Disease Diagnosis - 2019 New Year's Resolution fulfillment

With the unintentional help of Alex Tabarrok and Eric Helland, I fulfilled my annual New Year's Resolution to change my mind on something. Specifically, I changed my mind:

That the runaway cost increases in higher education over the past several decades were simply due to third-party funding (spending other-people's money by the education-industrial complex (Big Chalkboard)). It turns out there is a much more elegant, though less tribally satisfying, answer: the Baumol Effect (aka, Cost Disease).

If relative productivity doesn't rise in a sector for which demand is rising, prices in that sector must rise relative to the sectors for which productivity is rising. This elegant explanation applies to health spending as well. Here is Tabarrok on the prototypical example:

The Baumol effect is easy to explain but difficult to grasp. In 1826, when Beethoven’s String Quartet No. 14 was first played, it took four people 40 minutes to produce a performance. In 2010, it still took four people 40 minutes to produce a performance. Stated differently, in the nearly 200 years between 1826 and 2010, there was no growth in string quartet labor productivity. In 1826 it took 2.66 labor hours to produce one unit of output, and it took 2.66 labor hours to produce one unit of output in 2010.

Fortunately, most other sectors of the economy have experienced substantial growth in labor productivity since 1826. We can measure growth in labor productivity in the economy as a whole by looking at the growth in real wages. In 1826 the average hourly wage for a production worker was $1.14. In 2010 the average hourly wage for a production worker was $26.44, approximately 23 times higher in real (inflation-adjusted) terms. Growth in average labor productivity has a surprising implication: it makes the output of slow productivity-growth sectors (relatively) more expensive. In 1826, the average wage of $1.14 meant that the 2.66 hours needed to produce a performance of Beethoven’s String Quartet No. 14 had an opportunity cost of just $3.02. At a wage of $26.44, the 2.66 hours of labor in music production had an opportunity cost of $70.33. Thus, in 2010 it was 23 times (70.33/3.02) more expensive to produce a performance of Beethoven’s String Quartet No. 14 than in 1826. In other words, one had to give up more other goods and services to produce a music performance in 2010 than one did in 1826. Why? Simply because in 2010, society was better at producing other goods and services than in 1826.

The 23 times increase in the relative price of the string quartet is the driving force of Baumol’s cost disease. The focus on relative prices tells us that the cost disease is misnamed. The cost disease is not a disease but a blessing. To be sure, it would be better if productivity increased in all industries, but that is just to say that more is better. There is nothing negative about productivity growth, even if it is unbalanced.

And this has very interesting implications. Tabarrok again:

• The Baumol effect predicts that more spending will be accompanied by no increase in quality.
• The Baumol effect predicts that the increase in the relative price of the low productivity sector will be fastest when the economy is booming. i.e. the cost “disease” will be at its worst when the economy is most healthy!
• The Baumol effect cleanly resolves the mystery of higher prices accompanied by higher quantity demanded.

Note that this does not change my view that we have inappropriately encouraged too many people to go to college and we have pushed and pulled too many resources into that chasm. Other-people's money and wishful thinking are still in play (as this discussion with Bryan Caplan indicates). But it seems they are only contributing and potentially secondary factors.

See here for lots of brief blog posts. See here, here, and here for very good podcasts on the study.

To Infinity and Beyond

This is a bit of a followup to the Dracula post from earlier this year. 

Foundations and endowments DO NOT have infinite time horizons. Technically speaking, nothing does. But I would argue they don't even have extremely long time horizons. 

These types of entities have no reason to believe they will exist into the long, far future. At the very least they will transform so dramatically the future them is not the current them--donors, beneficiaries, and employees will all be different as will its mandates, goals, and mission. Over very long periods of time slight changes to average inflation or average rates of return very significantly affect the purchasing power of assets. These are highly uncertain variables where the difference between phenomenal growth and permanently impaired capital is almost imperceptibly small to a current observer. The tax structure governing these entities over the long-term future is also highly uncertain. A related but independent threat is if the powers that be and the powers that will be even allow the entity to exist . . . forever.

Perhaps despite all of this they should act as if they have infinite time horizons? Let's assume a few conditions: 

1. Foundations and endowments in at least some cases are the best available option to serve a desired purpose. (If you simply take this for granted, you probably are not thinking hard enough. These entities may not be the best way to accomplish the goals they ostensibly are designed for.)
2. It is desirable for foundations and endowments in some cases to exist into perpetuity. 
3. It is possible to design and implement an external and internal governing structure and to craft a mission statement conducive for the first two conditions. (This might be where this entire process deviates too far from reality.)

