Two Bits of Economic Jargon

Although I wasn’t able to post myself yesterday, I was able to read some blog posts. It occurred to me that there are a couple of bits of economic jargon that may prove helpful in some of the discussions of the situation in Wisconsin, the role of government, compensation, and so on. The two phrases are “market clearing price” and “deadweight loss”.

First, I want to commend Steven Taylor post at OTB disentangling the many issues that are being bundled together in the discussion of the controversy between Wisconsin’s governor and the public employees’ unions to your attention. I think it’s a very helpful contribution to the discussion.

On to the two phrases. There’s quite a bit of discussion going on about what the proper pay for public employees should be. James Joyner posted on the subject here and Alex Knapp post on it here. The tools they’re using to analyze the question are not only inappropriate, they’re counter-productive. So, for example, when James comments on teachers’ pay:

Schoolteachers, then, are part of an elite subsection of Wisconsin workers: the 25.4% who have a bachelor’s degree or higher. Many of them, in fact, have a master’s degree. Meanwhile, 45.3% of the state’s adults have a high school diploma or less.

And they do a job that we all agree is very important. Further, I think we can agree that getting an education is actually relevant to what they do on the job! Surely, then, we don’t want to pay them wages comparable to the 74.6% of workers who haven’t attained a college degree?

he’s effectively saying that a bachelors-only teacher who works a nine or ten month schedule should make more than police officers or firefighters, most of whom have high school only. Is that right? I think that the work that police officers and firefighters do is pretty important, too. I honestly don’t know whether we should be paying teachers or firefighters more and I don’t think that James or anybody else knows, either.

The confusion here is that he’s introducing a factor, investment in education, that, sadly, is irrelevant to compensation other than to determine return on investment. The way you determine whether you’re paying enough, too much, or just right is by determining the market clearing price.

The market clearing price of a good or service is the price when the quantity on offer is equal to the quantity demanded. In simplistic terms, if you turn away qualified candidates for a job, if there’s a waiting list for a job, you’re probably offering too much. We shouldn’t be trying to determine relative worth among dissimilar jobs in non-comparable circumstances in the hothouse of a bureaucract’s desk or as an exercise in abstract thought. The reason that the Soviets failed at it is not because they were evil or stupid but because it can’t be done. Trying to do so frivolous, futile, a waste of the public’s time and money, and a violation of fiduciary responsibility. It is both a crime and a mistake.

That brings us to “deadweight loss”. Alex writes:

But personally, I don’t see the point of comparing private vs. public sector compensation. For my own part, I think that public servants should be paid well. As economists are fond of pointing out, incentives matter. And good pay and benefits from the government helps to attract to the best workers to the government — which makes for a smoother running, more efficient government. Underpaying public servants, on the other hand, means that talented people will turn elsewhere — and that inevitably results in less efficient government.

There are so many things wrong with this statement, it’s hard to know where to start. For one, it fails to distinguish between intrinsic worth and extrinsic worth. If, rather than paying a starting kindergarten teacher $45,000 (as is the case in Chicago), you paid the starting teacher $4,500,000 would that result in better teachers or just teachers who are more motivated by money? I believe the latter.

I don’t believe that you want teachers whose main interest is becoming wealthy; I think that you want teachers whose main interest is teaching children. If you’re getting unqualified people, you don’t just need to increase the amount of pay you’re offering you need to raise the qualifications that are required. Doing the former without doing the latter in a bureaucratic system means although the intended effect may be to attract better candidates, the greater effect will be to pay the current (apparently unqualified) staff more. I don’t believe that produces “smoother running, more efficient government”. I believe it produces rapacious, avaricious government. Avarice is without limit. That’s why it’s considered one of the seven deadly sins.

However, there’s another reason that we should be thinking of right-pricing rather than just paying more and that reason is deadweight loss. In the sense that I’m using it deadweight loss is the loss in economic activity between paying the right price for something and overpaying for it and the loss in economic activity between doing whatever’s being done and doing what a market would have done. There is a deadweight loss of government activity. That is a fact. I am not arguing that we should have no government, merely that we should be very careful that we are getting the government we need and not a smidgeon more.

