Naked Economics

by Wheelan, Charles

  So Mr. Krueger and Ms. Dale took their analysis one step further. They examined the outcomes of students who were admitted to both a highly selective school and a moderately selective school. Some of those students headed to places like the Ivy League; others chose their less selective option. Mr. Krueger and Ms. Dale’s chief finding is best summarized by the title of the paper: “Children Smart Enough to Get into Elite Schools May Not Need to Bother.” The average earnings of students admitted to both a highly selective school and a moderately selective school were roughly the same regardless of which type of college they attended. (The one exception was students from lower-income families for whom attending a more selective school increased earnings significantly.) Overall, the quality of student appears to matter more later in life than the quality of the university he or she attended.

  Is it irrational to spend $150,000 or more to attend an Ivy League university? Not necessarily. At a minimum, a Princeton or Yale diploma is the résumé equivalent of Roger Ebert’s “thumbs up.” It pronounces you highly qualified so that others in life—employers, spouses, in-laws—will have fewer doubts. And there is always the possibility that you may learn something while huddling for four years with the world’s great minds. Still, Mr. Krueger offers this advice to students applying to college: “Don’t believe that the only school worth attending is one that would not admit you…. Recognize that your own motivation, ambition and talents will determine your success more than the college name on your diploma.”

  The notion that bright, motivated individuals (with similarly motivated parents) will do well, however or wherever they are schooled, is often lost on America’s school reformers. In Illinois, each fall is greeted with the release of the state’s school report cards. Every school in the state is evaluated based on how well its students have performed on a battery of standardized exams. The media quickly seize on these school report cards to identify the state’s “best” schools, most of which are usually in affluent suburbs. But does this process really tell us anything about which schools are the most effective? Not necessarily. “In many suburban communities, students would do well on standardized tests even if they went to school and sat in a closet every day for four years,” says University of Rochester economist Eric Hanushek, an expert on the somewhat tenuous relationship between school inputs and student outcomes. There is a fundamental piece of missing information: How much value is really being added at these “high-performing schools”? Do they have exceptional teachers and administrators, or are they repositories for privileged students who would do well on standardized tests regardless of where they went to school? It’s the Harvard question all over again.

  This chapter started with a serious social issue, and so it will end. Racial profiling is an information problem. There are two simple questions at the heart of the issue. First, does race or ethnicity—alone or in conjunction with some other circumstance—convey meaningful information related to potential criminal activity? If so, what do we do about it? The answer to the first question gets most of the attention. After the attacks of September 11, one could certainly make the case that thirty-five-year-old Arab men posed a greater risk to the country than sixty-five-year-old Polish women. Police officers have long argued that race can be a tip-off; well-dressed white kids in poor black neighborhoods are often looking to buy drugs. Criminal organizations have racial or ethnic affiliations. At the same time President Clinton was declaring racial profiling “morally indefensible,” the website of his drug czar, Barry McCaffrey, was doing just that. In Denver, the site noted, the heroin dealers are predominantly Mexican nationals. In Trenton, crack dealers are predominantly African-American males and the powdered cocaine dealers are predominantly Latino.8

  Indeed, we all profile in our own way. We are taught from a young age that one should never judge a book by its cover. But we must; it is often all we get to see. Imagine you are walking in a parking garage at night when you hear footsteps behind you. Ideally, you would ask this person for a résumé you and he would sit down for coffee and discuss his goals, his job, his family, his political philosophy, and, most important, the reason he is walking behind you in a dark parking garage. You would do a criminal background check. Then, with all this information in hand, you would decide whether or not to hit the panic button on your key ring. The reality, of course, is different. You get one quick glance over your shoulder. What information matters? Sex? Race? Age? Briefcase? Clothing?