For those entities where a perpetual time horizon is appropriate, we obviously do not want them to engage in behavior that unreasonably jeopardizes that goal. One quick and tempting way to jeopardize it is to spend too much money.* Another is to invest poorly. Notice that this bad behavior is a bit murkier. Investing could qualify as being done "poorly" in a number of contradictory ways. Defining it as taking the wrong risk(s) in the wrong way(s) doesn't provide any clarity other than to suggest how complex and complicated the error can be. 

Tying this back to the question at hand, should they act as if they have infinite time horizons, begs the question: what exactly does that mean? How would they be different as compared to acting as if they had long, but limited time horizons? Let me describe the difference in terms of a couple of problems I can foresee:

• Doing too little good now (spending too little!) so as to safeguard sustainability. Yes, this cuts a bit against the grain of what I've said and implied above. But it is a real risk especially for a perpetuity mindset. Doing more now might solve a problem that wouldn't otherwise exist in the future--keep in mind that our descendants are very likely to be extraordinarily wealthier than us with entirely different problems (even if they aren't that much richer). 
• Investing in a manner that jeopardizes near-term access to sufficient capital. If you have an infinite horizon, what do you care that your 5-year or 10-year or even 20-year returns are very bad as long as the long-term expectation is high enough? In fact, let's tie that money up in illiquid assets if that is the trade-off for above-market performance. Unfortunately, simple beats complex in almost all categories but not in the competition of hope. Which is why a perpetual outlook fosters an esoteric investment strategy. I think these entities should push back against this natural inclination to invest in opaque, illiquid, and non-benchmarkable assets. Any investment that is not accessible (lock-up periods), marketable (secondary market discount), or verifiable (Internal Rate of Return (IRR) is a useful fiction) for a period of time longer than the expected tenure of the investment staff recommending it is highly suspect. I would suggest the same evaluation against the average board member's remaining term. And this is all before we begin a discussion of manager selection and dispersion risk--alternative investing is not about asset allocation; it is about finding the best and avoiding the worst. Good luck with that. 

What about governments? Should they act like they will be around forever? Again, let's consider what this means by jumping to potential problems:

• A government that behaves as if it cannot fail to be or should not cease to be risks being way, way to aggressive--both to its own people as well as others. 
• This encourages disruptive experimentation since the government can simply outlast any temporary ill effects. Normally, disruptive experimentation is my jam, but not for government. Government lacks the proper incentives and the rightful decision makers. 
• Paradoxically this perpetuity outlook also encourages extreme neglect as any problem today will either be solved tomorrow or be some future government administrator's problem.

I think the assumption that foundations, endowments, governments, et al. should behave as if they have unlimited time horizons is sloppy at best and dangerous at worst. Long time horizons are appropriate and very useful for these entities, but there is a big gap between a long time and forever. 

My thoughts for this were spurred in part by listening to this episode of Macro Musings. 

*I will leave for another day further discussion on the well-debunked conventional wisdom that a 5% or even 4% spending rule is likely sustainable in real terms. 

Keep Looking Until You See It

Once you have a guess, scroll below for the answer . . .

In The News . . .

A vivid childhood memory for me that I think about every time I hear the phrase "in the news" are the shorts CBS used to run during Saturday morning cartoons during commercial breaks. Here is a long compilation.

Generally these bugged me--I didn't want to hear what they had to say and wanted my cartoon back on.

Something I've been thinking about is what does it take for something to be news.

Perhaps a measure of the relevancy and importance of something that is "news" (newsworthiness) is the answer to this puzzle: Imagine rescuing someone from a desert island. How long could they have been there such that a particular piece of news is still topical and worthy to tell them?

Given enough time anything of great importance in the moment will eventually fade into the background of oblivion. Its relevance will disappear.

I would suggest that 90% of news is entertainment and 90% of that entertainment is to one degree or another proverbial porn. On balance the most popular sources are simply NDDs (nonsense delivery devices), GDDs (gossip delivery devices), or PDDs (propaganda delivery devices).

Consider this a corollary to this post.

Another Newspaper Makes Its Inability to Turn a Profit an Asset

I was recently asked my opinion on the announcement of the Salt Lake Tribune being granted approval to become a nonprofit by the IRS. Specifically, the question was "What do you think of this model for newspapers?"

My quick answer:

For newspapers it is a lost cause—like all you can drink water for someone drowning in a river. Newspapers are a dead medium. Journalism is potentially a different story.

This is an old idea as indicated in the story. I think Tampa [Bay Times] went this route about 10 years ago. The Poynter Institute has advocated this for longer than that. On the one hand I like it from the standpoint of independence; however, I don’t think pragmatically it can be sustainable. It is just too expensive to fund journalism without advertising. And it doesn’t sound like they have any intention of giving up advertising.

On the other hand I don’t like it because I don’t think we should have a tax system that plays favorites (non-profit versus for-profit).

