The Curious Case of Friday's Employment Report

Labor markets are still tight

The labor market may be indicating an inflection point

The timing of the inflection point would be unusual

The implications would be far-reaching

Every once in a while employment reports get interesting. Most of the time, the various reports on employment are straightforward.   When different reports on employment are consistent, they are easy to interpret. But that's not always the case. The report 4/7/2017 for the month of March was one of those reports that requires more than a superficial review.

The WALL STREET JOURNAL on 4/8/2017 in the “Heard on the Street” section included an article entitled “Data Obscure Tight Jobs Market.” The theme of the article is that Friday's report can be subject to two different interpretations depending upon which source of data is considered more important.

It states “The best way to understand Friday’s employment report is to ignore the jobs number, which was lousy, and the unemployment rate, which looked good.” For those who missed the report it showed the economy added just 98,000 jobs last month, below expectations and well-off of the previous months’ gains. The contradiction is that the report also showed that the unemployment rate fell to 4.5% from 4.7%.

The article starts by pointing out that the best way to understand Friday's employment report is by ignoring some of the actual data items. Instead of trying to focus on either number, the article suggests focusing on differences in the implications of data from different sources. Unfortunately, the article limits its focus to just the Friday report.

The jobs number comes from a survey of businesses (with various adjustments made by the Department of Labor), while the unemployment rate is calculated from a survey of households which also contains a measure of employment gains. So the two numbers actually come from different reports. The approach of comparing different sources is definitely on target, but there's no reason to restrict attention to just the Friday report. On Wednesday there was unemployment report on private sector employment as estimated by Moody's Analytics using ADP data. On Thursday there was a report on new claims for unemployment insurance.

Labor markets are still tight

From the Friday report:

(1) The drop in the jobless rate occurred even as more people entered the labor force. In other words, the labor market is tight enough to be drawing people into employment who previously were not seeking work.

(2) An alternative measure of unemployment as well as underemployment, which includes those who have stopped looking and those in part-time jobs who want full-time positions, dropped to 8.9% in March, down from 9.2% the prior month and the lowest since December 2007.

(3) Similarly, there was a continued decline in the incidence of long-term unemployment.

(4) In another sign of labor-market tightness, average hourly earnings rose 2.7% from a year earlier. This indicates that the people who are finding employment either by entering the labor market or upgrading from part-time employment are not being forced into desperation jobs. They are probably abandoning desperation jobs for jobs that are more appealing.

(5) The survey of households, upon which the jobless rate is calculated, showed a large gain in employment— 472,000 for the month. There are reasons to believe the household survey is a more accurate measure this month. The difference in magnitude may be due to differences in definitions, but the relative size and direction of change is probably more accurately reflected in the household survey (as discussed below).

(6) The weak job growth number comes from the employer survey. A winter storm struck during the Department of Labor's survey week. People who missed a paycheck that week more often than not would not be counted in the business survey. However, in the household survey people who miss work because of the weather still get counted as employed.

From other employment-related reports:

(1) Unemployment insurance filings reported on Thursday show that the number of people applying for new unemployment benefits fell in the week ended April 1. Initial jobless claims decreased by 25,000 on a seasonally-adjusted basis. As the WALL STREET JOURNAL pointed out on 4/7/2017 in its “U.S. WATCH” section, last week’s report points to consistent job creation and certainly precludes the possibility of major layoffs on a large scale.

(2) On 4/6/2017 the WALL STREET JOURNAL reported on the employment report generated by Moody's Analytics and ADP. As pointed out in the article entitled “Hiring Robust in Private Sector,” private payrolls across the nation rose by 263,000 last month. Using payroll records and an alternative definition from the BLS survey avoids the weather impact that showed up in the Department of Labor's Friday's employment report. Thus, the ADP number is a better reflection of the underlying state of the labor market.

The labor market may be indicating an inflection point

A divergence between the jobs report from the employer survey and the employment component of the household survey can be a random fluctuation attributable to differences in samples and methodologies. However, occasionally it is a very telling sign of the change in the underlying dynamics of the economy. Consequently, “maybe" is the appropriate way to interpret this section. This can only be a “maybe,” but it's worth considering because it would have major implications because of the timing.

As has been pointed out a number of times in this blog, the household survey captures people who become self-employed, start businesses, or are hired by small companies. They generally aren’t counted or are undercounted by the employer survey. In fact, trying to get adjustments to the survey to reflect the undercount in business startups and small companies has been an ongoing problem for the Department of Labor.

Self-employment, business startups, and small business hiring have all been weak spots in this recovery. If those three sources of employment growth have finally kicked in, the economy has undergone a fundamental shift in the sources of growth. While still tentative, there is evidence that such a shift is occurring.

First, from the ADP report quoting directly from the WALL STREET JOURNAL article: “Most of the job gains came from small businesses, defined by ADP as companies with 49 or fewer employees. These firms added 118,000 jobs. Midsize firms with 50 to 499 employees added 100,000 workers, while large businesses added 45,000.”

It's no secret that small businesses are a major source of employment growth. However, the ADP report shows that they are now starting to respond in their traditional role as job creators rather than as the punching bags they seem to have been during most of this recovery.

Second, it's also no secret that the drop in the number of startups during this recovery has been frightening. It's been characterized as a “collapse” in startups. It has surfaced in numerous data sources including IPOs, new business registrations, and tax filings. Unfortunately, the most reliable data on business formations (tax filings) is only available with a lag.

