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Getting a Good Meal in D.C. Requires Some Ruthless Economics

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This article originally appeared in The Washington Post

It’s lunchtime in downtown Washington. How do you know where to go for a delicious meal at a fair price? Or better yet, how to avoid a bad one? An economist can help.

The city’s dining scene still falls short of the quality of Chicago or San Francisco, much less New York or Los Angeles. Nonetheless, it is possible to eat very well here, provided that one understands where the quality is distributed. As a longtime economist who has written ablog and a book on the economics of food, I have been studying and indeed living the economics of our local dining scene for more than two decades.

The key is to understand the culinary problems, and then figure out how to work around them. Let’s focus on the workaday crowd’s options downtown, which I will define as most of Northwest but not the top parts of Wisconsin or Connecticut.

First, much of downtown has an underdeveloped public street life. Washington empties out by early evening. It is easy to live in the Maryland or Virginia suburbs, which drains the city of potential energy, and this afflicts the daytime hours, too. Even U Street and Adams Morgan are lackluster by the standards of major global cities.

Second, a lot of Washington doesn’t have a very good public school system. Education-conscious Asian immigrants usually prefer the suburbs and that means D.C. proper doesn’t have a lot of first-rate Asian food.

Finally, the highest-status people in town — the politicians — usually have, or at least feel inclined to demonstrate, remarkably conservative taste in food (President Obama has been a welcome exception). Finance professionals in New York and entertainment moguls in L.A. set a flashier and more innovative tone for their favored dining-out places.

Washington does have its strengths. Namely, the city has a lot of high-income, highly educated transients. It attracts visitors, tourists, young interns and other workers who do a brief spell here but have no intention of staying. Because they come from all over, transients support food variety.

Yet transients also encourage restaurants that build up their reputations rapidly to appeal to a busy, underinformed and sometimes underseasoned audience. Those same restaurants also tend to fall in quality relatively rapidly; even when they don’t go outright bad, they usually descend into the realm of the ordinary.

Be the early bird

The key is to hit these restaurants in the “sweet spot” of their cycle of rise and fall. At any point in time Washington probably has five to 10 excellent restaurants; they just don’t last very long at their highest levels of quality.

Here’s how it works. A new chef opens a place or a well-known chef comes to town and starts up a branch. Good reviews are essential to get the place off the ground, and so they pull out all stops to make the opening three months, or six months, special. And it works. In today’s world of food blogs, Twitter and texting, the word gets out quickly.

Which restaurants have held this crown? A partial recent list would include The Source,Zengo, Sei, Palena, Oyamel, Hook, Equinox and Central Michel Richard, among many others. They all had their moments of glory.

Which places are peaking right now? I would nominate Little Serow and Rasika West. I have been seeing the right kind of stellar reviews for Mintwood Place (I have yet to visit). I had an excellent meal at Fiola a few months ago, but I’ve already heard reports of quality decline. I’ll continue to monitor the situation.

Avoid the beautiful people

Through information technology, we have speeded up the cycle of the rise and fall of a restaurant. Once these places become popular, their obsession with quality slacks off. They become socializing scenes, the bars fill up with beautiful women (which attracts male diners uncritically), and they become established as business and power broker spots. Their audiences become automatic. The transients of Washington hear about where their friends are going, but they are less likely to know about the hidden gem patronized by the guy who has been hanging around for 23 years, and that in turn means those gems are less likely to exist in the first place.

Most of these places remain above average in food quality, but they stay pricey or become even pricier. They are not incredible bargains, and they lose the edge and novelty and obsession with quality that defined their early days.

So here’s the key to eating well downtown: Find places in their golden opening, three- to six-month periods, noting that the first few weeks may involve working out some kinks in the kitchen. Figure most of these places will not stay excellent for more than a year. Go to the ones you like, as often as you can.

Leave when the magic is gone

And here is the clincher: Once you have one “pretty good but no longer special” experience at a relatively new restaurant, stop going.

Forever.

Weep but don’t look back, unless you hear consistent reports that it was truly an aberration. Most likely the magic is gone. Look around for the next excellent place because I promise you there will be one. Cultivate culinary disloyalty in yourself. That is more valuable advice — for Washington at least — than any restaurant recommendation I might send your way.

That may sound ruthless, but the odds are in your favor. We humans have what behavioral economists call a “status quo bias” for sticking with what we know and love. That bias makes sense when it comes to how we treat our friends and family, but it is a mistake to apply it to restaurants. The restaurant, of course, does not have the same loyalty to you.

If it makes you feel better, think of it this way: If more diners behaved in the manner I am suggesting, restaurants would have to keep their standards higher for a much longer period of time.

Don’t ignore the old standards

New York, Chicago and San Francisco are all more likely than Washington to have consistent, excellent restaurants that appeal to a solid, long-standing base of regulars; think Union Square Café in Manhattan. That said, the phenomenon of excess trendiness is spreading to restaurant markets across the nation, and in this regard you can think of Washington as a rather unfortunate forerunner of broader national trends.

Counterintuitively to many foodies, some of the better expensive meals downtown can be found at the old standards, such as The Palm or Prime Rib; they rely on regulars rather than on trendiness. Those restaurants are for my taste not as good as the top trending places. The menus at these establishments are for many diners less interesting and the prices are quite high. Still, if a meal were gifted to me, I probably would enjoy it more at either of those spots than at the average, watered-down trendy Washington place. You can do worse than to be treated to Morton’s, even if you’re not keen on steak.

Often knowing how to order is as important as choosing the restaurant.

●If you are in an ethnic restaurant, look around to see what the other diners have chosen.

●When speaking to the waiter and asking for advice, signal your knowledge of their country, culture and cuisine (prepare in advance if need be), and your request for information about the best menu items will be taken more seriously.

●At fine dining establishments, look for staff who will offer a firm opinion as to what is best, rather than responding with something like “Everything on our menu is good!”

●If there is a fixed-price menu for lunch, usually it is neither the worst nor the best items but rather those least likely to offend the mainstream patron. Aim to do better.

Another tip for eating well in downtown Washington is to show up at 5:30 for dinner, if you can, or at 11:30 for lunch. The service will be better, and there is virtually no chance of experiencing a kitchen breakdown, which is pretty common on a Saturday at 8 p.m. Oyamel for one is a much better restaurant in its off hours, and kitchen breakdown during peak hours is a common complaint about El Centro D.F., the Richard Sandoval establishment.

Don’t overlook gas station fare

Choosing the best ethnic food downtown is tougher, as high rents and tight space keep out the kinds of gems we find so frequently in the Virginia and Maryland suburbs. A reigning principle of good ethnic dining is to look for clusters of restaurants of the same kind, as we find with Vietnamese restaurants in Falls Church or the numerous Korean places in Annandale. The D.C. cluster of Ethiopian restaurants on 9th Street qualifies (I’ve enjoyed every single place in that row). But it is hard to find comparable examples around town.

Dupont Circle, Adams Morgan and U Street have not succeeded in generating first-rate clusters of particular ethnic cuisines. Dupont is now gentrified and expensive, while the other two neighborhoods bring too much automatic foot traffic, most of all from the young, to enforce high-quality standards on ethnic food. The population of Washington is in the range of a mere 600,000 people, and so few ethnic groups produce a large enough local critical mass of diners to support an informed level of taste. Washington’s Chinatown has been a food embarrassment for a long time, but you will find a thriving Chinese community, along with quality Chinese restaurants, up in Rockville.

Good ethnic food in D.C. is a matter of spotting the isolated outposts, usually in neighborhoods good enough to attract some visitors but in unexpected nooks and crannies. My favorite ethnic D.C. dining at the moment is Keren, at Florida Avenue and 18th, an Eritrean place under new ownership.

The area on and near 14th Street has promise, and I enjoy the Uruguyan sandwiches at Fast Gourmet at Lowest Best Price Gas, 1400 W Street. Yes, that is attached to a gas station. Get the chivito, a sandwich with beef, ham, mozzarella and escabeche.

Ethnic places don’t usually go through the boom-and-bust cycles of the trendy restaurants, unless it is a deliberately trendy and expensive ethnic place. Most ethnic spots already are appealing to an informed clientele, and the restaurant is likely to stay good as long as the proprietor sticks around.

To be sure, for D.C. ethnic food there are also the food trucks, which flourish when the law leaves them free to operate. Nonetheless, food trucks are as much a sign of underlying weakness as of strength. Think of them as proof that zoning and rents won’t allow for much nearby good, quick, sit-down, cheap ethnic food. In any case, the downtown food trucks do a much better job for lunch than for dinner.

If all else fails, gas up the car

Sometimes D.C. residents dream of going to the suburbs by Metro for first-rate ethnic food, but that’s harder than you might think. The restaurants near the closer Metro stops (think Bethesda or Clarendon) tend to be the most like ethnic food in D.C., with some quality expensive places, such as the Mediterranean food at Cava, but overall those sites tend toward the mainstream.

The best suburban ethnic food is far from the Metro stops and high rents, so think about travel by car or ZipCar or even cab (you may very well earn the cab fare back on the cheaper cost of dinner).

Eating “pretty well” in downtown D.C. is easy. Eating truly well, especially for your money, is a challenge. The options are there, but they require a bit of urban knowledge, some economic reasoning and a willingness to turn somewhat ruthless. Keep in mind that your discipline in choosing the best will improve the food options for everybody else, too.

 Slideshow: Secrets for Smart Dining in Washington 

A Power Vacuum Is Killing the Euro Zone

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This article was originally published in The New York Times

As problems mount in the euro zone, it’s increasingly evident that we’ve been witnessing an institutional failure of monumental proportions.

What is to be done about Greece? Simply keeping it in the euro zone won’t help much, even if it’s possible.  The continuing crisis has sapped confidence in banks not only in Greece, but also in Spain, Italy, Portugal and Ireland, though to varying degrees.  Unless there are explicit guarantees to these banks soon, the market will likely take a further turn for the worse.

An absence of guarantees could prompt a broader chain reaction of capital flight and bank collapses across several countries.

The basic problem is that many people won’t keep their euros in a Greek bank, and perhaps not in a Spanish bank, either, when those euros can be moved to Germany or some other haven.

Yet German citizens do not appear ready to guarantee Spanish banks or, by extension, the whole credit system of Spain and the other periphery nations. Guarantees of that scope are probably impossible and may also require constitutional changes in some nations.

We thus face the danger that the euro, the world’s No. 2 reserve currency, could implode.  Such an event wouldn’t be just another depreciation or collapse of a currency peg; instead, it would mean that one of the world’s major economic units doesn’t work as currently constituted.

We are realizing just how much international economic order depends on the role of a dominant country — sometimes known as a hegemon — that sets clear rules and accepts some responsibility for the consequences.  For historical reasons, Germany isn’t up to playing the role formerly held by Britain and, to some extent, still held today by the United States.  (But when it comes to the euro zone, the United States is on the sidelines.)

There appears to be a power vacuum, and the implications are alarming. We may be entering a new world where international cooperative arrangements, in environmental areas as well as finance, are commonly recognized as impossible.  If the core European nations cannot coordinate effectively, what can we expect in dealings with China, Russia and other countries that have less of a common background and understanding?

In the euro zone, we are seeing two refusals to cooperate: Germany won’t renew financial pledges to Greece without Greek compliance on previous agreements, and Greece doesn’t want Germany to control its national budget.  Both seem reasonable positions, and maybe they are, but reasonable positions can apparently destroy an international agreement rather easily.

Is there a way out?  To seek a binge of pro-growth government spending, in the hope of stimulating economies, is to assume what already stands in doubt. The crisis has reached a head partly because the market already lacks trust in the periphery governments to invest money for sustainable economic growth.

There is also talk of forming a true fiscal union, but that seems to be doubling down on a bad idea.  If the euro zone cannot summon enough cooperation now, how is any union requiring tighter cooperation supposed to work?  How would national budgets be set and approved?  A credit collapse remains a real possibility.

Is it too late for monetary policy to make a difference?  The other euro-zone nations might allow Greece to leave, while guaranteeing payments for food and fuel, both of which Greece imports, for a reasonable period.  Higher price inflation might then depreciate the euro, limit the need for difficult downward wage adjustments, and help Spain and Italy improve their competitiveness.  The inflation could come through central bank bond purchases from the troubled nations, thus easing their debt problems.  That may be the only useful option still on the table.

But that’s also not easy.  First, economically healthier nations may be reluctant to accept the inflation, which would represent a rather direct, continuing redistribution of wealth to the troubled debtor countries.

The second problem is that some of the banking systems in the periphery nations may be too broken for monetary policy to take hold.  Imagine the European Central Banktrying to infuse new money and credit into Spain, while bank deposits move quickly to Germany, Switzerland and other safer places.  Again, why would anyone want to keep money in the bank of a fiscally troubled nation?  That loss of confidence will not be easily repaired.

Since December, the European Central Bank has lent more than a trillion euros to euro-zone banks, but that has bought no more than a few months of peace.  It isn’t clear how much more can be done.  It probably is about time to judge the euro zone as a failed idea — and rarely is it wise to double down on failed ideas.

What is most disturbing is that the euro-zone nations are democratic, protective of basic liberties, and have advanced intellectual and research communities. The final lesson of this debacle is that smart nations with noble motives can make very big mistakes.  And that should concern us all.

Scaling the Great Wall

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This article was originally published in the May 2012 edition of Washingtonian

Shopping for a month at an Asian supermarket can open your eyes to wonderful foods, cause a lot of confusion, and yield some interesting discoveries about how we choose what to put on the table.

Most of us are familiar with the American supermarket–maybe too familiar. The Safeway or Wegmans or corner market supplies a lot of convenient food–and a lot of those aisles are full of things that are only a rough approximation of food–but that very convenience can make the local supermarket a rut. The deadening hand of routine takes over our shopping lives: We know what we want, where to find it, when to get it, and what to do with it. These habits can be the biggest obstacles to discovering new regions of the food universe.

But abstain from your routine for a week or so and your natural ability as an innovator flourishes. An innovating consumer has a profound effect on the marketplace and the food economy. After all, maybe the American supermarket, for all its conveniences, isn’t actually the best way to sell–or buy–food. At the very least, maybe it’s not the best way to do it all the time.

With that thought in mind, I conducted an experiment. For a month, I’d refrain from buying food from mainstream supermarkets and instead choose–exclusively–an ethnic grocery store, in this case a big Chinese/Asian market in Falls Church called Great Wall.

