Monday, September 30, 2013

On The Supposed Tuition Crisis

Looking For A Crisis That Doesn't Exist?

President Obama, pictured above in an official White House photo, recently unveiled proposals designed to rein in what he called the rising cost of attending college.  Focusing in particular on public universities, the President and the White House claimed that rising tuition leaves graduating students with too much debt, the prospect of which, the President said, even deters some students from attending college in the first place.  Under the President's plan, the national government would develop a metric for ascertaining how much "value" each college provides its matriculants and reward schools  deemed to be "higher performing" and "providing the best value."  In particular, low income students at "higher performing" schools will receive larger Pell grants than those who attend other schools.  Proposed metrics for assessing quality include percentage of students who graduate and "access," measured by the proportion of students from low income families.

Many commentators are considering these proposals for subsidizing centrally-determined indicia of value "on the merits," with many expressing skepticism about whether, if implemented, such proposals will further the President's objectives.  There is, however, a threshold question, namely, what justifies additional federal involvement in higher education in the first place? 

Less than a decade ago, the Economist  opined that, despite occasional controversy, "it is easy to lose sight of the real story: that America has the best system of higher education in the world."   The Economist also opined that the "main reason" for America's preeminence in higher education "lies in its organization." The "first principle" of  this organization, the Economist said, is that "the federal government plays a limited part.  America does not have a central plan for its universities. . . . Instead universities have a wide range of patrons, from state governments to religious bodies, from fee paying students to generous philanthropists."  Thus, America's system of higher education, which reflects the results of competitive federalism and private philanthropy, is the envy of the world.  While the national government provides some financial support, such assistance often takes the form of Pell Grants and various incarnations of the G.I. Bill, both of which  are the economic equivalent of vouchers that empower students to choose among innumerable institutions competing for their patronage. 

There is no reason to doubt the Economist's assessment of the quality of the U.S. system.  Recently the London Times published its World University Rankings.  20 of the top 25  universities are American, as are 34 of the top 50.  A different system, the Academic Rankings of World Universities, places 19 American universities in the top 25 and 35 in the top 50.  Moreover, each year thousands of foreign students flock to America's universities, leaving home temporarily and often paying significantly higher tuition than they would pay for an undergraduate education in their home country.  Given the virtues of competitive federalism and the advantages of private markets over planning, it is no surprise that such a decentralized system produces so many high quality institutions of higher education.

Proponents of the President's proposal to introduce additional planning would no doubt claim that high quality is beside the point if high prices prevent promising young Americans from matriculating.  Indeed, attempting to buttress claims that Federal action is needed, the White House released figures purporting to demonstrate a rapid increase in tuition over the past three decades at the nation's public colleges and universities.  Moreover, the White House also claims that two thirds of students graduate with an average $26,000 in college debt.  The prospect of high debt, it is said, deters some students from attending college in the first place and prevents others who start college from finishing.  Thus, it is said, there is a crisis of affordability in higher education, thereby justifying federal intervention.

Closer examination, however, reveals that, like the reports of Mark Twain's death, reports of an affordability crisis are greatly exaggerated.  In particular, White House data purporting to demonstrate large increases in tuition focus only on the "sticker price" of college and completely ignore the impact of financial aid that so many universities provide.  For instance, some public universities, including the University of North Carolina, Michigan State, William and Mary, and seven colleges in the University of Texas system (including UT Austin), provide free tuition, fees and room and board to low income students.  (See here, here, here and here for a description of these programs).  The University of Washington and Texas Tech offer such students free tuition and fees (see here and here).  Forty percent of students at the University of California at Berkeley pay no tuition.  (See here).   Students who attend Rutgers can receive a need-based grant of over  $9,000 per year, in addition to an educational opportunity grant up to $1,400 per year.  (See here).
Some private universities offer similar programs for families with low and modest incomes.   At the University of Richmond, for instance, Virginia families with incomes of $60,000 or less receive free tuition, fees and room and board. (See here).  Stanford also pays the full cost for families earning less than $60,000, while families earning between $60,000 and $100,000 need only pay room and board.  (See here for the details of the Stanford program.)  Brown University and several other Ivy League institutions have similar programs (see here and here )  Ditto for various other smaller private schools.  (See here).
Financial aid is not confined to that fraction of families with low incomes;  many schools also provide significant discounts to middle class families.  Vanderbilt, for instance, meets the financial need of all families, whether middle class or low income, with grants.  (See here).  So does Davidson.  (See here).       At the University of Virginia, middle class students who demonstrate financial need pay a maximum of 25 percent of the cost of attendance, with grants picking up the rest of the tab.   (See here.)   Texas A & M provides free tuition to families with incomes up to $60,000.  (See here).  At William and Mary, an in-state student from a family of four with an income of $100,000 will receive an annual discount of about $13,000.  (See here).  At the University of California Berkeley, a resident student from a family earning $100,000 would receive a grant of over $8,000; a student from a family earning $80,000 would receive a grant around $10,000.  (See here).   Some states also provide merit-based financial aid.  In Georgia, for instance, students who graduate from high school with a B average receive free tuition and fees at any Georgia public university.  (See here).
These programs are not cheap; the University of Washington, for instance, awarded $344 million in grants to 60 percent of its undergraduates in 2011-12.  (See here).   While federal aid in the form of so-called Pell grants helps fund aid for low income students, colleges make up the difference themselves, often raising money from alumni to cover this gap.  (See here for an example)