Here is a little more coverage from Nieman Lab. Unlike previous versions, this move to non-profit status is somehow more completely nonprofit. I am not quite clear if there is a material difference. I do find the appeal for charitable donations interesting in a kinda gross sort of way. Remember that every time you grant one entity tax-favored status, you increase the burden on all other tax-paying entities. Undoubtedly, many find this to be just fine.

In the religion of journalism, newspapers are a metaphorical holy land. There is a great sense that without them we cannot have credible news. Within this belief is a zealotry proclaiming local newspapers as the glue binding local society together. This like so many things in religion is not based on fact.

Our access to vacuous gossip and shallow conjecture is greater now than ever--we just don't have to pay so dearly for it and wait for it to be hand delivered to our doorstep. Newspapers like most of "professional" journalism have always delivered an array of facts that deserve more scrutiny and a biased narrative. That bias comes in one of three varieties: intentional slant to protect a powerful interest, unintentional slant repeating mistaken conventional wisdom, or simple ignorance introducing the ailment knowing enough to be dangerous.

I'm not saying non-professional journalism is better in any of these regards. I'm just pointing out that the only difference by and large is that being a professional really just meant you could (in some cases still can) get paid for it.

On The Cusp

In my experience some of the greatest happiness is found on the cusp of new plateaus. 

These are pictures of my kids in the Lufthansa lounge of Houston International Airport from our vacation in the summer of 2018. We were on our way to New York City and Washington, D.C. This was their first time in an airport luxury lounge. 

I’m glad my kids don’t feel entitled to that treatment. And I am glad they aren’t so used to that luxury that they can’t find the enjoyment in it. They felt like they were, at least for that moment, “big time”. 

One way to help others feel loved and important is simply to find ways to give them the feeling of being "big time". I am thinking in particular people who are in a position to really appreciate it meaning it, whatever "it" may be, is out of the ordinary for them. 

It's hard to appreciate what we see every day. I want to do more to feel and appreciate the amazement of the world around me. I want to be amazed and I want to help other people be amazed. The downside of progress is that a world more beautiful than the one we just left eventually becomes banal. There is an ever-present tension between reaching new heights and the last ratchet up not being enough. Once luxury becomes ordinary, there is much less if any room for more excitement--the thrill is gone. One way to recapture the thrill is to increase the luxury. But I’m not sure that’s the best choice. 

The best choice from the moral or ethical consideration might rather be to bring that same luxury to someone else. Rather than try to capture the joy all to myself, I should find joy in seeing someone else experience the same first thrill that I had experienced. And of course this is more of a gift when it is not one's own kids who are receiving the new-found joys--this is just my example. This is the virtue and the selfish pleasure in sharing, and I’m sure I don't do enough of it. I am not entirely to blame because the world is not quite effectively set up to enable that sharing. There are too many institutions and norms and attitudes that serve as obstacles to the sharing I describe. 

A new goal for myself is to try to do more to increase my sharing. This is not limited to sharing stuff, although that is usually easiest, but it also includes experiences. Some of this will be charity, but a larger portion will just be finding ways to expand opportunities and extend courtesies. And make no mistake; this is all apart from the very important question of how to add meaning to peoples' lives. Generally I think the answer here is simply to get out of their way. Help them by not helping. Let them do as they want as long as it is peaceful. If there is something for you to do, discover it with them not for them. Trust and respect their decisions.

What Do Weddings and College Football Have in Common?

Besides not going together as in: do not schedule your wedding in conflict with an OU football game and expect me to attend (the wedding).

Weddings, sporting events, and so much more are all subject to alternatives for the audience. And that competition is demanding that average is over.

Consider weddings first. They have to be getting more and more expensive and outlandish just to keep up--not just with each other but with the opportunity costs for the guests. The explicit cost of attending a wedding is time, travel, and gift. Since there is no admission fee to reduce, the only way a wedding can become more attractive is along the quality dimension (differentiation). In the extreme think about trying to get people to attend a Manhattan wedding. Of course it would have to be fabulous! The opportunity cost for guests would simply be too high to allow otherwise.

Now consider sporting events. They face opportunity costs from far substitutes (other leisure and non-leisure activities) and near substitutes (watching the game at home or a friend's house on a giant high-definition TV with no traffic, weather, cheaper food and drink, etc.). Sporting events do have admission fees which means these competitive forces are at work making college football et al. choose a strategy of differentiation (high quality, value-added experiences for select audiences) or low price (mass market to fill enormous venues). Over the long-term the latter strategy probably is suboptimal if not outright unfeasible given competitive pressures and expense demands. It might all become various first-class seating only at the highest levels of various sports.

Thinking back to weddings, people don't need the superficial opportunity to stay in touch that weddings once offered. Social media now provides this. With sports feeling like you are there and a part of it can be closely simulated through viewing on TV, interacting with others via social media or texting, and all the other media/internet follow up.

This goes a long way to explaining the wedding-industrial complex I pondered previously.