Full disclosure: During the experiment, I still traveled to other cities and ate in restaurants–supermarkets have never completely dominated my food life. In any case, for a month I’d go cold turkey on traditional American supermarkets, and for every day out of town I had to do an extra day shopping at the ethnic market.

The idea behind this experiment grew out of my economic approach: Food is a product of economic supply and demand, so try to figure out where the supplies are fresh, the suppliers are creative, and the demanders are informed.

When it comes to ethnic markets, most of the shoppers are well informed. They come from cultures where food preparation receives more attention than in the United States. They’re also largely immigrants or children of immigrants. Either they hail from cultures where most food prices are lower than they are here or the immigrants have lower incomes themselves, or both.

It seemed natural to select what’s probably the world’s oldest and perhaps most sophisticated food culture, Chinese.

Great Wall Supermarket is in the Merrifield area of Falls Church, about a 20-minute drive from DC in a part of Fairfax County with plenty of Chinese immigrants. The Chinese-owned store, in a strip mall, has ten long aisles as well as some side spaces.

The most daunting task is finding something. At first, even though I’d been there many times and I’m relatively familiar with Chinese cuisine–by Western standards at least–it could take me 20 minutes to find just one or two items. It felt like walking into a labyrinth, even with my savvy 21-year-old stepdaughter helping out.

Many of the jars are labeled in Chinese characters, with the English small and hard to find. So if you’re told “aisle eight, in the middle, on the right,” it’s a help but not a solution. You’re still confronted with an array of hard-to-distinguish jars. Even if you know something about Chinese food, “bean sauce” comes in a number of colors and varieties, and the store has dozens of soy sauces. Once I moved beyond the highly visible items such as meats, I struggled to find what I wanted–at least at first.

The dried goods and candy were hardest to browse through. Not everything had an English label. Often I didn’t know exactly what I was looking for, if only because the name of something in a book or cookbook didn’t correspond exactly to the name on the package. Was ya cai the same as “pickle mustard vegetable” or “pickled mustard green”? I still don’t know for sure, although I think so, and that’s assuming I can find the English inscription at all.

What’s more, when I entered those aisles, I sometimes had the feeling people were staring at me, thinking: What does he want here? I learned quickly how dependent I normally am on background cultural knowledge and simple rules of thumb.

I decided to consult a Chinese graduate student at George Mason University, where I teach. Rong Rong is studying for a PhD in economics and is from a region near Shanghai. She has a friendly manner and is possibly the sharpest student in her cohort. Rong Rong told me to try the double-mushroom soy sauce, which she claims tastes just like what her mother serves in China.

I asked Rong Rong if she had trouble finding items in Great Wall. The answer was no, although she did admit to being confused at Giant, despite almost five years living in the United States. She found Giant’s cereal aisles the hardest to master, and even though her English is very good she can’t read all of the labels nearly as fast as I can or recognize from a glance what an item is going to taste like.

Another obstacle in using Great Wall is asking for directions to sought-after items. By all appearances the staff works hard, and finding an employee isn’t difficult. The problem is that virtually all of the workers are–oddly enough–Spanish-speaking, most likely from El Salvador, with varying abilities in English.

I speak Spanish, but this isn’t always much help. I don’t know some of the words for Chinese items in Spanish, but more commonly there isn’t a good translation. Salsa dulce de los frijoles doesn’t carry the same connotation as “sweet bean sauce” and requesting it in Spanish didn’t get me where I wanted to go. Dulce y agrio does map directly into “sweet and sour,” but that simple translation is the exception. It’s not easy to find out the Spanish word for pickled fresh bamboo shoots.

In most cases, the Latino staff knows neither the English nor the Chinese words for what’s on their shelves. Entering the store is like being robbed of part of one’s linguistic facilities. Another Chinese graduate economics student, Siyu Wang, noted that the prevalence of Spanish speakers among the workers was one of her biggest surprises when she first visited Great Wall.

There are some Chinese staff, including most of the cashiers, but their English is limited. One strategy that does work, when it can be applied, is to bring a Chinese cookbook containing the characters for the desired items. Show the relevant characters to someone who works in the store. If you can find a Chinese employee, he or she will lead you directly and enthusiastically to the right place.

Mostly, I learned where things were by walking down all of the plausible aisles and then looking in places that seemed logical. Over time, that worked better as I got to know the market.

With each visit, I increasingly divided the store into “parts I use” and “parts I don’t use.” Those I used included the produce, the meats and fish and tofu, and the spices and sauces, plus the frozen goods, the dumplings, and the different noodles, dried and fresh. I didn’t do much with the American or Latino goods, the bags of dried fish, the cans of condensed milk, the Asian sweets, or the cookware.

Continue reading on Washingtonian.com 

Never Mind Europe. Worry About India

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This article was originally published in The New York Times

The economic slowdown in India is one of the world’s biggest economic stories, but it is commanding only a modicum of attention in the United States.

It may not even look like a slowdown because by developed standards, India’s growth — estimated by the International Monetary Fund at 6.9 percent for 2012 — is still strong. But a slowdown it is: the economy has decelerated from projected rates of more than 8 percent, and negative momentum may bring a further decline. The government reported year-over-year growth in the October-through-December quarter of only 6.1 percent.

What is disturbing is that much of the decline in the growth rate is distributed unevenly, with the greatest burden falling on the poor. If the slower rate continues or worsens, many millions of Indians, for another generation, will fail to rise above extreme penury and want. The problems of the euro zone are a pittance by comparison.

China commands more attention, but Scott B. Sumner, the Bentley College economist, has pointed out it is India that is likely to end up as the world’s largest economy by the next century. China’s population is likely to peak relatively soon while India’s will continue to grow, so under even modestly optimistic projections the Indian economy will be No. 1 in terms of total size.

India also is a potential force for energizing the economies of Bangladesh, Nepal and, perhaps someday, Pakistan and Myanmar. The losses from a poorer India go far beyond the country’s borders; furthermore, the wealthier India becomes, the stronger the allure of democracy in the region.

Why is India’s economic growth slowing? The causes are varied. They include a less than optimal attitude toward foreign business and investment: recall the Indian government’s reversal of its previous willingness to let Wal-Mart enter the retailing sector. The government also has been assessing retroactive taxation on foreign businesses years after incomes are earned and reported. Another problem is the country’s energy infrastructure, which has not geared up to meet industrial demand. Coal mining is dominated by an inefficient state-owned company and there are various price controls on both coal and natural gas. Over all, the country does not seem headed toward further liberalization and market-oriented reforms.

These problems can be solved. More troubling are the causes that have no easy fix.

Agriculture employs about half of India’s work force, for example, yet the agricultural revolution that flourished in the 1970s has slowed. Crop yields remain stubbornly low, transport and water infrastructure is poor, and the legal system is hostile to foreign investment in basic agriculture and to modern agribusiness. Note that the earlier general growth bursts of Japan, South Korea and Taiwan were all preceded by significant gains in agricultural productivity.

For all of India’s economic progress, it is hard to find comparable stirrings in Indian agriculture today. It is estimated that half of all Indian children under the age of 5 suffer from malnutrition.

Another worry is that India’s services-based growth spurt may have run much of its course. Call centers, for example, have succeeded by building their own infrastructure and they often function as self-contained, walled minicities. It’s impressive that those achievements have been possible, but these economically segregated islands of higher productivity suggest that success is achieved by separating oneself from the broader Indian economy, not by integrating with it.

India also has one of the world’s most unwieldy legal systems, and one that seems particularly hard to reform. On the World Bank’s Doing Business Index, the country ranks 132 out of 183 listed countries and regions, behind Honduras and the West Bank and Gaza, and just ahead of Nigeria and Syria. One undercurrent of talk is that the days of “the license Raj” have returned, referring to the country’s earlier subpar economic performance under a regime of heavy government regulation.

On the positive side of the ledger, the country retains a population with remarkable talent, energy and entrepreneurship. It has worldwide networks of trade and migration, and world-class achievements in entertainment and design, among numerous other strengths. Nonetheless, the previous pace of progress no longer seems guaranteed.

India may not be alone in this slowdown. There is a more general worry that the grouping of disparate giants known as the BRIC nations — Brazil, Russia, India and China — has, for some reason, lost much of its previous momentum. Last year Brazil grew at only a 2.7 percent rate, down from 7.5 percent, and Chinese and Russian G.D.P. growth are slowing too, to an unknown extent and duration. In the past, many countries engaged in catch-up growth have suddenly slowed and hit plateaus, although economists do not have firmly established theories as to when and why this happened. In any case it remains a real danger.

In the short run, we often focus on headlines, elections and fights between personalities and political parties. But the world is shaped by deeper structural forces, such as resources, technologies, demographics and economic growth rates. We ignore India’s troubling trends at our peril.

The Economics of For-Profit Higher Education

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Tyler Cowen and Sam Papenfuss released this paper on for-profit education on July 23, 2009. This paper has been reformatted for stylistic reasons and some content, including footnotes, has been removed. Please download the PDF to read the paper as it originally appeared.

Abstract

We consider why some educational institutions choose for-profit corporate status. For-profit educational institutions are prominent where the content of instruction is well-defined, high quality research is of little complementary value, students use education for learning rather than certification, and there are independent means of certifying student quality, such as vocational tests. We consider the explanatory power of some hypotheses that might explain these facts, involving government subsidies, donations to non-profits, agency problems, and the economics of producing reputation.

I. Introduction

For-profit higher education has grown rapidly in the United States over the last twenty years. Examples include vocational schools, technical training, in-house corporate education, the DeVry Institute, Phoenix University, and other new for-profit colleges. In addition, a number of developing countries, most prominently the Philippines, have experimented with for-profit higher education in the past. Adam Smith, writing in 1776, associated for-profit education with high levels of instructional quality, and claimed that endowed, nonprofit education resulted in shirking and poor teaching.

In spite of market experience, for-profit higher education has received little direct attention from economists. The literature treats the non-profit status of higher education as the state of affairs to be explained. We view this presupposition as question-begging and focus on what determines the distribution of for-profits and non-profits in higher education. Unlike many non-profits, for-profits do not offer high-reputation liberal arts education but instead specialize in teaching well-defined vocational skills.

Section II of the paper presents some examples of for-profit higher education and outlines their market niches. Section III consider some reasons why corporate status matters and considers some explanations of the patterns in the data, focusing on the relative role of subsidies, donations, agency problems, and the nature of reputation as a public good. We will see that all four factors play some role but none can explain all of the data or provide a fully satisfactory theoretical account.

Winston (1999) provides a survey of issues relevant to the non-profit status of many colleges and universities; see also Ruch (2001), Morey (2004), and Breneman, Pusser, and Turner (2007). In economic terms non-profits are institutions bound by a non-distribution constraint for their profits. Non-profits do not have owners with rights to residual income, and there are no shares which provide for both control and claims to profits. Net revenue must remain in the corporation, although some revenue will be distributed implicitly in the form of perks to managers, board members, and employees. As with for-profits, however, non-profits must cover the costs of their operations if they are to survive and many in fact earn very high returns. Pauly (1987) provides a dissenting perspective which minimizes the practical differences between for-profit and non-profit institutions. With regard to state and private schools, we treat the difference as one of degree, rather than kind. We view state schools as run as nonprofits, but having state-appointed officials on their boards. It is not even the case that state schools necessarily receive more subsidies than their “private” counterparts; governmental subsidies provide significant portions of the budgets of schools such as Johns Hopkins and MIT.

II. For-profit education

Technical and vocational training

For-profit technical training is common for business courses, barber and beauty schools, nursing programs, vocational and technical institutes, and correspondence courses (Lynch 1992, p.302). Berlitz International offers for-profit instruction around the world in a wide variety of foreign languages. Although Berlitz offers translation services and publishes guidebooks, eighty percent of their revenue comes from language training, through approximately five million lessons a year. Other work-related skills, such as computer programming and specific software classes, are taught frequently on a for-profit basis.

In-house corporate education

Other forms of higher education are provided within corporations. On-the-job training is hard to quantify since much of it is informal learning-by-doing or integrated into work routines. Nonetheless a survey by Training magazine estimated that more than 47 million workers in the United States received formal corporate training in 1994, at a direct expense of $50 billion. Informal training probably runs several times this amount (Hood 1996, p.68). Lynch (1994, p.12) estimates corporate training expenditures at 1.8 percent of the total wage bill in the United States.

One estimate found more than 1,600 corporate “colleges” in the United States. At “Hamburger University,” run in Illinois by McDonald’s corporation, trainees learn how to run a McDonald’s franchise, which includes learning how to cook hamburgers and french fries, how to enforce standards of cleanliness, and how to attract customers. Hamburger University offers a tailor-made education in the managerial skills needed for running a fast food franchise. The school trains 7,000 individuals a year. Ford, Disney, Motorola, and Dana Corporation run institutions of a similar nature.

Apprenticeships at for-profit corporations provide an indirect means of purchasing training in some skill or vocation. The apprentice typically accepts lower wages in return for a package which combines a job and training. Apprenticeships are rare in the United States but they are much more common in Europe, especially Germany, which has had measured rates of apprenticeship of over sixty percent (Blanchflower and Lynch 1994, p.240, Soskice 1994, p.26). Most of these apprenticeships are with for-profit companies rather than with non-profit institutions.

For-profit higher education in the United States

The DeVry Institute is the most prominent for-profit institution in United States higher education. DeVry is a for-profit, publicly traded company which dates from the 1970s and went public in 1991. The company is traded on the New York Stock Exchange and has private shareholders and other characteristics of a private corporation. DeVry receives no public funds, and student tuition fees account for approximately ninety percent of revenues which totaled over $1 Billion in 2008.

Approximately 68,000 individuals are taking DeVry programs at numerous campuses in the United States and Canada. Full-time undergraduate students pay from $56,000 to 59,000 for a four-year Bachelor’s degree. The DeVry institute offers a no-frills education oriented towards specific technical skills with high labor market returns. The school concentrates in fields such as electronics engineering, computer science, business, accounting, and telecommunications. A related branch of the school, the Keller Graduate School of Management, is currently serving several thousand students seeking MBAs. Numerous other for-profit institutions of higher education operate in the United States, including Colorado Technical College, Laboratory Institute of Merchandising (New York), School of Visual Arts (New York), Bassist College (Oregon), Huron University (South Dakota), and Strayer College (Northern Virginia), all of which are currently accredited. The largest is Phoenix University, which now has about 300,000 students.

