Reno 411

Mike Reno, a Michigan blogger and elected school board official, critiques my recent study of school district size and spending here. My 411 on his analysis:

His chief objection to the study is that I use per capita income as a proxy for a community’s level of demand for education. Mr. Reno “cannot agree that all wealthier communities have higher standards than less affluent communities.”

This is a non sequitur. The fact that income has been found to be strongly correlated with educational demand does not mean that all wealthier communities will have higher educational demand than all low income communities. It simply means that, on the whole, the correlation between the two is strong and positive. There are surely exceptions.

I use income per capita as my main proxy for a community’s demand for educational services because that has been the norm in econometric research on school district spending since such studies got going in the late 1950s. It is not, however, the only such proxy that I used. I also control for the share of the district’s population actually enrolled in public schools (which captures the extent to which community members and their relatives are personally affected by the system – and hence stand to gain from higher spending on it). In addition, I tested out a control variable which was an index of parental level of education, also commonly used as a proxy for educational demand (the more education you have, the higher your expectations for the education of your children).

As I explain in the paper, the coefficient for the public school enrollment per capita term is unexpectedly negative, and the parental level of education term was statistically insignificant and so dropped from the final model. Hence, after controlling for the other dozen or so variables in the model, no proxy for educational demand explains a substantial share of the variation in district spending, and one actually has a negative relationship to spending.

A second of Mr. Reno’s concerns is my observation that student achievement is not, on average, related to per-pupil spending, after controlling for other factors. He observes that spending can matter when the stars align and a public school district has efficient leadership. This is not an objection to the overall pattern. It simply illustrates that, on the whole, public school districts do not have efficient leadership. The lack of substantial correlation between public school spending and student achievement is a very well established research finding. In most cases, public schools are simply not efficient. As I explain in my paper, the evidence suggests a reason for that pattern: the current system provides incentives for public officials to spend as much as they can, and, on the whole, they apparently heed those incentives.

Mr. Reno’s final concern is that I do not deal with any systematic variation in the service mix offered by districts of varying size. Presumably, he is suggesting that larger districts are able to offer a wider range of services, and that this explains their somewhat higher spending. A key conclusion of my paper, however, is that size does not matter all that much in determining district spending. Realistically, breaking up large districts would reduce total spending by about 1 percent (that would be for a hypothetical savings of $200 million from district breakups, out of a budget of about $20 billion).

As I point out in the paper, what really determines district spending is the ease with which officials can raise per pupil revenues. The easier it is, the more they spend. Is it any wonder spending is out of control?

Corporate-Style Accounting Shows Growing Burden of Entitlements

A feature story in USA Today reveals the staggering burden of entitlement programs if future deficits are recognized today. These figures are revealing, but they can also be misleading. The key concern, for instance, should be the size of government in the future, not the share that is debt-financed. Funded liabilities and unfunded liabilities, after all, both result in the transfer of resources from the productive sector to government. Another problem with corporate accounting is that it assumes that political promises are binding. In reality, politicians can enact laws to completely eliminate unfunded liabilities (though they are more likely to pass bills to make the problem worse). Even with these caveats, however, the data is sobering since the numbers show that the U.S. is destined to become a European-style welfare state unless dramatic reforms are implemented:

The federal government recorded a $1.3 trillion loss last year — far more than the official $248 billion deficit — when corporate-style accounting standards are used, a USA TODAY analysis shows. The loss reflects a continued deterioration in the finances of Social Security and government retirement programs for civil servants and military personnel. The loss — equal to $11,434 per household — is more than Americans paid in income taxes in 2006. …Modern accounting requires that corporations, state governments and local governments count expenses immediately when a transaction occurs, even if the payment will be made later. The federal government does not follow the rule, so promises for Social Security and Medicare don’t show up when the government reports its financial condition. Bottom line: Taxpayers are now on the hook for a record $59.1 trillion in liabilities, a 2.3% increase from 2006. That amount is equal to $516,348 for every U.S. household. …Unfunded promises made for Medicare, Social Security and federal retirement programs account for 85% of taxpayer liabilities. State and local government retirement plans account for much of the rest. This hidden debt is the amount taxpayers would have to pay immediately to cover government’s financial obligations.

