. Indeed, if the person who got that loan from the bank spends her $9,000 to hire somebody a job, and that hiree then saves his $9,000, and the bank then loans out those $9,000 in cash to somebody else, then there is now $28,000 in money. As we can see, in the modern world, “money” is very different from “currency,” and so economists have very categories for measuring the money supply. “M0” refers to actual physical currency in circulation; “MB” (the Monetary Base) refers to currency in circulation, currency stored in bank vaults, and Federal Reserve credits to banks (see below); “M1” refers to currency, bank deposits, and traveler’s checks; “M2” includes savings accounts and money-market accounts as well; “M3” includes all those and a few other savings/investment vehicles. As you can see, M0 through M3 are ordered according to their relative liquidity — M0 is just actual cash, which is completely liquid, and M3 includes things that might take a bit more time for you to withdraw — savings accounts and money-market funds. Money, in the modern world, exists on a spectrum of liquidity. Indeed, it’s arguable that ‘money’ in these traditional categories is too conservatively defined. If you have $10,000 invested in an index ETF, and you can exit the ETF at any moment, you might think of those $10,000 as your money, but the Federal Reserve, at least when it pays attention only to M0-M3, would not.

So how does the Federal Reserve control the money supply? It doesn’t do so by “printing money,” as Fed-skeptics often put it — it’s even more aerie than that! The Fed actually mostly influences the money supply just by entering credits and debits into its and other banks’ digital balance sheets.  Suppose a bank has $100 in deposits from savers like you and me, and it has loaned those $100 to General Electric. At this point, there are $200 ($100 in deposits, and $100 in cash on hand for GE). But now, the Federal Reserve can buy GE’s debt obligation from the bank; the bank thus gets $100 (or whatever the market purchase price of the loan was) in cash credit from the Federal Reserve, which it can then loan out to another company, like Ford. So now there’s $300 of money in the economy ($100 for GE and Ford each and $100 for the banks’ original depositors), with the extra $100 having been created simply by the Fed crediting another bank’s account.

In reality, due to ‘fractional reserve banking,’ each purchase of X that the Federal Reserve makes creates much more than X new money, because banks often lend to other banks, or banks’ loanees deposit some of their loans in other banks, etc. So the Federal Reserve can have a large impact on the money supply simply by purchasing banks’ assets — by giving these banks fresh money, it allows them to lend more money to other people/banks who will lend to other people/banks who will lend again, creating new money at each iteration.

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I hope this is all the basic background one needs to understand the talk about inflation that we see in the business press. But I want to quickly touch on some implications:

1. This reason all this theory is important is that it explains why Federal Reserve policy is controversial and debatable. If there were a simple, linear relationship between the money supply and the price level, there would be no controversy — we could easily and uncontroversially predict inflation by quantifying the money supply. But Fed policy right now is controversial, for some, because we can’t actually be sure how changes in the money supply will affect inflation over the long run. It’s theoretically conceivable that a central bank could increase the money supply while observing very little inflation, because people largely hide their new money under their mattresses, only to see that 5 years later, everyone suddenly starts spending their mattress-savings, sending prices skyrocketing. The complex psychological factors that influence the velocity of money, including self-fulfilling expectations about inflation (see below), mean that there is always some uncertainty about what the consequences of the Fed’s actions will be. For the record, I’m not very worried about the prospect of very high inflation. The market’s expectations for future inflation are priced into price difference between TIPS (Treasury Inflation Protected Securities) and regular, non-inflation protected Treasuries. And TIPS continue to show low inflation expectations. If I were smarter than the market, I should probably be a billionaire right now. People who are very certain that high inflation is coming should put their money where their mouths are, by putting most of their savings in inflation-protected securities.

