When I was a grad student taking the middle of the three core macroeconomics courses, in early 1977, we got exposed to a debate that I didn't really understand at the time about economic policy - rules or discretion. This was specifically for "Monetary Policy" but thinking back I wonder if "Fiscal Policy" also was part of the equation for those advocating rules - mainly the so called Monetarists. Discretion was a Keynesian notion. The argument for rules was that it would help in the forming of stable long run expectations which, in turn, would drive the demand for money and affect other economic behavior. Discretion adds noise to the system, which would make things worse long term. This was the start of the Carter years and stagflation vexed many economists at the time. Carter mostly inherited the problem, a long run consequence of not taxing enough to finance the Viet Nam War and the ensuing Wage and Price Controls that were implemented under Nixon, which put substantial inflationary expectations into the system. The OPEC price hikes then served as a trigger to make things unravel.
At the time I was for discretion. The economy was under performing and we learned that stimulus was the way to move toward full employment. I still believe in that to a certain extent and mostly agree with Paul Krugman that we need another stimulus package. This country needs to do a lot more in the way of infrastructure spending, the renovation or replacement of bridges and the improvement of our water systems kind of infrastructure, even if investing in that is politically unpopular. And there is a need to boost aggregate demand near term. But I disagree with Krugman in his total fear of deflation. We need some targeted deflation in my view. The two most obvious areas are in Health Care and Higher Ed.
Before getting to that, take a quick look at this income distribution table. It is based on U.S. 2005 data, so before the financial crisis started. Roughly 3/4 of the over 25 population were earning under $50,000, with a majority of those earning less than $25,000. Some significant fraction of those must be retirees, but it is actually startling to consider the size of the low end part of the income distribution. The table shows that less than 7% of the over 25 population are making more than $100,000. (Those who work in the "cash economy" may have significant income that is unreported, though obviously that has fallen off considerably since the economy has gone into its tailspin. And even without that let's not fool ourselves into thinking people who reportedly make under $50,000 are well off. Mainly, they're not.)
Now let's briefly look at physician salaries. This post has a nice table that gives median salary by specialty. Do note that some component of the salary is a compensating differential for malpractice insurance premiums, which can be substantial and which correlate with salary. So it would be more informative to net out these premiums and have a table of that. Then one would like to see a time series of such a table. I don't have that here, but I think it not unreasonable to conjecture that there is hyperinflation - in physician salaries as a whole but particularly in those specialties that are at the high end in physician compensation. I bring this up simply to raise what I think is an obvious point. In the rather long and heated debate about Health Care Reform, there was comparatively little written that I am aware of of how much much physicians are compensated. There was much more on the form of compensation and that fee for service provides perverse incentives. Those perverse incentives don't, however, explain hyperinflation in salary. Something else explains that - persistent scarcity.
Now let's turn to Higher Ed, particularly research institutions. Here's a table of average faculty salaries by institution and by rank. It is important to note that faculty salaries in this table are given as 9-month salaries. The vast majority of these faculty earn an additional two ninths in summer salary, paid by a research grant or for additional teaching or other service rendered in the summer. A disciplinary division of these salaries would be even more informative. Humanities faculty are surely paid substantially below average, while Business faculty are paid well above. Stars in a discipline might command a substantial premium, earning double the average, perhaps even more.
The market for the stars has historically been a big driver in the Higher Ed hyperinflation. A star who is at institution X gets heavily recruited by institution Y. The star gets a big bump, whether movement ultimately occurs or not. The bump is mainly entirely orthogonal to the star's productivity. It is a recognition thing. The star will have pretty much the same productivity at either institution. Then, under the old rising tide lifts all boats theory that was in operation before the recent financial crisis, other faculty salary would also go up so they would not be envious of having the star present. If the costs could be passed on, either to donors who endowed chairs or to students in the form of higher tuition, why not? There has been historically little to no counter pressure to apply the brakes in the face of this salary escalation.
Now with revenue drying up the question has emerged, though still not yet front and center, what reasonable brakes can be applied. This piece, which appeared yesterday in our local paper, makes clear that leaders on my Campus are between a rock and a hard place. In spite of the economic downturn, the market for star faculty remains unabated. The Campus either runs the risk of losing its better people or runs the risk of raising expenditure at a time when it should be cutting spending. We've already had furlough days. Ask the rest of the the faculty and staff to take further cuts so the stars can get what the market will bear is a a very bitter pill to swallow.
This is a problem that can't be addressed on a campus by campus basis. It needs a systemic solution for Higher Ed as a whole. We are not the first sector of the economy to witness an out of control competition for the stars of the profession that had the potential to fully undo the profitability of the sector. The problem is a collective Prisoner's Dilemma played at the Department Head, Dean, Provost, Chancellor, and President level. We'll be better off if peers didn't compete for the stars, to hold salaries down. But these campus leaders can't afford not to. Just because the economy has gone into the tank, it doesn't mean this problem will go away on its own accord.
The world of professional sports has found an imperfect but workable solution to the problem - a salary cap. The salary cap doesn't completely rule out the competition, as all the to do about LeBron James surely demonstrates. But the cap does act as a real and credible brake on overall spending. So we witness stars voluntarily taking less so the team can better operate within the cap. And as a result of the cap the entire system is more transparent.
Applying a salary cap system would be much harder to do at the research universities. There is no one cartel like the NBA to administrate and enforce a cap system. There are many more personnel who would have to be covered by a cap and even if there were firm caps at the Campus level how those would get pushed down to have effective caps at the College and at the Department level would still be a significant thing to work through. But, cycling back to my original macroeconomics theme, rules could be designed that would do precisely that and we in Higher Ed could learn to play by those rules.
Of course the devil is in the details. Yet there is a lot of mileage to be had simply by recognizing that we need a solution that is systemic. Responses by individual institutions, no matter how well intended, can't solve the problem. We aren't there yet with that recognition. I hope we get there quickly.
In the meantime, however, there will be a look for other solutions. At my university the State of Illinois pays the lion's share of the benefits for employees - mainly health care, also retirement (though the state has not been making its contribution for the last several years). As the state pulls the plug on funding the university (and all other public higher education in the state) those benefit costs will be passed on to employees. That seems inevitable and appears to be a substantial savings, in reality a wage reduction to the faculty and staff. But the stars will have that cut offset and perhaps even see other increases, for the reasons I've already articulated. This will offset the savings and leave budgets out of whack.
There may then be a further adjustment, to select areas of excellence where this luring of the stars remains but then either to entirely get out of other areas of specialization or to stay in them but have a more cursory presence. This sort of response is predictable. But it is not stable, especially if there isn't coordination on this point across all of Higher Ed. One might envision regional cartels forming to counteract this. My university is part of the CIC, which could become a virtual mega university. Each member institution can maintain excellence by being part of the consortium and cut down substantially on the need to be great across the board. But I think that mainly a pipe dream. The member campuses, even if in fiscal straits, are strong while the CIC is weak. And further, even if the CIC were successful there are still other big publics (think about the big athletic conferences), the Ivy League, MIT, Stanford, etc. all who very likely will still be playing the game of competing for star faculty. So it won't truly solve the problem.
We really should be talking about a salary cap for Higher Ed as a whole. I wonder when that idea will see the light of day.