To be sure, some students still pay the "sticker price" or a large fraction of the sticker price, and some of these students emerge from college with significant debt.  However, as previously explained on this blog, taking on such debt to pay full tuition can be a very good investment, particularly at the nation's public universities.  For instance, tuition and fees at the University of Virginia, ranked 23rd among national universities, stands at just under $12,500 per year.    (See here)   At the University of North Carolina, the figure is about $8400.   Thus, even those students who pay "full price" pay only a portion of the cost of their education.  At UVA, for instance, tuition and fees equaled 53 percent of the cost of educating an undergraduate in 2010.  (See here).

Given these programs and aid programs at numerous other schools, the "sticker price" is a meaningless indicator of the actual cost of a college education. Indeed, the actual price of attending some of the colleges listed above is lower for some students, even before adjusting for inflation, than it was three decades ago, when many such financial aid programs did not exist. In the University of California system, for instance, 65 percent of undergraduates receive grant aid, and the net combination of tuition and fees for California residents equals just 40 percent of the sticker price. (See here).   Before declaring a "crisis" and embarking on expanded supervision of our nation's colleges and universities, Congress and the President should generate reliable data about the actual prices and benefits of higher education.  Indeed, the national government seems well-positioned to gather and disseminate such data to prospective students and policy experts alike.

None of this is to say that America's college students "have it made."  Upon graduation, such students will face an unfriendly job market, the product of the slowest economic recovery since the Great Depression.  (See also here and here).  Instead of attempting to micromanage our nation's colleges, the national government should focus on its core responsibility of encouraging robust economic growth and resulting economic opportunity for all Americans, including those who attend college.

Obamacare Imploding Already?

Architect of Implosion?

A recent story on CNNMoney explains why various Americans are choosing to pay a penalty instead of purchasing the health insurance nominally required by the so-called "Affordable Care Act" ("ACA").  Basically the insurance mandated by the ACA is far too expensive for some compared to the actual benefits such individuals would expect to receive.  Most importantly, like the Massachusetts reform that inspired it, the statute requires health insurance companies to charge younger, healthy individuals premiums that far exceed their expected health expenses, thereby subsidizing coverage for other Americans with higher-than-average expenses.  (See this previous post for an explanation of the Massachusetts approach and its onerous impact on younger, healthier individuals.)   As a result, and as previously explained on this blog, many rational individuals will be better off if they decline to purchase the mandated insurance, pay the penalty, and thereby self-insure, that is, pay their health care expenses "out-of-pocket."

The story profiles one such individual, a 29 year old who works as a medical assistant while attending nursing school.  According to the story, the insurance mandated by the Act would cost this single individual between $2400 and $3600 per year, despite taxpayer subsidies provided by the ACA, while the penalty for failure to purchase such a plan is about $300 per year.  It is therefore no surprise that this individual has concluded that "it is more economical for me to pay $300 a year [in fines] than $200 to $300 a month for insurance I don't use."

