Friday, November 22, 2013

On Economics Education

One of my favorite economics stories relates to textiles in New York City.  Decades ago the big apple was a major hub of the textile industry. The government wished to promote the industry further and therefore changed the depreciation schedule for textile machinery, thus reducing their tax burden.  This then led to firms purchasing far more machinery due to the favorable depreciation rates.  However, as factory floor space to house the machinery was prohibitively expensive in New York the firms quickly moved out of the city in order to have room for their new machines.  Thus, a tax modification meant to promote a healthy industries growth ended up driving it out of a city completely.

This is the sort of story that economists are bred upon.  Tales of unintended consequences adorn the syllabuses of economics professors in universities throughout the nation.  Yet, at times it's difficult to find what real world application such stories hold.

Let's back up a moment and talk about what economics does right.  Firstly, any decent economics program is going to expose students to a large variety of mathematical tools.  These tools are useful for solving an enormous variety of problems from profit maximization to crafting employee benefit packages.  This portion of economics curriculum is beyond reproach.

Secondly, economics programs generally offer highly specialized courses such as healthcare economics, economics of technology and innovation and labor economics which delve deeply into how economics is applied to certain topics or industries. These classes in general are useful and informative for someone going into a specific field.  For example, healthcare economics details how hospitals function, important regulations regarding hospital construction, different insurance methods, how insurance functions, the difficulties that arise due to insurance, etc.  These are all clearly topics that a hospital administrator or insurance executive would find applicable to their work.  However, these courses generally don't translate well into other arenas.  Health insurance and auto insurance do share some similarities but it's difficult to make a case that auto insurance leads to massively higher auto collisions whereas it's relatively easy to show health insurance leads to massively higher healthcare costs and utilization.  Similarly hospital construction regulations have little to do with monetary policy or unemployment rates.

Economics programs also effectively promote critical thinking skills.  Our textile story given above endeavors to this end.  A professor may present the first part of the story to the class and ask, "What are the expected ramifications of accelerating the depreciation schedule for machinery?"  A student will correctly answer that accelerating the depreciation rate will encourage firms to buy more machinery.  Then the instructor reveals the unintended consequence of the change thus demonstrating that policy makers must think beyond the obvious ramifications of their decisions. Hopefully students learn that sound policy decisions must be thoroughly examined for any potentially unwanted repercussions.

But herein lies the difficulty, we give no context from which to draw conclusions. Give an enthusiastic economics student a real world problem and they'll likely be able to give you a great deal of useful information.  They'll very correctly tell you that universal healthcare eliminates the problems of adverse selection while likely increasing healthcare utilization, but their conclusions regarding whether the Affordable Care Act will help reign in healthcare costs will likely be based on which news channel they watch.  They'll accurately inform you that a depreciation of Greece's currency would greatly improve their global competitiveness, but they won't be able to tell you if Greece would be better off leaving the Euro.  Economists cultivate a great deal of skill identifying the direction of different forces acting upon individuals, firms and economies.  However, we often fail at identifying which force is greater.  Only historical context can inform such questions and it is a topic often ignored in economics education.

Largely this is due to the fact that economics is an ever changing field in an ever changing world.  Why discuss the tulip bubble of the 1600s when we can demonstrate similar lessons from the more recent housing bubble?  For the most part this logic holds up. The housing bubble is more recent and generally more relevant to the economy of today.  However, there are differences between the two events which make both worth study.  Tulip bulbs for example were mostly sold during only four months of the year with transactions during the rest of the year taking place in a futures market.  Additionally, tulips were easily traded, more than quadrupled in price over the space of under six months before eventually collapsing, and had little intrinsic value.  In contrast homes and mortgages are sold year round, are often complex to buy or sell, took far longer to rise in price and are always worth at least the land they're built upon.  Which bubble is then a more apt comparison to the recent rise of the bitcoin market?  Inherently valuable, real world real estate or popularity based, easily traded tulips?

A stronger tie to historical examples would help economics students draw conclusions of what was likely to happen in similar modern scenarios.  It would provide a basis to draw from which can then be modified by the application of critical thinking. However, the current paradigm of teaching students to speculate all the potential ramifications without giving a mechanism to reduce those ramification into a final conclusion leads to a lack of applicability in practice.

That's all for this week. Until next time stay safe and rationale. 

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