The Wrong and Right Approach on U.S.-China Trade

The economic illiteracy that drives the “revalue-your-currency-immediately-and-dramatically-or-else-we’ll-impose-a-27.5 percent tariff” mantra has become a huge political problem.  The more that policymakers (and columnists) imply parity between the economic effects of a stronger Chinese Yuan and those of a huge import tax on Chinese goods at the U.S. border, the more likely we are to cross the precipice into astoundingly stupid economic policy.

On that score, Washington Post business columnist Steven Pearlstein deserves scorn.  In his column on Sunday, Pearlstein touted his preference for populist bromides over any desire to comprehend and convey truth to his readers about trade.  Pearlstein has joined the ranks of those agitating for an across-the-board tariff on Chinese imports since China “cannot take the one step that would restore some [trade] balance—revalu[ing] its currency.”  Though Pearlstein has grown increasingly hostile to trade recently, Sunday’s column, in which he describes the upside of a massive levy against all Chinese imports, is probably the most irresponsible one I’ve read from him. 

The “currency issue” is the most prominent source of contention afflicting the U.S.-China economic relationship.  But it is merely a proxy for broader concern over the U.S. trade deficit with China.  From the large and growing deficit, many policymakers conclude that we are losing at trade, and we’re losing because China is cheating.  Intervention in the currency market by China’s central bank to keep the Yuan artificially low is the chief form of cheating, which acts as a subsidy on exports and a tax on imports.  Fix the currency manipulation, and you fix the trade account.

That is an extremely simplistic take on the cause and effect of Chinese intervention in the currency market. 

And even if trade balance or a trade surplus were a legitimate and worthwhile objective of policy, measures to encourage consumption in the surplus country or to encourage savings in the deficit country or some combination of both would be the proper course of action.  (Note: To those who believe a trade surplus should be the objective of policy, take a look at Japan and Germany.  Both have had large and persistent trade surpluses for decades.  But for the better part of the past two decades, Japan has experienced anemic economic growth. Germany, during the same period, has had mostly double-digit unemployment.  Meanwhile, the United States, with its large and growing deficit, has experienced steady, consistent economic growth and job creation over the same period.)

But the trade account has very little to do with trade policy.  Attempts to achieve greater trade balance by tinkering with trade policy levers, particularly the levers that discourage trade and investment altogether, should be avoided.  The trade account is a function of habits of savings and consumption, which are to some degree a function of fiscal and monetary policy, as well as relative confidence in local institutions and general outlook.

In that regard, last week’s Strategic Economic Dialogue between U.S. and Chinese officials in Washington was quite successful.  Of course the meetings were characterized by those who fail to look beneath the surface as the last chance for China to bow to U.S. demands and avoid sanctions.  That the Chinese didn’t say “how high” in response to U.S. demands to “jump” is evidence of the failure of the SED.  But the SED is part of a process, and that process has yielded very important progress (if progress is defined as movement toward greater trade balance, which has become a political, rather than an economic, necessity).

In the weeks leading up to last week’s SED congregation in Washington, through its conclusion on Thursday, all sorts of incremental steps have been taken in the name of achieving greater trade balance.  The Chinese announced a broader band within which the Yuan can fluctuate on a daily basis.  The Yuan can now appreciate more quickly than in the past.  Since July 2005, the Yuan has appreciated by over 8 percent against the dollar.  It is now on a steeper appreciation trajectory.  (But has it even occurred to anyone that the deficit has only grown larger during this period of Yuan appreciation?  That fact certainly hasn’t deterred the currency-or-sanctions hawks.)

In response to a U.S. WTO complaint filed in March, the Chinese agreed to cut export tax rebates, which allegedly subsidize Chinese exporters, and to reduce certain import taxes, which allegedly hamper import competition in China.  Also, the Chinese agreed to improved market access for U.S. commercial airliners and other industries, and they agreed to go on a shopping spree to boost U.S. exports (even though U.S. exports to China have been growing by leaps and bounds – by 32% in 2006 versus about 15% overall). 