For-profit education in the Philippines

For-profit higher education started in the Philippines in the early part of this century and blossomed after the Second World War. Later in the 1980s, the Marcos regime of martial law imposed restrictions and unfavorable taxes on proprietary educational institutions; until that time, for-profit colleges and universities competed on a nearly level playing field. We focus on the earlier period – the 1960s and 1970s – when for-profits competed against non-profits with few legal hindrances.

The private sector has traditionally covered most of Filipino higher education, often more than ninety percent (Zwaenepoel 1975, pp.162-4). In 1969 the Philippines had 36 private universities and 559 private colleges, serving 573,094 students at the graduate and undergraduate levels. 274 or 49.37 percent of these institutions were run as for-profit corporations, 281 or 50.63 percent, were run as non-profits, and another forty could not be classified due to limitations in the data (Zwaenepoel 1975, pp.71-2). The for-profits covered roughly three-fifths of all students receiving higher education in the Philippines (Miao 1971, p.207). Many of the for-profit colleges have been publicly held corporations traded on the Manila Stock Exchange (Geiger 1986, p.58). One observer noted: “The Filipino passion for education has become a lucrative market and private education is dominated by schools, colleges and universities which operate as profit-making stock corporations and which actually declare dividends on their stock. These include the largest universities in the country.”

The Philippines is not the only developing country to have relied upon for-profit higher education. We also find significant numbers of for-profit institutions in Indonesia, Malaysia, and Turkey, at various points in time.

Overall patterns in the data

Two primary features characterize the observed educational for-profits. First, for-profits tend to specialize in highly practical or vocational forms of training. For-profits are especially prominent in areas where student performance can be measured by a relatively objective, standardized test. Nonprofits, in contrast, have a stronger presence in the liberal arts, although they are by no means restricted to that arena.

Second, for-profits offer products of lower academic reputation, relative to non-profits. Educational for-profits tend to sell their services at a relatively low price to students who otherwise would not seek higher education or who are marginal applicants. Students who wish to become automobile mechanics or beauticians are more likely to patronize for-profits, as are older students who wish to learn some specific skill, such as accounting or computer programming.

The relevant distinctions between for-profits and non-profits depend on which part of the non-profit sector we examine. The difference is most marked when we examine research institutions of high academic reputation, such as Harvard, Princeton, and Yale. These schools serve the students with the strongest academic records and hire faculty with the strongest research performance. The difference is less marked when we compare for-profits to community colleges or mid-level regional teaching schools. The community colleges, for instance, resemble for-profits by having relatively loose admissions standards. Nonetheless even in these cases the for-profits are more heavily specialized in vocational education and place less emphasis on the liberal arts. Non-profit business and law schools offer a kind of vocational training, and in that sense they resemble for-profits; non-profit business schools of low academic reputation, of all parts of the non-profit sector, are perhaps closest to for-profits in their orientation. Few if any non-profits, however, offer vocational training for barbers and beauticians, to name just a two areas of for-profit specialization.

A comparison of for-profit and non-profit institutions in the Philippines bears out many of the differences noted above. Filipino for-profits tend to charge lower fees, specialize in education of lower academic reputation, spend less on capital equipment, and serve students who plan on pursuing vocational careers or taking a standardized vocational test upon graduation.
We observe similar tendencies in the DeVry Institutes in the United States, but the large number of Filipino for-profits, especially if we look back in time a bit, allows for a more systematic comparison.

Unlike Filipino non-profits, the for-profits typically did not have entrance examinations, and accepted any student who has completed a secondary education and can pay the relevant fees (Zwaenepoel 1975, pp.163-4). From a survey of Manila institutions, the for-profit institution had an average student to fulltime faculty ratio of 27:1, whereas the non-profit religious institutions had an average ratio of 19:1 (Miao 1971, pp.71-2). For-profit institutions tend to invest in classrooms to accommodate large enrollments, rather than investing in library facilities, book holdings, or laboratory facilities. Furthermore, Filipino for-profit institutions tend to limit their class offerings to low-cost, labor-intensive classes, such as teacher education and commerce (Zwaenepoel 1975, pp.322, 342, 348, 587). As of 1970, nonsectarian institutions (typically for- profits) spent four percent of their total budget on sites, equipment, and facilities, whereas sectarian institutions (typically non-profits) spent a much higher 12.41 percent (Isidro and Ramos 1973, p.157). As of 1971, for-profits held an average of 2.58 books per student, whereas non-profits held an average of 8.9 books per student (Zwaenepoel 1975, pp.347-8).

Filipino for-profits also produce a different kind of education. Students from for-profit institutions tend to take standardized vocational exams in much greater number, although they pass them at a lower rate. These facts reflect both the vocational emphasis of for-profits as well as the lower academic reputation of their students. Based on a sample of institutions from the Manila area (from 1963 and 1968), students from nonprofit religious institutions pass these standardized tests at an average rate of 38 percent, whereas students from for-profit institutions pass the same tests at a lower rate of 18 percent. For-profits, however, produce a much greater number of students taking the tests, and therefore pass a much greater number of students through the tests. Students at for-profits are approximately ten times more likely to take the tests. Adjusting for the lower pass rate from for-profits, the for-profits are putting about five times the number of students through the tests as the non-profits, even though for-profits educated no more than three-fifths of all Filipino students at the time (Miao 1971, p. 207).

American experience with the DeVry Institute supports this characterization of for-profit education. DeVry maintains a tough curriculum which focuses on practical skills and vocational training. The school has a good record of getting jobs for its students, but it does not pursue academic prestige, as defined by the standards of research universities. Few joint products are provided with the education. DeVry does not have campuses in the traditional sense, but rather holds its classes in office buildings. The school funds only those sports teams and clubs that are directly related to job placement, and they do not encourage their faculty to do research or publish; many faculty do not even have graduate degrees. Faculty work year round and have very high teaching loads (Glass 1995, Spencer 1995).

III. Why does corporate status matter?
We can think of a few relevant hypotheses as to why corporate status might matter for an education institution; we will survey each in turn.

Subsidies

Subsidies discourage many institutions from achieving for-profit status. In the United States non-profits are exempt from corporate and property taxation. Donations to non-profit organizations are tax deductible but donations to for-profits are not. Many non-profits have the ability to issue tax-exempt bonds or enjoy lower postage rates. In addition, for-profit educational institutions often have faced legal or collusive barriers from governments or from other educators. For-profit education in the Philippines declined when the Marcos regime of martial law instituted unfavorable regulatory and tax treatment. In the contemporary United States, for- profit institutions of higher education have difficulty receiving accreditation; prevailing accreditation bodies are controlled by educators who believe in non-profit education.

The evidence does suggest that subsidies matter. In the Philippines, where educational for-profits have been most prominent, for-profit colleges and universities paid a relatively- favorable income tax rate of 10%, at least prior to Marcos’s crackdown. The 10% rate compared favorably to other corporate income tax rates, which typically ran from 25% to 35% (Miao 1971, p.211, Zwaenepoel 1975, pp.311-2). The relatively equal tax treatment of for-profit and non- profit educational institutions accounted for some of the prominence of for-profits in the Philippines. For-profits also had no special difficulty receiving accreditation in the Philippines.

Nonetheless subsidies are not the only reason why many educational institutions choose non-profit status. Subsidies matter most for those segments of the non-profit market that are closest to for-profits in some of their operations, such as local community colleges or nonprofit business schools of low academic reputation. Subsidies have increased the size and scope of non-profit institutions in these areas. Subsidies, however, are less relevant for explaining the end of the market with high academic reputation, such as Harvard University or Middlebury College, a high quality teaching school. The fundamental question remains why educational for-profits, without subsidies, compete successfully with the local community college but not with Harvard or Middlebury. In other words, the subsidies hypothesis does not explain the cross-sectional variation in the data.

Furthermore, non-profit educational institutions predated the existence of personal and corporate income taxes and predated governmental subsidies to the non-profit form. Lock-in effects and path dependence do not suffice to explain the persistence of the non-profit form. Non-profit universities have succeeded in a wide variety of countries and cultures, and it appears that the form is too robust to be explained by history alone. Furthermore, non-profits can switch to for-profit status if the latter is more efficient; many hospitals have made this change in recent times. The switch can go in the opposite direction as well. American medical schools were once largely for-profit, but they switched to non-profit status in the late nineteenth century (Rothstein 1972, 1987).

Donations

The possibility of receiving donations encourages many institutions to choose the non- profit form (Hansmann 1980, 1987, 1990, Fama and Jensen 1983b). In the United States, donations represent approximately fourteen percent of revenues for non-profit institutions of higher education (Okten and Weisbrod, 2000, p.262). Harvard University has a multi-billion dollar endowment and is one of America’s largest institutional investors.

While we can imagine a for-profit that receives donations, most donors would be reluctant to give to an institution whose mission is to enrich the shareholders. The possibility of donations encourages non-profit status, since many colleges and universities have shown they are effective in fundraising on a large scale. Individuals give money to maintain an ongoing connection as alumni, to achieve status in the philanthropic community or in their local country club, or to buy “packaged” goods, such as admission for their children, good seats at college football games, contact with renowned faculty, invitations to exclusive parties, and so on.

Like subsidies, donations play a clear role but do not tell the entire story. Many non- profit educational institutions receive few donations and have little or no endowment. In the United States many higher educational institutions fund themselves primarily through tuition. In other countries, such as Brazil, Japan, and Chile we find considerable numbers of private educational non-profits, even though donations are not usually an important source of funds. Donations help explain the non-profit status of Harvard and Yale, but they do not account for many other non-profit educational institutions.

In the Philippines, when for-profits have enjoyed a nearly level playing field, non-profits nonetheless held nearly half of the market, despite receiving virtually no donations. Although most educational non-profits are run by the Catholic Church, tuition remains their primary source of revenue. Of the private Catholic universities in the Philippines (most of the non-profits are sectarian and Catholic), only two had endowments at all. Ateneo de Manila University had an endowment of $600,000, and the University of San Carlos had an even smaller endowment of $92,000 (Zwaenepoel 1975, p.146). Five private institutions did indicate additional private sources of income, but these were aimed at scholarship grants rather than for operating expenses. Philanthropy towards universities is almost unknown in the Philippines (Respose 1971, pp.107- 8). Even for the church-related non-profit institutions of higher education, gifts and donations account for only 3.08 percent of total income (Isidro and Ramos 1973, p.149).

Agency problems

For-profit and non-profit educators exhibit different advantages at solving agency problems. For-profits appear to be relatively efficient at monitoring the quantity of teaching when the subject matter is well-defined. Non-profits, in contrast, appear to be relatively efficient at monitoring the quality of research.

Faculty governance may play a central role in this distinction. For-profit institutions are controlled by their shareholders. The issue of control is more complex in non-profits, but faculty play a central role in steering institutional priorities, making hiring decisions, and setting pay raises. The faculty have veto power over many proposed changes in non-profits, but not typically in educational for-profits.

Non-profit faculty governance militates against high teaching loads. Within non-profit schools, the faculty pressure the administration to make overall teaching loads low rather than high. The non-profit form therefore is inefficient when a high teaching load is called for. When the content of teaching is relatively well-defined, uncontroversial, and requires little independent thought, it makes sense to work the faculty relatively hard as defined by the preferences of administration.

Most educational for-profits have teaching loads well in excess of what even non-profit teaching colleges demand. For-profits keep their instructors on a tight rein and extract maximum teaching effort from them, while discouraging research. Part-time instruction is common and many of the instructors are not expected to invest in the university. In essence, the for-profit is specializing in areas where the relevant output is easily defined and measured, such as teaching hours. A residual claimant needs no particular expertise to monitor this variable, nor is faculty governance required. The traditional efficiencies of for-profit firms dominate in these cases.

Similarly, for-profits appear more prevalent when the content of instruction is well- defined and uncontroversial. As discussed above, most for-profits specialize in vocational training, rather than the liberal arts. The body of knowledge for most vocational skills is concrete and well-defined, rather than abstract or controversial. Schools for auto mechanics, beauticians, and computer programmers are examples here. The for-profit has a smaller advantage, or perhaps no advantage at all, in determining what schools of philosophy should be taught, or in deciding whether students should read Dickens or Garcia Marquez. In these cases, the other advantages of non-profit institutions, discussed throughout the paper, become relatively more important and the for-profit form is less likely.

For-profits do not offer their faculty the teaching discretion that is given to Harvard philosophers or faculty at nonprofit teaching institutions of high academic reputations. When the institution specializes in a well-defined instructional product, academic freedom involves costs but no corresponding benefits. Driving schools do not give academic freedom to their instructors behind the wheel, but instead require that they teach skills of braking, signaling, merging, parking, observing traffic signals, and so on.

Note that the relevant agency problem involves the internal enforcement of quality standards, not a demonstration of quality to the outside world. Outside parties arguably can observe the quality of teaching for an institution as a whole. The U.S. News & World Report rankings, for instance, offer publicly available assessments of university quality. To the extent these rankings are controversial, part of the problem is the intrinsic difficulty of ranking in the area, rather than the poor information of outsiders. In any case, the availability of aggregate rankings does not alleviate the internal agency problem. Inside managers must be able to spur faculty and other participants in joint production to pursue quality. If the for-profit has no comparative advantage at this task, the corporate form is more likely to be non-profit.

McCormick and Meiners (1988) make the related argument that the non-profit form is superior for monitoring faculty research. They claim that the research outputs of university faculty often are difficult for outsiders or non-specialists to monitor or measure. Most university research can be evaluated only by peers, colleagues, and other faculty. Again, outside parties can observe the overall research quality of an institution (we all know that Yale faculty are better than faculty at Podunk U.), but the governance structure must support effective internal monitoring to produce the proper ex ante incentives for individual faculty.

According to the McCormick-Meiners argument, faculty governance serves this end. Faculty and administrators receive a large share of their perks and marketability from the reputation of their institution in the external academic marketplace. Both departments and promotion and tenure committees enforce relatively high standards, based ultimately on peer review in the form of journal articles and outside letters of recommendation. Tenured faculty, by insisting on high standards for their tenured peers, raise the reputational value of the franchise they hold. University faculty usually oppose policies that will lower the academic reputation of the university, even when net university revenues would increase.