These data are of course only anecdotal, although they are consistent with more systematic analyses of the law's impact.  (See e.g. here).   These data are not surprising in light of the economic incentives that the ACA's centrally-determined pricing structure creates.  Moreover, if these data are in fact representative, this would be both good news and bad news for proponents of the Affordable Care Act.  The "good news" is that such data would bolster the Supreme Court's July, 2012 determination that the so-called "individual mandate" is an exercise of Congress's taxing power and thus constitutional.  As many will recall, a majority of the Supreme Court (Chief Justice Roberts and Justices Scalia, Kennedy, Thomas and Alito) properly held that Congress lacks the authority under the Commerce Clause of the Constitution to compel individuals to purchase health insurance, because coercing individuals to purchase a product against their will is not, under the standard announced by Chief Justice John Marshall in Gibbons v. Ogden, 22 U.S. 1 (1824),  a "regulation" of commerce.  (See here and here).  At the same time, a different majority of the Court, in an opinion by Chief Justice Roberts, sustained the law as an exercise of the taxing power, construing the Act's "penalty" for failure to comply with the mandate as a mere "tax" on such a failure to purchase.  As previously explained on this blog, the holding that the penalty was in fact a tax rested upon a determination that the tax is low enough that individuals have a "meaningful choice" between purchasing the "mandated" insurance, on the one hand, or paying the penalty and self-insuring, on the other.  Thus, evidence that individuals are in fact choosing the penalty/self-insurance route helps confirm that, at least under the majority's test, the individual mandate is no mandate at all, but instead an option, albeit one distorted by the requirement that individuals without health insurance pay a modest tax if they lack health insurance.
Now for the bad news.  As explained in a previous post, the ACA's financial model, like that of its Massachusetts predecessor, depends upon enrolling millions of young, healthy citizens and then charging such individuals premia that far exceed their expected cost of health care during the term of the policy.  However, as Thom Lambert has explained in a recent paper in Regulation, the prospect of paying these high premia will induce many individuals to forgo such insurance, thereby changing the characteristics of the risk pool and increasing the per capita expected health care expenses of those who remain in the pool.    (See also here).  The result, of course, will be even higher premia, thereby inducing additional individuals to forgo coverage, altering further the risk profile of those remaining in the pool and once again increasing the premium necessary to meet the expect health care costs of those who remain in the pool.  Such a vicious cycle will, Lambert explains, will cause the Affordable Care Act to "implode."

To be sure, Congress could arrest this spiral by raising the penalty that individuals who decline insurance must pay and/or threatening such individuals with jail time, thereby transforming an option into a mandate.  However, such legislation would contradict the Court's recent holding that such a mandate exceeds the scope of Congress's power, thereby placing any such fix in immedate legal jeopardy.  In short, a Congress serious about real health reform should begin to examine alternative means of achieving  the Affordable Care Act's objectives by, for instance, altering regulatory policies that increase the price of health care.   (See here, here, and here, for previous entries on this blog proposing such reforms). 

How Tenure Reduces Tuition

A recent article in CNNFortune repeats claims that eliminating tenure for law school faculty (and presumably university faculty generally) will reduce schools' costs, thereby allowing schools to reduce or stabilize tuition.  In particular, the article states as follows: 

"But with signs mounting that the law school predicament is not a blip, administrators are looking to address their biggest fixed cost -- the full-time faculty. . . .  While salaries and secure employment are not inextricably linked, they are related. With tenure comes the security of consistent paychecks, regular raises, and no abrupt layoffs -- and most universities bestow tenure, or near-guaranteed employment, to guard against firing teachers for expressing controversial or unpopular views. But decades ago, the American Bar Association, which accredits law schools, took it a step further by tying accreditation with tenure protection for most full-time professors. But last month, amid complaints from graduates who cannot find sufficient work, the professional body decided to float two proposals that would sever this link. . . . [C]hanges to faculty tenure -- and compensation -- are inevitable as law school tuition costs barrel ahead."
This assertion echoes similar claims that eliminating tenure would reduce the cost of higher education in general and at law schools in particular.  (See here and here.)

However, and as previously explained on this blog, those who claim that the institution of tenure increases labor costs and thus tuition seem to have things backwards. Both common sense and basic economic theory predict that, other things being equal, eliminating tenure will actually increase costs, as schools increase faculty salaries to retain high quality faculty and thus maintain the quality of the education they provide.  Moreover, schools that failed to increase salaries after eliminating tenure would see faculty quality suffer and thus reduce the quality of the education they provide, without an correlative reduction in tuition. 
Presumably universities pay whatever total compensation they deem necessary to attract and retain desireable faculty.  Such compensation generally includes a mix of salary and non-salary compensation, the latter of which can include such benefits as health insurance, paid vacation, free parking, or free day care, to name just a few.  Tenure, of course, is a form of non-salary compensation, economically indistinguishable from the benefits just described.    Actual or prospective employees will interpret the elimination of tenure in the same way they would interpret the elimination of health insurance or free parking, that is, as a reduction in compensation.  As a result, schools that eliminated tenure would thus effectively cut faculty compensation and thus attract and retain less qualified faculty, thereby reducing the quality of the education provided.  Students at such schools would thus pay the same tuition for a lower quality product, the economic equivalent of higher tuition for the same product.
Of course, schools that eliminated tenure could maintain faculty quality by increasing salaries, thereby offsetting the elimination of a non-salary benefit.  Such salary increases, however, would increase schools' overall costs, and schools would presumably pass such costs on to students.  In these circumstances, then, eliminating tenure would increase and not decrease tuition. 
Some may still contend that the elimination of tenure will empower schools to fire incumbent faculty, hired long ago, thereby reducing labor costs. (Though of course universities would have to hire new faculty to perform the varies duties once performed by fired faculty.)    However, this contention does not withstand close scrutiny.  To be sure, like any other firm, a university can reduce its nominal costs by breaching its long term contracts.   For instance, a university that has borrowed $100 million to construct a new building could reduce its costs by repudiating that debt and thus attempting to avoid its obligation to pay annual debt service.  While such a tactic might reduce costs in the short run, it will have the opposite effect in the medium and long run, as firms pay damages for breach of contract to disappointed creditors and find it more expensive to borrow in the future, as future creditors demand an interest premium as compensation for the risk that the firm will default again.  In the same way, a school that breaches its contracts by firing tenured faculty will find itself liable for contract damages.  Such a school will also tarnish its reputation for trustworthiness, thereby making it far more difficult for the school to make credible promises to prospective faculty, staff and administrators, who will demand higher salaries to offset the risk that the university will breach such promises.