  I’ll never forget my own experience as a victim of racial profiling. I boarded a westbound bus from downtown Chicago just as it started to get dark. Chicago is a very segregated city; most of the neighborhoods west of downtown are predominantly African-American. I was wearing a suit, and after a few blocks I was the only white guy on the bus. Around that time, an older black woman asked kindly, “Oh, are the Bulls playing tonight?” The Chicago Bulls play at the Chicago Stadium, which is also directly west of the city center. This woman had inferred, innocently enough, that the only reason a white guy in a suit would be on this bus around 7:00 p.m. would be to go to a Bulls game. Obviously it was unfair and potentially hurtful for her to draw any conclusion about my destination based only on my skin color and style of dress. The really weird thing is that I was on my way to the Bulls game.

  Race, age, ethnicity, and/or country of origin can convey information in some circumstances, particularly when other better information is lacking. From a social policy standpoint, however, the fact that these attributes may convey meaningful information is a red herring. The question that matters is: Are we willing to systematically harass individuals who fit a broad racial or ethnic profile that may, on average, have some statistical support but will still be wrong far more often than it is right? Most people would answer no in most circumstances. We’ve built a society that values civil liberties even at the expense of social order. Opponents of racial profiling always seem to get dragged into the quagmire of whether or not it is good police work or an effective counterterrorism tool. That’s not the only relevant point—and it may be completely irrelevant in some cases. If economics teaches us anything, it’s that we ought to weigh costs and benefits. The costs of harassing ten or twenty or one hundred law-abiding people to catch one more drug dealer are not worth it. Terrorism is trickier because the potential costs of letting just one person slip through the cracks are so devastatingly high. So what exactly should we do about it? That is one of the tough trade-offs in the post–September 11 world.

  In the world of Econ 101, all parties have “perfect information.” The graphs are neat and tidy; consumers and producers know everything they could possibly want to know. The world outside of Econ 101 is more interesting, albeit messier. A state patrolman who has pulled over a 1990 Grand Am with a broken taillight on a deserted stretch of Florida highway does not have perfect information. Nor does a young family looking for a safe and dependable nanny, or an insurance company seeking to protect itself from the extraordinary costs of HIV/AIDS. Information matters. Economists study what we do with it, and, sometimes more important, what we do without it.

  CHAPTER 6

  Productivity and Human Capital:

  Why is Bill Gates so much richer than you are?

  Like many people, Bill Gates found his house a little cramped once he had children. The software mogul moved into his $100 million dollar mansion in 1997; not long after, it needed some tweaking. The 37,000-square-foot home has a twenty-seat theater, a reception hall, parking for twenty-eight cars, an indoor trampoline pit, and all kinds of computer gadgetry, such as phones that ring only when the person being called is nearby. But the house was not quite big enough.1 According to documents filed with the zoning board in suburban Medina, Washington, Mr. Gates and his wife added another bedroom and some additional play and study areas for their children.

  There are a lot of things one might infer from Mr. Gates’s home addition, but one of them is fairly obvious: It is good to be Bill Gates. The world is a fascinating playground when y
ou have $50 billion or so. One might also ponder some larger questions: Why do some people have indoor trampolines and private jets while others sleep in bus station bathrooms? How is it that roughly 13 percent of Americans are poor, which is an improvement from a recent peak of 15 percent in 1993 but not significantly better than it was during any year in the 1970s? Meanwhile, one in five American children—and a staggering 35 percent of black children—live in poverty. Of course, America is the rich guy on the block. At the dawn of the third millennium, vast swathes of the world’s population—some three billion people—are desperately poor.

  Economists study poverty and income inequality. They seek to understand who is poor, why they are poor, and what can be done about it. Any discussion of why Bill Gates is so much richer than the men and women sleeping in steam tunnels must begin with a concept economists refer to as human capital. Human capital is the sum total of skills embodied within an individual: education, intelligence, charisma, creativity, work experience, entrepreneurial vigor, even the ability to throw a baseball fast. It is what you would be left with if someone stripped away all of your assets—your job, your money, your home, your possessions—and left you on a street corner with only the clothes on your back. How would Bill Gates fare in such a situation? Very well. Even if his wealth were confiscated, other companies would snap him up as a consultant, a board member, a CEO, a motivational speaker. (When Steve Jobs was fired from Apple, the company that he founded, he turned around and founded Pixar; only later did Apple invite him back.) How would Tiger Woods do? Just fine. If someone lent him golf clubs, he could be winning a tournament by the weekend.