But in my view, the most important breakthrough last week was China’s decision to open its financial services sector even further than it has bound itself to do under its WTO commitments.  This is more important than anything the Congress is raging about in Washington because it addresses a huge structural impediment to Chinese consumption: the dearth of consumer credit, life insurance, and disability insurance markets.  The scarcity of these services encourages thrift, as medical emergencies, education expenses, big ticket purchases, and expenses related to catastrophic events must be financed, in most cases, from personal savings.

Treasury Secretary Henry Paulson has long held that the key to improving the trade balance is encouraging Chinese consumption.  The Chinese government is trying to encourage that as well.  Paulson’s suggestion that U.S. financial services providers can help in that task (given how skilled we are at consuming), and China’s acceptance of that proposal is testament to the validity and value of the SED.

While Schumer and Graham and Pearlstein advocate dropping the bomb, Paulson and Schwab and Wu Yi contemplate the keys to a successful bilateral relationship with economic growth for all.

Phil Bond Doesn’t Understand Security

Here’s an interesting Washington Technology article on the security issues that would be created by implementing the REAL ID Act. Complying with the law would require states to create huge, nationally accessible databases of information about all licensed drivers and ID card-holders. Computer security guru Bruce Schneier, chief technology officer at BT Counterpane Internet Security, is quoted, saying “Computer scientists don’t know how to keep a database of this magnitude secure.”

The really striking quote from the article, though, goes to a different kind of security: security against terrorist attacks. Information Technology Association president Phil Bond is quoted in a statement on the REAL ID Act:

“Today’s system is the system that helped to bring us the terrorist attacks of Sept. 11, 2001,” said Phil Bond, ITAA president, in the statement. “We know the problem, and we have the technology to fix it.”

How many different ways has Bond gotten security wrong? I can’t list them all, but …

The first is the implied causal relationship between our present-day ID card system and terror attacks. There are many causes of terrorism and terrorist attacks - Ron Paul recently stirred the Republican pot by suggesting they include an interventionist foreign policy. To respond to the literal import of Bond’s statement: the ID system in our country did not cause weak groups elsewhere to adopt the strategy of terrorism. Our current ID and licensing system did not “bring us” the terrorist attacks of September 11, 2001.

But Bond was making purposeful use of inaccurate language. His implication is that the current driver licensing system is so lacking in security measures that it can be treated as an equivalent to a real cause of terrorist attack. This is where Bond’s security ignorance shines like a beacon.

For all the benefits they provide, including a modicum of security, identity systems provide almost no security against committed opponents like terrorist organizations, criminal enterprises, or even hardened criminals. In my book Identity Crisis: How Identification is Overused and Misunderstood, I show how identity acts as an economic and social glue. It brings people together for all kinds of transactions, and it holds them together if and when things go wrong. But I also show how breakable this glue is. Identity does not reveal intention.

People who have studied identity and security know that you can’t extrapolate from the use of identity in every-day transactions to the use of identity in counter-terrorism. Commited bad actors will defraud, inflitrate, or corrupt card issuing systems, or create fraudulent identity documents directly - to say nothing of simply avoiding targets that are controlled by identification checks. (That’s not a big improvement in security. There are far more uncontrolled targets than controlled targets.)

Evidently, Phil Bond is not someone who has studied identity and security, which is a shame given that he is the highly regarded leader of a significant technology-industry trade association.

I’ll Take the Frying Pan over the Fire

Via Ars Technica, here’s a Quad-Cities Online report on the state of Illinois using $1 million in taxpayer dollars to fund litigation in support of an unconstitutional ban on video game violence. The money was taken from other budget areas, including public health, welfare, and economic development.

The ideal would be to give the money back to taxpayers. It rightly belongs to them. But given the choice between using the funds to erode free speech rights or using them to support the welfare state, I’ll take the welfare state.

The Search for the Libertarian Vote

An NPR report on independent voters in Nebraska included this comment from a hospital diversity director: “There’s a large group of people in this country that believe in smaller government, that believe in balanced budget. I think that’s a pretty popular concept. Where [the Republicans] run into trouble is strict adherence to a couple of social issues.” As we’ve been saying.

What does a diversity director do in Nebraska, anyway? I’m thinking he tries to persuade people that “the farmer and the cowman should be friends.”