Contrary to the Wall Street focus, new business formations usually originate below the financial radar. Individuals go out and start a business. Only later is a clear that they did more than just become self-employed. So, the fact that employment rose while the unemployment rate fell is significant. That phenomenon, in combination with low growth in the jobs number, is often associated with an increase in self-employment.

The timing of the inflection point would be unusual

A posting on August 4, 2010 entitled “An Article about a Fiction and theEmployment Report” noted that: when the business cycle is just turning up, a divergence between the jobs number from the employer survey and the employment figure from the household survey would indicate a normal recovery. The reason is simple: as confidence increases, and John Maynard Keynes’ animal spirits surface, people are more willing to start a business or try self-employment. Further, as that posting noted: “Recoveries don’t come from having the same set of employers hire back people. Recoveries have always come mainly from new or different companies hiring. Interestingly, it tends to be smaller companies and often startups from the current or the last cycle.”

However, as noted above, new business startups have collapsed during this recovery. The divergence never showed up. So, if next month's employment report confirms the divergence that appears to have occurred in Friday's data, the timing would be quite unusual. It's usually a phenomena observed at turning points when the cycle turns positive.

There are reasons to believe that phenomenon is real. Business confidence surveys ranging from surveys of small businesses to announced hiring plans of the large businesses would be consistent. They all show an increase in optimism. Even more telling for the particular data we’re discussing is the increase in consumer confidence. Self-employment is very much a function of consumer confidence.

The implications would be far-reaching

The divergence might not persist. The normal interpretation of such a divergence could be wrong given that it's occurring at an abnormal point in the business cycle. However, if it is real and the normal interpretation is appropriate, it has major implications across a variety of areas.

Economic Implications

(1) It has cyclical implications. Resurgence in small business, startups, and self-employment this late in a recovery would, at a minimum, indicate a need to rethink where the economy is in its recovery. Perhaps this cycle lasts longer than is typical or maybe it will just require a different kind of shock in order to produce a downturn. Or, perhaps the recovery is just now gaining its footing.

(2) It has structural implications. As noted in the WALL STREET JOURNAL on 4/7/2017 in a special "In Depth" section under the title “Why You Work for a Giant Company,” the US economy has undergone a transition from being largely composed of small businesses to one dominated by large businesses. A revival of small business at this point could reverse the trend and restore the structure that was characteristic of the US economy historically.

(3) It has growth implications. The lack of productivity gains during this recovery is a major concern. Without productivity increases it is very difficult to get wage and income increases. Not to demean the research done by large companies, but traditionally startups and new businesses have been responsible for much of the growth in productivity. Federal Reserve Board in one paper estimated that changes in the number of startups create a persistent increase in GDP through productivity growth. Specifically, they found that a one-standard deviation shock to the number of startups led to an increase of real GDP culminating to 1-1.5% and lasting 10 years or longer.

(4) It has policy implications. The divergence between the household survey and the employer survey would indicate that the labor pool is deeper than superficial employment measures indicate. Thus, inflation is less of a risk than superficial employment measures imply. In essence, if this age of the business cycle is “younger” than its chronological age, then perhaps fiscal stimulus is appropriate.

Investment Implications

(1) As financial markets seem to have surmised, the headline number (98,000 new jobs) is meaningless. It's one of those flukes that show up in any series. It is worth noting that previous postings have argued that trying to invest based upon monthly employment numbers is a fool’s errand. Even if it was a valid measure of employment, a couple more months’ of data would be required before one could surmise that it's a trend. Then one would have to conclude that the employment trend has implications for future profitability. That would be a reversal of the way the economy actually works. Employment is a lagging indicator.

(2) Since the headline number is meaningless, any investment implications arise from the discrepancies between the different reports. Since interpreting those discrepancies involves a lot of “maybes,” there is considerable investment risk associated with making any asset allocation decisions based upon currently available employment data. Now, that's not unusual given that employment levels are a lagging indicator.

However, employment levels aren't the same as structural changes in the economy that are reflected in employment data. Employment data may be the first indicator of structural changes. Most leading indicators provide little or no information about structural changes. The best leading indicator on structural changes is new business formations by industry and size. It is only available with a considerable lag. Thus, even if the phenomenon (new business formations) leads, the data lags.

(3) The issue is investment implications, not speculative implications. Consequently, structural changes are extremely important since they tend the last over a reasonable investment horizon. They are persistent; there's no harm in waiting for confirmation of the implications of the current employment data. The advantage of identifying the structural implications of the current employment data is that it points to a potential trend. Trends are a much better basis for investing then cycles.

(4) Trends are such a firm foundation for investment decisions that most commentators are willing to jump the gun and call any two points a trend. There is a risk of making the same mistake with regard to the structural change being discussed here. There are, however, two differences.

Structural changes are very different from changes in direction in a cycle. Structural changes only appear dramatic after-the-fact; they are subtle while they are occurring. Thus, changes in the direction of the headline number seldom provide any information about structural change. The composition of economic activity revealed by the detailed data is where structural change can be identified. 

(5) Acting on the investment implications of this potential structural change does not have major negative implications if the structural change never appears. To illustrate, a posting on February 11, 2014 introduced “The Three FundPortfolios.” Subsequent postings on the topic provided the rationale and examples of individual funds that can be used to construct a portfolio. One objective of the three fund portfolio is to get exposure to small and medium-size companies without having to select a portfolio of individual companies.

