Bryan Caplan on Time Preference

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In a 2005 blog entry from economist and George Mason professor, Bryan Caplan disputes the veracity of time preference proving why interest rates tend to be positive. Time preference asserts that people prefer present consumption over future consumption. Providing some insight into why people would be willing to receive money now and later pay it back with interest. From the standpoint of an individual’s assessment of value, $1000.00 today is worth more than $1000.00 three months from now. Dr. Caplan launches a two-pronged attack against the assumption that time preference explains why interest rates are positive. Caplan suggests that dimmishing marginal utlity, not time preference demonstrates the proclivity of interest rates being positive.

Professor Caplan’s first point regarding the failure of time preference to adequately explain positive interest rates relates to the allocation of nonmonetary resources. He details a scenario where an individual is marooned on a desert island with only two bananas. Per a loose application of time preference, in theory, the person stuck on the island would eat both bananas today. Since we prefer present consumption to future consumption. A “perfectly patient” person would be willing to eat only one banana a day to more effectively curb their hunger. This is because we disvalue hunger today equally as much as we do tomorrow. Making dividing consumption between the two days a more effective use of resources.

Caplan goes further elucidates this point by demonstrating the fact that often in barter interest rates are negative. Per the blog entry:

“Suppose we knew the price of food would double next year. Then a pound of food now trades for half a pound of food one year from now. Translation: a negative 50% interest rate!

If this seems crazy to you, suppose the food was the only commodity, and you expect a famine next year. Wouldn’t you happily trade 2 pounds of current food in exchange for a promissory note good for 1 pound of food next year?”

This example explicates depending on the context we may forgo present consumption for future consumption. Even when we are expected to take a loss on the value of that commodity. This foils the main tenants of time preference. If we were to delay current consumption for future consumption we tend to do so for future gain. To quote the Austrian economist Roger Garrison “ We save up for something”. We hang on to stocks, gold, annuities, bonds, or cash holdings with the anticipation they will increase in value. It is important to note that inflation does take its toll on cash holdings. In the mind of the average person, it is more about amassing large quantities of money than an expected increase in value. Per time preference, if we did anticipate no gain from delaying consumption, we would be more apt to consume now than take the loss. However, in the situation presented by Dr. Caplan, it may be reasonable that a logical person may do the opposite. The rationale why loans for money tend to be positive is the fact that money does not spoil and is of little cost to store.

The second prong of Professor Caplan’s argument is the most compelling. In modern society, people have the ex-ante perception that they will be richer in the future. Anticipating being wealthier at a later date will drive a person’s demand for consumption up for the present. As the individual exhausts their desire to consume, the hope is that they have more money to pay back the sum that was loaned with interest.  That is certainly a point that the Austrian perspective on interest rates ignores. Is it possible that if we excepted to get a raise in our compensation next year, we are more apt to spend more now and around the time we start to experience the disutility of consumption we experience a bump in pay?   This is a very likely scenario.  Presents arguably the biggest blind spot in the theory of time preference.

However, there is one looming question that Dr. Caplan does sidestep in his arguments. Few sane economists would ever argue that the law of diminishing marginal utility doesn’t apply to consumer behavior. But are we truly measuring the utility of the same commodities if we delay present consumption?  Our Christmas decorations three weeks before December 25th the same commodity as these same decorations on the clearance rack the first week of January?  It could be reasonable to argue no. While diminishing marginal utility could explain this decrease in demand, but it fails to consider the full scope of the customer’s subjective evaluation of the goods. The marginal utility can only explain the assessment of the value of a commodity. It cannot explain if the customer perceives the good as being categorically different. The variable of time could very well influence whether Christmas decorations now or a month ago are truly the same product. Applying this reasoning to interest rates, this point becomes quite clear. Is $1000.00 today plus avoiding a late payment on a credit card the same as $1,000.00 next week? Especially when we consider late fees, damage to our credit score, etc. On top of it, you still owe the credit card company $1,000.00.  It is difficult to quantify the intrinsic value of having a clear credit score. $1,000.00 plus interest may be worth more to the individual than taking a hit on their credit score.

Credential Inflation: Is College Worth It?

 

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As a society, we invest in many things. We invested in promising startups. We invest time in our community through charity. We even invest in ourselves. Which explains the plethora of fad diets and gym members we have to choose from in America. Americans also invest in human capital. Mainly through acquiring college degrees. Does a bachelor’s degree look impressive when nearly half of all Millennials have one? [1].