No doubt pundits will continue to debate what accounts for the cost of higher education.  (See here for one important contribution.)  It should be clear, however, that tenure reduces that cost.


Saturday, September 7, 2013

Some Thoughts on the Legacy of Ronald Coase

Taught Us Why Firms Exist, And Much More
Earlier this week Ronald Coase passed away at 102.  Coase was the Clinton R. Musser Professor of Economics Emeritus at the University of Chicago Law School.   The University of Chicago has published an obituary here.

In 1991, Coase won the Nobel Prize in Economic Science.  The statement by the Royal Swedish Academy of Sciences that accompanied the award credited Coase with a "Breakthrough in Understanding the Institutional Structure of the Economy."   The Academy explained the "breakthrough" as follows:

"By means of a radical extension of economic micro theory, Ronald Coase succeeded in specifying principles for explaining the institutional structure of the economy, thereby also making new contributions to our understanding of the way the economy functions.  . . . .  Coase showed that traditional basic microeconomic theory was incomplete because it only included production and transport costs, whereas it neglected the costs of entering into and executing contracts and managing organizations. Such costs are commonly known as transaction costs and they account for a considerable share of the total use of resources in the economy. Thus, traditional theory had not embodied all of the restrictions which bind the allocations of economic agents. When transaction costs are taken into account, it turns out that the existence of firms, different corporate forms, variations in contract arrangements, the structure of the financial system and even fundamental features of the legal system can be given relatively simple explanations. By incorporating different types of transaction costs, Coase paved the way for a systematic analysis of institutions in the economic system and their significance." 
The core of Coase's contributions can be found in two articles:  The Problem of Social Cost, 3 J. Law and Economics 1 (1960) and The Nature of the Firm, 4 Economica (n.s.) 381 (1937).  Coase summarized and restated these contributions in his Nobel Lecture, The Institutional Structure of Production, 82 American Economic Review 713 (1992).

 In "The Nature of the Firm," Coase began by noting that a competitive, decentralized market economy "worked itself," without any central direction.  Despite this fact, much economic activity occurs within firms which, as Coase noted, involve a significant amount of planning.  For instance, owners do not make repeated daily or hourly bargains with employees about what tasks employees should perform, but instead simply direct them to perform this or that task.  Coase then posed the following question:

"Having regard to the fact that if production is regulated by price movements, production could be carried on without any organization [that is, without any firms] at all, well might we ask; Why is there any organization?"

When Coase posed this question in 1937, economists universally identified two, and only two, possible reasons for complete vertical integration in a decentralized market economy.  First, such integration could create technological efficiencies and thus reduce production costs.  The classic example of such technologically-induced integration was the combination of iron production and steel manufacture under single ownership.  See George J. Stigler, The Extent and Bases of Monopoly, 32 Amer. Econ. Rev. 1, 22 (1942) (referring to the "hot strip mill" as the "stock example" of "technological economies" that can result from vertical integration).  Such a combination, it was said, would avoid the cost of reheating iron ingot before transforming that ingot into steel.     Second, forward or backward integration could foreclose rivals from important  sources of inputs, thereby creating or fortifying the integrating party's market power.  See Stigler, Extent and Bases of Monopoly, 32 Amer. Econ. Rev. at 22. 
Coase offered a completely different explanation for vertical integration and thus the existence of firms.  According to Coase, reliance upon the decentralized market to conduct economic activity was not costless, contrary to what economists generally assumed in their static models.   See Coase, Nature of the Firm, 4 Economica at 390, n. 4 (noting that "static theory" assumes that all prices are known to everyone but that "this is clearly not true of the real world").  Instead, such reliance entailed various costs of arranging and consumating a transaction, what economists would later call "transaction costs."  See Coase, Nature of the Firm, 4 Economica at 390 ("The main reason why it is profitable to establish a firm would seem to be that there is a cost of using the price mechanism.")    According to Coase, such costs included the costs of discovering the prices of various inputs as well as the cost of negotiating with the input's owner over the terms of sale, including, for instance, wages and other terms governing contracts for labor.   By integrating vertically and thus performing an additional task itself, then, a firm could avoid such transaction costs it would otherwise incur.  When it came to individual labor, for instance, vertical integration replaced numerous discrete contracts for labor services with one overall contract, the employment contract, pursuant to which an individual employee agreed to follow the directions of the owner of the firm within certain limits, in return for a fixed wage.      