2. Expectations for inflation are largely self-fulfilling: If you expect wage rates to rise 10% next year, you might try to lure a new hire with a contract at a 8% premium (relative to current wages), to lock her in at a price that will be a 2% savings relative to what you expect for the future. If you expect prices for your supplies to rise next year, you might raise prices on your merchandise right now, in order to earn enough cash to afford those higher-priced supplies. If you think your competitors are raising their prices right now, then you know you can raise your prices without losing customers. Etc., etc., etc.. The fact that inflation is a sort of self-creating phenomenon, ultimately based on everyone’s best guess about what everyone else thinks about what everyone else thinks about how much prices will rise in the future, is one thing that sometimes makes it hard to control. Most episodes of hyperinflation ultimately originate from governments printing massive amounts of new money — but from there, inflation radically outpaces the printing presses, as everyone keeps raising prices in response to everyone else’s price hikes in a downward spiral. More, one of the most effective ways for the Fed to control inflation is for the Fed chairman to literally make statements — in words — about future inflation. If the Fed says, “we are committed to ensuring that inflation is 3% next year,” the average company will have a good reason to raise prices by 3%.

3. Most mainstream economists believe that moderately higher-than-usual inflation can help boost an economy out of a recession. There are at least four mechanisms through which inflation can benefit a recessionary economy:

          (i) If you own a company and you expect prices to be 8% higher next year, all else equal that fact will make you more inclined to purchase more merchandise now, while prices are still lower. You also might ramp up your production and investment right now, so you’ll be well-position to meet that high nominal demand.  This boost can help an economy get out of the recessionary downward spiral in which low demand and low production begets more low demand and low production.

          (ii)  Most of us think about our salaries in nominal terms. Most of us do not like to take paycuts. However, during a recession, individual workers’ productivity decreases (i.e., if I’m a car salesman, I’m worth more to my company during a time when lots of people want to buy cars). The problem is that if workers’ contribution to companies’ bottom lines decreases, but workers’ salaries stay the same, then firms will hire less and fire more, and/or become less competitive. Inflation allows firms to lower their employees’ real wages, without needing to lower their nominal wages. Economists think this is a good thing — the alternative to lower real wages during a recession is mass unemployment and bankruptcy.

          (iii) Inflating a currency typically devalues it relative to other world currencies. If we make the dollar worth less relative to the Brazilian real, then Brazilians will be able to more easily afford to buy American goods. This should help America’s exporters, which is another thing that can help drag a country out of a recessionary downward spiral. (The flip side of this, of course, is that it will be more expensive for Americans to import things from Brazil — so policymakers have to think carefully through the full industrial implications of a devalued currency).

          (iv) Inflating a currency benefits debtors (at the expense of creditors). If I owe my very wealthy landlord $1 million next year, but prices rise 15% in the interim, then the “real” value of my obligation to my landlord will only be some $850,000. If I as a middle-class consumer am more likely to spend extra money than my ultra-wealthy landlord, then this inflation-driven decrease in my debt/increase in my wealth (and decrease in my landlord’s wealth) will mean greater net demand in the economy. Again, this short-term boost to demand can help jolt an economy out of a downward spiral. You often hear that the problem we’re facing in the U.S. is that, after the financial crisis, everybody tried to “de-leverage” (that is, reduce their debt obligations) at the same time, which led to a “demand shortfall.” (This is often called the “paradox of thrift” — saving more money is good for any individual, but when everybody does it at the same time, it can cause a recession). Inflation can make it easier to reduce our debt obligations, thus weakening the demand shortfall problem that comes with deleveraging.

On the flip side, most mainstream economists believe that in non-recession times, relatively low, stable inflation is good. This is because it’s easier for people to enter into short-term and long-term economic contracts when they can have relatively certain expectation about what things will cost and be worth in the future.

The weird and awful/wonderful economics of taste and contemporary artisanship

This is a post about a weird and interesting space in economic theory, but it starts with a short anecdote.