Agency problems do explain some of the differences between for-profit and non-profit institutions, but the hypothesis is incomplete. Most importantly, the hypothesis takes the current governance differences between for-profits and non-profits as given. It is true that faculty governance plays an important role in most non-profits today. But it is possible to imagine non- profit institutions of higher education without faculty governance, or with faculty governance of a different kind. Charities, for instance, are non-profits, but they are not typically governed by their employees. If faculty governance prevents non-profits from requiring high teaching loads, why do we not observe the evolution of some non-profits without faculty governance? Such hypothetical non-profits might prove effective competitors with for-profits in areas where teaching loads should be high. The very existence of for-profits implies that faculty governance cannot have a decisive efficiency value in all cases.

Similarly, when faculty governance is desirable, why do not for-profits try to replicate those incentives by giving faculty a greater voice in institutional management? Commercial for- profit corporations use employee governance in a variety of manners, including company unions or simply heeding employee feedback for higher-level decisions.

The agency problems hypothesis requires some broader account of the differences between for- and non-profits, and a treatment of which organizational differences are flexible at the margin and which are immutable. The agency hypothesis has micro-foundations only if faculty governance, and its concomitant benefits, can somehow be demonstrated as less costly in non-profits than in for-profits. While this supposition accords with the evidence, we do not yet have a satisfactory theoretical account of why it might be true.

The agency hypothesis also explains only part of the cross-sectional variation between for- and non-profits. It explains why research-oriented liberal arts institutions of high academic reputation do not covet for-profit status. It is less effective in explaining why community colleges, which have high teaching loads and do not subsidize research, choose non-profit status and to answer that question we probably must look to the legal status of community colleges as government-supported entities. Like many of the other hypotheses considered, it explains some of the corners of the distribution rather than the distribution of institutions in the middle of the spectrum.

Reputation as a public good

When reputation is a public good, non-profit institutions may produce that public good with greater effectiveness. Consider Halls of Fame and scientific prizes. The Nobel Prize, like university attendance, provides quality certification. The Nobel Prize is given out by a non- profit committee, rather than being sold to the highest bidder by a for-profit. A for-profit scientific prize would yield less prestige than the Nobel Prize; in dollar terms, Bill Gates may value a Nobel Prize more than did John Hicks. We can imagine that a profit-maximizing version of the Nobel Prize would award it to Samuelson and Arrow, to build up initial prestige, and then sell it to Gates for a high return. The for-profit Nobel Prize would care only about its reputation with its paying customers, not about its reputation with the outside world per se. We therefore find that the most prestigious prizes tend to be awarded by non-profit institutions.

An analogous mechanism may contribute to the non-profit status of colleges and universities of high academic reputation. Faculty governance implies that for-profits and non- profits place different relative weight on reputation and profits. The for-profit selects students and faculty on the basis of how easily their reputational benefits can be captured by shareholders, whereas the non-profit places greater weight on the reputational benefits that are kept by faculty. The for-profit pursues “reputation as valued by students in dollar terms” and the nonprofit pursues “reputation with the external world,” or “reputation as a public good.” In the resulting equilibrium, for-profits achieve lower status.

For-profits pursue only those reputational benefits that they can charge for and convert into profit. They seek to capture as much of the reputational surplus of students and faculty as possible, even if the total reputation of the institution falls. A for-profit version of Harvard, if we can temporarily imagine such a counterfactual, would look at how much potential students and faculty would pay to reap the private reputational benefits of being at Harvard. Non-profits seek out the students and faculty who reflect the greatest reputation back on the university, even if those same individuals are not willing to pay much for their private reputational benefits.

Not all forms of career success – and thus reputational payback to the university – translate into high incomes and high student demands for university services. Training great moral leaders, politicians, and philosophers, for instance, enhances a school’s reputation, but these individuals do not necessarily have a high willingness to pay for university slots, given their relatively low lifetime incomes. Some individuals seek to become Supreme Court Justices, while others shoot for more lucrative positions as firm partner. The non-profit, which is ruled by reputation-conscious faculty, will pursue academic status as an end in itself.

Note that faculty governance need not account directly for the entire reputational difference between for-profits and nonprofits. Reputation often possesses increasing returns to scale or “snowball” properties. Once a given set of institutions has a reputational advantage over others, that advantage may be self-reinforcing. Top faculty and students will be attracted to the institutions with highest reputation, which will in turn support their reputations even further. Consistent with this mechanism, the list of top universities has changed little over decades, whereas there has been considerable turnover in the largest or most profitable for-profit corporations.

The superior reputations of non-profits will feed back into their broader admissions and fundraising strategies. Non-profits can offer potential status and status-related goods to their donors, which strengthens their comparative advantage in raising donations. Furthermore, the non-profits of highest academic quality will adopt exclusive admissions standards but then “sell” admission to the children of the wealthy on a case-by-case basis. Some non-profits will become increasingly driven by the pursuit of reputation and status, whereas the for-profit will drop out of these market segments, which is precisely what we observe.

The hypothesis therefore predicts a segmented market for higher education. Students who seek the highest levels of certification and reputation will attend non-profit institutions, which are run by faculty and use their prestige to raise donations. Students whose quality can be certified by an outside vocational exam do not need the non-profit reputational endorsement. They will pursue the more efficient instruction offered by for-profits.

This hypothesis does not explain why non-profit local community colleges, and other non-profits with indiscriminate admissions standards, can compete with for-profits. These institutions appear to offer little prestige or certification. Nonetheless we do observe some confirming patterns of evidence in other areas. Education for corporate purposes is conducted on a for-profit basis, rather than by non-profit contractors or subsidiaries. If a multinational wishes to instruct its employees in another language, the hypothesis predicts that it will send them to Berlitz. They seek efficiency of instruction and do not need external certification. Similarly, we expect that a small business owner who needed to learn Japanese would prefer Berlitz as well. In the U.S., one sampling from the 1990s found that sixty percent of Berlitz students are employed full or part time and only ten percent were attending colleges or universities. Seventy percent of Berlitz students cited work requirements or relocation as a reason for studying a foreign language.

In addition, older individuals are more likely to purchase for-profit education, whereas the reputation-conscious young will prefer to attend non-profits. Older individuals already have established reputations through their vita (for better or worse), and cannot produce reputation so easily through university attendance. Given their more advanced age, older individuals also face lower benefits from producing reputation. We therefore expect the ambitious young to learn languages, and other skills, in non-profits such as colleges and universities. The old, in contrast, will learn languages by going to Berlitz.

Again, this prediction corresponds to the facts. At least half of all Berlitz students are over the age of thirty (the actual percentage may be higher, as roughly twenty percent of Berlitz students did not give their age). Data from Strayer College, a for-profit in northern Virginia, illustrates a similar pattern. Roughly sixty percent of Strayer students are over the age of thirty, with almost twenty percent over the age of forty. In contrast the vast majority of students are below the age of twenty-two in most non-profit universities and colleges of high academic reputation.

Some predictions of the reputation hypothesis, however, appear to be falsified. Specifically, the hypothesis predicts that for-profits will proliferate in sectors where income and status are closely linked. Unlike in philosophy and many of the liberal arts, most of the high- status businessmen are the richest businessmen. When money and status coincide, pursuit of for- profit goals should maximize institutional status as well. Yet the top business schools and MBA programs are at non-profit universities, not at for-profits.

It is true that MBA programs are run more like for-profit institutions than are most other non-profit educational programs. In this sense the prediction is partially confirmed. Non-profit business schools demand good teaching, they collect tuition rather than offering scholarships, and historically they have placed less stress on faculty research (although this has changed in the last fifteen years). The same cannot be said for nonprofit graduate training in philosophy. Nonetheless the ability of non-profit business schools to take on certain for-profit characteristics again raises deeper difficulties with any explanation of corporate status. A complete account of for-profit education cannot take observed differences between non- and for-profits for granted, but rather must derive the observed inflexibilities of these forms from more primitive assumptions. We still do not have a full account of why non- and for-profit institutions cannot easily “morph into each other” when circumstances dictate, or for particular segments of their market.

IV. Concluding remarks

We have examined the cross-sectional distribution of for-profit and non-profit institutions of higher education. A complex mix of factors, including subsidies, donations, agency problems, and the production of reputation, explain some of the observed patterns in the data. Unlike earlier approaches, which focus solely on the non-profit side of the ledger, we have stressed the need to explain the observed differences across corporate forms and governance structures. At the same time, however, we have found that no single explanation covers all of the ground or can respond to all objections. In that regard significant puzzles remain outstanding.

In terms of practical implications, the analysis suggests limits to the future of for-profit higher education. Non-profit institutions appear to have basic advantages in their ability to reap subsidies, raise donations, produce high quality research, generate academic status, and certify students and faculty in non-vocational areas. For-profit institutions, although they have grown in recent years, do not show serious signs of breaching these barriers.

The properties of the current equilibrium do not always yield accurate predictions about what would result from more dramatic changes in institutions. Nonetheless it is our belief that many forms of higher education are non-profit or not-for-profit for good reason. The reduction of government subsidies, or the privatization of many educational entities, probably would not bring the universal reign of the for-profit form. We expect the non-profit form to remain robust in many sectors of the higher education market.

The Wilson Quarterly: The New Invisible Competitors

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This excerpt from an article by Tyler Cowen appeared in The Wilson Quarterly on January 22, 2008. Please go to the website to read more.

Remember the Archie comics? Archie and his conceited rival Reggie battle for the affections of Betty and Veronica, and the two girls, though they are best friends, jockey for the attention of Archie, the affable ­all-­American boy. They have been at it for more than 60 years, and in the early days the basic situation wasn’t far removed from the experience of many Americans, especially in small towns. Indeed, cartoonist Bob Montana based the Archie characters on people he knew from his high school days during the 1930s in Haverhill, Massachusetts. Most romantic competition occurred within small groups of people who knew one another. The girl or guy would choose, perhaps the couple would marry and settle down, and often the loser ended up living down the street or across town. Romance was full of heartbreak and anxiety, but at least you knew who your rivals were and who was beating ­you.

The Wilson Quarterly: The Micromagic of Microcredit

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This excerpt from an article by Tyler Cowen and Karol Boudreaux appeared in The Wilson Quarterly on January 12, 2008. Please go to the website to read more.

Microcredit has star power. In 2006, the Nobel Committee called it “an important liberating force” and awarded the Nobel Peace Prize to Muhammad Yunus, the “godfather of microcredit.” The actress Natalie Portman is a believer too; she advocates support for the Village Banking Campaign on its MySpace page. The end of poverty is “just a mouse click away,” she promises. A button on the site swiftly redirects you to paypal.com, where you can make a contribution to microcredit ­initiatives.

New Zealand Business Roundtable: Using Cost-Benefit Analysis to Review Regulation

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Tyler Cowen prepared these thoughts for a New Zealand Business Roundtable in August of 2007. Footnotes and citations have been removed, Please download the PDG to view content in its original format.

1. Introduction

One set of proposals for regulatory reform calls for the government to apply cost-benefit analyses to new regulations, or to apply such analyses to old regulations.

Cost-benefit analysis is an analytic procedure which estimates the net economic value of a given policy or project. It converts all costs and benefits into a monetary metric and then measures whether the benefits outweigh the costs.

Cost-benefit analysis may be characterised by the following concrete procedures:

  • take most of the world as a given, and ask whether a single policy change would be desirable;
  • specify all relevant benefits and costs of that policy;
  • measure those benefits and costs in dollar terms;
  • take those measurements from evidence on market demand and supply functions, as given by economics;
  • discount future costs and benefits accordingly to their location in time, according to appropriate economic formulae;
  • come up with a final figure for net benefits or net costs, using the information generated.Under the proposals considered in this chapter, regulations that did not pass a cost-benefit test would be struck down, not enacted, or at least required to undergo some further process of scrutiny. We consider these proposals by asking three questions. First, does cost-benefit analysis feasibly evaluate the quality of regulations (section 2)? Second, does cost-benefit analysis provide a morally acceptable means of judging regulatory policy (section 3)? Third, is there a feasible institutional machinery for giving cost-benefit significant influence over the regulatory process? (section 4)

    2. What are the Practical Limits of Cost-Benefit Analysis?

    The meaning of cost-benefit analysis is subject to conflicting interpretations. Under one extreme view, cost-benefit analysis can tell us directly whether or not a given policy should be implemented. If the policy passes the cost-benefit test, relative to alternatives, it should be enacted. If the policy fails, it should be rejected. This view, however, requires the extreme claim that economic efficiency is the only value. This view thus commands little assent, by either academicians, policymakers, or the general public.A more modest view suggests that cost-benefit analysis provides a summary statistic for the efficiency of a given project, but that efficiency is only one consideration of many. Nonetheless we need cost-benefit analysis to know the trade-offs involved in policy choice, such as how much efficiency we must sacrifice to achieve other values, if we are so inclined. Cost-benefit tells us the menu of trade-offs which policymakers face.While this second conception of the normative scope of cost-benefit analysis is more reasonable and defensible, it has little bite for regulatory reform. As discussed in earlier chapters of this report, the problems of regulation stem from the poor incentives and information of regulators. Simply doing a cost-benefit study, and telling regulators to think about or weigh the results, is unlikely to improve policy outcomes or strike down bad regulations. We can too easily imagine the regulators simply noting that they have thought about the relevant trade-offs and proceeding apace with costly regulations. The requirement for a cost-benefit study would have simply created another layer of costly bureaucracy.Within the practical realm of regulatory reform, cost-benefit analysis must take on the status of a veto mechanism, if it is to have any bite at all. That is, agencies must somehow be influenced or constrained to reject policies that fail a cost-benefit test. With this in mind, we evaluate cost-benefit analysis in these terms, as a method that can yield an unambiguous no but not produce an unambiguous yes. However overly ambitious this normative conception of cost-benefit analysis may be, it is the only conception that can have a significant impact on real world policy. We must evaluate cost-benefit analysis in more extreme form than its most sophisticated proponents would be willing to defend, and we must evaluate it as a source of policy veto. No one has proposed that an agency is obliged to pass every regulation that passes a cost-benefit test nor would this be a feasible idea, given the nearly infinite number of potential regulations that could be tested.

    The remainder of this section considers a number of the critical issues in cost-benefit analysis and whether these issues are capable of resolution. For a variety of reasons, cost-benefit analysis may be theoretically suspect, practically indeterminate, or susceptible to manipulation. We now survey the key problem areas for cost-benefit studies, including the difference between willingness to pay and willingness to be paid, choice of discount rate, the valuation of human life, option value, non-use values, distributional issues, and whether market prices reflect social opportunity costs. The discussion focuses on whether cost-benefit analysis can yield useable answers; section 3, to follow, focuses on whether these answers are morally sound, just, or acceptable.

