Banks and Colleges Are Wasting Our Money
Let’s say you’re willing to do some job — say, regrouting a bathroom — for $15 an hour. Now let’s say you find a homeowner so desperate to replace his sand-brown grout with fashionable charcoal gray that he is willing to pay you $30 an hour if you will just come over and get it done right now. That extra $15 is what economists call a “rent.”
Naturally, all of us would like to be paid more than the minimum we’d accept. This can lead to what economists call “rent seeking,” where you try to arrange things so that you have less competition, and therefore more room to jack up prices.
The minimum wage is rent-seeking. So is a homeowner’s group that fights development in its area, making members' homes more valuable in the process. Or a professional group calling for stiff licensing exams to exclude new entrants from their market. Or a big business seeking tax breaks or regulatory favors that will advantage them over competitors. A huge amount of what governments do consists of arbitrating between various groups trying to get a little extra in their pockets.
Rent-seeking is not an activity much loved by economists. It makes markets less efficient and often involves wasting time and money on lobbying. That’s why, when people are accused of it, they normally adopt a stupefied expression and say: “I don’t know what you’re talking about! There are no rents here, just public-spirited regulators and fiercely competitive markets coming together to bring you, the American Public, the best of all possible worlds.”
Since no one will admit that they’re collecting rents, how do we identify industries and corporations that are getting more than they strictly need to do a good job?
I recently came across an interesting suggestion from Gerald Epstein, an economist at the University of Massachusetts. He observed that there's a "massive excess supply" of workers wanting to go into finance. This, he concluded, "is the clearest evidence of rents.” That's plausible. And it made me wonder where else we should look for wasteful rents.
One obvious place is in Epstein’s own profession, the professariate. The ratio of Ph.D.-holders to tenured professors has been bad for decades, and is steadily getting worse. This year, history departments created more doctorates than job listings with the American Historical Association (some of which were, presumably, for people other than newly-minted Ph.Ds). Yet every year, thousands of bright young people decide to commit a decade or so of their lives to becoming a tenured professor. Many of them will end up slaving away at pittance wages as adjunct professors, just for some chance to live the dream.
By Epstein’s metric, this suggests that rents are quite high in academia. Professors do not, to be sure, make private-jet money. But why should we only look at financial rents? Many people would like to have a prestigious and stimulating job that gives you incredible control over your workday and protection from being fired. A substantial number apparently think it’s worth spending a decade of life in poverty and hard labor just to get a small chance at these benefits.
I know that right now professors are already tapping away at the keyboard, explaining that their job is hard. I believe them. However, most of the investment bankers I know work much harder than the professors of my acquaintance, at jobs that are less interesting and involve quite a bit of ritual humiliation at the hands of superiors and clients. When we’re looking at rents, the question is not, “Do you work hard for what you get?” but, “Would we have an adequate supply of workers if employers offered less in the way of wages and benefits?” The answer, in both banking and academia, would seem to be “Yes.”
The next question is, “How are these guys managing to capture so much rent?” The classic answer is “barriers to entry,” which means pretty much what it sounds like: aspiring entrepreneurs might like to compete with your products, but there’s some reason it’s hard for them to do so.
It’s hard to start a new college or a new investment bank. There are regulatory barriers, but there are also market factors. In both cases, customers are often paying for the reputation of an institution. Reputations are hard to amass, and that protects banks and colleges from competition. Thus shielded from new entrants, bankers can collect multi-million dollar fees and colleges robust tuitions to fund a bloated and top-heavy institutional form that has, if anything, seen falling productivity while the rest of the world races ahead.
To be fair, both banks and colleges have lost some of their rent-collecting ability in recent years, but both sets of institutions still seem to be getting sweeter deals than you’d expect from a perfectly competitive market.
Any economist will tell you that the best cure for rent-seeking is to get rid of the opportunities to collect them — along with the inefficiency that those collections represent. Not all barriers to entry can be removed in either market, but we should ask what we can do about the regulatory and structural factors that make a college diploma almost necessary for a successful middle-class life — and a bulge-bracket investment bank similarly essential for a successful IPO.
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