A simple strategy to capitalize on any structural shift toward small and medium-size companies would be to increase the assets allocated to mutual funds targeting that asset class. A posting on February 4, 2016 entitled “The ThreeFund Portfolio in 2016” discussed the ongoing management of the portfolio. It recommended dollar cost averaging into the portfolio. One could capitalize on any structural shift toward small and medium-size companies by targeting the new investment into the mutual fund containing small and medium-size companies.

Dollar cost averaging is a good example of an approach that reduces the risk associated with investing based upon any thesis (i.e., forecast). If the forecast doesn't materialize, as actually was the case with respect to developments in 2016, dollar cost averaging allows one to respond. With respect to the structural change being discussed in this posting, after a few months' of allocating new investments to the fund targeting small and medium-size companies it should be apparent whether the structural change is actually occurring. If it is, one has the option either to continue investing in that mutual fund on a monthly basis or accelerate the rebalancing toward that mutual fund. Given the “maybes” associated with structural changes, dollar cost averaging is a low risk approach to a potentially important investment opportunity.

Friday's job report at first seemed to muddy the water regarding the trend in employment, but on close examination, the issue raised is more subtle. The headline number in the employment report is seldom justification for changing one's financial plan. But, the report does provide information about the performance of the economy. Often that information is just a lagging indicator, but sometimes it reveals underlying trends that has not shown up in other data. When that is the case, it does create opportunities for investors.

Student Loans and the Need to Abandon Ideology.

Ideology is just a cover for shallow thinking.

There are real issues associated with student loans. Once they are identified it should be possible to avoid the ideological biases that inhibit effective public policy. Yet, much of the current discussion about policy related to student loans only addresses the symptoms of the issue (e.g., defaults and the cost the taxpayers, students graduating with unmanageable debt burdens, students who don't feel any sense of responsibility for the cost of their education). It is much easier to address symptoms within the ideological framework.  It doesn't even require any thought. The ideology is all one needs. Real issues, by contrast, often present intractable problems that require thought rather than ideology.

The last posting on the topic, “The Hypocrisy Should Bother Them: Student Loans,” pointed out some of the most egregious examples of ideologically induced policy blindness. This posting will look more closely at the real issues associated with student loans and illustrates how better policy options become apparent once ideology is set aside.

As discussed in a previous posting (“Educational Loans: Dare We Ask Who Benefits from the Subsidy?”) educational loans subsidized demand rather than supply. As a consequence, they increase the price of education. Last month the General Accounting Office (GAO) estimated that the loan forgiveness provisions of the student loan program would result in a cost of at least $108 billion (that's billion with a B not million). That's a pretty big oops.

Ideologues can focus on whether college is too expensive, the loan program was mismanaged by the Department of Education, or the Obama administration intentionally deceived the public. But, lost in the ideological arguments is the fact that this massive failure suggests an over emphasis on subsidizing demand rather than supply. Perhaps we should be considering taking that $108 billion out of the student loan program and allocating it directly to supply subsidies. Granted $108 billion is probably not the right figure but at least it's focused on the right issue: what's the most effective way for the public sector to subsidized post-secondary education?

Student loans undoubtedly have a role to play in the appropriate policy mix, but under the current institutional arrangements they are bearing too much of the burden. There are three groups that benefit from the subsidy implied by government guarantees of student loans. They are the students themselves, the academic institution, and society in general. But, as economists love to say," There is no free lunch." There are costs associated with student loans that have to be borne by someone. An obvious cost is the opportunity costs. The money used for student loans could be spent on something else.

There are issues associated with how costs are distributed. Just shifting from subsidizing demand to subsidizing supply assumes that the benefit to society in general justifies the cost. However, it's unlikely that currently the cost to society of subsidizing postsecondary education is equivalent to the benefits to society. If there are allocation issues associated with the benefits to the students and the academic institutions, those allocation issues almost certainly distort the return to society from its subsidies.

The distribution of costs should relate to the benefit derived from the student loans. The government's loan guarantee program is particularly poorly designed to accomplish that objective. The government guarantees the full amount of the loan, but the government is not the exclusive beneficiary of the loan.

The government isn't the only party to the loan or benefits and costs are improperly aligned. The cost borne by the student should reflect the value of the education to the student. If that were the case, the education would increase the individual’s income enough to pay back the loan. Clearly, that's not the case to the tune of $108 billion plus all the defaults beyond the part of the debt that is forgiven. The high and rising number of ex-students who are not meeting their loan obligation attests to the fact that the $108 billion is not the full extent of the exploitation of the students.

It is easy to ignore the root of the problem if your bias allows you to blame it totally on Obama for shifting student lending to the government. People who strongly believe in the private sector versus the public sector are prone to that bias. To them the entire problem is government inefficiency. The exploitation of the students is not intentional; it is just a byproduct of inefficiency. By contrast, many supporters of shifting student lending to the government supported the move out of fear that private sector lenders would intentionally exploit students. The problem with both biases is that they ignore the fact that defaults have occurred both when the loans were done by private bankers and when they were done by the government. The problem isn't properly addressed by vilifying the lender regardless of whether the lender is government or banks. The problem is the structure of the transaction (i.e. the student loan).

Saying that students are bearing $108 billion of costs that they can’t justify is not the same as saying that the $108 billion is not justified. The $108 billion may represent benefits but not necessarily benefits that accrue to the student who borrowed the money. A posting entitled “It's a Wonderful Life: Student Loans” suggested that part of the problem is that student loans are going to individuals with no sense of responsibility. 