Today, I went to my local barbershop and sat for an extra half hour browsing terrible magazines so that I could get my hair cut, specifically, by the owner of the place, an older man with blazing white hair and a thick Greek accent that he still retains from his boyhood in Samos. I feel subjectively that I look better when I get my haircut by the owner, as compared to the other barbers. But as a good junior social scientist, I always try to be skeptical of subjective impressions. Objective social science has been very good at obliterating a lot of our pious impressions about the superior quality of goods produced by lofty artisans and craftsmen — in blind taste tests connoisseurs can’t distinguish a fine wine/cheese from an ordinary one, etc. So what about my haircut? Is there any objective basis for my belief that the owner gives me a better one? What could explain my impression?

I have a couple of hypotheses:

#1: My first was that it’s is that it’s totally an illusion and I’ve just been primed by the owner’s foreign accent, old age, etc., to trust him as a craftsman. I.e., perhaps when the other barbers, with thick south Boston accents, cut my hair, prejudice leads me to watch their work with an overly-critical eye. I look in the mirror afterwards seeking to identify their mistakes and misjudgments and find them for this very reason. The owner’s wise-old-man aesthetic primes me to discover the evidence of his excellent good taste when I look in the mirror, and I see it for this very reason.

Is hypothesis #1 correct? Maybe — perhaps even probably. But my girlfriend, who is a fairly unbiased intellect and never present when I get haircuts, has agreed that my haircuts with the old man have been better. So I want to investigate the possibility that his haircuts really do look better. What in turn could explain this?

#2: The main objective difference I can observe in the barbershop is that the old owner of the place uses only scissors, while the other barbers use the modern electric tools. Could this explain the difference? It’d be really easy to say something like this: “Modern electric scissors save time but sacrifice quality. They impose uniform lengths and increments on men’s hair, while a truly good look depends on the layered textures, and smooth, non-discrete cuts that come only from scissors and the experienced judgments of a craftsman.”

This story could be true, but I’m skeptical. The reason I’m skeptical is that in an alternative universe people might be telling the exact opposite story just as plausibly. Supposed we lived in a world in which fine electric-mechanical devices were prohibitively expensive and rare. Scissors were abundant, but electric scissors were a luxury that only elites could afford. In this world, I’d bet that the electric look would be vaunted as desirable and superior. People in this world would probably say things like: “The electric haircut is a huge improvement over its pre-industrial equivalents. It allows the highly trained electric-scissor-certified barber to cut the hair in fine and exact geometries, as opposed to the rough, shabby, hastily layered looks of the past. A buzz cut is chic, crisp art deco on your head. Such a pity that only a few can afford it…”

See the problem? Our story about how the truly authentic scissored haircuts are better sounds nice; but there’s no way to objectively confirm it, so a person who is a critical outsider to our culture would argue that we’re just reverse-engineering a rationalization for our prejudices. If this is true, my impression makes a lot of sense: I don’t like the look my head gets when electric-scissored because of the cultural/affiliational/class-based reactions that have been ingrained into all of us. In my city, the buzzed, electric-scissored look is associated with the military, chains, Budget Cuts, etc. The look of hair cut by scissors, by contract, is associated with people and places that are willing to pay and wait extra to achieve a more fashionable appearance. And so the old-fashioned-scissored look seems more attractive not because of anything inhering in its geometry, but because of associations inhering in our culture and affiliations.

***

So the theory here is that there’s a kind of circular process going on: (1) Aesthetics and taste are not objective. (2) Electric scissors take less time and training to operate properly, so haircuts done with them are cheaper. (3) Therefore, aesthetics aside, income-constrained people will be more disposed to get electric-scissor haircuts; the hairstyles of elite people and elite urban areas will disproportionately be drafted by real scissors. (4) Therefore, the culture will come to associate electric-scissor haircuts with low social standing and regular-scissor haircuts with high social standing. (5) Therefore, the old-fashioned scissor haircuts will be upheld as “objective good taste” and self-conscious elites will be willing to pay more and wait longer for them, which will reinforce the distinction.
It is the superior price efficiency of the electric scissors that causes the look they produce to be associated with low social-standing, which causes it to be devalued. A generalization of this insight is that in matters of ‘taste’ (which is to say: in markers of social distinction) democratizing, price-lowering innovations are at least partly self-defeating.