  How would Bubba, who dropped out of school in tenth grade and has a methamphetamine addiction, fare? Not so well. The difference is human capital; Bubba doesn’t have much. (Ironically, some very rich individuals, such as the sultan of Brunei, might not do particularly well in this exercise either; the sultan is rich because his kingdom sits atop an enormous oil reserve.) The labor market is no different from the market for anything else; some kinds of talent are in greater demand than others. The more nearly unique a set of skills, the better compensated their owner will be. Alex Rodriguez will earn $275 million over ten years playing baseball for the New York Yankees because he can hit a round ball traveling ninety-plus miles an hour harder and more often than other people can. “A-Rod” will help the Yankees win games, which will fill stadiums, sell merchandise, and earn television revenues. Virtually no one else on the planet can do that as well as he can.

  As with other aspects of the market economy, the price of a certain skill bears no inherent relation to its social value, only its scarcity. I once interviewed Robert Solow, winner of the 1987 Nobel Prize in Economics and a noted baseball enthusiast. I asked if it bothered him that he received less money for winning the Nobel Prize than Roger Clemens, who was pitching for the Red Sox at the time, earned in a single season. “No,” Solow said. “There are a lot of good economists, but there is only one Roger Clemens.” That is how economists think.

  Who is wealthy in America, or at least comfortable? Software programmers, hand surgeons, nuclear engineers, writers, accountants, bankers, teachers. Sometimes these individuals have natural talent; more often they have acquired their skills through specialized training and education. In other words, they have made significant investments in human capital. Like any other kind of investment—from building a manufacturing plant to buying a bond—money invested today in human capital will yield a return in the future. A very good return. A college education is reckoned to yield about a 10 percent return on investment, meaning that if you put down money today for college tuition, you can expect to earn that money back plus about 10 percent a year in higher earnings. Few people on Wall Street make better investments than that on a regular basis.

  Human capital is an economic passport—literally, in some cases. When I was an undergraduate in the late 1980s, I met a young Palestinian man named Gamal Abouali. Gamal’s family, who lived in Kuwait, were insistent that their son finish his degree in three years instead of four. This required taking extra classes each quarter and attending school every summer, all of which seemed rather extreme to me at the time. What about internships and foreign study, or even a winter in Colorado as a ski bum? I had lunch with Gamal’s father once, and he explained that the Palestinian existence was itinerant and precarious. Mr. Abouali was an accountant, a profession that he could practice nearly anywhere in the world—because, he explained, that is where he might end up. The family had lived in Canada before moving to Kuwait; they could easily be somewhere else in five years, he said.

  Gamal was studying engineering, a similarly universal skill. The sooner he had his degree, his father insisted, the more secure he would be. Not only would the degree allow him to earn a living, but it might also enable him to find a home. In some developed countries, the right to immigrate is based on skills and education—human capital.

  Mr. Abouali’s thoughts were strikingly prescient. After Saddam Hussein’s retreat from Kuwait in 1990, most of the Palestinian population, including Gamal’s family, was expelled because the Kuwaiti government felt that the Palestinians had been sympathetic to the Iraqi aggressors. Mr. Abouali’s daughter gave him a copy of the first edition of this book. When he read the above section, he exclaimed, “See, I was right!”

