Category Archives: Top 10 Policy Papers

Reinventing Competitiveness – American Affairs Journal

It’s time for some soul-searching with respect to our economic future. Will we restore our ability to produce world-class products here in America? Will we invest in our capacity to lead innovation in the industries of the future? Or will we simply take solace in the comforting numbers from Wall Street, resigning ourselves to an economy focused on finance and services? At the level of geo-economics, we need to ask some bigger ques­tions: How have we, the most advanced technological power with the largest research budgets and many of the best universities, managed to lose our most essential assets for innovation and produc­tion? How have we managed to lose the economic foundations of our industrial heartland in the Midwest? How have other legacy industrial powers like Germany and Japan—with higher wages, higher energy costs, and stricter regulations—managed to weather competition from rising industrial powers more successfully? How have we allowed our medical supply chains and defense readiness to become utterly dependent on China?

Source: Reinventing Competitiveness – American Affairs Journal

The College Graduate as Collateral – The New York Times

Investors could finance students’ education with equity, not debt. In exchange, investors would receive a fraction of students’ future income.

ACADEMIC economists like to make fun of businesspeople: they want competition when they enter a new market but are quick to lobby for subsidies and barriers to competitors once they get in. Yet scholars like me are no better. We work in the least competitive and most subsidized industry of all: higher education.

We criticize predatory loans by mortgage brokers, when student loans can be just as abusive. To avoid the next credit bubble and debt crisis, we need to eliminate government subsidies and link tuition financing to the incomes of college graduates.

Nearly eight million students received Pell grants in 2010, costing $28 billion. In addition, the federal direct loan program, which allows nonaffluent students to get government-guaranteed loans at low interest rates, cost taxpayers $13 billion in 2010-11. Total subsidies to university education amount to $43 billion a year, including around $2 billion in Congressional earmarks — and that does not even include tax subsidies (for college funds); tax breaks (for university endowments, for example); and subsidies dedicated to research.

Just as subsidies for homeownership have increased the price of houses, so have education subsidies contributed to the soaring price of college. Between 1977 and 2009 the real average cost of university tuition more than doubled.

These subsidies also distort the credit market. Since the government guarantees student loans, lenders have no incentive to lend wisely. All the burden of making the right decision falls on the borrowers. Unfortunately, 18-year-olds aren’t particularly good at judging the profitability of an investment without expert advice, and when they do get such advice, it generally counsels taking the largest possible loan. The stock of student loans has reached $1 trillion, while the percentage of borrowers in default jumped to 8.8 percent in 2009 from 6.7 percent in 2007.

Last but not least, these subsidized loans keep afloat colleges that do not add much value for their students, preventing people from accumulating useful skills.

I do not want to suggest that helping underprivileged students attend college is bad. A true free-market system equalizes opportunities, if not for fairness, at least for efficiency: talent should not be wasted.

The best way to fix this inefficiency is to address the root of the problem: most bright students do not have any collateral and cannot easily pledge their future income. Yet the venture-capital industry has shown that the private sector can do a good job at financing new ventures with no collateral. So why can’t they finance bright students?

Investors could finance students’ education with equity rather than debt. In exchange for their capital, the investors would receive a fraction of a student’s future income — or, even better, a fraction of the increase in her income that derives from college attendance. (This increase can be easily calculated as the difference between the actual income and the average income of high school graduates in the same area.)

This is not a modern form of indentured servitude, but a voluntary form of taxation, one that would make only the beneficiaries of a college education — not all taxpayers — pay for the costs of it.

The cost of enforcing contracts contingent on future income is very large, but there is an effective solution: piggybacking on the tax collection system. The Internal Revenue Service could perform collection services on behalf of private lenders, and at no cost to taxpayers. (In Australia, such a system has been in place since the 1980s. The national tax agency enforces repayment of loans contingent on income, though the payments of the wealthiest graduates are capped, and therefore less affluent graduates need to be charged more to make the program viable than in the system I am proposing.)