***

This basic idea is key to understanding a lot of markets based around taste, cultural affiliations, etc., and is also troubling to the general optimistic picture of how markets work. Normally, we hope markets work something like this: When we all really want and/or need something, we bid up the price of it; the high price attracts entrepreneurs who want to make a lot of money meeting this demand; entrepreneurs uncover new technologies and production processes to make the thing more cheaply; the entrepreneurs compete with each other to market the good, driving their prices down; and so now everyone can get the thing they want on the cheap. See, e.g., automobiles, computers, etc. But for goods whose value comes at least partially from social distinction (i.e., “positional goods”), entrepreneurs can’t do quite so much good for us, because the technology and production processes that broaden access to the good will, ipso facto, reduce the value of the good (and be panned by cultural arbiters as ‘bad taste’). The value that electric scissors could provide to the world has been partially limited by the fact that their efficiency created a new distinction.

I find this interesting purely as a theoretical contrast to classical economic theory: In these domains, technology improves the objective features of a good, but in doing so detracts from its value as a token in human social hierarchies. In the supply-and-demand curves we saw in Econ 101, the demand for a good increases as its price declines; for these positional goods, the relationship is more ambiguous. But beyond theory, there are a couple interesting implications:

(1) Right now, Apple enjoys famously high margins on and earnings from its products. As Apple faces increasing competition and loses market share, it might be tempted to lower its prices, the natural response for any company fighting off competitors. As an economist, I should love this decision — more individuals could buy more great Apple products more easily. But if I were a consultant to the company, I might be hesitant: It seems to me that a large part of Apple’s brand value comes from the price distinction itself. Today, buying a non-iPhone smartphone labels you as someone who’s too eager to save a couple hundred bucks, a gaffe among yuppies. So Apple lowering its prices might not unambiguously raise its sales. What can Apple do? Personally, I think there’s just realistically no way Apple can keep up its current earnings and margins and so the company warrants its very low PE ratio. But this is not what consultants are hired to say.

(2) This theory provides some hope for an “artisanal economy” in the future. The basic idea, which I first heard proposed by Adam Davidson, is this: Throughout human history, improvements in technology have improved human welfare overall, even though technological disruptions caused short-term harm to the workers whom they made obsolete. But now some really smart people are starting to worry that this time is different. Once artificial intelligence advances sufficiently that robots can do literally anything that humans can do, there will be no way that we humans can complement technology and we’ll all start to be replaced by it instead. So who will have jobs in the future? Well, people who are part of protected licensing cartels might: As long as the government says you need to see a human doctor to get XYZ prescription, doctors will still have jobs. The people who own the capital and intellectual property used to make the robots will also still have plenty of income. But what about the rest of us?
Davidson has proposed that the future looks like Brooklyn, NY, in whose hip neighborhoods you can find artisinal offerings of just about anything. How is this economy supported? Mostly by people across the river, in Manhattan, whose incomes are either directly or indirectly tied to financial services. Are artisanal versions of goods better than their mass-produced industrial counterparts? A lot of artisanal foods probably wouldn’t come out ahead in a blind taste test, but artisanal goods in general are useful for us for expressing cultural affiliations and in-the-know-ness, or adding a unique quality to a dinner party or a unique aesthetic to an interior design. Artisanal goods are mostly useful as social tokens. And that’s a good thing. As such, they’re largely protected from competition from technology, because getting them cheap and efficiently is not the point — the point is having the experience of visiting the artisan’s boutique shop in a hip neighborhood, and telling the story of the good when you bring it home. I wonder if the economy of the future will look a bit like the economy that currently crosses the East River: technology does all the real work in satisfying our objective basic needs; the owners of capital and intellectual property earn huge profits as a result; and the rest of us are employed in vaguely creative professions, doing things that objectively robots could do, but which some rich capitalists want a unique human fingerprint on. I will let the reader decide whether that is utopia or dystopia.