The problem with our economy right now is that we don’t have enough economic activity. If there were more economic activity people would be selling and buying more and more people would be employed. We do not have excess economic activity to burn and allocating resources inefficiently is doing just that.

33 comments… add one
  • john personna

    I was pretty much alone arguing for market pricing over there.

    FWIW, a complication in police/fire pricing is that people do want to pay them “well” for the risks they take. A component of the pay system becomes how the tax payer feels about themselves.

    Perhaps this expends to teachers, for some. They’d overpay them (accept that dead-weight loss) to signal appreciation.

    … that’s fine when you’ve got the money, and states who have the money, and in good times, tend to do it more.

    BTW, interesting tables here:

    http://www.ritholtz.com/blog/2011/02/whos-breaking-the-bank-in-wisconsin/

    Odd that Wisconsin underpays their firefighters relative to their police, most keep the two somewhat in line.

  • a complication in police/fire pricing is that people do want to pay them “well” for the risks they take

    Another interesting subject but a different one. The homicide rate for Chicago police officers is lower than the homicide rate for Chicagoans, generally.

  • accept that dead-weight loss

    The cognitive dissonance of the electorate! You can’t complain simultaneously that public employees are paid too poorly and about unemployment. Some portion of that unemployment is a consequence of high pay for people who without the help of government wouldn’t be receiving it.

    I understand that we wish that everybody be paid handsomely. Things just don’t work that way and never will.

  • john personna

    “Another interesting subject but a different one. The homicide rate for Chicago police officers is lower than the homicide rate for Chicagoans, generally.”

    It could also be solved by lower pay but higher death or injury compensation. Though for that you’d have to address the gaming of “disability” in police and fire. We all know people on “full” disability enjoying second careers, right?

  • PD Shaw

    I’m glad you answered your own question, I have no idea who should be paid more. I think some police jobs are far less dangerous than others. I think some teaching positions are far less attractive than others, particularly if you are going to have your job security dependent upon student performance.

    (Firefighters around here work 2-3 24 hour shifts and then run some sort of business on the side, usually construction or property rental. In that way they are somewhat like treachers)

  • PD Shaw

    Watching local news last night, the county sheriff was announcing that crime in the rural areas was up about 1 third, while his office has had a 67% cutoff in payroll (I think that last bit is probably true, but deceptive). Anyway, I think law enforcement services have a broad immediacy that educaton lacks, but education spending is popular when there is money for it.

  • PD Shaw

    A jargon question: Did Arnold Kling or someone suggest that education was a “comparative good,” or use some other similar term for a good that you value in comparison to what another has?

    Anyway, I think that’s the market problem with teacher salary, or at least we don’t know how to value educational services in general. These problems tend to move price up without necessarily increasing value.

  • john personna

    This relates to the value of teachers, unions, and education:

    http://www.slate.com/id/2285927/

    FWIW, having been in schools myself, and having had parents who worked in schools … I’d say that people know who the good teachers are.

  • Sam

    Having lived in one place where teachers are ridiculously overpaid (Ontario Canada), and another where they are underpaid (Arizona), I have to say I 100% agree. Arizona has a lot of trouble finding good science and math teachers. Well, time to pony up – for math and science teachers. Ontario had tons of good teachers who had to substitute for years before getting something full time – most give up before they got there. Minimum requirements were two bachelor’s degrees and a master in teaching. Salaries had to come down. I have to say though, I only had one bad teacher in high school.
    The line for fire and police jobs is long everywhere so the pay could probably come down. There’s a balancing act with police though, you have to make sure the job pays well enough that corruption is not enticing.

  • michael reynolds

    I could teach writing, and probably do a better job than the average teacher. But the school system couldn’t afford me. So they get a worse teacher at a lower rate of pay. So much worse in my opinion that in most cases they’d be better off dropping the subject altogether.

    Pay is not irrelevant to the quality of teaching. A lot of the best teachers are those who can “do,” and not just teach. Those who can do, tend to get paid a bit better in life, and if you want them you have to pay them.

    I don’t know that the best teachers are those who want to teach kids, I think the best are those who can teach kids, whether or not teaching is their mission in life.