People who strongly believe in the private sector versus the public sector are prone to see that as a major source of the problem. By abandoning the loan standards of the private sector the government failed to take into account the character of the borrowers. The problem with that argument is that the loan itself may be the source of the failure of the individual to meet their responsibility. Further, while the abandoning of private sector loan standards by the Obama administration may explain the exponential growth in student loan defaults, defaults are not restricted to individuals who borrowed since the responsibility for lending was shifted the government.

The problem with the student loan market is that it is burdened with government imposed distortions. Those distortions were imposed in order to achieve the social objective of having a broadly educated population. But, that objective can’t be optimized unless the distortions are either eliminated or taken into account. 

Currently the risk associated with the loan is borne by the student and taxpayers. The government guarantee of the loan puts taxpayers on the hook for a substantial portion of the cost of the inefficiency produced by this misallocation of the risk associated with student loans. Because as guaranteed by the government, the student can borrow more money for longer periods of time than would be the case if there were no guarantee. At the same time, in order to protect the taxpayers the government has given student loans what might be referred to as super priority in bankruptcy. In fact, student loans can't be dismissed in bankruptcy. As a consequence, student loans appear to have very little risk: they’re guaranteed by the government and can't be dismissed in bankruptcy. Thus, market forces can't be relied upon.

Eliminating the government guarantees and treating student loans like any unsecured loan in bankruptcy would eliminate the distortions and allow the market to function. A functioning market isn't an objective in-and-of-itself. However, the existence of a properly functioning market for student loans would position the government to more rationally address the issue of what is the proper way to subsidized post-secondary education. Currently, the government has to respond to the distorted demand for student loans that result from distortions they've introduced into the market.

People with an inherent distrust of markets will oppose this solution regardless of its potential benefits. That will be the case especially if, like academic institutions, they are major beneficiaries of the distortions in the market. People more favorably disposed toward markets may view correcting the distortions as all that is required. Neither is correct; illuminating the distortions still leaves the issue of how much society should subsidize post-secondary education. That's a social decision independent of the market result. There are social benefits to an educated population and economists are quick to point out that when there are such externalities the market does not generate an optimal result.

Externalities can surface in a variety of ways. By definition they involve a benefit or cost to a non-market participant. In the case of student loans the participants are the government as the guarantor of the loan (or its proxy if banks are doing the actual lending for the government) and the student. That brings us to the third beneficiary of student loans. The academic institutions benefit from student loans because they increase the demand for the services of the institutions, but they don't directly participate in the loan.

Academic institutions may prefer to avoid responsibility for their refusal to refrain from abusing the trust students and taxpayers have placed in them. However, the abuse has been so bad that politicians of many persuasions have called for a response. Often the response focuses on the symptom rather than the cause. The responses often focus on trying to take back the financial benefit (e.g., finding the institution) or forbidding the institution from responding to the incentive (e. g., insisting on limits on tuitions). They don't generally address the incentives that the government has created.

Further, ideology can influence the perception of the symptom. To illustrate, the Obama administration in 2014 created rules to punish educational programs that graduated large numbers of students with high debt burdens relative to what they could earn upon leaving school. Rightly they focused on whether students were repaying their debt as a way to identify schools that should be punished. The rules are an acknowledgment that there are benefits flowing to the academic institutions beyond those earned by providing benefit to the students.

Even with that acknowledgment there was an inability to recognize that the problem is with the student loan program. Rather, the Obama administration went looking for villains. Naturally, given its ideological bias they found them in the profit motive or at least tried to present it that way. First, they identified hundreds of for-profit colleges as subject to the rules. Then, they discovered that they grossly underestimated the number of students who were not paying back their loans. Once they corrected for the underestimation they discovered that the problem related much more to the composition of the student body than whether the institution was a state institution, a private nonprofit, or a for-profit institution.

Unfortunately, the intentional or unintended mishandling of the Obama administration's efforts to recapture the externalities created by the student loan program led those less inclined to distrust anything private sector to focus on the mishandling by the public sector. They could view it as an issue of regulatory overreach and government effort to pick winners and losers.

The simple expediency of having the educational institution take some responsibility for the loan can be avoided as long as one's prejudice allows one to ignore the fact that the educational institution is the free rider.

The Reality of NAFTA

Trade is not a zero-sum game.

Neither trade nor negotiations are zero-sum games. Unfortunately, Mary Anastasia O’Grady in “President Trump’s Mexican Standoff” (1/30/2017 WALL STREET JOURNAL) misses that point. As a strong advocate of free trade and one who favored NAFTA consistently since its initial negotiation during the Bush administration, I commend her for her efforts to present the benefits of freer trade with Mexico. One of my complaints about Bill Clinton's run for the presidency was the hypocrisy in his campaigning against NAFTA and then claiming its signing as a major accomplishment. The hypocrisy of cultivating a distrust of free trade despite knowing that it is desirable has been a hallmark of Democratic politics. A legitimate concern is that the consistent failure of politicians to defend free-trade while demonizing those who do defend it has led to the election of a president who may not understand those benefits.

However, it is extremely important to present the benefits as well as the costs honestly. Much of the protectionist sentiment in America reflects a failure to honestly acknowledge both the costs and benefits. Thus, it is extremely important when trying to defend free-trade that the economics be clearly stated. The author’s presentation falls short of an honest presentation of the counter argument against the proposed tariff on Mexican exports. It is not honest to say that the 20% cost of the tariff would be paid by American consumers. Assuming no currency adjustment, the cost of the tariff will be distributed between consumers in the form of higher prices and producers in the form of lower output depending upon the elasticity of demand for the product. If the product is considered a “must have” by US consumers, they will pay the 20%. If the product is very discretionary, consumers will rebel against a 20% price increase and just do without the product. Mexican producers will suffer a loss of sales equal to that reduced consumption.