As Coase noted at the time, this explanation for vertical integration had nothing to do with market power or monopoly considerations. Nor did this explanation depend upon any reduction in technological production costs.  On the contrary, Coase's explanation completely undermined the "technological" account of vertical integration.  After all, absent transaction costs, independent economic actors can, by contract, create any technological combination of labor, capital and other inputs they collectively choose, without integrating vertically.   See Oliver E. Williamson, The Economic Institutions of Capitalism, 86-90 (1985) (explaining why technological considerations cannot explain vertical integration); Victor P. Goldberg, Production Functions and Transaction Costs, 397, in Issues in Contemporary Microeconomics & Welfare (George R. Feiwel, ed. 1985)  (explaining that technical economies cannot explain firm boundaries because, absent transaction costs, such economies can “be achieved equally well [by market contracting] if the factors of production are owned by independent individuals.”).  For instance, assume that making iron and steel in close proximity reduces production costs for the reasons explained above.  If so, then parties can, by contract, agree to locate their production facilities next door to each other, even "under the same roof," without vertical integration that combines such facilities under a single owner.   Thus, there must be some other motive, aside from a desire to operate in close proximity, that induces vertical integration in this setting.  Coase found that motive in transaction costs.  It is no understatement to say, as the Economist did yesterday, that Ronald Coase "explained why firms exist."  (See also e.g. here.)

Coase's argument about the rationale for complete integration also inspired others who were seeking explanations for partial contractual integration.  During the 1960s, for instance, Robert Bork relied upon The Nature of the Firm for the proposition that  "contract integration" and "ownership integration" were economically identical phenomena, both of which could reduce the costs of relying upon atomistic markets to distribute a manufacturer's product.   See Robert H. Bork, The Rule of Reason and the Per Se Concept: Price Fixing and Market Division, 75 Yale L. J. 383 (1966).   (Even before Bork, Lester Telser had argued that minimum resale price maintenance could encourage dealers to engage in optimal promotion of a manufacturer's product, by preventing dealers from free riding on the promotional expenditures of their fellow dealers.  See Lester G. Telser, Why Do Manufacturers Want Fair Trade?, 3 J. Law & Economics 86 (1960).  Unlike Bork, however, Telser did not cite Coase.)  For instance, Bork argued that vertically-imposed exclusive territories and exclusive territories ancillary to the formation of a joint venture could encourage promotional expenditures by dealers and joint venture partners by ensuring that each party could recapture the benefits of such expenditures.  

Subsequently other scholars, including Oliver Williamson and Benjamin Klein, would also identify transaction cost rationales for partial integration.   Such work also expanded the definition of "transaction costs" that could give rise to both partial and complete integration.  While Coase had focused on the cost of discerning prices and negotiating and memorializing agreements, costs analogous to technological production costs, these other scholars called attention to the problem of opportunism by trading partners, the risk of which constituted a cost of relying upon the market to conduct economic activity.  See generally Benjamin Klein, Transaction Cost Determinants of "Unfair" Contractual Arrangements, 70 American Economic Review 356 (1980); Benjamin Klein, Robert Crawford and Armen Alchian, Vertical Integration, Appropriable Rents and the Competitive Contracting Process, 21 J. L. & Econ. 297 (1978); Oliver E. Williamson, Markets and Hierarchies (1975).   See also Bork, Price Fixing and Market Division, 75 Yale L. J. at 382  (characterizing dealer free riding as "parasitical" conduct that "victimized" fellow venturers by "appropriating" to [the free rider] the contributions of other members of the group").   
Coase's 1960 work, the Problem of Social Cost, was equally revolutionary.   Before 1960, economists often asserted that market failure in the form of externalities could co-exist with perfect competition.  In 1957, for instance, future Nobel Laureate George Stigler opined that perfect competition would result in an optimal allocation of resources, unless there were positive or negative externalities which, according to Stigler, "the competitive individual ignores." See George J. Stigler, Perfect Competition, Historically Contemplated, 65 J. Pol. Econ. 1, 16-17 (1957).  More than two decades earlier, Arthur Cecil Pigou had similarly contended that externalities could persist in a world of "simple competition."  See  A.C. Pigou, The Economics of Welfare (1932).   Moreover, economists uniformly believed that some form of government intervention was necessary to correct such externalities.   Where "negative" externalities were concerned, such intervention could include so-called "Pigouvian taxes," or traditional "command and control" regulation. Where "positive externalities" were involved, such intervention could include state ownership, subsidies, and/or altering background rules so as to better specify and protect property rights.