  • The market clearing price of a good or service is the price when the quantity on offer is equal to the quantity demanded. In simplistic terms, if you turn away qualified candidates for a job, if there’s a waiting list for a job, you’re probably offering too much.

    This and your deadweight loss comment really should bring the discussion into focus. If there is a waiting list for teaching jobs, then the pay/benefits is too high. Further, people are misallocating resources towards teaching when we already have an over-supplied market.

    The issue of who gets paid what in the private sector vs. the pay for a similar degree in the public sector is just a distraction. Although if you are going to look at such statistics, for the love God use the median and not the average.

  • sam

    “The market clearing price of a good or service is the price when the quantity on offer is equal to the quantity demanded. In simplistic terms, if you turn away qualified candidates for a job, if there’s a waiting list for a job, you’re probably offering too much.”

    I guess nurses are grossly underpaid, huh?

  • The subject of nursing is a complex one. Here’s a good overview of the situation. Key problem: there’s a supply bottleneck caused by inadequate billets in programs. Most programs have lengthy wait lists.

  • sam

    I dunno, Dave. The folks needed to fill those teaching billets are nurses. If there’s a shortage there, seems to me that’s only one more data point in support of the argument that there’s a nursing shortage.

  • steve

    Is education a merit good?
    Steve

  • john personna

    Education might be steve, but education has a slight mismatch with teacher pay. I mean, my fav, the public library, contributes to the former without improving the later.

  • There’s no way to tell whether education is a merit good or not since neither is rigorously defined. Essentially, something is a “merit good” if you say it is. It’s tautological.

  • john personna

    Any one person can argue a “merit good” but they are only “real” when broadly accepted. In that sense, they are a valid tautology.

    I’ve been thinking about cross-national comparisons, and those folk who say “the Scandinavians have teachers unions, and good outcomes, therefore teachers unions are good here.”

    Well, they may not be the same sorts of unions, and their society may have a different relationship with children and education.

    “One way of understanding this difference is to see that while in the US marriage is a highly public matter, and the family a sacred institution, children are by and large seen as a kind of private property, or something to which every adult individual has a right. In Sweden, on the other hand, the family is a private matter, while it is the child who is the public matter.”

    http://www.marginalrevolution.com/marginalrevolution/2011/02/the-pippi-longstocking-essay.html

  • john personna

    I’m reminded of a story … I believe some years ago a woman won custody of her children in Swedish court (possibly after leaving the US in violation of our courts).

    Why was she granted custody? The Swedish court agreed that raising children in America amounted to child abuse.

  • PD Shaw

    I think the jargon I was looking for was “positional good.”

  • steve

    ” If there is a waiting list for teaching jobs, then the pay/benefits is too high. Further, people are misallocating resources towards teaching when we already have an over-supplied market.”

    What if all the people on the waiting lists graduated with 2.0 GPAs? What if we are not getting applicants who can achieve anything other than a C in non-education classes? Does not quality matter?

    I am still in the process of hiring two new docs. I have received CVs from at least people whom I will not bother to interview. They look mediocre to awful on paper. Using your logic, there are way too many docs available.

    Steve

  • steve

    Oops, meant to say 50 people.

    Steve

  • john personna

    The way I’ve put it steve, is that you set wages to attract enough qualified applicants.

    It’s amazing how people can miss that “qualified” even if you say it many, many, times.

  • Drew

    When I read comments like the last two by steve and jp I don’t know whether to laugh or cry. I’m assuming it was tongue in cheek, because such overly and uneccesarily literal interpretations are absurd.

    To illustrate how absurd, no one would claim that a long line of applicants for a position as an airline pilot………by people who cannot fly, is evidence of pilot’s wages being too high. Or closer to the mark, steve’s disappointment with his application pool. Quality, (or qualifications) are an integral part of the “quantity demanded” equation.

    And I don’t know what crowd you hang with, jp, but I don’t know anyone who would make the mistake of thinking a line of warm, non-comatose bodies is evidence of an overly generous wage.

  • PD Shaw

    steve, if you want all teachers to have received As in biology and chemistry, where are you going to find physicians to hire?

