Reader Response: Competing With the Private Sector
Economists are free to make up their own dictionary for conversations among themselves. If they wish, they can use “shmoo” for “car.” As the Nobel laureate economist Kenneth Arrow, however, reminds his colleagues, they should be careful not to use their own dictionary in conversations with lay people, especially not policy makers with the power to reallocate resources. As Professor Arrow puts it:
A definition is just a definition, but when the definiendum is a word already in common use with highly favorable connotations, it is clear that we [economists] are really trying to be persuasive; we are implicitly recommending the achievement of optimal states.
The terms “welfare-maximizing” and “optimal” are such suspect definitions. Many situations that economists would call “welfare-maximizing” or “optimal” would actually be abhorrent to lay people who impute to these terms highly favorable connotations. Of two situations, one in which some people are near starvation and others live in gluttony, and another in which economic privilege is more equally distributed among members of society, economists might well declare the first “welfare-maximizing” and “optimal.” It takes years of graduate training in economics actually to believe that this is meaningful language.
I teach my students that what economists call “economic welfare analysis” is really just a preferred ethical doctrine that economists like to foist on the public. There is no reason why lay people should automatically share that ethic. In this regard, see my paper, “Can Efficiency in Health Care Be Left to the Market?”
Thus, in my view, whether a public policy or pricing scheme is “welfare maximizing” in the economist’s definition of that term is neither interesting nor should it dictate public policy.
Does the Federal Direct Loan Program take its prices (interest rates) from the market? Not really. The rates charged students are linked to the market rate for (riskless) Treasury bills. But whether the rates actually charged students reflect the true actuarial risk inherent in these loans, as interest rates on such loans would in a free market for financing education, I would not know. I rather doubt it. The rate is bound to be implicitly subsidized relative to a free-market rate.
On the other hand, the interest rates charged students by private lenders cannot be true market rates because either (a) these lenders get an interest-rate subsidy from the government or (b) they get a loan guarantee from the government on the loans they make. Therefore, there is no reason to assume that the rates charged students reflect a properly priced market risk premium either. What we have here is private profits at socialized, public risk.
Of course, the very purpose of the government’s student loan program is not to charge students the high risk premiums that would be likely to obtain in a completely free financial market for human capital (the economist’s term for education and training). Those actuarially fair risk premiums probably would deter students from borrowing to finance their educations.
As to TIE’s question “In the case of health care, how do you determine welfare-maximizing prices and quantities with a heavy government hand?”: once again I have no idea whether the prices driven by the heavy hand of government are “welfare maximizing” as economists define it — nor do I care, nor should anyone else.
Economists really do not know what “human welfare” actually is, and they should not pretend they do. Indeed, economists have not really understood what makes human beings tick (as the new school of “behavioral economics” is trying to establish).
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