    Willingness to pay vs. willingness to be paid

    Cost-benefit analysis has two ways of measuring the benefits of a policy change; namely, willingness to pay and willingness to be paid (henceforth WTP and WTBP). Both sums attempt to measure how many dollars a given change is worth to an individual – how much would an individual pay for that change, for instance, or how much would an individual have to be paid to receive a sum of equal value.

    Problems arise when WTP and WTBP differ by a considerable amount. Consider a simple example. An individual might report that he is willing to pay only $200 to save the sperm whale from extinction. That same individual, if asked how much he would have to be paid, to accept the extinction of the sperm whale, usually will cite a much higher figure. The individual might be willing to accept sperm whale extinction for a payment of, say, $2,000. In this case, which is the correct value for saving the sperm whales for this individual – $200 or $2,000? Economic attempts to evaluate policy are potentially indeterminate.

    In standard economic theory the difference between WTP and WTBP arises from income effects. The postulated individual cannot so easily give up money to save the whales, given budget constraints, but he does not have an equally strong need for extra funds. In the absence of income effects, WTP and WTBP are equal because an individual’s valuation of a policy change is independent of his level of income. And according to standard theory, if income effects are small, WTP and WTBP will differ only slightly. Willig (1976) argued that for apparently reasonable assumptions, both figures would be within a few percent of consumer surplus on each side.

    In practice WTP measures of welfare are usually significantly lower than WTBP measures. Studies of the value of human life which use WTBP, for instance, yield significantly higher values than studies which use WTP. Thaler (1980) reports that the minimal compensation demanded for accepting a .001 risk of sudden death is one or two orders of magnitude higher than the WTP to eliminate a comparable risk, even though a risk so small should not be expected to generate a significant income effect.

    Other significant WTP-WTBP discrepancies from cost-benefit analyses are reported by Knetsch and Sinden (1984, p.508). A sample of duck hunters from the United States indicated that on average, each would pay $247 to maintain a wetlands area for hunting, but would require compensation of $1,044 if the area were to be eliminated (Hammack and Brown, 1984). Survey evidence concerning air pollution found that the average WTBP for giving up clean air exceeded the average WTP for receiving clean air by a factor of four to six (Rowe et al., 1980). Boardman, et.al. (1996, chapter eleven), in their survey of the literature, note differences between WTP and WTBP which range from four to fifteen times.

    Knetsch and Sinden (1984) use laboratory experiments to test the relationship between WTP and WTBP. Individuals confronted with actual monetary payments and compensations revealed unexpectedly wide variations between WTP and WTBP, even for small sums of money. Average WTP for a lottery ticket of small value was estimated at $1.28, whereas average WTBP for the same ticket was $5.18, more than four times greater. Significant disparities between WTP and WTBP can also be found in the experiments developed by Kahneman and Tversky (1982), who find strong evidence for an “endowment effect.” Individuals appear to value their current endowment far higher than any potential additions to that endowment; that is, they attach special value to the property they already own.

    Numerous tests of the endowment effect are examined by Kahneman, Knetsch, and Thaler (1990, 1991). In hypothetical surveys, the ratio between WTBP and WTP for various commodities ranges from 2.6 to 16.5, even though none of the commodities examined accounts for a large part of individuals’ budgets. These gaps do not narrow significantly for real exchange experiments. Heberlein and Bishop’s (1985) study of deer hunting produces a ratio of 6.9 for WTBP vs. WTP, and the study of park trees by Brookshire and Coursey (1987) yields a ratio of 5.6.4

    WTP-WTBP differentials persist even when we control for income effects as traditionally conceived. Knetsch, Thaler and Kahneman (1987, pp.10-11) ran experiments where they adjusted for income effects by appropriately adjusting the wealth endowments of experiment participants. Members of one group, who were designated Sellers, were given a coffee mug and asked whether they would sell the mug at a series of prices ranging up to $9.25. Another group, Choosers, were asked to choose, for the same set of prices, if they would prefer receiving the mug or cash. Median values of Sellers for the mug were more than twice the median values of Choosers, even though income effects (as traditionally understood) were not present.

    The implications of these studies are clear. First, cost-benefit analysis is subject to potential manipulation. If some governmental agency or monitor is given the task of performing cost- benefit analyses, it can produce high or low policy valuations by simply choosing WTBP or WTP. An agency can control outcomes to suit its tastes, to a considerable degree. Second and more importantly, even an honest or non-manipulating agency will not know which figure to use. We simply do not know which policy evaluation is the correct one. We cannot define which figure is the “manipulative” one and which figure is the “correct” one.

    The literature on WTP and WTBP really reflects a more general problem that is simply easier to see in this context, since WTP and WTPB can be measured with relative ease. When we ask how much an individual values a policy change, there is no simple fact of the matter, most of the time. Preferences are never given in pure form, but rather they are mixed in with the context of the choice, how a choice is presented, what is the baseline for the choice, and numerous other factors. For this reason, cost-benefit analysis does not typically produce unique or even closely bunched figures for demand valuations.

    Discount rates

    When costs and benefits accrue in the future, they are typically discounted for time. That is, a cost or benefit in the future counts for less than a cost or benefit occurring in the present. The application of discount rates creates further ambiguities for cost-benefit analysis, especially for policies with long or far-reaching implications, such as environmental policy (Lind 1982 surveys the relevant issues behind choice of discount rate).

    There are two primary methods of choosing a discount rate for policy analysis. The first method uses the real rate of return on private capital to compare future and present values. One typical study (Holland and Myers 1979) estimated such rates of returns at 12.41 percent. After adjusting these returns for risk premiums (more on this below), this method typically generates discount rates between five and ten percent, although these figures vary with country and time period. The second method estimates the social rate of time preference by examining the real rate of return on the near-riskless obligations of the relevant government or fiscal authority. This procedure usually generates discount rates between one and two percent for the United States, although real rates of return in New Zealand often have been higher than that in recent times. The final rate yielded by this second method again will depend on country and time period, but typically it yields significantly lower rates than the first method (for further examples of studies which generate numerical social discount rates, see Boardman et.al., 1991, chapter five).

    A more extreme view, defended by Solow (1974) and Cowen and Parfit (1991) claims that a zero rate of discount should be used for intergenerational decisions. If policymakers create a forthcoming benefit for future generations, those individuals do not have to engage in waiting or abstinence in the meantime. A cost or benefit experienced by the current generation ought not count for more than a cost or benefit to come in the more distant future. Future generations cannot trade in today’s markets and interest rates therefore do not reflect all relevant preferences. Defenders of this view, however, do not necessarily suggest that a zero rate should be used for decisions within a generation. Furthermore, discounting for the uncertainty of future benefits and costs still makes sense, under this view.

    A related literature examines whether policymakers should use riskless or risk-adjusted rates of discount. Kenneth Arrow and Robert Lind, in a famous article, argued that government should use the riskless rate of discount. Arrow and Lind claim that when the government is large and takes on a variety of projects, the social risk of any single project approaches zero. This reasoning subsequently has been criticised by Samuelson (1966) and Bailey and Jensen (1972). Arguably the government and the private sector should use the same discount rate. In a world of well-developed capital markets, as we find in most developed countries, the government and the private sector have access to roughly the same risk-shifting and insurance possibilities. The government typically is large and initiates many projects, but private markets can mobilise a large pool of capital and a large number of shareholders, if doing so would usefully reduce risk. The arguments of Samuelson (1966) imply that the large number of government projects is irrelevant, since adding more risky projects increases rather than decreases risk. Bailey and Jensen (1972) argue that Arrow focuses too much on financial risk and not enough on real risk, in this case the risk of the value of the project output, which is invariant across government or private supply.

    The choice of discount rate has a significant effect on the evaluation of costs and benefits when the time horizon is long. At a five percent rate of discount, the value of one dollar today is more than $4.30 thirty years from now and worth more than $11.40 fifty years from now. Looking even further into the future, one current dollar is worth five billion dollars four hundred and sixty years from now.

    We will not pretend to settle or even fully survey the relevant issues about which discount rate is the correct one. The essential point is that the literature has not reached a consensus on this matter and is unlikely to reach such a consensus in the near future. The proper rate of discount, depending upon one’s theoretical loyalties, can be from as low as zero percent and as high as twelve to fifteen percent. The absence of a consensus reflects the weakness of cost- benefit analysis in generating determinate normative recommendations.

    Governmental agencies cannot be expected to apply the proper discount rate, even if there were a correct answer as to what the proper rate is. The likelihood of correct application here is small, except by accident. Regulatory agencies, even if they are staffed and controlled by very good economists, do not typically have answers to unsolved intellectual problems of this kind. Furthermore, staff economists do not typically control regulatory agencies.

    In practice, regulatory agencies have few incentives to find or apply the correct discount rate. Agency heads are typically not evaluated on the basis of the intellectual contributions or sophistication of their divisions. Rather, the agency is evaluated on the basis of whether its projects and regulations are popular with voters, special interest groups, and other politicians. When agencies are given freedom, they tend to first decide which projects or regulations they want to implement, and then work backwards and apply a discount rate on that basis. The indeterminate status of the academic debate allows for easy manipulability on this count, without the agency even facing a charge of intellectual dishonesty or “excess intellectual flexibility.” If, after all, no one knows what the correct rate is, policymakers have no alternative but to use their own seasoned judgment and intuition.

    Governments typically apply a variety of discount rates without insisting on consistency. In the United States, the Office of Management and Budget tells most regulatory agencies to use a real rate of ten percent. (The Canadian Treasury Board Secretariat advises the same rate and most provincial governments follow suit.) Even in this case, U.S. agencies can use an alternative rate if they can provide justification. The Congressional Budget Office, an advisory arm of Congress, however, uses a real discount rate of two percent. The General Accounting Office, an oversight agency, applies rates more flexibly. For lease-purchase decisions, the Federal government uses the Treasury borrowing rate, plus one-eighth of one percent. We find further examples of flexibility even within single agencies. While the Office of Management and Budget usually uses ten percent, for water projects it follows a different lead. The real rate on water projects is to be taken from the nominal rate on U.S. Treasury borrowing. This rate is usually relatively low but it can be relatively high in times of inflation (Boardman et.al., 1996, pp.176-7). In both theory and practice, the choice of the proper rate of discount remains an unresolved issue.

    Valuing lives

    The valuation of human life provides one of the most difficult issues in cost-benefit theory. As discussed in the opening section of this chapter, cost-benefit analysis works best for changes in government policy which have very small effects on the margin. Yet economics is based on methodological individualism, the view that all costs and benefits are defined only in terms of the preferences of individual persons. A death is anything but a small change for the victim and therefore it resists easy economic measurement.

    The valuation of human life features prominently in cost-benefit issues. Health care, health regulations, safety regulation, welfare policy, disease inoculation, research and development into many kinds of new products, and many other areas of government policy affect who lives and who dies. If we consider all of the consequences of policy, nearly every policy has life and death implications. Nearly all policies change the prevailing level of wealth, in one direction or the other. Lower levels of wealth usually end up leading to the death of some individuals or others. Poorer people take more dangerous jobs, buy less safe cars, and more generally they invest less in protecting their lives. Given that most policies are matters of life and death, at least for some, cost-benefit analysis cannot avoid taking a stance on how a human life should be valued.

    Cost-benefit analysis usually treats the value of life by measuring the value of risks of death or increased chances of safety. Economists can examine, for instance, how much an individual will pay to lower the risk of dying in a fire. Purchase of a smoke detector, for instance, may lower fire-related death probability by 000.1 percent, or one thousandth of one percent. If a purchased smoke detector costs 50 dollars, cost-benefit analysis can value a one percent chance of death at $50,000 dollars. Going even further, these figures can be used to value a certain death at five million dollars. This final sum of five million dollars can be constructed from a group experiment. If we subject a set of 100,000 individuals to this given risk, on average one of them will die, given the laws of probability. The value that the group would pay to avoid this risk, taken collectively, is five million dollars. Cost-benefit analysis therefore takes the value of one life as equal to five million dollars, at least given the numbers postulated for the example. In the terminology of some economists, cost-benefit analysis values “risk reduction for groups”, rather than valuing life per se.

    Ted Miller (1989) performed a comprehensive survey of valuation of life studies, examining 49 studies and picking the 29 that best met standards of scientific accuracy. From these 29 studies, the average value of life was U.S. $1.95 million, measured in 1985 dollars. Most of the valuations were within the range of $1 to $3 million. The studies based on contingent valuation, which used surveys and questionnaires, yielded somewhat higher results than average, typically generating figures above $2 million. Fisher, Chestnut, and Violette (1989) find figures ranging from $1.6 million to $8.5 million in their survey of 21 studies, noting that the lower figures appear to be the more reliable ones. Viscusi (1993) examines 14 labour market studies and comes up with figures ranging from $3 to $7 million, using 1990 U.S. dollars. It is difficult to assess whether this consensus is more illusory than real, given that researchers may aim to have their results fall within the appropriate range and that “publication bias” may discriminate against estimates outside of that range.

    A variety of critics have questioned the appropriateness of these procedures. The extant criticisms can be broken into two categories, practical and conceptual. The practical criticisms question whether we do in fact have good measures of the value of risk reduction. Data are usually taken from market demands for safety equipment (such as smoke detectors) or wage premia for especially risky jobs.

    Neither provides an exact measure of risk reduction in the pure sense. In the case of smoke detectors, for instance, individuals may not have a good idea of the fire risks involved or the ability of smoke detectors to lessen those risks. The demand for smoke detectors may depend more on public relations campaigns and peer pressure, than on objective assessment of the value of risk and the value of life. Furthermore, smoke detectors (or any other safety device) provide a host of ancillary services, such as property protection. The “value of life component” of the price is difficult to separate out. Wage data for risky jobs present similar ambiguities of interpretation. Jobs differ in many concrete aspects, and even advanced regression analysis cannot easily separate out the “risk component” for a particular job and attached salary. Furthermore, the individuals who take relatively risky jobs most likely value their lives less than average, again making the selected measure unreliable. Finally, individuals do not always judge small probabilities with full rationality (Kahneman and Tversky 1979).

    The second and more fundamental set of criticisms question whether economic analysis can value a life at all, even in principle. Extant methods place great stress on the value of “risk reduction,” and are loathe to examine cases where analysts know that one individual will die with certainty. Cases of certain death, however, pose more fundamental difficulties for the cost-benefit method.

