Sunday, May 25, 2014

The visible handout

I'm trying to put together several disparate pieces of information into a coherent narrative.  Let's see if that goal is achieved by the end of the piece.  The operative question to be kept in mind while reading is whether we can tell if a certain type of competition is healthy or not. We'll start with some of those info bits.

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The College of Engineering graduation had two ceremonies back to back, because Huff Gym wasn't big enough to hold everyone (and the Assembly Hall is being renovated).  Fortunately for us, my son graduated in the earlier ceremony.  During the ceremony it was repeatedly mentioned that this is one of the great engineering colleges in the world.  (Say something enough....)  Here I'm going to take that as true.  One of my subsidiary questions is this.  What's implied by that regarding the education of the undergraduate engineering students?

I had the feeling that during the ceremony I was watching a reincarnation of Thomas Friedman's The World Is Flat.  Part of this was the featured speaker, an alum of the College of Engineering and now Dean of the Booth Graduate School of Business at the University of Chicago.  He is the only Business School Dean in the top ten b-schools who has his doctorate in Engineering.  (Most were in Economics.)  He did his undergraduate work in Bangalore (and maybe he grew up there, but on this I'm not sure) and then came to Champaign-Urbana, but not directly.  He worked first and at the time didn't want want to be a student any more - the student life was too austere or so he thought.  It turned out he didn't like work so he went to graduate school and this time fell in love with academe.  His career trajectory is the personification of meritocracy.  It also demonstrates the value of engineering thinking even in non-engineering environments. 

The other part in this World Is Flat redux was the demographics of the students and their families.  My eyeballing of the audience indicated there were more students whose lineage is Asian than there were students whose lineage is European.  The College of Engineering is its own sort of melting pot.  In contrast, the class I taught in Economics last fall did have a couple of Chinese students and several more Asian-American students, but taken together they were less than a third of the class.

My son's department, Industrial and Enterprise Systems Engineering, had a comparatively small number of graduates at the ceremony.  The big departments in that session were Computer Science and ECE (Electrical and Computer Engineering).  After the ceremony and some picture taking in the parking lot between BIF and Huff Hall, we drove our son back to his apartment.  On the way I mentioned to my son that I thought the student body in engineering was majority non-white. He said....maybe.  Then after thinking for a minute he added that Civil and Mechanical Engineering, the big departments in the later session, probably were majority white.  Computer Science and ECE, in contrast, attracted a lot of Asian students.  I wonder if the data actually bear that out.

My younger son is in Computer Science.  The day before I drove him to Indy so he could start his internship. (The first work day was last Monday.)  We chit chatted for a good part of the drive.  Much of that was about school.  Somewhere along the way he said - engineering is just so damn competitive.  I had heard somebody else say that recently - a grad from the 1990s who now works on campus.  I'm not sure exactly what that's in reference to, so I'll speculate a bit. It has me wondering.

Engineering has always been a grind, with more work assigned in Engineering courses than in courses elsewhere around campus.  My first semester after transferring to Cornell (this was spring 1974) I lived in a dorm and one of the guys on my floor was in Engineering.  He seemed to be working all the time, while the rest of, in Liberal Arts had more time to engage in conversations - about politics, life in general, music, who knows what?  This engineering student didn't participate most of the time.  He was a nice guy, but not as quick mentally as some of the other kids on the floor.  He was the personification for me of the "grinder type."

There is a difference between being a grind - lots of coursework to do - and being so competitive.  One way to get the latter is for all grading to be on a curve - the top 20% get an A, the next 20% get a B, etc.  This sort of grading does indeed induce competition between the students, the sort where they try to outwork each other.  In this respect it shares elements with certain types of sports competition, like golf tournaments.  There is an economic literature on when "relative performance contracts," aka tournaments, are better than absolute performance contracts and vice versa.  If an instructor doesn't know whether the exam is easy or hard (they all seem easy to the instructor) then grading on a curve is a way to control for exam difficulty.