Also, the author’s presenting the fall in the Mexican peso as something the Trump administration would welcome is sheer nonsense. The perception that it strengthened Trump’s negotiating position seems to be based upon a perception that the objective of the negotiation is to win a zero-sum game where one side wins and the other loses. It makes no sense if the objective of the Trump administration is their professed desire for more balanced trade. The weaker peso makes Mexican exports more desirable to US consumers. It only increases the urgency of the administration's need to resolve the issue and constrains their flexibility in the negotiations. Not only does it weaken Trump’s position with respect to Mexico, it also weakens his position vis-à-vis Republican’s advocating a border adjustment tax instead of Trump’s approach. The drop in the peso is exactly the currency responses that advocates of the border adjustment tax say will eliminate any inflationary impact of their tax plans.

When presenting the benefits of free trade, economists can show that relative advantage results in all parties involved in free-trade being better off in aggregate. However, as is illustrated by the peso's adjustment, the theoretical underpinnings of the advantages of free trade are often illustrated by exclusively focusing on goods and services. In the real world there is an important additional commodity being traded: it is the currency.  It would behoove those thinking about what constitutes more balanced trade between the US and Mexico to keep in mind the fact that the dollar is a reserve currency. To the extent Mexico requires reserves it will need to export more to the US than it imports from the US. That's the only way Mexico can accumulate the dollars it needs to hold as a currency reserve. By contrast the US has no need to import pesos. Consequently, it's totally unrealistic to think that the US exports to Mexico should, or could, ever equal Mexico's exports to the US over a long period of time.

NAFTA should be evaluated based upon the extent to which it allows the free exchange of goods between willing parties. It's totally inappropriate to pretend that the balance of that exchange provides the criteria by which NAFTA can be evaluated. If the balance of trade is lopsided, it isn't due to the structure of free-trade. No country has a relative advantage in all things.

The Hypocrisy Should Bother Them: Student Loans

Or perhaps they're not so smart

This is the third posting on student loans. The first two postings focused upon how we could organize student lending to achieve greater social benefit. They reflect the general philosophy that it is more productive to focus on potential improvements than to concentrate on failures of the current environment.

Unfortunately, many people are so wedded to rigid ideologies that they are blind to alternatives. Others lack the imagination, intelligence, and open-mindedness to see any alternative other than what exists. Either many people formulating policy are tremendously hypocritical or they just aren't smart enough to see alternatives to the disaster they are creating.

So, critique of the current system may be a prerequisite for getting people to address its deficiencies. However, it would be totally unproductive to just critique the current system without at least providing the outline of a viable alternative. With that in mind, this posting begins with a brief summary of the general outline of the major conclusions from the previous two postings.

An alternative approach.

The previous two postings suggested an approach that involves having the government discontinue most subsidies of demand for post-secondary education and shift resources to subsidizing supply. Academic institutions should be forced to bear some risk associated with the product they deliver by making them partially responsible for the risks that individuals incur in order to finance education. The risk that individuals bear by borrowing to finance education should be treated the same way as the risk associated with any loan. Student loans should be treated in bankruptcy like any other consumer loan.

The previous postings.

The first posting done on October 27, 2015 was entitled "Educational Loans: Dare We Ask Who Benefits from the Subsidy? Sometimes it pays to ask the right question.” It focused on questions related to what should be the proper objective of subsidies to post-secondary education. It acknowledged the need for subsidies and discussed how the benefits of subsidies end up being distributed.

It pointed out that the appropriate objective for public subsidies to post-secondary education is a level of post-secondary education that is justified in terms of the benefits it provides to society. That definition of an objective implies an assumption that post-secondary education provides social benefits. Put differently, it assumes that we all benefit from an educated population. However, it also points out that while that social benefit exists, its magnitude is open to debate. Thus, the posting emphasizes methods for ensuring the socially desirable level of post-secondary education without specifically defining the magnitude of the social benefit.

To achieve that objective, most public subsidies should focus on increasing the supply rather than increasing the demand for education.  Public subsidies of student loans may actually be counterproductive in terms of the public policy objective. There is considerable evidence that the educational establishment from the lowest instructor through the administrative apparatus, including the Department of Education, has positioned itself to capture the benefits of subsidies to demand. Any supplier of a good has an incentive to respond to increased demand by increasing price and constraining supply. The educational establishment is no different.

At the same time, student loans are a necessary component to making access to post-secondary education available to the entire population, another desirable social objective. The benefits to the individual from post-secondary education accrue at a different time from the cost. Not all families and individuals are in a position to finance that difference in timing. Educational loans can fill that void, but since that benefit accrues to the individual, it does not need to be subsidized by public entities. Demand subsidies, such as government guaranteed student loans, increase the price of post-secondary education and thus make it less available to those with limited financial resources.

The difference in efficient methods appropriate to achieving these two social objectives has tripped up those responsible for formulating policy. The problem is not new.  As the posting states, “When addressing subsidies for post-secondary education, policy makers should first compare who benefits from post-secondary educational loans to who bears the risk of those loans.