 

Investing in a college degree is certainly a costly endeavor. The typical college student who graduated in 2017 owed on average $28,650 in loans [2]. The assumption being that the student is going into debt to purchase a degree that will be the golden ticket to a good salary. Unfortunately, this is a somewhat faulty assumption. The significant numbers of college graduates are underemployed [3]. In 2008, it was estimated that 17 million college graduates employed in jobs that did not require a college degree (Vedder, 2012, P. 8) [4]. Notably, examples of underemployment being 29 % of flight attendants, 17 % of hotel clerks, and 23.5 % of amusement park attendants hold 4-year degrees (Vedder, 2012, P. 8) [5]. There is nothing wrong with any of the listed occupations. Is it wise to go into debt to take a job that requires no more than a high school diploma?

 

Underemployment is a key fixture of what has been credential inflation. Similar to monetary inflation is the depreciation of requisite education for a specific job. In a fiat system of currency when we print more money the purchasing power of our currency decreases. Likewise, flooding the job market with applicants possessing  4-year degrees diminishes the “purchasing power” of this previously advantageous form of human capital. The law of diminishing returns applies to education and the underemployment of college graduates being symptomatic of over-investment (Vedder, 2016, P.3) [6]. That’s why expanding college education universally will only compound the issue. The prevalence of college degrees has deduced this level of educational attainment to a bare-bones requirement. Putting into question the value of investing in a bachelor’s degree.

 

To really illustrate the dramatic increase in college obtainment it is important note when World War II started less than 5 % of adults had a degree (Bankston, 2011, P.3) [7]. Truly making a college degree a prestigious achievement. Part of what has driven the dramatic influx in college attendance has been government subsidies. For example, the Pell Grant established in 1972 to provide funding for low income students to attend college. Which ended up providing assistance to 5,428,000 students in the 2007-2008 academic year (Bankston, 2011, P.11) [8]. Outside of grants loans and other forms of financial aide have also contributed to the sizable increase in college attendance. It should also be noted that societal pressure also come into play. Your parents, teachers, society, and even politicians urging you to go to college.

 

Some would argue that there is  a two-sided debasement of the college degree. Not only is there any increased quantity, but a decrease in the quality. Some experts believe that the college curriculum has been “dumbed down” (Bankston, 2011, P.20) [9]. Which I personally find to be difficult to empirically determine. We are making a qualitative statement that can be swayed by perception. Standardize testing results perhaps? SAT scores for math have improved since 1966-67 school year, however, reading scores have been on the decline (Bankston, 2011, P.20) [10]. Is college admissions testing specific enough of a criterion to assess curriculum quality? I believe that is an open question. It is fair to question the conviction of current college students. The typical college student spends 900-400 hours a year on school related activities (studying, class attendance, etc.). In contrast the average full-time employee spends 1,800 to 2,000 hours annually (Vedder, 2012, P. 5)[11]. This may not necessarily measure the same variable. However, it does put into question strongly encouraging young people to attend college. If their priorities are video games, beer-pong, and dating then maybe it might not be the strongest option.

 

It is it really wise to be pushing recent High School graduates towards college? Considering odds are even with a college degree they will be underemployed. While away at college will spend more time hitting the beer-pong table than the library. Not too mention the cost. There was a 32.4% increase in the cost of college from 2001-2011 (Lemke & Shughart II, 2016, P.1) [12].The costs are only going to continue to rise. I would suggest that perspective students judicially choose their majors for what will have the biggest return in the job market.  Otherwise your decision will be a prime example of malinvestment. You will end up with massive student loans making 13.00/hr at a call center. However, computer science, applied mathematics, healthcare, and engineering  (P. 12) are “safer” bets than a philosophy degree.

 

Fortunately companies such as Google are not weight college degrees as heavily in the process of job candidate selection. Which is a shrewd move considering the number of programming certificates that exist. In all honest maybe more beneficial than a degree.  Even some grants now are predicated on the contingency that the recipient does not attend college. Example being the Thiel Fellowship. Shifting away from the college degree signaling model discussed by economists such as Bryan Caplan [13].

 

I have been personally impacted by credential inflation and have been lucky enough to rebound from underemployment. I was urged by my mother to attend college. I wasn’t too keen on it , so I decided to get my core requirements satisfied at a Community College. Due to my academic achievement at Community College I received a break on my tuition when I transferred to a 4-year institution. Luckily, I got my partying days out of the way in High School. Graduated Summa Cum Laude from University and was then in the massive expanse known as the job market. Armed with a mere Bachelor’s of Science in Psychology, needless to say I didn’t fare too well. Ended up working as a janitor at a casino. Thankfully, due to my strategic planning I graduated with virtually no debt. Then ended up working several office jobs. Typically, corporate offices prefer candidates with college degrees. Which is gratuitous because there is nothing about the job that makes inherently necessary to hold a college degree.