But there are issues with it for learning.  If somebody is already motivated to study hard (whatever that means, I'll get back to that) then is the added pressure useful?  Watching sports tournaments, sometimes it seems that players choke up.  (See definition 18b.)  Performance anxiety can happen in a variety of circumstances.  Grading on a curve is likely to exacerbate performance anxiety for some students.  Then there is a related big deal issue - students get discouraged because of  early poor performance.  Some of these students will double there efforts thereafter and get by.  In that case the early poor performance serves as a wake up call. But other students will become so discouraged that they will drop out.  Indeed, some of this is by design in Engineering and certain courses serve, unofficially, in the capacity of "weeding out" the less well prepared or less committed students.  Consequently, engineering education has an aspect of Social Darwinsim to it.

Engineering at Illinois can afford this approach for two reasons. First, the students who drop out of Engineering typically transfer to another college at Illinois, so they still end up getting a degree from the university. Second, Engineering is committed to take in a substantial number of transfer students, mainly community college graduates from around the state. In a business sense, these transfer students fill the slots of the students who have dropped.  In this way the college can maintain essentially equal size of cohorts, from the freshman through the senior years. 

One can argue the merits on a Social Darwinism approach to undergraduate education, but the reality on the ground is that it's extremely unlikely to see it implemented broadly across campus (and broadly across the nation).  High graduation rates are a brag point for campuses that have them and a shame point for campuses that don't.  If  Liberal Arts and Sciences at Illinois produced dropout rates like what Engineering has, that would be a cause of concern for the campus, since most of those students would not transfer to another college; they'd leave the university entirely. So, instead, to the extent that teaching and learning is emphasized, the focus is on pedagogy and student engagement or, more recently, on student creativity.  (No doubt, highly creative students are engaged, but what of the not so creative students?)

And there is still a chicken and egg problem on the creativity front.  Do some students find a creative approach pretty much on their own and then use school as a means of expressing that creativity or does school develop creativity in these students where it wasn't present previously?  At the graduation ceremony, several of the famous products developed by Illinois Engineering grads were mentioned - Netscape, PayPal, YouTube, etc. - wanting the audience to believe that the Engineering College caused the creativity that led to these new products.  The social science on that is far from clear.  I know that Mosaic, the predecessor of Netscape, was a skunk-works project done by a few graduate students.   Perhaps there was a similarly informal development environment at the gestation of each of the other products.  If so, maybe Engineering should get credit for providing the milieu in which such playfulness occurs, a necessary if not sufficient component for a successful innovation.

It's possible that a handful of this year's graduating class will produce equally successful but not yet known products that will make a bundle for their creators and will serve as brag points for the College of Engineering during commencement for the class of 2025.  That many will try, there is little doubt.  The winners, if there are any, will be aided by substantial good luck.  That a competition among ideas in the form of new products or services occasionally produces big winners is good.  We all benefit when that happens.

* * * * *

I want to switch gears and talk about a different sort of competition, the one between the Titans of Wall Street and the American tax payer.  The recent release of Stress Test by Timothy Geithner, the former Secretary of Treasury caused, a substantial reaction in the media.  Here I will comment on several pieces that I've read in the last week or so.  To introduce the issue, let me quote from John Cassidy's book review of Elizabeth Warren's new book, A Fighting Chance.

Even if Warren doesn’t run for president, she is a significant figure, and her arguments demand to be taken seriously. When she declares, “Today the game is rigged—rigged to work for those who have money and power,” she is reflecting the beliefs of countless Americans, many of whom don’t share her progressive outlook, but do share her scathing views of the Wall Street–Washington nexus.