  The opposite is true at the other end of the labor pool. The skills necessary to ask “Would you like fries with that?” are not scarce. There are probably 150 million people in America capable of selling value meals at McDonald’s. Fast-food restaurants need only pay a wage high enough to put warm bodies behind all of their cash registers. That may be $7.25 an hour when the economy is slow or $11 an hour when the labor market is especially tight; it will never be $500 an hour, which is the kind of fee that a top trial lawyer can command. Excellent trial lawyers are scarce; burger flippers are not. The most insightful way to think about poverty, in this country or anywhere else in the world, is as a dearth of human capital. True, people are poor in America because they cannot find good jobs. But that is the symptom, not the illness. The underlying problem is a lack of skills, or human capital. The poverty rate for high school dropouts in America is 12 times the poverty rate for college graduates. Why is India one of the poorest countries in the world? Primarily because 35 percent of the population is illiterate (down from almost 50 percent in the early 1990s).2 Or individuals may suffer from conditions that render their human capital less useful. A high proportion of America’s homeless population suffers from substance abuse, disability, or mental illness.

  A healthy economy matters, too. It was easier to find a job in 2001 than it was in 1975 or 1932. A rising tide does indeed lift all boats; economic growth is a very good thing for poor people. Period. But even at high tide, low-skilled workers are clinging to driftwood while their better-skilled peers are having cocktails on their yachts. A robust economy does not transform valet parking attendants into college professors. Investments in human capital do that. Macroeconomic factors control the tides; human capital determines the quality of the boat. Conversely, a bad economy is usually most devastating for workers at the shallow end of the labor pool.

  Consider this thought experiment. Imagine that on some Monday morning we dropped off 100,000 high school dropouts on the corner of State Street and Madison Street in Chicago. It would be a social calamity. Government services would be stretched to capacity or beyond; crime would go up. Businesses would be deterred from locating in downtown Chicago. Politicians would plead for help from the state or the federal government: Either give us enough money to support these people or help us get rid of them. When business leaders in Sacramento, California, decided to crack down on the homeless, one strategy was to offer them one-way bus tickets out of town.3 (Atlanta reportedly did the same before the 1996 Olympics.)

  Now imagine the same corner and let’s drop off 100,000 graduates from America’s top universities. The buses arrive at the corner of State and Madison and be
gin unloading lawyers, doctors, artists, geneticists, software engineers, and a lot of smart, motivated people with general skills. Many of these individuals would find jobs immediately. (Remember, human capital embodies not only classroom training but also perseverance, honesty, creativity—virtues that lend themselves to finding work.) Some of these highly skilled graduates would start their own businesses; entrepreneurial flair is certainly an important component of human capital. Some of them would leave for other places; highly skilled workers are more mobile than their low-skilled peers. In some cases, firms would relocate to Chicago or open up offices and plants in Chicago to take advantage of this temporary glut of talent. Economic pundits would later describe this freak unloading of buses as a boon for Chicago’s economic development, much as waves of immigration helped America to develop.

  If this example sounds contrived, consider the case of the Naval Air Warfare Center (NAWC) in Indianapolis, a facility that produced advanced electronics for the navy until the late 1990s. NAWC, which employed roughly 2,600 workers, was slated to be closed as part of the military’s downsizing. We’re all familiar with these plant-closing stories. Hundreds or thousands of workers lose their jobs; businesses in the surrounding community begin to wither because so much purchasing power has been lost. Someone comes on camera and says, “When the plant closed back in [some year], this town just began to die.” But NAWC was a very different story.4 One of its most valuable assets was its workforce, some 40 percent of whom were scientists or engineers. Astute local leaders, led by Mayor Stephen Goldsmith, believed that the plant could be sold to a private buyer. Seven companies filed bids; Hughes Electronics was the winner.

  On a Friday in January 1997, the NAWC employees went home as government employees; the following Monday, 98 percent of them came to work as Hughes employees. (And NAWC became HAWC.) The Hughes executives I interviewed said that the value of the acquisition lay in the people, not just the bricks and mortar. Hughes was buying a massive amount of human capital that it could not easily find anywhere else. This story contrasts sharply with the plant closings that Bruce Springsteen sings about, where workers with limited education find that their narrow sets of skills have no value once the mill/mine/factory/plant is gone. The difference is human capital. Indeed, economists can even provide empirical support for those Springsteen songs. Labor economist Robert Topel has estimated that experienced workers lose 25 percent of their earnings capacity in the long run when they are forced to change jobs by a plant closing.