Comments on economics, mystery fiction, drama, and art.

Friday, January 27, 2006

World Steel Consolidation:

And now comes word that Mittal Steel, the world's largest steelmaker (and owner of the northwest Indiana peices that once were Inland, LTV, and Bethlehem), has made a bid to acquire the world's #2 steelmaker, Arcelor. If this acquisition, which Arcelor calls hostile and unwelcome, goes through, the combines company will have about 100 million tons of production capacity. In the context of the global market for steel--apparently 1,116 million tons in 2005--we're not talking a really large share of the market (about 9%), and the steel analysts quoted in the NYT piece don't think the merger will give Mittal much, if any,pricing power.

Nothing's a done-deal yet, obviously, but if this acquisition does go through, we need to ask whether it has implications fot northwest Indiana. At this time, the answer is, "Who knows?" But that might become clearer as things progress.

In a related note, China's output in 2005 rose by 77 million tons; steel output in the rest of the world declined by about 11 million tons. China has gone, in one year, from being a fairly significant importer to being a fairly significant exporter. This has happened much more quickly than I, for one, thought it would.

Fourth Quarter 2005: Not Good News

"Economy Grows At Slowest Pace In 3 Years." 1.1% increase in real GDP in the fourth quarter. This is not good news. The particularly bad news is the fairly large increase in the rate of inventory accumulation. Businesses are highly likely to cut back on inventory purchases; it's not unlikely that inventories will fall in the first quarter of 2006.

Wednesday, January 25, 2006

Privatizing the Indiana Toll Road

Following Mark Thoma’s comments on the sale of the Indiana Toll Road, I thought I’d add some comments here. It looks like Indiana has reached an agreement to lease the Indiana Toll Road to a consortium of Cintra and the Macquarie, two firms with a history of such investments (they were the winners, as I recall, in the lease of the Chicago Skyway toll road). Their winning bid was $3.85 billion for a 75-year lease. According to Toll Road News, the lease payment will be a lump-sum, not an annual payment.

Apparently, the Indiana Toll Road’s revenue has been slightly less than $100 million a year recently (with plans to add about $77 million a year in revenue from toll increases), with operations costs (toll collecting and routine maintenance) of around $65 million a year; this is a nice spread for Indiana, in the absence of long-term infrastructure investments and in the absence of meaningful accounting for depreciation. Indiana has developed plans to spend about $770 million on improvements (not routine maintenance) on the Toll Road over the next decade; it is not clear whether those improvements will be paid for by Cintra-Macquarie under the terms of the lease, or whether the State of Indiana will make them, and pay for them.

What seems clear, unless I’m missing something, is that Cintra-Macquarie will be hard pressed to turn a profit unless tolls increase substantially. Assume they have to pay 7% per year to fund the $3.85 billion lease payment (or, alternatively, that they could have earned 7% per year on cash on hand that they use to make the payment). That’s an annual cost of funds of $269.5 million. Assume that they manage to hold the operating costs 20% below what Indiana has been paying, from a combination of smarter management, cost-saving technological change, and lower wages. That’s $52 million a year in operating costs (which seems damned low to me, in any event). We’re up to $320 million or so in annual costs, in the absence of depreciation or improvements.

Indiana’s plan called for revenues of about $175 million per year over the next 10 years. Cintra-Macquarie will need about $600 million to earn an after-cost-of-funds return of 7% on its investment. That’s more than three times what Indiana planned to collect in tolls (and other revenue). That suggests that tolls will need to triple—or more—on the Toll Road.

But it’s worse than that. For much of its length, and especially for the heavily-traveled western end of its length, the Toll Road has direct competition from a freeway. Now the freeway (I80/94, known locally as the Borman Expressway) is highly congested, and already a fair amount of the Toll Road traffic is a diversion because of that congestion. But if the tolls triple, then some, perhaps significant, portion of the traffic will divert back to the freeway.

Perhaps I’m missing something. Perhaps there’s some obvious way in which this can be a profitable venture. I can’t believe Cintra-Macquarie would offer up $3.85 billion if they didn’t have a plan to make a reasonable profit. But, right now, I just can’t see it

Wednesday, January 18, 2006

Higher Education and Productivity

Thomas Garrett and William Poole (both with the Federal Reserve Bank of St. Louis) have written an important article proposing an ambitious agenda for restructuring higher education. They provide an attractive, almost seductive framework, focusing on ways to increase productivity (and, along with that, lowering costs) in higher education. I suspect this article will find a receptive audience among state legislators and in many university administrators' offices.

They note that tuition has increased much more rapidly than prices in general, rising 5.9% per year at public institutions between 1991 and 2003, compared with an overall rate of inflation of only 2.5%. This suggests a rate of growth in “real”—inflation-adjusted tuition of 3.4% per year. (They also note, but do not deal with the implications of, rising financial aid. That is, they compare increases in the “sticker price” of higher ed, rather than “actual discounted prices,” to increases in prices in general. Although it’s not clear whether such an adjustment would increase or decrease the “after-aid” rate of increase in tuition.) While they note the decline in state support for higher education (real instructional expenditure per student is up only 17%, and real instructional plus real administrative expenditures are up 27%), they do not follow through with a full discussion of that.