  • What if all the people on the waiting lists graduated with 2.0 GPAs? What if we are not getting applicants who can achieve anything other than a C in non-education classes? Does not quality matter?

    Clearly these people should not have allocated their time and effort towards acquiring the credentials to teach. That is, we have badly allocated resources–which is what I said.

    I am still in the process of hiring two new docs. I have received CVs from at least people whom I will not bother to interview. They look mediocre to awful on paper. Using your logic, there are way too many docs available.

    Are you the only person hiring doctors in your area? If not, then I don’t know what this shows.

  • PD Shaw

    Part of the reason steve is looking to non-educational classes to evaluate whether someone would be a good teacher is because education is a positional good:

    “the positional good perspective, argues that there is uncertainty
    and unawareness among employers concerning the marginal productivity of potential employees. Employers do not know very well which knowledge and skills employees bring with them to the labour market, let alone how these competencies affect productivity. That is why employers look for crude signals that are associated to groups of applicants . . ..”

    http://www.equalsoc.org/uploaded_files/regular/SOTAR_2_ProductiveSkillsPositionalGoodorSocialClosure_HermanvandeWerfhorst.pdf

    The link is an interesting survey of the different theories of the value of education, only one of which is positional good theory. Others are that education provides productive skills, or alternatively education serves the purpose of closing off access to resources and rewards to non-elites. I suspect all of these values are true to one extent or another, with different intensities in different fields.

    The extent to which education is used for signaling that one is better than someone else has financial and social costs IMHO. The link also states, through does not explain, that the market clearing price of positional goods moves from an equilibrium to a situation of imperfection. To me that suggests we will tend to overinvest in education goods.

  • john personna

    WTF drew, you too miss “qualified” applicants?

    Or chose to think I have an opposite meaning?

  • Drew

    No, jp, the notion that “qualified” needs to be pointed out, and is not implicit in the theme of the thread is simply a blinding flash of the obvious. I’m hoping steve was just being snarky.

    And this: “It’s amazing how people can miss that “qualified” even if you say it many, many, times.”

    Like I said, I don’t know who you hang with, but I don’t know people who miss this.

    .

  • john personna

    Sorry.

    I was asked over at OTB variations of the same question. The idea suggested was that if we priced per the (qualified) applicant pool, we’d have declining standards, “a race to the bottom.”

  • steve

    Well yes, I was being just a bit over the top, but I was making a point. The crude measure of lots of people waiting for a job does not mean that it is overpaid. Things are seldom that simple. in a non-planned economy we will always have mismatches in quantities and quality needed. In the long term, they should even out, but in the short term, not necessarily. I dont really know what the numbers are for people waiting to get into teacher positions. Would be interested in the data.

    @PD- In theory, at least my theory, if we have the best students going into teaching biology and chemistry I should have a better class of students to recruit from.

    @Steve- No. Several of us are hiring, but not quite as many as usual.

    Steve

  • I agree with the argument that public teachers don’t need a pay rise to make them more motivated or qualified. Maybe there are lots of poor teachers that would need more qualification and a better attitude, but money won’t help with that. Principals should manage this and just throw out the ones who don’t comply with the standards. In my experience, teachers are mostly people fond of their job and would teach children even if they didn’t earn as much, they just love their job so much. Your are absolutely right in the point that what matters is what kind of teachers do we want for our kinds. Money-hungry or self-motivated?

    Although I don’t think that paying teachers more will solve all the education problems, I think that the public should be really careful about underpaying teachers, because any employee has to have a certain pay to reach the threshold where he doesn’t think about money (and money stops being that much of an incentive) and focuses on the job.

  • @Steve- No. Several of us are hiring, but not quite as many as usual.

    Then I don’t see the problem. The issue with teachers is that the government is typically the largest employer and has several things going for it you wont find with a private employer, namely much more secure employment (usually) and a very, very nice retirement package. As such, people are likely over investing in the requirements to become a teacher. People often over estimate their abilities and their chances of securing a favorable outcome (the pseudocertainty effect).

    Things are seldom that simple. in a non-planned economy we will always have mismatches in quantities and quality needed.

    The government is part of the planned portion of our economy so this observation is irrelevant.

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