Taking the Wall Street side of this equation is how I got my title, the visible handout.  In various ways those on Wall Street influence what is going on in Washington and in return cash is put into their palms, most of the time, but with the possibility that overall the activity destabilizes the system.   I want to try to explain the Wall Street position here, but to do so I want to make the case that this position isn't strictly rational.  I need to explain what I mean by strictly rational.  Then I will make a brief detour to offer a plausible explanation why Wall Street doesn't behave in a rational way.  Then I'll return to the pieces about Geithner's book.

Because of the explicit guarantees with deposit insurance and implicit guarantees behind institutions that are "too big to fail," from the perspective of the big financial houses the game is a bit like heads I win, tails you lose.  Understanding that, the quid pro quo should be that the tax payer has the right to impose prudent regulations on the financial industry, to prevent tails from coming up.  And the industry should agree to this regulation because if it is always heads, they win.  This is what I mean by the rational view.  But instead what we seem to be getting is that with heads they want to win even more, yet by doing that tails remains a possibility.

Now for the detour.  Last January there was an interesting piece in the NY Times Sunday Review, For the Love of Money.  It was written by a former Wall Street trader who was addicted to money, as were his bosses.

But in the end, it was actually my absurdly wealthy bosses who helped me see the limitations of unlimited wealth. I was in a meeting with one of them, and a few other traders, and they were talking about the new hedge-fund regulations. Most everyone on Wall Street thought they were a bad idea. “But isn’t it better for the system as a whole?” I asked. The room went quiet, and my boss shot me a withering look. I remember his saying, “I don’t have the brain capacity to think about the system as a whole. All I’m concerned with is how this affects our company.”

I felt as if I’d been punched in the gut. He was afraid of losing money, despite all that he had.

The "not having enough brain capacity" itself signifies a lack of rationality.  But this, in itself, didn't seem like a full enough explanation for the full behavior of Wall Street.  Lloyd Blankfein, CEO of Goldman Sachs, has enough brain capacity.  So does Jamie Dimon, CEO of JP Morgan-Chase.  And there are others on Wall Street too with enough brain capacity.  Yet in dealing with Washington they don't seem to make it their business to develop a system that is stable - all the time - tails doesn't come up.  Why not?

By means of explanation, I thought addiction was on the right track, but addiction to money couldn't be it.  For the guys mentioned in the preceding paragraph, they have so much money already how can they be addicted to making more?  For them, that's merely the accoutrement, how the score is kept in the game of high finance.  So I did a Google search on "addicted to winning" (without the quotes). This first hit made it seem as if many of us are likewise so addicted, but otherwise the piece wasn't that helpful.  Then I found this piece written by a psychologist, which was more useful.  His explanation, which I found quite plausible, is that we have a fear of being ordinary.  Winning "proves" we're not.  The beauty in this straightforward explanation is that the fear must be greater for individuals who are way up in the hierarchy of a large organization and who are visible by their brethren from below.  They need to win all the time, just for personal validation. 

(There is also a related issue as described in John Cassidy's book, How Markets Fail, in that there is a prisoner's dilemma aspect to the determination of whether winning has happened.  The firm is judged via its near-term performance relative to its competitors in the industry.  If a prominent rival takes a riskier long term approach but that approach is also more lucrative near term, then taking a more sensible approach appears like losing.  This puts the pressure on to also embrace the riskier approach.)

Effective financial regulation serves as an impediment to this win-at-all-costs mentality.  Alas, we don't seem to have effective regulation.  Now to those promised pieces that are a reaction to Geithner's book, which do agree that we don't have effective regulation.  This first one, from The Atlantic, was written by someone who worked under Geithner when both were at the New York Fed.  His thesis is that Geithner is a particularly cautious sort of person, especially in the clutch.  The argument the author makes is that in the aftermath of the crisis once it appeared that the contagion would be contained and no more big institutions would fail, roughly around summer 2009, there was the opportunity to impose effective regulation.  What was needed was a strong voice - from Geithner who was then Treasury Secretary - to argue for the legislation that would do the job in combination with executive mandates that he could initiate on his own. But this Geithner did not do, presumably because he felt there was still a risk of the financial markets freezing up again.  Yet by putting time between the crisis and when a sense of stability was restored and doing nothing else about the financial system in the interim, the author argues that Geithner "blew it" insofar as getting tough and effective regulation into being. 