The Problem of Social Cost debunked this universal consensus, altering how economists and others think about externalities and market failure.  In particular, Coase demonstrated that "market failure" is not an absolute or exogenous condition but instead depends upon the presence of transaction costs.  Indeed, Coase demonstrated that, in a world with no transaction costs, private parties --- what Stigler had called "the competitive individual" --- would internalize such externalities by bargaining, thereby eliminating any market failure.  (Coase also explained how some externalities do not result in market failure, given that the value of the activity producing the externality could exceed the resulting harm.  In such cases, internalizing the cost of harm via bargaining or otherwise will not alter the activity.)   This insight gave rise to what Stigler would later call the "Coase Theorem," i.e., that "under perfect competition, private and social costs will be equal."      See  George J. Stigler, The Theory of Price 133 (4th Edition 1966).

To be sure, as Coase himself recognized, transaction costs are never completely absent in the real world.  Still, such costs are often low enough that parties can negotiate to overcome a market failure that would otherwise result from an initial allocation and definition of legal entitlements.  Business format franchising provides a classic example of such bargaining.  Instead of creating and then owning franchise outlets itself, the franchisor grants licenses to independent operators, each of whom is thus entitled to operate under the franchisor's trademark.  Franchisors could stop there, allowing each franchisee to operate however he or she pleased.  In the real world, however, granting franchisees such absolute discretion in an unfettered market would result in market failure, as each individual franchisee made product design and quality decisions that would impact other members of the franchise system.  Not surprisingly, then, franchisors often include detailed provisions in contracts granting franchisees the right to operate under the franchise trademark, provisions designed to ensure optimal franchisee investments in quality.  See Paul Rubin, The Theory of the Firm and the Structure of the Franchise Contract, 21 J. Law & Economics 223 (1978).  As Coase would later explain, the legal system can facilitate such contracting by, for instance, making it easier to form contracts that overcome market failure.  See Ronald H. Coase, The Firm, the Market and the Law, 28 in Ronald H. Coase, The Firm, The Market and the Law (1988).
Taken together, Coase's work had obvious implications for numerous fields of legal study, including "common law" subjects such as Contract, Property and Tort, as well as statutory subjects such as Corporations and Antitrust.   For instance, Coase's assertion that the business firm is a particular type of contract inspired scholars to model corporations and other firms as a "nexus of contracts," the creation and maintenance of which the State could  facilitate by promulgating enabling corporate law consisting of mainly default rules that parties to the corporate contract could alter by satisfying formal requirements, such as shareholder vote.    See Frank H. Easterbrook and Daniel Fischel, The Economic Structure of Corporate Law (1991). 
Transaction cost economics also had a profound impact on antitrust law and policy.  During the 1950s and 1960s, courts articulating antitrust doctrine became increasingly hostile to various forms of complete and partial integration.  Such hostility followed naturally from the dominant economic account of the causes and consequences of such integration.  As noted earlier, economists believed that the only benefits of vertical integration were technological in nature. These supposed benefits naturally arose "within" the firm, as part of the process of production.  Thus, when economists, or, for that matter, antitrust courts or enforcement agencies, could not identify any efficiency purposes for such integration, they naturally inferred that the conduct was an anticompetitive effort  to obtain or protect market power.  Hostility toward partial contractual integration such as minimum and maximum resale price maintenance, tying, exclusive dealing, exclusive territories and exclusive supply contracts was particularly intense.  After all, such agreements reached beyond the firm, controlling the activities of trading partners before a firm took title to inputs or after a firm relinquished title by selling a finished product.  As a result, there were simply no apparent efficiency purposes of such agreements, which reduced rivalry of one form or another and thus reduced competition without any offsetting benefits.   The result was the so-called "inhospitality tradition" of antitrust law, pursuant to which the Supreme Court condemned vertical mergers in unconcentrated markets under Section 7 of the Clayton Act as well as  various forms of partial integration as unlawful per se or nearly so under Section 1 of the Sherman Act.

However, the work of Bork, Telser, Williamson, Klein and others completely undermined the economic premises of the inhospitality tradition, by explaining how complete and partial integration were often voluntary methods of overcoming market failures and thus producing non-technological efficiencies. See Oliver E. Williamson, The Economic Institutions of Capitalism, 28 (1985) (articulating rebuttable presumption that partial and complete integration has transaction cost origins).  See also here, explaining Bork's contributions in this regard.  Thus, beginning with Continental T.V. v. GTE Sylvania, 433 U.S. 36 (1977), the Supreme Court has repudiated or narrowed  several per se rules announced during the inhospitality era.  At the same time, the antitrust enforcement agencies have reversed their previous hostility to vertical mergers, and lower courts have uniformly adopted a more friendly stance to such transactions. Society's economic welfare has increased significantly as a result, thanks in large part to Ronald Coase.  Society is richer, literally, as a result.


