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Student Loans: Solutions vs. Delusions

The total amount of federal student loans has been growing quickly. The following diagram from the Federal Reserve shows the growth of student loans since 2006.

StudentDebt

The total amount at the time of writing is over 1.3 trillion dollars, and the federal student loan portfolio is 1.221 trillion dollars according to the latest data from the department of education. This huge increase in spending on student loans indicates both an increase in the number of people seeking a college education and a rise in the cost of college education.

The problem of student loans is one of the hot topics this election cycle with both presidential candidates on the left proposing some variations of free college to solve the problem. Many young students with large student loan balances surely cheer that, who doesn’t like free stuff? Free college may make some voters happy and may even win someone the elections but it won’t solve the fundamental problem with higher education.

Let’s start with asking why do people get a college education? Sound economic thinking says that they do that to raise their human capital and raise their productivity and income. College then is an investment that has expected return in the form of future earnings. People who don’t have the financial resources to make needed investments get loans to finance their projects. The interest rate on a loan is determined by the lender based on the borrowers’ ability to pay which depends on the risk of the project. So if two students with similar academic abilities applied for loans one for an engineering degree and the other for an animal studies degree the first will definitely get lower interest rate on his loan because an engineer has a higher earning potential than a person with an animal studies degree. The effect of interest rates will be to steer students towards more productive majors and only students who really are interested in low productivity majors will take the high-interest loans to get into these majors. The other effect of the interest rate is that they force borrowers to take the smallest loans that can meet their goals so each student will have a strong incentive to select the cheapest college program that gives him the education he needs. This will pressure the universities to be more efficient and offer better education packages to attract students with different budgets.

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Government Regulations: Costs and Dangers

A government regulation is a set of rules written by some executive branch agency to organize a certain economic activity. They start when the legislature passes a law to organize some economic activity and as part of that law, it creates a new executive agency or tasks existing agency to create the rules that people and businesses have to follow to comply with that law. The agency then maintains these rules, updates them as it sees fit and enforces them through either financial penalties or prosecution for violation.

Federal Government regulations are violating the Constitution because the Congress is delegating lawmaking to the executive branch. The Constitution has a clear separation of power between the three branches and it doesn’t give the power to any of the branches to delegate its powers to another branch. Not only does Congress delegates its power to write law regarding a certain area, but also it effectively loses that power. Once created, the regulatory agencies can write as many regulations as they want and Congress can only repeal a regulation by passing a bill, but given that the President still has the veto power the Congress can repeal a regulation only if it has a two-thirds majority support for that repeal. This effectively eliminates the power of Congress in every area regulated by an executive agency. According to the information on the federal register, which maintains all the federal rules, Congress had  only disapproved one rule since 1996.

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Government Spending vs. Revenue

The classical view in democratic countries is that the government taxes the citizens to finance its spending. The Congress on the federal level and the legislature on the state level debate a yearly budget to spend the tax receipts on the different priorities. The government may raise the tax rates if it needs to spend more money that it bring in tax revenue. The reality of democratic politics is far from that classical view. Raising taxes and cutting government spending are both politically unpopular options, so governments use deficit spending.
To finance the deficit the government issues bonds and sell them to creditors. These bonds have different maturity dates, interest rates, and sale prices depending on the creditworthiness of the government, and they add a new item to the government’s budget which is the debt service for paying the interest rate on outstanding bonds and paying the face value of matured bonds. Because of the same political factors that prevent raising taxes and cutting government spending the government ends up having a deficit every year and these deficits accumulate and increase the government debt.
A common way to express the debt is as a percentage of the Gross Domestic Product (GDP), this gives an indication of the size of the debt in comparison to the economy. The debt to GDP ratio might hide the debt increase if the GDP grew at a higher rate than debt for few years, so it is important to look at the absolute value of debt as well. The following chart shows the growth of the federal debt as percent of the GDP:

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Individual vs. Group

As Ludwig von Mises explained in his masterpiece book Human Action, the economy consists of individuals performing actions based on their individual preferences and engage in market exchanges “catallactics” with other individuals. People act to satisfy their needs and the needs of other citizens involved. For example, an employee performs his job to meet the goals set by his employer and to earn compensation. We can understand what happens in the market through analyzing the actions people make and the needs they satisfy. For example, when an entrepreneur starts a business that provides a product or a service that meet a certain need, people who value this need will buy this product or service to meet that need and while doing that they satisfy the entrepreneur’s need to have a successful business. If that business doesn’t satisfy enough customers to generate a profit, the entrepreneur will have to either adapt his business to the market or go out of business freeing his time and resources to work on something else.

Many politicians rely on a different standard in the analysis. They explain everything as a conflict between two groups of people:

  • Karl Marx and his followers explain everything through a class struggle between the workers and the business owners, proletariat vs. bourgeois.
  • Progressives in the United States explain everything in terms of business exploiting customers and the need for government to protect the customers.
  • Race activists explain everything in terms of whites exploiting other races.

Of course, there are business owners that abuse their workers, businesses that cheat their customers and white people who discriminate against minority people. But there are also many business owners that treat their workers very well, many businesses that do everything they can to serve their customers and many people who don’t consider race at all in their actions.

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How to compare?

AvsB

Many of the political discussions we have every day involve comparison. Income redistribution advocates compare the incomes of the top 1% or 10% with the income of the bottom 1% or %10, Gun restriction advocates compare gun murder rates in the U.S. versus the same rates in France and Nationalized heath care advocates compare the cost of health care in the U.S. vs. the cost in U.K. or France. Activists cite these comparisons to create a single punch line such as “the top 1% control majority of wealth” or “Nationalized healthcare will save the U.S. a lot of money” but these are misleading comparisons.

When you shop for a car you don’t just look at the price then buy the cheapest option. You look at the individual features, safety, price, warranty and many other variables and then you make your decision. Not all aspects will have the same weight and you will take that into consideration but if you care about price more than anything you may still buy a car that is a bit more expensive if it has a nice feature and the difference in price is acceptable to you.

We should use the same mentality when we evaluate options offered by politicians for a certain problem. When socialists claim that it is unfair for a CEO to have much more income than a typical employee in a company, we should look to other differences between the two people such as education, skills and productivity.Read More »How to compare?