    Many policy options involve cases where we know that an identifiable individual will die, unless specific action is taken to prevent this outcome. Health care economics provides the most obvious set of examples, or cases where a mountaineer is lost and resources are being devoted to rescue. How far should society go in saving a set of known victims? If an individual or group of individuals suffers from a potentially fatal disease, how many resources should be devoted to trying to find a cure?

    The economic cost-benefit method, if applied naively, suggests using either willingness to pay or willingness to be paid criteria for these decisions. Yet these magnitudes do not appear to provide satisfactory answers. Willingness to pay, to save one’s own life, is bounded by how much money an individual has. This magnitude simply happens to measure historically accumulated wealth, rather than how much the life is actually worth. To that individual, the life has infinite or near-infinite value. Some individuals may not be willing to give up all their money to save their lives, given altruistic bequest motives, and this may keep down willingness to pay for staying alive. Nonetheless it does not seem proper to conclude that these lives should be worth less; if anything, the presence of familial altruism should make the life worth more. Cost-benefit analysis, as expressed through willingness to pay magnitudes, works best for small changes in wealth but works very poorly for large changes, as represented by a potential death. Valuing “risk reduction” is a fudge which does not work in all circumstances, if indeed in any.

    Instead of using willingness to pay to stay alive, the analyst could look at willingness to be paid for dying. The conceptual difficulties mount even further, though. For a purely selfish individual, the compensating variation for death is infinite. That is, no amount of money will induce that individual to die. WTBP may be less than infinite for altruistic individuals, who wish to die and donate the money to family or charity, but again this does not mean that the lives of these individuals are worth less. It simply implies that they feel more altruism towards others, not that they care less about themselves.

    The inability of cost-benefit analysis to handle cases of certain death raises questions about stochastic death as well, that is about valuing risk reduction. Say that a given policy creates risk for some set of individuals. Why should it matter whether or not we know the exact identities of who dies? Take a policy that would spend $500 million to increase food safety for a small number of products. The expected number of lives saved is, by construction of the example, one. Cost-benefit analysis normally would reject such an investment but it is not clear why. If we knew the identity of the saved life, the value of that life would be infinite or near-infinite to that individual. Why shouldn’t the internal logic of cost-benefit analysis suggest using the value that is based on greater information about the final outcome? Consider the comparison between the perfect information WTBP and the imperfectly informed WTBP. The real world has imperfect information and we do not always know who will die. Nonetheless we do know that the perfect information WTBP is very high, perhaps infinite, no matter who dies. So why not use this latter magnitude? Such a move, however, would cause cost-benefit analysis to break down and cease to yield useful or determinate answers.

    This argument is not suggesting that individual lives in fact have infinite or near-infinite value, relative to other social goals. Virtually all plausible moral theories reject this conclusion; we should not devote the entirety of gross domestic product to research into terminal diseases, for instance. Rather the argument is that cost-benefit analysis, which relies exclusively on dollar valuations, cannot meaningfully bound the value of human life. Our rationale for bounding the value of human life must come from outside of cost-benefit analysis, implying that cost-benefit analysis is missing something fundamental about the value of an individual life to society.

    To sum up this discussion, economic analysis has not provided a fully satisfactory means of valuing human lives. Current methods for valuing risk reduction are useful in the sense that they often make correct recommendations: we should not spend an infinite amount to save a life. Nonetheless these methods do not grapple with or resolve the difficult issues. For both practical and conceptual reasons, the value of a human life does not appear to be adequately expressible in dollar-based terms. Economic methods for valuing human life therefore represent a value judgment on the part of the economist, rather than a fully objective application of the cost-benefit method.

    Option value

    The concept of option value provides another potential ambiguity in the application of cost- benefit analysis. As the name would indicate, option value refers to the value that consumers place on having the “option” to consume a given good or service. The example of National Parks illustrates the concept. According to the option value hypothesis, the value of National Parks is greater than is measured by the number of people who go in a given year. The value depends also on the options of going, as experienced by many people, some of whom end up not visiting. Even though many New Zealanders did not go to National Parks last year, they had the option of going. This option was worth something to them and arguably should enter the cost-benefit calculus.

    Option value is an attempt to express the ex ante value of economic resources. Older cost- benefit techniques typically measured the expected value of consumer surplus, that is the benefits that would be expected to materialise ex post. Option value measures the value of a policy, given that consumers do not know exactly which contingencies will occur (e.g., they do not know whether or not they wish to visit a National Park, in the context of the example).

    Option value can dramatically affect the outcome of a cost-benefit study. Many goods and services, or policies, do not affect the immediate consumption patterns of large numbers of people. The potential holders of “option value” often are very large, relative to those who actually pay for the good or service. When individuals are asked about their option value for a National Park, they typically will give an answer of at least some positive sum, even if they live far away from the Park or never go to parks. Counting option value can significantly increase the measured benefits of a public good.

    The debate over option value has not been resolved. Critics of the concept charge that it is ghostlike and mystical and that individuals claiming to have “option value” are simply engaging in cheap talk. After all, many of those individuals do not end up making the trip to the relevant National Park. The critics also argue that if we count all the people who make the trip, over a sufficiently long period of time, that we have a close enough approximation to option value in any case. Finally, the costs of the project also involved an “option value” on other goods and services; if we count option value for the benefits we should count an option value for the costs as well. Why not then simplify the entire procedure by not counting option value in the first place?

    Defenders of the option value concept point to its established place in economic theory. In a world of uncertainty, individuals truly do have demands for the ability or option to consume a good or service. The value of warranties, contracts, and financial options reflects this value in tangible form. Although the value of the relevant option is less tangible when we consider public goods like National Parks, it need not be less real.

    We will not attempt to resolve the option value debate in this context. The relevant issues span both philosophy and economics and have been the subject of numerous articles in the academic literature, as cited above. The relevant point again is that option value decreases the ability of the cost-benefit method to yield determinate results. A policy can look much better or worse, simply through the decision of whether or not to count option value. Cost-benefit analysis becomes more malleable, more susceptible to political influence, and less likely to serve as an independent check on policymakers.

    Non-use values

    Non-use values are a concept related to option value, but they do not rely on consumer uncertainty about prices or quantity. Non-use values arise when some individuals value a given state of affairs, even if they are not consumers of the relevant good or service. Again, environmental issues provide an example of the relevant issues. Some individuals may value the very existence of the blue whale, even if they never go see a blue whale or directly benefit from the blue whale in any way. These individuals simply take a kind of comfort in the existence of the blue whale, or in its ability to withstand extinction.

    The concept of non-use value is theoretically sound, given the emphasis in economics upon the subjectivity of value. “Use” is in any case not defined objectively, but rather in terms of whether or not consumers value a given state of affairs. Despite this sound theoretical foundation, non-use value creates practical problems for cost-benefit analysis. In the absence of measured or estimated market demands, there is no easy way to measure non-use values. In the case of blue whales and other environmental amenities, for instance, the relevant goods and services are not traded on any active market.

    In practice, the cost-benefit analyst must rely on questionnaire and survey evidence, when seeking to estimate non-use values. These forms of evidence are unreliable for a variety of well-known reasons. Most significantly, individuals do not always report their true demands when asked. Individuals will claim to value the blue whale more than they really do. It is easier to announce a high valuation when the queried individual does not actually have to put up the money. In other cases, non-use values will depend critically on how the questions or questionnaire are being worded.

    Non-use demands also may be subject to manipulability by outside parties. In 1989 several whales were saved off northern Alaska from encroaching ice; the rescue became a media event and attracted worldwide attention. Presumably the “non-use” values for these whales skyrocketed at this time; suddenly the fate of the whales had significant value to millions of people. Whether this preference was “real” or just a “temporary creation of media dramatisation,” remains a moot point.

    The cost-benefit analyst also needs to find out how many individuals have non-use values for a given good or service. Again, since no market exists for non-use values, this enterprise is largely speculative in nature. The cost-benefit analyst might try to obtain a sample population for estimation, but non-use values may differ with demographics, geography, and other factors which are difficult to adjust for. If the number of excluded individuals, or falsely included individuals is large, the outcome of the cost-benefit study could be seriously affected. As with option value or choice of discount rate, we see that non-use values render cost-benefit judgments more problematic, and more easily susceptible to manipulation, than cost-benefit advocates would have us believe.

    Distribution of wealth

    Applications of cost-benefit analysis must start from a given distribution of wealth. That is, given some pattern of resource ownership, what is the most efficient or wealth-maximising policy? Cost-benefit analysis cannot tell us what is the best outcome, among all possible outcomes that might exist. Rather, it compares small changes from some given starting point. For instance, given the current distribution of wealth in New Zealand, should new regulations on food safety be implemented or not?

    Although cost-benefit analysis takes the initial distribution of wealth as given, cost-benefit analysis nonetheless can incorporate some kinds of equity considerations. Cost-benefit analysis can treat “economic value for poor people” differently from “economic value for rich people,” for instance. Economists have developed methods for weighting the value of dollars, depending upon who receives them. A cost-benefit analysis might, for instance, value a given dollar 1.5 if it goes to the very poor, where dollars to the rich remain valued at 1.0. This practice is sometimes called distributional weighting (Harberger 1978, Holtmann 1991).

    The ability of cost-benefit analysis to incorporate equity values at the margin is both a strength and a weakness. On one hand, cost-benefit analysis shows its ability to reflect the common moral intuition that the distribution of wealth matters. On the other hand, considering distributional concerns moves cost-benefit analysis away from its role as “efficiency watchdog.” The very purpose of cost-benefit analysis is to show whether a proposed policy is consistent with economic efficiency. If not, there may be some other, better way of achieving the same ends. If cost-benefit analysis gives up this watchdog role, and tries to incorporate ancillary ethical considerations, it loses its bite and effectiveness. The trade-off between distribution and efficiency perhaps is best performed during final policy debate, once the cost-benefit analysis is finished, rather than within the cost-benefit analysis itself.

    Distributional weights also increase the manipulability of cost-benefit analysis. Given that distributional weights are an established academic procedure (albeit one that does not command universal acceptance), cost-benefit practitioners can use such weights at the regulatory level to make a given policy look better or worse. Since there is no academic consensus on what the weights should be, if they are to be used, there is no intellectual check, much less an effective practical check, on the agencies in this regard.

    Finally, critics have argued that the efficiency cost of distributional weights is likely to be high. Distributional weights can easily lead us to approve policies that destroy considerable sums of economic value (Harberger 1978). The tax system, or welfare policy, provide arguably more efficacious means of redistributing wealth.

    Market prices and equilibrium

    Finally, cost-benefit analysis requires that market prices are relatively close to their equilibrium values. The price of a resource is used to measure its social opportunity cost, that is, how much value can be produced with that resource. So if it costs $500 million to equip automobiles with air bags, the cost-benefit study assumes that if not for the regulation, those same resources could have produced $500 million in value elsewhere.

    The assumption that price reflects social opportunity cost relies upon ancillary presuppositions. First, market participants must be relatively well-informed about how to maximise value and how to spot profitable opportunities for resource deployment. Perceptual biases of the kind identified by Kahneman and Tversky (1979) will lead to splits between prices and true social values. Second, the relevant markets must come closer to market- clearing; that is, prices must balance supply and demand to a point of equality or near equality. Otherwise the price is reflecting artificial conditions of bottlenecks, surpluses, or regulations, rather than resource value. Third, resource uses should not involve positive or negative social externalities; that is, the price should reflect social value as well as private value. Consider, for instance, a regulation which destroys or consumes real resources that would otherwise have gone into pollution-producing economic sectors. The real social value of these resources will be less than their observed market prices.

    Cost-benefit analysts can attempt to adjust for these imperfections in market prices when performing their studies. Nonetheless the attempted adjustments are conjectural to large de- gree. The analyst must try to estimate some equilibrium other than the state of affairs that prevails in the market. For the same reasons that central planning is so difficult, the external observer, the economist, cannot predict another equilibrium with much confidence either. Application of cost-benefit analysis therefore is of moot validity, given that the above assumptions about prices and equilibrium do not typically hold.

    Summary remarks on section 2

    The survey of the above issues indicates that the practical and theoretical application of cost- benefit analysis is problematic on a variety of grounds. We do not intend these remarks as dismissing cost-benefit analysis altogether. As we will discuss further below, cost-benefit studies still may provide useful information to policymakers. Nonetheless proposals for cost- benefit analysis cannot claim a mantle of pure scientific objectivity and efficiency. The practical application of cost-benefit analysis involve a significant number of controversial value judgments. Proposals to expand the use of cost-benefit analysis should be viewed in that light. The cost-benefit method is not a fully objective means of measuring value, but rather relies upon a series of value judgments that have become embedded in the practice of economics as we know it.

    3. Moral Presuppositions of Cost-Benefit Analysis

    We also must consider whether we should follow the guidance of the cost-benefit method, even if cost-benefit studies have no practical or conceptual problems. This section turns to that topic and considers the normative limitations of cost-benefit analysis.

    The following discussion, throughout, draws a distinction between the advanced frontiers of welfare economics and the actual practice of cost-benefit analysis. Over the last several decades, welfare economists have developed rich and challenging analyses of cardinal utility, changing preferences, and how to analyse varying distributions of wealth. But these ideas have not filtered down into practice of cost-benefit analysis, nor will they in the foreseeable future. For better or worse, they are primarily theoretical constructs, based more in philosophy than in practical policy evaluation. The more philosophical parts of welfare economics are useful for helping us think about moral problems, but they do not provide useful and replicable means for policy analysis by regulatory agencies. Both the virtue and the failing of cost-benefit analysis is its (ostensible) simplicity. Cost-benefit analysis must be based on measurable dollar magnitudes if it is to have operational meaning. This reliance on measurable dollar figures forces the cost-benefit analyst into relying on observable, ordinal demands, based on the prevailing distribution of wealth.

    Wealth vs. utility

    Cost-benefit analysis encounters problems from its unwillingness to consider cardinality and interpersonal comparisons of utility. Most welfare judgments, whether economists like it or not, express underlying interpersonal comparisons of utility and intuitions of basic cardinality. Most people believe that New Zealand has a better economic system than does Albania, and they are willing to offer advice on this basis, as either economists, politicians, citizens, or in other capacities as well. Yet upon inspection, this judgment requires interpersonal comparisons of utility. At least some individuals in Albania, such as political leaders, may be better off than some New Zealanders. So we cannot say that all New Zealanders are better off than all Albanians. In a strictly ordinalist framework we cannot even say that any New Zealanders are better off than any Albanians. The New Zealanders and Albanians have different utility functions, which do not admit of direct comparison. We do observe that more people would emigrate from Albania to New Zealand than vice versa, if they could, but even this fact cannot be directly translated into a comparison of aggregate welfare for one group of citizens against the other, at least not without stepping outside a narrowly ordinalist framework. It means only that a given set of Albanians would prefer to live in New Zealand.