If they did, they would realize that analyzing who benefits is a prerequisite to addressing the appropriate level of expenditures for education” (i.e., combined public and private expenditures on education) “and the appropriate participation of the public sector” (i.e., a public subsidy that reflects the social benefit of an educated population). The distribution of benefits has to be addressed because if student loans result in benefits that are captured by the educational establishment, it follows that “The US will never get the right level of investment in education and a justified public subsidy to post-secondary education...”

 “They would also realize that it is clear that the educational establishment should be bearing some of the risk” (i.e., the risk that the student is bearing by taking on debt under the assumption that the education will produce an adequate positive return to pay back the debt). In short, educational establishments should have to bear some of the risk associated with student loans.

The misplaced incentives created by the current system are widely recognized.  For example, Mr. Duncan, a former secretary of the Department of Education, has noted the problem and stated: “Government, at both the federal and state level, along with accreditors and Congress, need to flip the current incentives in higher education,” Mr. Duncan said. “In the current system, only students, their families and taxpayers lose when students do not succeed. That simply doesn’t make sense.” 

Having educational institutions bear some of the risk for student loans would be a very efficient way to force them to ensure that education delivers a benefit to the student that justifies the loan. The alternative of having students sue the school, professors, and the faculty unions whenever their education is disappointing would be far less efficient. Further, it is unlikely that the government will sue academic institutions when their graduates are unable to repay their loans, although government suits would be more efficient than individual student suits.

The second posting on student loans was on December 28, 2016. It was entitled "It's a Wonderful Life: Student Loans: It isn't whether you win or lose but…." It focuses on the impact of student loans on individuals and families.

It points out that:   “If the government is taken out of the role of the student lender or guarantor of student loans, the basic structure of the student loans is no different from any other loan. The government may provide a subsidy in a form other than a loan guarantee, but there's no reason why that subsidy has to dictate the terms of the loan.”

The failure of the current system

WALL STREET JOURNAL on December 27 ran an article entitled “Student-Loan Market Warms Up: Trump administration is seen as making the sector friendlier to private lenders.” It illustrates how ideology can blind observer to options. It treats government lending or private lending, primarily bank lending, as if they are the only alternatives.

It ignores important aspects of the issue. For example, should the government be guarantee student loans at all? Should bankruptcy proceedings include student loans along with other types of debt? At the same time, the article is to be commended for pointing out that student debt has become an issue with over $100 billion (by government estimates) that the government plans to forgive. Also, the article is a report rather than an editorial, and thus, can be forgiven for just reporting on the two sides taken by various policy advocates. The real critique is that none of the policy advocates has the imagination to see that the either/or decision they're posing is a blueprint for failure regardless of who wins.

The article points out the expectation that some change will take place. The Republican Party’s platform called for a return of private lenders. “The federal government should not be in the business of originating student loans. In order to bring down college costs and give students access to a multitude of financing options, private-sector participation in student financing should be restored.”

It fails to knowledge how government guarantees on any loans can cause the loans to be mispriced. 

Regardless of whether the government or banks make the loans, if there is a government guarantee, the loans will be mispriced because the value of the risk in the loan has been shifted to the taxpayers. Consequently, many individuals will be encouraged to take on larger loans with longer payment periods than is appropriate. The fact that we currently have some people on Social Security who are still paying back their student loans clearly indicates that the issue of government versus bank loans only addresses part of the problem.

But those who are ideologically blinded to the true issue because of their commitment to private-sector financing aren't the only ones at fault. The magnitude and crisis nature of the ballooning student loan burden goes way beyond the results of mispricing. The problems that the private sector can create when government guarantees distort loan risk pale compared to the mess that can be created if the government takes responsibility for actually doing the lending. It is very hard to come up with any conceivable justification for the exponential growth of the student debt burden under the Obama administration.

The Obama administration has either been totally blind to the mess they created or extremely hypocritical in its handling of the student loan issue. Giving the Obama administration the benefit of the doubt, one can only conclude that they were not smart enough to see the disaster they created. As the article points out, under President Barack Obama, responsibility for student lending “was transferred entirely to the U.S. government, already the dominant force in the market.”

“The move was designed to lower lending costs for the government….” They were wearing complete ideological blinders if they really believed that taking on increased responsibility for mispriced loans would lower cost. The WALL STREET JOURNAL article points out that they “wanted to redirect savings to student grants and to offset costs associated with the Affordable Care Act.” Whether one endorses those objectives or not, the mechanism by which they tried to accomplish them just wasn't smart. (In passing, it is worth noting that the previous postings endorsed their objective of increasing student grants as an alternative to mispriced lending).

The article notes that: “The result has been a student-loan market run almost entirely by the federal government— and for which taxpayers are ultimately on the hook.” By government estimates that hook is already over $100 billion, and there are numerous reasons to think it will grow.

The article goes on: “An added concern: Most of this federal debt was extended to borrowers without checking their credit scores.” When the government totally ignores the benefits of the market allocation of credit, loans go from just being mispriced to being mispriced and distributed in ways that are irrational.   How could anyone imagine that it benefits anyone to lend to individuals without any regard to their ability and likelihood to repay the loan? The borrower ends up with a debt burden they can't pay and the lender loses their money.

Clearly, the policies of the Obama administration were going to saddle some students with an unbearable loan burden. The hopelessness of the situation that the government was putting them in was clearly going to undermine their future. Many students have no hope of ever being able to demonstrate the responsible behavior that would allow them access to the financial resources they'll need later in life. Even if the loans are forgiven, that failure to repay their debt is going to undermine their sense of financial responsibility for their behavior. It's almost as if the Obama administration is pursuing a policy designed to undermine students’ sense of achievement and sense of responsibility.

