Scandalous Loopholes: You’d Do It, Too!

This year, we’ve watched journalists uncover multiple instances of questionable behavior in the college admissions and financial aid process. Just google “college admissions” AND “scandal” and you will find all the evidence that you need that people are trying to bend the letter of the law in order to save some cash. From turning over guardianship of one’s kid to qualify for more financial aid to bribing coaches to recruit one’s child to get accepted to Ivy League schools, parents and students are looking for loopholes to attain that coveted college degree.

Whenever I hear the word “loophole”, I think about incentives. Incentives are both monetary and nonmonetary costs or benefits that individuals respond to when choosing between alternative actions. In other words, what motivates people to do things—or not do things.

We all know that when the price of something increases, we buy less of it. But what’s going on in the mind of the individual? When the price of a good rises, will the individual pay the higher price and buy less of something else? Or, will they  substitute the good for a good with a lower price tag? However, as the stakes get higher, the higher the price. And, substitutes sometimes become harder to find. Individuals then look for other ways to cheat the system. How can I still get the good I want, at a lower price without having to stop purchasing it altogether? Think of couponing or searching for discounts or sales. Individuals are incentivized to act differently, searching for alternatives, as the price increases. We want our cake and eat it, too!

College is expensive! I don’t know about you, but I am still paying off my student loans. Student loan debt has steadily increased for the past 10 years. Not just for students, but for parents as well.

Both students and parents are searching for alternatives to taking out a quarter of a MILLION dollars to pay for a 4 year degree. Granted, the average student loan debt for students was just under $30,000, while the average debt for parents was closer to $35,000. But that is still a lot of money! Parents and students look for anything that can lower their bottom line, from “life hacks” to AP and community college courses to loopholes in financial aid.

When news about the scandals broke, there was a huge backlash. Many acted surprised! Unsurprisingly, though,they are responding to incentives! Because college costs so much money nowadays, most parents and students can’t afford the ticket price and look for alternatives such as seeking out counselors and education consultants to find ways to still get the college degree but without taking out a second mortgage. 
However, incentives only help us predict how individuals will act, or at the very least, see trends of behavior when a good becomes more expensive. Incentives do not tell us if what Lora Georgieva did was right. They tell us what people are likely to do, given the costs and benefits. Even though it wasn’t exactly ethical to get a bigger financial package by transferring guardianship of a student to the neighbor so that the student looks to have come from a home with zero income, you would’ve done it as well had you known! Especially, if you knew it was a perfectly legal maneuver! Because, well, we find ways to minimize our costs and maximize our benefits. Economics teaches us to find the reason behind why people act the way they do. For better or worse, it makes “scandals” not so scandalous at all! Who can blame those who take advantage of the system when all of the incentives were saying:

ICYMI: We Are Buying More Than We Can Afford

A new WSJ piece describes the current financial landscape for a bunch of people, including myself! We are in tons of debt. Though being in debt is nothing new, the type of debt has changed quite a bit. 

Most of the debt normal Americans would take on in the past was attributed to housing. But since 2013, non-housing consumer debt shot up by $1 trillion, while housing debt only shot up by half of that. Total consumer debt is higher than it has ever been.

Like this article, most will point to the top 1 percent, the finance folks, as the culprits of why this is happening. This may surprise you, but… 

I agree!

Well, kind of. Though, money from financial services has flowed to the top of the socioeconomic ladder, it is hardly their fault. When the government is supposedly at the helm of the economy, it is helping steer the money in that direction. And, this is not due to “deregulation.” But, mainly due to moral hazard. 

No Risk, Tons of Reward

Let’s think about it for a second. 

By deregulating an industry, it opens the door for innovation, more competition, and better quality services. This is exactly what happened in the airline industry when it was deregulated in 1978. 

Moral hazard means that people are less likely to guard themselves against risks when they are protected from the consequences. For example, I would be much more likely to be more daring on the ski slopes if I have health insurance. Why? It’s because I know that if I break some bones, my insurance will cover it. 

The same thing has happened in the financial sector. The Financial Crisis of 2009 is a testament to how the government will act if the financial system is on the plank of the ship. That said, banks will lend out much more than they would if they knew they would have to bear all of the consequences. 

The moral hazard in the financial sector has also driven interest rates down. Low-interest rates increase the number of people wanting to take out loans. It also decreases the number of people wanting to save in less risky accounts. In a world of low-interest rates, millennials need to learn how to save more. 

The same thing can be said about the education system. For the past 40 years, at least, bank loans to pay for college were backed by the federal government. Remember moral hazard? Since 2009, the government has been the sole financier of college degrees. They have subsidized schools and students willy-nilly and have made it very easy to not have to pay back the student loans. So, universities can increase tuition (since the access to funds for students has increased the demand for a college education). And, students don’t have to try so hard in class or in finding a job comparable to the money spent on the degree. The new generation has no clue as to how to work and pay for college on their own.

Given our inclination to borrow more money with such low-interest rates, we tend to have more expensive tastes. A new couple doesn’t want the 1-bedroom, 900 square foot home. They want the three-bedroom, 1,400 square foot home. Moreover, zoning laws have mandated square footage necessary for building homes. So, governments are essentially forcing people into larger homes. Larger homes mean fewer homes are built because they take up more space. Fewer homes mean prices increase. 

How to fix all this?