    The need for cardinal or quasi-cardinal judgments in policy analysis is common. Very few policies constitute universal Pareto improvements, making everyone better off (or worse off, for that matter). Arguably there is not a single policy that avoids having to weight conflicting interests. How then does cost-benefit analysis arrive at a final policy recommendation, given that Paretian unanimity so rarely holds?

    Wealth maximisation as a standard

    Defenders of cost-benefit analysis have not offered a compelling reason for its normative validity. Why is a policy good if it passes a cost-benefit test, and conversely, why is a policy bad if it fails a cost-benefit test?

    One option is the modest claim that cost-benefit analysis merely represents one consideration and does not provide a final normative standard. This claim, while reasonable, does not provide much bite for practical policy analysis. As discussed in the second section of this chapter, we must consider varieties of cost-benefit analysis which actually veto policies which fail the cost-benefit test, otherwise the cost-benefit mandate will have little practical effect on regulatory policy. In other words, we must examine interpretations of cost-benefit analysis which carry relatively strong normative claims.

    A more ambitious argument for cost-benefit analysis cites wealth maximisation as an appropriate normative end (Posner 1981; see also the “Kaldor-Hicks” standard of cost-benefit analysis, which looks only at total wealth, rather than whether every person benefits). Wealth maximisation includes not only measurable material wealth, but also the dollar value of intangibles such as leisure time, environmental amenities, the value of social capital, etc. Wealth maximisation therefore is a modified version of utilitarianism, the philosophy of maximising utility. It suggests maximising the total amount of good in society, while measuring “good” through the medium of monetary values. It does not require or suggest that money or material values are the only goods in society.

    Sometimes wealth maximisation is given a contractarian or Rawlsian defense (Leonard and Zeckhauser 1986). That is, if individuals were placed behind a veil of ignorance, not knowing their future identities, they might prefer a standard of wealth maximisation. This argument, however, is question-begging. We do not know what individuals would choose behind a veil of ignorance. Furthermore, that choice should be determined by “correct moral principles,” which is precisely what we are trying to discover and agree upon.

    The case for wealth maximisation has not commanded universal or even general assent. Most generally, wealth may not be a good proxy for other, non-wealth values, such as justice, equality, dignity, and human rights, especially along the margins of very small changes. (It is more plausible to claim that very wealthy countries have more of these other non-wealth values than do very poor countries.) The connection between wealth and other values would have to be demonstrated before a wealth maximisation standard could be accepted.

    A further criticism applies a reductio ad absurdum to the wealth maximisation standard. If we take wealth maximisation seriously as a value, why should we stop at the limited, partial equilibrium perspective of cost-benefit analysis? Cost-benefit analysis takes the distribution of wealth as given, but a more general wealth maximisation standard need not do so. The wealth maximisation standard, if taken literally, suggests that we should evaluate the entire prevailing distribution of wealth in terms of its ability to maximise wealth. Why not, for instance, confiscate the assets of old ladies and redistribute them to Bill Gates? Gates presumably can create more wealth with those assets than the old ladies can.

    Most individuals resist this conclusion because they believe it would violate rights and be unfair. Furthermore, the victimised old ladies may have “basic needs” which are lexicographically more important than the wealth which Gates could create. All of these considerations, rooted in common sense, militate against a strict wealth maximisation standard. They also raise questions about the applicability of wealth maximisation in more limited contexts, such as the partial equilibrium assumptions which underlie cost-benefit analysis. Individuals attach importance to social values which cannot be reduced to wealth and which may even conflict with creating more wealth.

    Other critics (Kelman 1981) have charged that using a wealth maximisation standard is inherently undesirable and degrading, because it seeks to attach a dollar value to everything. Some commentators find cost-benefit analysis repugnant for this reason.

    We are unwilling to attach dollar values to many states of affairs in ordinary life. Individuals do not, for instance, usually place dollar values on their marriages. Individuals do not say “my marriage is worth three million dollars to me.” Not only would this kind of statement be distasteful, but making the statement would belittle the marriage and make it worth less. Individuals create value in our lives, in part, by deliberately refusing to make or even countenance some trade-offs. In similar fashion individuals do not attach direct monetary value to their children, friendships, or lives.

    These same individuals nonetheless make economic trade-offs when it comes to these values. Parents, for instance, do not spend all their money on the very safest (and most expensive) automobile, even though such a vehicle would make their children safer. In that sense parents do place economic value on the lives of their children. We can say that in one sense parents do not place economic value on their children and that in another sense they do. The question then remains which of these attitudes should be distilled into public policy. Critics of cost-benefit analysis favor the first attitude, the one in which parents do not place direct economic value on the lives of their children. They believe that public policy should reflect the same kind of attitude. At some margin we must make economic trade-offs, but a humane and caring society should nonetheless limit how much it views these trade-offs in explicitly economic terms.

    In addition, the wealth maximisation standard assumes that the best outcome can be determined by adding up separate values, in particular by adding up sums of wealth; this assumption has been questioned by many philosophers (see, for instance, Hurka 1993). Value may be irreducible and holistic, rather than additive. When comparing one social outcome to another, the evaluation of overall patterns cannot always be broken down into separate additive parts.

    We may, for instance, judge Switzerland to be a better society than India, for largely holistic reasons and not because we have “added up” more value in Switzerland. Switzerland arguably is more free, more just, and places greater emphasis on human dignity. It comes closer to our idea of a good society. We could imagine an economic policy that made Switzerland poorer, by making Switzerland more like India, and therefore increased Swiss population, albeit at considerable cost to the overall desirability of Swiss society. Holistic views of ethics imply we do not necessarily have to perform a cost-benefit analysis to reject this alternative. We know that making Switzerland more like India runs counter to fundamental human values and we reject the decision outright. We need not measure the gains from a greater Swiss population, and weigh them against the lower level of per capita wealth, to reject the policy. Instead, we simply note that Switzerland would have moved away from our vision of a good society.

    Critics charge that cost-benefit analysis, by seeking to add and sum all values, gives short shrift to the holistic nature of value and inherently non-economic considerations. This argument has been applied, for instance, to the debate over public access for the handicapped. Many buses in the United States are equipped with special lifts that allow for handicapped boarding [do you have a comparable NZ example?]. The technology is very expensive and some critics have noted that it often would be cheaper to hire a private chauffeur for each and every handicapped person. In this sense the handicapped lifts fail a cost-benefit test. Many defenders of the handicapped lifts nonetheless stand by the policy, even though they are aware of the great expense, relative to hiring chauffeurs. They believe that the value “equal treatment for the handicapped” takes priority over the cost-benefit stipulation “save money by hiring chauffeurs.” The former value corresponds more closely to their idea of a good society, even if it costs more.

    Defenders of cost-benefit analysis typically defend the nature of their enterprise and the additivity assumption on the grounds of methodological individualism. In this view, all values are values to specific individuals. The claim “X is good” is reducible, ultimately, to claims of X being good for some specific set of individuals. This is exactly the claim which holism denies. Holism claims that social states of affairs can be good (or bad) on the grounds of objective values such as freedom, equality, meeting basic human needs, etc. In the holistic view, these values carry weight independently of our ability to trace them back to the interests or preferences of specific individuals.

    Judging preferences

    Policies which change preferences provide a further challenge to the presuppositions of cost- benefit analysis and also to the case for wealth maximisation. As mentioned in the first section of this chapter, cost-benefit analysis takes preferences as fixed and given in estimating market demands. Cost-benefit analysis therefore has a difficult time evaluating policies which change preferences, since such policies remove the fixed benchmark for comparison.

    Consider a government which is evaluating two alternative educational policies. One policy will instill a strict work ethic in the citizenry, but at the cost of diminishing some of their ability to enjoy life (note that the concept of an “ability to enjoy life” cannot even be defined in a strictly ordinalist economic framework, which cannot compare one set of preferences to the other). The second policy leads to a weaker work ethic but arguably a greater ability to enjoy life. Cost-benefit analysis will, without hesitation, recommend the first educational policy. It creates greater wealth and therefore beats out the second policy in a cost-benefit comparison.

    Yet it is not clear that the first policy is better, all things considered. Not only does cost- benefit analysis give us the wrong answer in many cases, it does not even give us a frame- work for considering questions of cardinal utility and interpersonal comparisons. Cost- benefit analysis gives us no means of comparing the two educational policies and the two sets of preferences which result. In other words, cost-benefit analysis gives us no guidance as to how wealth translates into utility or human well-being.

    The issue of how wealth translates into well-being applies generally across a range of cost- benefit issues. Critics of cost-benefit analysis argue that some forms of wealth translate into ultimate human well-being more readily than do other forms of wealth. An environmentalist, for instance, might believe that the economic value of a beautiful view produces more “real” human satisfaction than an equivalent economic value found in ordinary consumer markets, such as beer or potato chips. While this argument may smack of paternalism to some, it cannot be answered within a purely economic, cost-benefit framework, it simply lies outside of that paradigm. Similarly, the economic value of meeting “basic needs” for all citizens may produce more real satisfaction than an equivalent quantity of economic value produced through financial market activity. Again, the point is not that either of these claims is necessarily correct. Rather, cost-benefit analysis has no general mechanism for helping us analyse or evaluate such claims.

    4. Implementation of Cost-Benefit Proposals

    The above discussions have focused on the normative status of cost-benefit analysis, but they have not considered how cost-benefit analysis might be given greater influence over policy. This section considers a number of proposals for reform, focusing on what is actually feasible. The question is not how cost-benefit analysis might be best used ideally, but rather how can it be used in the real world, given the imperfections of politics.

    The simplest and most direct option requires the issuing agency to perform the cost-benefit study itself. A second and arguably more radical option would create a separate agency or institution empowered to conduct cost-benefit studies of the regulations of other agencies. The United States Office of Management and Budget performed this function partially during the Reagan years, as we will discuss in more detail further below.

    The trade-off between these two kinds of proposals is clear – put simply, the first proposal is easier to implement but also less effective. It is cheaper to allow agencies to perform their own cost-benefit analyses. Agencies are intimately familiar with their own activities and with the industries or sectors they regulate. The agencies might need to add economists and other researchers to fulfill a cost-benefit mandate, but the proposal for cost-benefit analysis of regulation could be enacted within the structure of the current bureaucracy. In this regard the first option involves lower costs and could be implemented more easily.

    This same cost advantage, however, points to the problem with agency cost-benefit studies. Agencies which evaluate their own activities are unlikely to provide a substantial independent check on their excesses. If a given agency wishes to pass a particular regulation, we can imagine that same agency manipulating the cost-benefit study to produced the desired outcome (the manipulability of cost-benefit analysis is discussed further below). The first proposal, in essence, is asking the fox to guard the henhouse.

    The creation of an independent agency, with the ability to strike down regulations of other agencies, would change the balance of regulatory influence, with both positive and negative effects, at least if the independent agency had a real mandate to apply cost-benefit checks. Individual regulatory agencies would lose power, at the expense of this hypothetical supra- agency. Agency policy decisions would never be final but always would be subject to this further check and balance.

    Most importantly, the supra-agency would have considerable control over the individual agencies and would use that control to achieve a variety of ends, not just striking down inefficient regulations. The supra-agency could influence the content of regulation for ideological, political, or special interest ends. Agencies would have to comply with these influences, knowing that their proffered regulations could otherwise be struck down, held up, or changed beyond recognition. Most likely, some kind of bargaining equilibrium would be established between the supra-agency and the individual agencies, due to repeated trading and dealing over time. Regulatory power would become more centralised and more subject to external non-agency manipulation; such manipulation, of course, can produce both desirable and undesirable results.

    Whether a centralisation of regulatory power would improve the quality of regulation is open to dispute. On one hand centralisation increases the likelihood of sweeping, dramatic reforms for the better. The reformers need only control or influence a single central agency. On the other hand, the greater centralisation could favour a long-run expansion of regulation. Regulation would become more politicised, easier to manipulate, and more easily subject to political horse-trading. This does not necessarily provide a favourable long-run recipe for regulatory reform.

    The evidence on this matter is mixed, largely because experience with serious procedural regulatory reform is scanty. Administrations have undertaken regulatory reform, across the world, but these reforms have usually been accompanied by sympathetic regulatory appointments. That is, those same governments appointed agency heads who favoured deregulation or regulatory reform and were willing to work towards those ends. It is difficult to trace how much of the deregulatory impetus came from procedural reforms and how much came from the sympathetic appointments, but the appointments appear to have been the more significant factor in most cases. How a pure procedural change would operate, if not accompanied by sympathetic regulatory appointments, remains an open question.

    The Reagan experience with cost-benefit analysis

    The experience of the Reagan administration in the United States illustrates the difficulty of implementing cost-benefit analysis for regulations. Although the United States and New Zealand forms of government differ considerably, the United States nonetheless offers some lessons about potential pitfalls in regulatory reform. For the most part, serious applications of cost-benefit analysis did not get off the ground in the United States, despite a sympathetic executive branch.

    In the first month of the Reagan administration, Reagan issued Executive Order 12291, which called for all regulatory agencies to submit proposed major regulations to the Office of Information and Regulatory Affairs (OIRA). OIRA is part of the Office of Management and Budget, which answers directly to the President, rather than to Congress. OIRA was then bound to submit all proposed regulations to a cost-benefit test and recommend rejection for those that failed. While an agency could still promulgate a regulation that failed the OIRA test, it would have much less political support and risk future presidential or OMB reprisals on other issues. “Major” regulatory initiatives are defined as exceeding $U.S. one hundred million in cost.

    Reagan neither changed the agencies which generated regulations, changed the procedures of those agencies, nor did he manage to pass a new legislative statute governing the implemen- tation of such regulations. He simply issued an Executive Order that created one additional check on the regulation-generating process. Later, at the beginning of Reagan’s second term, he issued another Executive Order 12498, which required agencies to disclose regulations that were “planned or underway” and evaluate them with cost-benefit criteria.

    OIRA immediately became unpopular with the Washington bureaucracy, for obvious reasons. The agencies suddenly had less power and had to answer to external authorities whose knowledge and expertise they did not respect (Friedman 1995, chapter 3).