Tribe Football Home Opener Tonight!

William and Mary fans are looking forward to the Tribe's 7:00 PM home opener tonight against the Hampton University Pirates at Zable Stadium in Williamsburg.  Like Hampton, the Green and Gold will be looking for its first win, after narrowly dropping its first game against FBS opponent West Virginia in Morgantown, 24-17.  (Go here for a story about the game and  here for highlights.)  (Hampton dropped its first game to Western Illinois, 42-9.)  (See here).    Neither team is ranked in the top 25, although William and Mary received eight votes in the most recent coaches' poll.  For extensive game notes prepared by the William and Mary Athletic Department, go here.  (Game notes prepared by Hampton University were not available at the time of this post.)

Saturday night's clash will be only the fourth meeting between the two peninsula universities, and the Tribe leads the series 3-0.  The last such meeting took place in Williamsburg in the first round of the 2004 FBS playoffs, where the Tribe, powered by 592 yards total offense and three touchdowns by wide out Dominique Thompson (including a 92 yard kickoff return), edged the Pirates 42-35.  The Pirates led 13-0 at the end of the first quarter, in an exciting seesaw contest witnessed by this blogger that saw several lead changes.

Good luck to both teams, and Go Tribe!

Friday, September 6, 2013

Liberty, Power and Hobby Lobby v. Sebelius

Imposers in Chief
Understood the Difference Between "Liberty" and "Power"
A recent essay in Slate magazine by Dahlia Lithwick takes issues with the Tenth Circuit's decision in Hobby Lobby v. Sebelius, which invalidated, as applied to Hobby Lobby, Inc., regulations promulgated by Secretary of Health and Human Services (HHS) Kathleen Sebelius (pictured above with President Obama)  pursuant to the Affordable Care Act.  The regulations require corporations and other firms with fifty or more employees  to purchase various forms of contraception for their employees, even when purchasing such contraception violates the owners' unanimous and deeply held religious beliefs.  Like several other federal courts, the Tenth Circuit held that coercing the owners of Hobby Lobby, a closely-held corporation owned by five family members, to violate their religious beliefs in this manner contravened the Religious Freedom Restoration Act ("RFRA").   RFRA is a federal statute, the core of which prevents the Federal Government from  burdening religious liberty.    Passed after Employment Division v. Smith, 494 U.S. 872 (1990), which held that generally-applicable and neutral laws do not violate the Free Exercise Clause of the First Amendment, the statute prevents federal agencies from placing a substantial burden on the exercise of religion, even by means of a generally-applicable regulation, unless such a burden is the least restrictive means of accomplishing a compelling state interest.  In short, the statute reinstates, as against federal agencies, the standard articulated by Justices Brennan and Douglas, respectively, in opinions for the Court in Sherbert v. Verner, 374 U.S. 398 (1963) and Wisconsin v. Yoder, 406 U.S. 205 (1972), both of which Smith overruled.    See also Smith, 494 U.S. at 893-900  (O'Connor, J. concurring in the judgment) (endorsing the Sherbert test).   
Lithwick's essay repeatedly asserts that firms such as Hobby Lobby are claiming the right to impose their owners' religious beliefs on others by somehow barring their employees from using contraception.  For instance, the subtitle of the essay predicts that: "[t]he Supreme Court will soon decide if CEOs can impose their religious convictions on the people who work for them."    The piece also contends that  "[e]mployees who choose to use contraception (as 99 percent of us will do at some point) shouldn’t do so at the sufferance of their bosses."  The piece also asserts that, under the Tenth Circuit's approach:  "Constitutional protections of a single employer’s individual rights of conscience and belief become a bludgeon by which he [or she] can dictate the most intimate health decisions of his [or her] workers, whose own religious rights and constitutional freedoms become immaterial." (emphasis supplied)  In other words, Lithwick claims that Hobby Lobby's exercise of religious liberty reduces the liberty of some of its employees, with the result that the HHS regulations invalidated in Hobby Lobby actually promote liberty.