The full extent of the hypocrisy of the Obama administration can be appreciated when one considers some of the steps the Obama administration took to ensure that it had control of all student lending. As the article points out: “Regulatory scrutiny of private lenders also intensified after the Consumer Financial Protection Bureau opened in 2011.”

Keep in mind that the Consumer Financial Protection Bureau is supposed to protect consumers from predatory lending. Even a cursory examination of student loan debt burdens and default rates make it clear that the predatory lender in the student loan market is not private lenders. It is the government. Yet, the Consumer Financial Protection Bureau has not initiated any steps to rein in the abusive lending practices of the Department of Education. It is the epitome of hypocrisy for the Consumer Financial Protection Bureau to ignore predatory lending by government agencies.

Technically one could argue that the Consumer Financial Protection Bureau is an independent agency that is not a part of the Obama administration. In fact, it is an agency that is responsible to no one. But that would be extremely disingenuous given that it was created as a result of the Dodd-Frank financial reforms and that the Democratic party has refused to acknowledge that Dodd-Frank could be less-than-perfect.

If we don't address the deficiencies in the student loan market, taxpayers, many of whom never had the benefit of college, will be saddled with the bill for hundreds of billions of dollars. Unfortunately, the result of that tax will not be a responsible educated population. Forgiving the debt of students who can't repay it will cultivate the selfish attitude that they, the college-educated students, have no responsibility for returning the resources to society that society put into their education.

Summary

Students taking on a post-secondary education deserve every opportunity to start adult life with a sense of accomplishment, an appreciation of the importance of responsibility, and a chance to demonstrate responsible behavior. They should be able to graduate with a sense of pride rather than responsibility for government insured loans that do nothing but guarantee that some of them will experience financial failure.

A major benefit of the approach outlined in the previous two blogs is that if the “Student loans could then be treated like other loans, and if it’s impossible to repay them, they could be dismissed in bankruptcy. Thus, students who borrow and then repay or that finance the education within the family, as in the “It's a Wonderful Life,” will demonstrate how to play the game: take responsibility, be grateful for the opportunity, be thankful for the subsidy that would replace the loan guarantee, and do the best you can. Win or lose that seems like a better route to wonderful life than living with the illusion that others are responsible for your future.” 

It's a Wonderful Life: Student Loans

It isn't whether you win or lose, but….

Whether one even sees that there is an issue associated with student loans depends upon one's approach to the game of accomplishing socially desirable objectives. Differences in attitudes about student loans reveal how people approach the game. Some people see only one way to subside demand for education. Their approach whenever there is a problem is for the government to throw money at it. A totally different approach is to try to figure out how society can be organized so that the educational objective is achieved as a natural result of the way things are organized.

A previous posting suggested that the wrong institution, government, is accepting responsibility for guaranteeing student loans. If subsidizing educational demand by lending students money to finance education is appropriate, primary beneficiaries of subsidized demand are the academic institutions and their faculties. They should participate in risk associated with the loans in some fashion.

The academic institutions that benefit from subsidizing demand are only a part of the story. Those who overlook the possibility that there are solutions other than the government throwing money at the problem, frequently fail to recognize that all policy issues involve individuals. Students and their families are involved.

At this time of year it seems appropriate to use the classic movie "It's a Wonderful Life" to illustrate the point. In previous years the movie was used to illustrate points about good financial management both at the personal and national policy levels. That is not too surprising given the relationship between good personal financial management and a wonderful life.  In addition, national financial events are an important backdrop for events in the movie. However, the movie's relevance to how student loans relate to a wonderful life is more subtle. It illustrates an unfortunate and telling change in attitudes toward how one should achieve a wonderful life.

“It's a Wonderful Life” reveals so much about how to achieve a wonderful life that it's easy to miss the message regarding student loans. However, attitudes toward getting a higher education appear at a number of points during the movie. But the dinner conversation between George Bailey and his father is particularly telling.

Dinner scene

The conversation covers a number of topics, most importantly the father-son relationship between George Bailey and his father. But, with regard to education, it shows just how much achieving an education was considered a family affair. George references working to save up money to go to college, and he discusses how he and his brother plan to coordinate their efforts to get a higher education.

What is particularly relevant is that there is no assumption that the world owes them an education. Rather, it is something they can achieve, and it's their responsibility to achieve it if that's what they want. Perhaps the message of the movie is that that attitude of accepting responsibility is the key to a wonderful life.

It is unfortunate that we as a society are depriving a generation of that sense of achievement. As discussed in a previous posting entitled “Educational Loans: Dare We Ask Who Benefits from the Subsidy?” there are social benefits to having an educated population. That previous posting argued that given our current approach, it is unlikely that we will get a level of investment in education that results in achieving the appropriate social benefits. One might also argue that achieving that objective without facilitating the growth of a sense of responsibility is inappropriate and is a disservice to the individuals involved.

More importantly, acknowledging the benefit to society is quite different from saying that any individual is entitled to education because of the potential social benefit of having a generally educated population. The issue is illustrated in a December 13 WALL STREET JOURNAL article. The article is entitled, “Student-Debt Plan Faulted: Some people who paid off their loans see an injustice in federal forgiveness programs.”

The subtitle pretty much says it all, but the article is quite explicit. It reports that some people who paid back their student loan are “enraged to learn that millions of other borrowers will get off easier. The government is set to forgive at least $108 billion in student debt in coming years under plans that set payments as a share of borrowers’ earnings and eventually forgive a portion of their balances.”