    In reality, OIRA did not place much heed on cost-benefit analysis. If a given set of proposed regulations achieved unpopular press, OIRA officials were under strong political pressure to strike that regulation down. OIRA employees knew that they could advance through the bureaucracy by striking down regulations with bad press. While the failed regulations may well have been undesirable, the reality was that politics and publicity had greater influence than dispassionate economic analysis (Friedman 1995, chapter 4). OIRA never demonstrated its expertise with cost-benefit analysis, and some OIRA officials confessed that their major strategy was a “laugh test”; if a given regulation induced laughter, they struck it down. To some extent, OIRA also became a “final court of appeals” that business lobbyists could go to, if they believed that a given regulation was too costly but could not convince Congress to repeal it.

    The Reagan campaign against regulation failed to attract public support, in part because the regulatory reforms appear no more legitimate than the regulations themselves. Reagan’s Executive Order never passed any legislative process or was given any kind of mandate, unless one counts Reagan’s initial presidential victory as a mandate for deregulation (which is arguable, since Carter had been pursuing deregulation already). Numerous opinion polls documented that public support for government regulation increased, rather than decreased, over Reagan’s terms (Friedman 1995, p.155). Most of the victories won by OIRA were one- time only, and concentrated in highly visible areas. Reagan’s program for regulatory reform did not portend any permanent decline in the burden of regulation.

    The eventual fate of the Reagan regulatory reform program reflects its failures to orchestrate systematic change. In the closing years of the Reagan administration, Reagan had less political capital to expend on fighting regulations. Leadership at OIRA became moderate and the process of regulatory review settled into a routine. By the time the Bush administration took over, in early 1989, regulation was again on the rise; the Bush administration is commonly considered to have been a “regulatory renaissance.” Regulation, whether measured by number of rules, number of pages in the Federal Register (where new regulations are published), or measured by expenditures, was again growing in real terms. Bush simply did not have the commitment to regulatory reform that Reagan did and Bush did not make equally “deregulatory” appointments (on the Bush era, see Friedman 1995, chapter 10).

    Under Clinton, of course, regulation has continued to grow with few checks. In 1993, Clinton issued Executive Order 12866, which in letter supported and strengthened Reagan’s Executive Order. The reality has been quite different though, and free market economists typically have criticized the Clinton Administration for promulgating excessively costly regulations. The Clinton Administration experience with this Executive Order lends further support to the view that the key issues are ones of personnel, and the agendas of regulators, and not whether some formal mechanism mandates a cost-benefit study.

    In sum, cost-benefit proposals have yet to specify an adequate institutional machinery for implementation. Either the forces favoring the status quo ex ante tend to re-emerge, or cost- benefit proposals must create a supra-authority with potentially expansionary powers.

    5. Summary Remarks on Cost-Benefit Analysis

    The arguments against the ambitious normative interpretations of cost-benefit analysis are numerous and relatively strong. These arguments concern issues of political implement- ability, practical and conceptual limitations, and moral foundations.

    Cost-benefit analysis nonetheless continues to command influence and respect. The reason is simple. There is a wide class of decisions for which cost-benefit analysis does in fact give the right answer. If someone were to suggest towing in icebergs from the North Pole to address New Zealand water shortages, cost-benefit analysis will give what we intuitively know is the proper answer, which is no, the iceberg towing should not occur. As long as cost-benefit analysis satisfies this gut level intuitive test, it will retain some role in the evaluation of policy, even though its more ambitious interpretations are subject to the limitations discussed above.

    When attempting to construct a program of regulatory reform, however, cost-benefit analysis should not take the primary seat. In practice cost-benefit analysis is unlikely to serve as an independent, objective check on regulatory policy, for better or worse. In normative terms, cost-benefit analysis is largely another set of value judgments, albeit a set of value judgments in line with modern economic thinking. For purposes of practical regulatory reform, cost- benefit is, at best, a useful label under which some ridiculously costly policies can be struck down. It is a myth to think that cost-benefit analysis could ever serve as an objective gatekeeper and measurer of efficiency on a truly widespread scale.

    Interestingly, cost-benefit analysis itself has not been subject to a cost-benefit test. Depending on the scope and quality of the analysis, a good cost-benefit study can cost up to $U.S. 800,000 (Friedman 1995, p.47). The political and lobbying resources needed to have the test made in the first place are, in many cases, much greater. These factors also militate against placing too much hope in cost-benefit analysis.

    Nonetheless if cost-benefit analysis does result in even a few costly proposals being struck down, its role in policy analysis should not be resisted, whatever its normative and practical limitations. Cost-benefit procedures may provide a useful supplement to some other well- thought out program for regulatory reform. This more modest claim, however, is quite distinct from arguing that we should push for greater use of the cost-benefit method. Perhaps the most accurate recommendation is to say that a call for a cost-benefit test should not be resisted, provided that the political and material resources for the test come from elsewhere. Giving cost-benefit analysis a greater voice in policy may lead to fewer bad regulations than otherwise, but cost-benefit analysis is not up to serving as a centerpiece for regulatory reform.

The Camilo Ayala Brothers: Lost Treasures of the Art World

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The paintings of the three brothers — Marcial Camilo, Juan Camilo, and Felix Camilo Ayala — stand among the high points of modern Mexican folk art, and represent the most ambitious creations to have come from the province of Guerrero . The joyous traditions of Guerrero rival the better-known outputs of Oaxaca or Michoacan in quality but they have not received comparable attention from collectors or museums.

The state of Guerrero lies between Mexico City and Acapulco and includes the cities of Taxco , Iguala, and Acapulco . Of particular importance is the indigenous Nahua community in the state of Guerrero. The local Nahuas live in a series of villages along the Rio Balsas, dating prior to the Spanish conquest. San Agustin Oapan, with approximately 1500 citizens, is the largest of these villages, and the entire local Nahua community numbers no more than 40,000 individuals. Yet they have evolved a unique culture, as reflected in their distinctive artistic traditions.

Nahuas can be found in several parts of Mexico but the Rio Balsas community has been isolated for a long time. It is protected by the mountains and by the absence of any very large city in the immediate area. (There are two paths to San Agustin. One is to take the road up from Xalitla, which is about fifteen minutes from the city of Iguala . The other is an unmarked turn-off from the Mexico City-Cuernavaca highway, just before the Puente Mezcala.)

I first discovered the brothers when I was visiting the late Haitian art dealer and author, Selden Rodman. Rodman owned a number of fine pictures by the brothers, but he was not keen to sell them to me. Since that visit, I have been tracking down the works.

After buying some works from dealers, I decided to take a trip to San Agustin, using a Mexico City taxi driver. I asked in the village for the brothers, and found that only Juan Camilo was at home. I drove to Juan’s house, spoke to him, left him some money for paintings, and told him I would be back within a year.

The following year I tracked down Marcial Camilo in Taxco , as Juan had told me Marcial now spends most of his time outside the village. I went to the central square of Taxco and asked the local artisans if they knew where I could find Marcial.

Fortunately I stumbled upon Marcial’s daughter, Oliva, selling pots in the central square, and she directed me straight to him. As I asked her if she knew a Marcial Camilo Ayala, I recognized her similarity to a portrait that Marcial had painted of her many years ago, which now hangs in my living room. She was embarrassed to hear that I look at her portrait every evening at home.

To this day, only about half of the road to San Agustin is paved. A journey of no more than twelve kilometers takes several hours, and potentially more in the rainy season. Most Nahuas in the area do not read and write much and they have Spanish as a second language, if they speak it at all. Juan Camilo claims that no one in the town speaks English or has migrated to the United States . San Agustin has no stores to speak of and most residents do not have television or radio. The local religion is Catholic, though heavily infused with animistic elements, which are manifest in the numerous local festivals.

The landscape around San Agustin is beautiful, similar to many parts of the American Southwest, though wilder in feel. The river, Rio Balsas, is central to life and plays a prominent role in many of the artworks. Residents bathe in the river, fish in the river, wash their clothes in the river, and conduct their social lives in the river.

The local painting started with pottery. For as long as records exist, Rio Balsas artisans painted a variety of designs on pots, which were then shipped out and sold. In the early 1960s, however, Rio Balsas artisans switched to painting on amate. Amate is made on a bark paper, originally coming from a small village near Puebla . Amate paintings were cheaper to transport and suffered no breakage. The idea of painting on amate came from Max Kerlow, a folk art dealer in Mexico City who introduced the idea to some Nahua artisans. Amate painting rapidly took off and a new genre was born.

Amate painting developed in two directions. First, some amate creations are highly original works of art and are sold to relatively exclusive buyers. Many of these amate works are detailed black and white sketches, rather than colored works. Far more common, however, is the second branch of amate painting, which is largely for tourists. This kind of amate is sold on the streets and in the artisan markets of many Mexican cities and in Olivera Street in Los Angeles . Themes tend to be highly generic and the artistic quality is usually no better than satisfactory.

Low and high quality amate nonetheless share a common iconography. The most frequent topics are village scenes, local religious festivals, and weddings. These pictures draw upon the San Agustin landscape of river, cactus, wild animals, and vivid stars. Some of the more sharply drawn high quality works resemble older Arabic miniatures in style. One branch of amate portrays animals, usually birds, with twisting, sinuous lines and sharp, vivid colors. The village scenes use a vertical form of perspective, as is found in nineteenth century Japanese prints. Black and white amate drawings frequently portray nativity scenes in great detail. In more recent times, amate has been used as a form of political protest (more on this below).

Virtually everyone in San Agustin and neighboring villages learns how to draw and paint at a very young age. A typical lifestyle involves tilling the fields during the rainy season (late summer through fall) and otherwise turning to artisan work to make a living. In earlier times San Augustin had been a center for the salt trade, but when that source of income dried up, earlier in this century, artisanship became more important.

The Ayala brothers started as amate painters in San Augustin but were encouraged by outside patrons to try larger scale works. In the 1972 an American, Edmond Rabkin, was in Cuernavaca with his wife, the artist Carolyn Mae Lassiter. Rabkin accidentally encountered Marcial in the streets and found his presence and his personality compelling. He bought all of the amate that Marcial was carrying and the two quickly established a friendship. Rabkin encouraged Marcial to paint on a larger scale, and the idea spread to Marcial’s brothers, Juan Camilo and Felix Camilo, and to several of their cousins, Felix Jimenez Chino, Inocencio Chino, and Roberto Mauricio. While these individuals were starting to paint, and also in later years, Rabkin offered generous support.

The group soon proved to have a remarkable talent for painting. Marcial has always been the leader, the most conceptual, and the most original. His paintings draw upon sources as diverse as surrealism and Diego Rivera, but are always rooted in native Nahua traditions. Marcial once noted that: “Painting is my way of looking into my past, my people’s past…”

His pictures have a deep, mysterious quality and often concern dreams or multiple perspectives on a single event. As much as any mainstream artist, Marcial’s work shows imagination to be a vital method of philosophical presentation, a way of recapturing deep ideas about a collective past. Marcial’s pictures have been exhibited in the United States several times, including in the permanent collection of the Museum for International Folk Art in Santa Fe , and he is usually considered the most talented of the group. Marcial also has two paintings in the new Museum of the American Indian, the newly opened Smithsonian museum. The accompanying video display features him talking about amate painting. He is charismatic, articulate, and worldly.

Juan Camilo is more conservative, sticking closer to the amate tradition, but he has painted some of the loveliest of the Ayala pictures. A vertical landscape, with Nahua festivals in the foreground and stars in the sky, is his signature style. Some of his most accomplished paintings rely primarily on shades of black and grey, with only occasional splashes of color. Juan is quieter than Marcial and spends more of his time in San Agustin.

Many of Juan’s paintings reflect the animistic religion of the local Nahuas. The sun, moon, stars, and animals are all portrayed with a god-like presence. In some pictures, birds and foxes sit high in the trees. Men are more base. They have mastered the earth, in the form of pottery, but they can only aspire to godliness by killing these animals with bows and arrows, or by honoring them with festivals. In Juan’s artistic world, gods still stalk the earth. In Marcial’s artistic world, the ancient gods are no longer present, but we must nonetheless dream them and give them an existence of another kind.

Felix is the younger brother and his style is more derivative, though he has a number of fine works. Felix Jimenez, a cousin, is the second most conceptual and experimental painter of the group, after Marcial; he lives in San Miguel Allende rather than in San Augustin. Some of Felix’s best works portray very large female figures juxtaposed with very small male figures. Inocencio Chino and Roberto Mauricio, two other cousins, have painted quality works as well. Inocencio lives near Felix Jimenez and Roberto Mauricio splits his time between painting amate and playing in a mariachi band.

About thirty years ago, the painters made their first impact on the art world. Rabkin introduced the works to Selden Rodman, the well-known writer on folk and Naïve art, and their reputation quickly spread. Mr. and Mrs. Maurice C. Thompson, who have perhaps the best private collection of Haitian art in the United States, bought numerous paintings. Selden Rodman proclaimed that the tradition would turn out to be no less important than the Naïve Art of Haiti , and he featured the painters prominently in his book Artists in Tune With Their World . Rabkin opened a Santa Fe gallery, called Galeria Lara, devoted largely to works from the region.

All of the brothers maintain homes in San Agustin, although they spend much of their time in other locales for commercial reasons. The population of San Agustin has become increasingly itinerant, as individuals leave during the winter months to look for work elsewhere, returning to till the fields in the summer and fall.

The Rio Balsas Nahua community will not last forever. Over ten years ago the Mexican government had plans to build a dam that would have inundated most of the villages and required forcible removal of the inhabitants. The plans were called off, in part because of well-organized local protests, and Marcial was one of the leaders of this movement. Anthropologist Jonathan Amith subsequent reproduced some of the resulting “protest amates” in his book The Amate Tradition , which remains the best introduction to the art of the region).

Local residents fear that the dam will eventually be built. Whether or not this is true, the Rio Balsas community will in any case be transformed by time. As outside opportunities become more lucrative, the community will fray. A generation ago, hardly anyone left San Agustin, but now many people leave, if only for part of the year. The culture may lose the sense of innocence and charm portrayed in many Nahua artworks, and perhaps lose its unique visual sense and perspective as well. The Rio Balsas painters are aware of this danger, and they are seeking to preserve their history and their traditions through their painting.

Tyler Cowen is Professor of Economics at George Mason University, author of In Praise of Commercial Culture (Harvard University Press 1998), and can be reached at tcowen@gmu.edu. He can also help you reach the Ayalas, or other neighboring artisans, if you wish.

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