If in fact employers were coercively dictating their employees' religious beliefs,  regulations necessary to forbid such coercion would satisfy RFRA's compelling state interest test.  However, Lithwick's colorful rhetoric fundamentally mischaracterizes the question that was before the Tenth Circuit in Hobby Lobby.   For one thing, the court expressly disclaimed any reliance upon the Constitution, choosing instead to ground its decision on RFRA.  (See page 9, n. 2)    More fundamentally, Hobby Lobby's  owners do not seek to impose their beliefs on anyone or otherwise prevent their employees from using contraception.  Nor does the rationale of the Tenth Circuit's decision even remotely threaten such a result.  After all, Hobby Lobby has no power to conscript employees to work for it; nor does it have the power unilaterally to impose particular terms of employment.  Instead, its employees are members of a free society who voluntarily consent to their place and conditions of employment. (Lithwick provides no evidence that Hobby Lobby or other religiously-motivated firms have used fraud, unfair bargaining tactics or coercion to induce employees to work for them.)  In these circumstances, an employer's failure to cover a particular medical service or procedure does not "impose" the employer's convictions (religious or otherwise) on the employee any more than the enforcement of a standard deductible or co-pay is such an imposition.  Invoking such reasoning, an employer could also claim that an employee who declines to work extra hours for no pay "imposes" its will on the employer.  
To be sure, some employment agreements may appear less than voluntary.  For instance, a particular firm might be the only employer in a small, remote town.  Or, an employee may have remained so long at a particular firm that his or her skills may be useless elsewhere, with the result that he or she has no meaningful choice but to remain at the same employer.  In such cases the employer in question could have market power in the labor market, power that it could use to pay unduly low wages or foist on employees terms of employment that would not survive in a more competitive environment.  Even in such circumstances, however, a failure to pay for contraception would not "impose" the firm's beliefs upon its employees.   After all, failure to pay for someone else's contraception is just that; a failure to pay.  Hobby Lobby has not sought to prevent employees from using their own incomes to purchase contraception, or anything else for that matter.  Indeed, firms that do not  provide such coverage will incur slightly lower costs, realize a slightly larger net marginal product from each employee and thus pay slightly higher wages, wages that employees can use to purchase whatever they wish, including contraception.  (This is true, it should be noted, even if a firm possesses market power.  Such firms cannot both use the same power to reduce wages and impose inferior benefits.  They must choose one or the other.)  Hobby Lobby's employees remain perfectly free to purchase their own contraception.  Treating such employees as victims of coercive interference with their own liberty, religious or otherwise, stretches such concepts well beyond any useful meaning.  One might just as well claim that a Progressive employer "dictates" employees' beliefs and reduces their liberty when he or she refuses to provide free parking because he or she has a religiously-grounded objection to global climate change and commuting by car. 

Indeed, Lithwick's claim of religious coercion proves far too much.  After all, if Hobby Lobby is dictating its employees' beliefs, then so too is every firm and individual that declines, because of religious beliefs, to purchase contraception (or anything else) for someone else.  Assume for a moment that some pharmacists provide free contraception to their customers, perhaps as a loss leader, to lure them away from competing pharmacists.  Assume further that other pharmacists decline to adopt such a strategy because of their religious beliefs.  Under Lithwick's reasoning, those pharmacists who decline to subsidize their customers' use of contraceptives are "dictating" these customers' beliefs and interfering with their liberty, even though the customers remain perfectly free (as do Hobby Lobby's employees) to purchase contraceptives at market prices.  Such a claim of coercion refutes itself and incorrectly equates individual liberty with a legal right to extract financial resources from others. 

Lithwick's argument exemplifies what F.A. Hayek once characterized as the unfortunate tendency to redefine liberty as an individual's "power to do certain things," or "the effective power to do what we want," without external constraint.  See  Friedrich H. Hayek, The Constitution of Liberty, 16-20 (1960). Redefined in this way, such "positive liberty" often consists of the power to coerce others to subsidize the individual's chosen activities, whether parking or contraception.  This redefinition deprives the term "liberty" of any useful meaning, transforming normative questions about the proper scope of liberty into a policy choice between the wants and desires of competing individuals, each of whom can claim that a choice in his or her favor enhances (his or her) "liberty."  Even slave owners could (and did) claim that slavery enhanced their liberty, by increasing the slave owner's material welfare at the tragic expense of those unjustly enslaved.  Lincoln, of course, properly rejected this definition of liberty and the concomitant equation of "liberty" with power over others, calling such "liberty" the alleged right of "some men to do what they please with other men, and the product of their labor."  (See Address At A Baltimore Sanitary Fair, April  1864).  He instead preferred the right "of each man to do as he pleases with himself, and the product of his labor."

No doubt Lithwick, too, would sincerely reject the slaveowners' claim, although without invoking Lincoln's straightforward distinction between negative and positive liberty.  Still, her argument diverts attention from the real source of coercion in this context.  After all, as the Tenth Circuit held, the regulationsc hallenged in Hobby Lobby coerce some employers to violate their own religious beliefs.  That is, it is the Obama Administration, and not Hobby Lobby, that seeks to impose its views on others.  Legislative imposition of views is not ipso facto inappropriate; by its nature, laws "impose" some view on others.  However, regulations that require individuals to violate their sincerely held religious beliefs are prima facie violations of RFRA.  As shown above, such regulations do not enhance anyone's liberty, but instead extinguish it.  Absent identification of some other compelling state interest, RFRA's protection for liberty must prevail.