One can focus on the injustice of it, but there is a more important point. Those who have paid off their student debt have a right to feel that they earned the right to their education. They achieved it by accepting responsibility to return to society the resources that society provided to them to facilitate their education. Is it legitimate for them to feel that the federal government wasted $108 billion by educating people who are proving that they didn't deserve the subsidy the government provided by lending them the money?

It's possible that the $108 billion wasn't a waste. It is just possible that a subsidy of that magnitude in addition to the subsidy implied by the government guarantee of their loans is justified. Perhaps there is that much benefit in having people educated. However, it would seem illogical to argue that subsidizing people who don't repay the debt is more productive than subsidizing the more responsible borrowers who chose to pay back the loan.  Arguing that lending to irresponsible people is desirable seems like a stretch. Especially when one considers that if the loans are repaid, society can then lend to other students.

One also has to wonder:  How do those who were never able to go to college for financial reasons feel about paying a share of the $108 billion? The injustice argument certainly seems relevant since they never had the benefits of college but are paying so that others can. One also has to wonder why individuals who never went to college but lead responsible adult life aren’t equally deserving of a subsidy.

The last posting on educational loans was over a year ago, October 27, 2015. Further, the inappropriate structure associated with student loans is not a new phenomenon. The WALL STREET JOURNAL on December 21 had an article entitled “Unpaid Student Loans Bite Seniors.” The article reports that, “The federal government is increasingly taking money out of Americans’ Social Security checks to recover millions in unpaid student debt, a trend set to accelerate as more baby boomers retire….Overall, about seven million Americans age 50 and older owed about $205 billion in federal student debt last year. About 1 in 3 was in default, raising the likelihood that garnishments will increase as more boomers retire.” So, why is another posting on the topic timely now?

There are four reasons to revisit the issue. One is the sheer size of the misallocation of resources involved. $108 billion is a significant sum, and, like any government expenditure, there's no reason to believe that it won't grow. Especially, when one considers that many baby boomers and current students don't view their student loans as an obligation to society.

Second, we have raised a generation who don't think in terms of being worthy, but rather think in terms of being entitled. People who think the government should pay for their education are not likely to feel responsible for repaying society for the resources they've used in getting their education. We certainly haven’t created an educational system that instills a sense of responsibility in students.

Third, both political parties should be willing to address the issue. One political party likes to emphasize the social benefits of higher education to the absurd level of suggesting it should be “free,” or put more honestly, paid for by someone other than the recipient. The other is headed by a president-elect who has acknowledged the obligation of higher education to provide a service of value:  By settling a lawsuit related to the University that bore his name, he has acknowledged that responsibility. Perhaps he will realize that the same approach should extend to all institutions of higher learning. Every college would have to provide value if they were forced to accept the financial risk associated with student loans. It would certainly be a more socially efficient approach than forcing students to sue their colleges when they don't think they received adequate value.

Finally, the previous posting back in October of 2015 was incomplete. If the government is taken out of the role of the student lender or guarantor of student loans, the basic structure of the student loans is no different from any other loan. The government may provide a subsidy in a form other than a loan guarantee, but there's no reason why that subsidy has to dictate the terms of the loan.

Student loans could then be treated like other loans, and if it’s impossible to repay them, they could be dismissed in bankruptcy. Thus, students who borrow and then repay or that finance the education within the family, as in the “It's a Wonderful Life,” will demonstrate how to play the game: take responsibility, be grateful for the opportunity, be thankful for the subsidy that would replace the loan guarantee, and do the best you can. Win or lose that seems like a better route to wonderful life than living with the illusion that others are responsible for your future.

Liberal Macroeconomics and Free Trade

Friday, April 22 the WALL STREET JOURNAL had an opinion piece entitled “Five Big Truths About Trade,” by Alan S. Blinder.  It was an excellent description of why trade benefits a society.  It was also revealing because it illustrates why liberal macroeconomics is failing the general population of the US and many other countries.  The very fact that Dr. Blinder felt that the opinion piece was timely reveals that failure.  However, all one would have to do to know that the failure has occurred is to realize that Dr. Blinder's analysis of the benefits of free trade are accurate and to compare that to the absolute nonsense being spouted by all of the leading political candidates for the US presidency. 

The reason for the failure can be seen in the opinion piece.  It correctly points out that trade has winners and losers.  But then it goes on to suggest that the public sector can somehow provide assistance that will mitigate the detrimental effects on the losers.  It does this as an article of faith.  There is absolutely no justification presented for why one should believe that the public sector has any incentive to mitigate the harm that is incidental to the benefits related to free trade.  That failure to look at the incentives of the public-sector and provide any analysis of why one would believe that the public sector could mitigate the effects of trade is telling.  Liberal macroeconomists repeatedly make the assumption that the public-sector can somehow address the costs associated with a functioning marketplace.  Better they should brush off their microeconomics and analyze whether the public sector has any incentive to undertake the tasks that they blithely assume it can address.

By cultivating a blind faith in the public sector's ability, they are only encouraging the protectionism being demonstrated by current leading political candidates.  After all, if the public sector can solve this problem and hasn't with the current policies it is pursuing, then it is perfectly logical to assume that it could solve the problem with the different policy like protective tariffs.  By failing to address the fact that the public sector is not the appropriate mechanism for mitigating the side effects of free trade, Liberal macroeconomists are in fact cultivating very protectionism that this opinion piece is designed to offset.