This next one is more specific about the requisite effective regulation, where the entire focus is to make the system stable.  In other words, it ignores consumer protection issues, another part of financial regulation.  For system stability, there needs to be stern minimum capital requirements for each bank and there needs to be transparent accounting (which there isn't now) about how capital is measured, so an auditor can readily read the banks balance sheet and determine whether it is healthy or not.  The author of this piece argues that the current capital requirements are too weak and the accounting standards too opaque.  The blame is spread around.  Dodd-Frank is taken to task.  The legislation is too complex.  The regulators are taken to task.  Only about 50% of Dodd-Frank has been implemented.  Nobody seems in an uproar about the other 50%, perhaps because financial markets have settled down.  The clear message is that half a loaf is all we expect regarding financial regulation. 

This last piece, a recent column by Joe Nocera, Rethinking Campaign Finance, is not specifically about regulating Wall Street, but it does look at the dilemma that Members of Congress face at present.  In the current model, campaign financing is a major focus and most campaigns rely on donations from a small group of big donors.  The views of the big donors become well known to the campaign they are giving to, so much so that they drown out the views of the ordinary voters.  The proposal is for campaigns to be able to opt for the small donor route - no contribution over $150, but have matching funds that are 6 to 1 (or possibly larger, I have no sense where they get the multiple from) so that a candidate taking this approach can compete with a rival who is going after large donors.

I know that Nocera intended this column to show serious people are thinking about how to do something effective to address the problem.  But it had the opposite impact on me, particularly with regard to regulating Wall Street.  Campaign financing is but one way to influence Members of Congress.  Most lobbying happens between elections, not during them.  There is also that we now seem to have these PACs which are not part of the campaign but can spread publicity as if they were.  Even if the campaign part goes the small donor route, there is no reason why these PACs shouldn't woo big givers.  Then there is the issue of how Members of Congress come to their views on issues.  If a MOC relies on small donors, and most voters are not well informed on most issues, what then?  Do Members of Congress have the means to educate themselves on issues other than through the people who are lobbying them?  If so, how?  And finally, there was no discussion of personal integrity.  It's the last part that is really disheartening.  It seems to doom the entire process.

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This next bit of info is about administrative bloat in two sectors of the economy, healthcare and higher education.  There seems no doubt about the phenomenon.  The issue is the cause.  To the outsider, this may seem a similar thing as to what is happening on Wall Street.  Maybe that is true in healthcare, particularly at the big insurance companies.  But in higher education, where I know something about what is going on, I believe the explanation lies elsewhere.  There are two distinct issues.

First is how higher education embraces the new.  Quite often, new initiatives happen on top of everything else that is being done.  Old activities are only rarely phased out.  If new activities require somebody to run them and existing activities see no reduction in personnel, then it is simple arithmetic that the new activity must be a cost add.  For example, when I moved from the campus information technology organization to the College of Business at Illinois, I took on a position that hadn't existed previously, and in my negotiations with the College I asked for and was allowed to hire two people who would report to me.  As it turns out, one of those people was already working for the College and her old job was not backfilled.  So that was a cost neutral change.  But my position and the other person who was hired constituted cost adds.

This sort of thing happens over and over again with the consequence a proliferation of administrative positions.  Ironically, one area that has seen steady growth is advancement (fund raising coupled with alumni relations).  Higher education has seen greater reliance on gifts as a source of income.  Small gifts may come like manna from heaven.   But large gifts require cultivation by the institution.  Somebody has to do the cultivating.    And with more cultivating to be done...

