Why the Prices Are So Damn High: Reply to Alex

Alex has already posted a reply to my critique of Why Are the Prices So Damn High?   Here’s my point-by-point reply, with Alex in blockquotes.

In contrast, my friend Bryan Caplan is not happy. Bryan’s basic point is to argue, ‘look around at all the stupid ways in which the government prevents health care and education prices from falling. Of course, government is the explanation for higher prices.’ In point of fact, I agree with many of Bryan’s points. Bryan says, for example, that immigration would lower health care prices. Indeed it would.

So far, so good.

(Aside: it does seem odd for Bryan to argue that if K-12 education were privately funded schools would not continue their insane practice of requiring primary school teachers to have B.A.s when in fact, as Bryan knows, credentialism has occurred throughout the economy)

Yes, but credential inflation is clearly worse in the public sector.  Public-sector jobs for high-school dropouts, for example, have virtually vanished.  The private sector is markedly more open-minded.  But private schools don’t hire non-college grads to teach either?  Accreditation requirements aside, there’s a straightforward explanation.

The problem with Bryan’s critiques is that they miss what we are trying to explain which is why some prices have risen while others have fallen. Immigration would indeed lower health care prices but it would also lower the price of automobiles leaving the net difference unexplained.

On the contrary!  Alex says there’s a cost disease driven by labor costs.  Immigration laws restrict the import of labor far more strictly than they restrict the import of other inputs.  So deregulation wouldn’t just lower prices in general; it would lower the prices of labor-intensive goods to an especially strong degree.

When you put all these regulations together it’s not at all obvious that there is more regulation in education than in auto manufacturing. Indeed, since the major increase in regulation since the 1970s has been in environmental regulation, which impacts manufacturing more than services, it seems plausible that regulation has increased more for auto manufacturing.

To repeat, the more labor-intensive the sector, the more regulated it effectively is, because immigration restrictions are restrictions on the supply of labor.  Standard measures of regulation don’t capture this difference because they take immigration restrictions for granted, but those measures are therefore sadly flawed.

Furthermore, Alex misses my most undeniable point: the education industry, unlike the auto industry, is funded almost entirely by government – and this funding has swelled over time.  If government had not increased funding for education, education prices would have risen far less.  In contrast, government spent very little on cars throughout.  (Government’s role in health care isn’t quite as monolithic, but remains vast nonetheless).

As an empirical economist, I am interested in testable hypotheses. A testable hypothesis is that the industries with the biggest increases in regulation have seen the biggest increases in prices over time. Yet, when we test that hypothesis as best we can it appears to be false.

That is one testable hypothesis.  Here’s another: The industries where government provides a larger share of funding will have bigger increases in prices over time.  Or how about: The industries where government funding has increased the most will have bigger increases in prices over time.  Helland and Tabarrok strangely fail to consider either of these hypotheses.  And as long as you weight by size of the sector, they’ll almost surely check out, because education and health care are two huge sectors with huge price increases, high government funding, and large increases in government funding.

Remember, this does not mean that regulation doesn’t increase prices! It can and probably does it’s just that regulation is not the explanation for the differences in prices we see across industries. (Note also that Bryan argues that you don’t need increasing regulation to explain increasing prices, which is true, but I still need a testable hypotheses not an unfalsifiable claim.)

If my claim is true, then several of Helland and Tabarrok’s “tests” are conceptually confused.  So they don’t “falsify” what they claim to falsify.

So by all means let’s deregulate, but don’t expect 70+ year price trends to reverse until robots and AI start improving productivity in services faster than in manufacturing.

I say that when these technological changes come, education will barely change, and health care change only modestly.  Why?  First, because when you’re funded by the government, you have little incentive to cut costs.  Second, even if you want to cut costs, many long-standing regulations (not increasing regulation!) get in the way.

In any case, why isn’t Alex equally willing to predict the “70+ year price trends to reverse” if we deregulate the movement of labor?  Or just slash the education and health care budgets?  I am puzzled by his fatalism in the face of gross government failure.

Let me close with this. What I found most convincing about the Baumol effect is consilience. Here, for example, are two figures which did not make the book. The first shows car prices versus car repair prices. The second shows shoe and clothing prices versus shoe repair, tailors, dry cleaners and hair styling. In both cases, the goods price is way down and the service price is up. The Baumol effect offers a unifying account of trends such as this across many different industries. Other theories tend to be ad hoc, false, or unfalsifiable.

I agree that the Baumol effect is important.  It explains many things.  Helland-Tabarrok provide a nice tour of the evidence.  But many other effects are also important, and they explain many facts that the Baumol effect fails to address.  The upshot is that a pure Baumol theory isn’t just falsifiable; it’s demonstrably false.

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