They suggest that the problem is that productivity has not increased and that it is essential to look for ways to increase productivity in higher education. They do note the difficulty of measuring productivity; what is interesting is that there is no direct mention of student learning in this discussion (although learning might be thought to be subsumed under “student quality”). And they propose a number of ways in which productivity might be increased.

But here’s where the real gains are to be found; the rest is window dressing: Increased flexibility of faculty staffing.

"Much of the discussion relating to the role of faculty in contributing to productivity in higher education involves lengthening the time that faculty spend in the classroom, enhancing the quality of instruction and increasing flexibility of faculty staffing. Given the size of instruction as a percentage of total university expenditures (35 percent on average), an important cost-saving and quality-enhancing strategy is to better align faculty with student needs. At many universities, as student demand for certain majors or classes ebbs and flows over time, there is little change in the number of faculty in each department. A failure to match teaching capacity with student demand is completely opposite the private sector, where changes in business conditions directly influence staffing levels.

"To rein in costs, universities must have the flexibility to hire more faculty or increase teaching loads of current faculty when demand for a major increases and, conversely, universities must have the flexibility to reduce the number of faculty when demand for a major decreases. Just as an automaker must be able to shift production from large SUVs to small cars when energy prices soar, universities must make similar adjustments when student interest in subject X soars and interest in subject Y sags.

"Probably the greatest obstacle to increased flexibility of faculty is tenure. An economic argument for tenure is that it saves initial expense on the part of the university. The saving arises because faculty with tenure, or those hired with the possibility of tenure, will work at a lower salary in return for the guarantee of lifetime employment. Thus, tenure can be viewed as a nonpecuniary payment in lieu of salary. However, while there may be initial cost savings from tenure, the resulting inflexibility imposed by tenure has greater costs in terms of both dollars and student quality. Tenure prevents significant staffing changes in response to changes in student demands; tenure also prevents lower quality faculty from being replaced by higher quality faculty. Clearly, however, the abolition of tenure would be met with opposition from faculty and would even face legal challenges. Strong department leadership would be willing to take such risks, as is typical of strong leadership in the business world."

There’s so much to be said here. First, note that this discussion apparently assumes the faculty has no interest in, or control over, what programs an institution offers, what courses their departments offer—or, perhaps more accurately, that the faculty ought to have no such interest. Faculty are to be treated purely as an input, not as anything more central to the academic process.

Second, their argument essentially presumes that tenure is essentially an economic institution. And clearly tenure has significant economic aspects and implications. (I'm no fan of tenure, by the way. I think most of its benefits could be achieved by using a "rolling" multi-year contract for faculty past a probationary period. That system, however, might be as pernicious, from Garrett and Polley's point of view, in limiting administrative flexibility.) But tenure is more than an economic institution. It also provides protection for faculty whose research or teaching creates conflict with administrators, legislators, or the public. And if universities are to fulfil one part of their bargain with society--extending the boundaries of knowledge--faculty will frequently come into such conflicts, and need some sort of protection.

Third, this proposal assumes that the only activity in which the university engages (ought to engage?) is teaching—the transmission of knowledge. For land-grant colleges, Congress explicitly identified a mission that includes generation of knowledge as well as transmission. And, at most research-oriented institutions, outside research funding generally more than covers research costs and can be an important contributor to the institution’s budget.

Fourth, this proposal would almost certainly lead to increased turnover in academic programs, which would, over time, almost certainly lead in instability and to a failure to develop substantive expertise.

Fifth, this proposal assumes that the best arbiters of what academic programs ought to include are the students. Now, I’m broadly sympathetic with the notion that student concerns ought to be incorporated into the decision-making. But at my institution, taken to its limit, this would mean that business majors (for example) would know no statistics. Um. That’s a good idea.

Finally, and of practical concern, universities have already moved a long way toward contingent staffing, as more and more courses are taught by part-time or non-tenurable faculty. So this source of inflexibility is, well, not so important as it once was.

Garrett and Polley explicitly put forward a vision of higher education that is cramped and narrow-minded, the transformation of universities as homes for seekers after knowledge and well as institutions that conserve and transmit knowledge into something else, something much smaller. The transformation would diminish our society even as the Garretts and Polleys see universities becoming more productive.

It’s a future in which we all work for the University of Phoenix.

Tuesday, January 10, 2006

Employment Growth in Recoveries

Since World War II, the average monthly percentage growth in employment from the trough of a recession to the peak of the recovery (both measured in terms of employment) has been 0.238% per month. Generally, employment growth has been fastest in the early months of the recovery. Which of these recoveries does not look like the others?

Thursday, January 05, 2006

Reading Early in the New Year

Right now, the top of the pile includes Douglass North's Understanding the Process of Economic Change and Benjamin Friedman's The Moral Consequences of Economic Growth. Having (just) started North's book, I already find myself being drawn in to his analysis. One brief quotation should make clear why (from p. 7): "In the Western World, and in particular in the United States, we tend to take order for granted. We should not. Disorder--revolution, lack of personal security, chaos--has characterized a great deal of the human condition..."

More as I work my way through the argument.