The other is the rise in administrative salaries over time.  Here I believe the story is more complex.  I will begin with my own experience.  I witnessed a doubling of my own salary over a 10-year period, from 1999-2009.  This amounts to a hefty 8% annual growth.  The general rise in salaries over that period was much more modest.  While I don't have the precise figures, I'd guess it was less than 3% annual growth.  But annual growth rate is misleading.  Indeed, my experience was that within a specific job my salary would grow at the campus rate.  (Sometimes it grew slower than the campus rate because, being already paid well, during years where there were modest salary programs there was a tendency for administrators to get smaller percentage increases than the rest of the staff.)   There were big steps up in salary after promotion or after a switch in jobs.  While for me those all happened at Illinois, for many other administrators the job switches occur by moving from one campus to another.

When a campus is recruiting to fill a position, new or old, there is a need to pay "market" at the least.  This is basic economics.  But what exactly does it mean for administrative positions?   Here I want to distinguish between a candidate who is money grubbing, which does happen, from one who is not really in it for the money but wants his or her boss to appreciate the candidate.  This is true in the job over time but, for the reasons I discussed in the previous paragraph, it is especially true for the initial salary offer.  I have had several friends tell me recently that they turned down job offers where the institution tried to low-ball it. To these candidates they were making an inference about what that initial offer said would happen during the course of working in the position.  And the inference they were making is that they'd feel squeezed and under pressure all the time.  Nobody wants to move into that sort of position.  On the flip side of that, filling a vacant position is not the time to practice cost containment.  All that will do is either leave the position vacant or have it filled with an unattractive candidate. 

So there is a feedback loop between the new employer demonstrating they do care for the candidate and what the market salary for the position is.  The market salary is benchmarked by the history of salaries at similar positions nationally that were filled recently.  If in the filling of each of those positions the offers were generous relative to the market at the time, then the market salary for the position will rise.

Candidates who end up taking a job at another campus often do so to climb the job latter.  The saying goes - to move up, move out.  Moving up is associated with a salary increase to accompany the increase in responsibilities.  But the feedback loop mentioned in the previous paragraph suggests that even horizontal moves will be associated with salary increases, because the candidate wants to be "shown the love" and those filling the position want to satisfy the candidate's wish.

But here is the thing.  What the candidate wants is not something absolute.  It is relative to a reference point, one provided by the market.  If the reference point were lower the candidate would be just as happy should the position come with an offer that seemed generous relative to that lower reference point. 

* * * * *

Let me wrap up.  When markets work, laissez-faire is right.  What it means in practice for markets to work, however, may be something like beauty - it's in the mind of the beholder.  Above I've given three distinct scenarios.  Some might argue that markets work in each of them.  Others, in none of them.  I'm closer to the latter view.

When markets don't work, some sort of regulation is preferable.  Before I started at Illinois (fall 1980) there was an informal cartel that set the salaries of new assistant professors in economics.  I recall the cartel price at the time was $19,000.  (That was a nine month salary and didn't include summer money.)  I was able to get a $500 bump on top of that because I had another offer from a credible competitor.

I don't know if this informal cartel still exists but it makes sense to me that something similar should exist now for upper level administrative salaries in higher education, as a method of cost containment.  A general inflation would also be needed to make this work.  Then the market reference point could fall in real terms even as it rose in nominal terms.  One reason there is this focus on administrative salaries now is that inflation has been so low.  The cost add aspect of administrative pay then becomes more prominent.

I'm less hopeful for a realistic prospect to rein in Wall Street.  Congress appears to be broken as does the relationship between Congress and the White House.  But reining in Wall Street is what we need.  I hope there would be general agreement on that score.

As to Social Darwinism in undergraduate education, it is something to contemplate if only to contrast with current practice and for us to get a more realistic view of undergraduate education as it actually occurs.  Until the last decade undergraduate education was largely praised.  Now the vogue seems to require demonizing undergraduate education.   Perhaps that is a necessary stage to pass through before sensible improvements can be made.

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