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Control Costs, Boost Growth

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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What can the U.S. do to boost growth during the next 20 years? I have an idea -- a big, overarching vision. It might not be right, but I want to put it forward. 

I think it’s time for the era of cost control. 

Most of  the suggestions for boosting growth involve cutting government -- reducing restrictions on real-estate development, letting in more high-skilled immigrants, reducing occupational licensing, cutting the corporate tax rate and easing the regulatory burden. These are not necessarily bad suggestions. But they are basically minor extensions of the approach we took in the 1980s and 1990s. 

Instead, I want to make an observation and then make the case for doing something about it. There are big things in the U.S. that simply cost way, way too much. I can think of at least four: 

1. Health care

2. College

3. Retirement saving

4. Infrastructure

Everyone knows by now that the American health care system is overpriced. We get about the same health outcomes as people in Europe and Asia, but we pay about twice the price. However you measure productivity, the U.S. health-care system comes out looking pretty bad.

As for college, educational methods haven’t changed substantially, but prices have shot through the roof. The lifetime earnings premium from going to college has risen, but it's increased nowhere  as much as college prices -- and it’s far from clear whether that premium represents a causal effect or is due to the fact that highly skilled, motivated people go to college in the first place.

The high cost of retirement saving has been responsible for much of the ballooning of finance industry profits during the past few decades. Huge chunks of people’s retirement savings are gobbled up by a Gordian knot of fees and middlemen known as “active management.” New York University economist Thomas Philippon has shown that our finance industry has actually become less productive over time.

As for infrastructure, it simply costs far more to repair roads and bridges and to build public transit in the U.S. than in other developed countries. That’s one big reason our roads and bridges are falling apart.

All of these are a concern because when a rising share of gross domestic product is devoted to industries where productivity is shrinking or increasing only slowly, economic growth slows.

I see two main reasons for the cost bloat in these industries. The first is an information problem -- information can be hard to understand, difficult to get or intentionally withheld. The second is something I like to call public-private dysfunction. This happens when the government pays for something but exerts no control over how the money is spent.

Government subsidizes health care through Medicare, Medicaid and a host of other programs, and also by the tax break on employer-provided health insurance. But its power to negotiate lower prices is constrained.

Government subsidizes college through student loans, for which the government is the main lender. But it doesn’t take tuition increases into account when making loans; it simply lends more.

Government subsidizes retirement savings through government pension plans, and also through implicit subsidies for large banks, which allows them to pay depositors less than they otherwise would.

Finally, government obviously pays for infrastructure, but has proven incapable of pushing down costs.

Public-private dysfunction seems to me like a perverse effect of the push for smaller government in the 1980s and 1990s. In some sectors, government was cut out of the picture, but in others -- such as health care, education, and infrastructure -- it would just wreck the industries to cut out the government. So we got a weird faux-privatization, with the government continuing to foot the bill but private companies and institutions deciding how the money is spent. Without accountability, there is no incentive to keep spending in check.

So how do we control these rampaging costs? The first way is for people to simply wake up and realize that these things cost too much. In some ways, this is already happening. Active money management is on the decline as investors cut out the middlemen and go with low-cost exchange-traded funds and indexed mutual funds. Fewer people are going to college, showing that continued price increases can’t be borne.  There are ways the government can speed this process along -- for example, by mandating price transparency in health care.

The second thing is for government to fight public-private dysfunction, by exerting greater direct control over costs. Basically, the government should either get in or get out -- and in sectors where full privatization doesn’t work, the government should accept the responsibility of forcing down costs.

In health care, this can happen by Congress giving Medicare greater authority to negotiate lower prices. In infrastructure, it can be done by altering the contracting process to give the government more leverage to demand lower prices. In finance, higher capital requirements for big banks are already reducing the implicit subsidies for banks deemed too big to fail, reducing their funding advantage. And college can be made cheaper by capping student loans at a certain dollar amount, because that would deter colleges from jacking up prices simply to gobble up more government money.

This cost-control approach is very different from our approach in the past. In the past, we trusted the market and got government out of the way. We shied away from having experts make judgments about whether society was paying too much for things. I believe that approach yielded dividends, but like all solutions, it wasn’t a cure-all.

But cost control simply shouldn’t be seen in terms of expanding or shrinking government. What I am envisioning increases the scope of government intervention in the economy, but shrinks the amount of government spending (and the taxes needed to cover that spending). The old dichotomy of bigger versus smaller government is a simplistic anachronism that once served a purpose but now needs to be thrown out.

We need to think about a new approach to raising growth. Cutting costs in overgrown sectors of the economy should give us a boost, possibly lasting decades, and would free up resources to flow toward private industries, where productivity growth happens rapidly on its own.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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