I dunno. Sorry. But, we could start saving more, right? I mean, stop buying stuff you can’t afford. And, let’s shoot for policies that reduce the moral hazard. It seems the government safety net under these sectors is not so safe after all.

Maxing Out: The Value of College

By Clayton Dines (Creighton University)

Once upon a time, college was considered a guaranteed ticket to career success. But these days, many college graduates enter the real world with a degree in one hand and a massive amount of student loan debt weighing them down in the other. A college degree can be a great tool for career advancement but it comes at a very high cost – tuition, time, (and for some) your mental sanity. So in this post, I ask the very important question: is a college education worth the investment?

Tjalling Koopmans: The Economics of Why I’m Always Late

I’m going to start this post with a story that was quite common at my undergraduate institution, Western Carolina University, when I went there. You’re driving to campus for a class that starts in five minutes. You should have left earlier, but as a 20-something in college, you aren’t known for planning ahead.

Feeling hopeful, you pull into the parking lot looking for a spot. As you begin your search, you realize you’re in trouble. There are no spots to be found in the first lot! You frantically speed from parking lot to parking lot until you’ve covered virtually every square foot of your campus. Throwing up the white flag, you end up parking in that one lot in the middle of nowhere that’s at least a mile walk from your class, which results in you showing up awkwardly, rather than fashionably late for.

How I felt like parking some days

How can we solve such an issue? The students at WCU had no shortage of complaints, but very few solutions. Part of the answer can be found in the work of one of the two men awarded the 1975 Nobel Prize in Economics, Tjalling Koopmans.

The award was given “for their contributions to the theory of the optimal allocation of resources.” This may sound similar to some of our previous posts, and here’s why: These economists were awarded in the midst of what is known as “The Socialist Calculation Debate.” I won’t go too in-depth with its description, since it may be necessary for our posts with other laureates. Looking at you, Hayek!

However, the point is that the debate was over whether we could actually calculate the best way of divvying up scarce resources (often called “chalkboard economics). That said, anybody who contributed to that discussion would likely win a Nobel.

Koopmans focused primarily on the optimal allocation of resources when it comes to city planning, specifically traffic. He applied the basic ideas of optimal allocation to the transportation market.

“If cost is minimized in each branch of production on the basis of such a system of prices, each unit of any (divisible) factor of production will be used in such a manner that its contribution to the satisfaction of ultimate consumers is highest.”

Okay, that was a mouthful. What he means is that if we are acting competitively, i.e. behaving like a free market, every part of the industry will be geared towards making people as happy as possible.

In the same paper, Koopmans conjures huge brilliant theories at attempt to precisely coordinate the transportation sector by using marginal costs and benefits of the industry. Although they are definitely well thought out, they still fall short. So, without these massive theoretical undertakings to guide our transportation industries, how does the shipping industry, for example, effectively coordinate its transportation? Koopmans answers this, saying that perfectly competitive markets are closely tied to marginal benefit and marginal cost.

Who would have thought? The best way to imitate free markets was to allow free markets.

This idea is more fleshed out in a later book called “The High Costs of Free Parking” by Donald Shoup (Many thanks to Nick Zaiac for the recommendation). This came to the same conclusion with parking that Tjalling Koopmans did with shipping. When parking is heavily subsidized and made free to most, this messes up marginal costs and benefits, making it hard to analyze and correct inefficiencies. As a result, we have over-parking issues.

When examining the parking situation at WCU (or most college campuses), what we had was an over-subsidizing of our parking lots. Granted, I know the lots already had costs, such as the distance from classes, traffic jams, rambunctious drivers, parking fines, etc., but they were clearly not high enough with almost every student driving a car to school every day. We needed to increase the cost of parking so students would actually think if bringing a car was worth it, rather than attempting to create a free market situation through clever models.

Koopmans also had an interesting paper that discussed an issue that we’re still facing many years later, called “Measurement Without Theory”. He was speaking out against people gathering and analyzing data without having some general idea of what they’re looking for or why they’re looking for it.

With the advent of big data, many researchers and data scientists are succumbing to the idea that the data will just speak to them through patterns that just emerge from the data. Though patterns and trends may come about from large swaths of data, is it really meaningful without an underlying theory of what you think is happening? We can use data to observe, but meaningful research questions are exactly that: questions backed by some theory of how we think the world is supposed to work and some method of how to come close to finding the answer. For example, spurious correlations, though are pretty out there, illustrate the point of what you get when you seek answers without a theory.

Well, I guess an argument could be made… (Credit to http://www.tylervigen.com/spurious-correlations)

I think this is a good warning to end on with Koopmans’ theories. He examined the effects and costs of transportation, and created brilliant models to try to recreate free markets. However, it’s important to note that doing this type of data collection without having some sort of mental framework is dangerous, and something we see in big data all the time.

If anything, at least we have a better idea as to why parking is such a hassle on college campuses. Focusing the debate on how to find the balance between parking spots and costs should prove helpful in reducing our parking frustrations when rushing to class.

Who To Blame? The Student Debt Accountability Question

“We need to hold universities accountable!” This buzz phrase has taken hold of Gen Y as they take on the student debt crisis facing our nation.

How Gen X Helped Create the Modern Economy Before Leaving Us a Wreck

Our series exploring the formation of the modern economy rolls on with our rollercoaster-riding aunts and uncles of Generation X. This was the group that experienced both historic peacetime economic growth and set us up for the financial implosion of the Great Recession — the hand-me-down we never wanted.