Yale tried a form of loan repayment contingent on income in 1972. It failed, but the problem was that the Yale plan made all students mutually responsible with respect to the repayment of the total debt, generating a snowball effect in defaults: the burden on nondefaulting students was increased by the default of their classmates. (Similar problems afflicted a company, My Rich Uncle, that went bankrupt in 2009.) Furthermore, Yale had a comparative disadvantage in enforcing these contracts, because the act of enforcement was alienating its own alumni, creating bad will.

In fact, top colleges like Yale are already — implicitly — using a form of equity contract. They charge the average student less than the average cost of educating each student, while financing the shortfall with donations from the wealthiest alumni. It is tantamount to an implicit stake on the wealthiest alumni’s income. This system works very well for the top schools, which produce at least a few multibillionaires. It is much less effective for normal, middle-of-the-road colleges. It is precisely for these colleges that a formal equity contract would work best.

Equity contracts would diversify the risk of failure, with highly compensated superstars helping to finance the educations of less successful college graduates. They will also avoid pushing graduates into lucrative jobs just to pay off debt. Most important, these contracts would provide financiers with an incentive to counsel students wisely, as financiers would profit from good educational investments and lose from bad ones. This would create more informed demand for the schools, exerting pressure on them to contain costs and improve quality.

The most important effect of these equity contracts would be to show that it is possible to intervene to help the disadvantaged without turning that help into an undue subsidy for the producers (universities) and the creation of a privileged class (professors like me) at the expense of everybody else (students and taxpayers). After all, how can we scholars criticize crony capitalism when we benefit from it?

Big Pharma Incentives Are Out of Whack: Why We Need an X-Prize for Drugs | WIRED

Our patent system grants drug companies the exclusive right to sell their innovations without “generic” competition for years. Big Pharma points out that such patents are necessary because without them it can’t recoup the massive costs of creating new products. There’s another solution to this problem: a way to directly fund the drugs we’re not getting and avoid the high cost of artificial monopolies.

Source: Big Pharma Incentives Are Out of Whack: Why We Need an X-Prize for Drugs | WIRED


The entire U.S. patent system needs serious repair, but the most broken thing about it is the way we patent prescription drugs. Federal and state governments spend billions of dollars on basic medical research, and the resulting science winds up informing (at least indirectly) the development of blockbuster pharmaceuticals. But our patent system then grants drug companies the exclusive right to sell their innovations without “generic” competition for years. Big Pharma points out that such patents are necessary because without them it can’t recoup the massive costs of creating new products. Meanwhile, there are some classes of drugs that the world desperately needs—new lines of antibiotics, for example, or treatments for tropical, emerging, and rare diseases—but that the current system, dependent on blockbusters, doesn’t readily produce. The incentives are out of whack.

There’s another solution to this problem—a way to directly fund the drugs we’re not getting and avoid the high cost of artificial monopolies. Let’s take a page from some of our deep-pocketed philanthropists, who have used competitions to rejuvenate space technology (the X Prizes), mathematics (the Millennium Prize), and more. Instead of granting patents, the government should offer lump-sum payouts.

History shows this is not such a heretical idea. Indeed, stimulating innovation through prizes is actually as old as patent law. In the 1750s, Britain’s Royal Society of Arts offered what it called premiums, rewards for solutions to pressing technical or commercial problems: Spinning wheels, mechanical telegraphs, naval construction, and brocade weaving were all “premium” inventions. Although the winners got a handsome prize in return—in total, the RSA paid out tens of millions in today’s dollars—the solutions could not be patented. This meant that other people could adapt and improve on them.

Prizes create a kind of artificial economic system that maintains most of the key advantages of the free market. They create incentives and competition, and they diversify the number of minds working on the problem. But the prizes eliminate wasteful spending, since they are rewarded only when genuine solutions have been achieved. And when combined with limits on patent monopolies, prizes can ensure that those innovations will flow more readily through the society at large.

>Prizes can ensure that those innovations will flow more readily through the society at large.

Right now, most of the marquee prize-backed challenges are still funded by philanthropists or the nonprofit sector. But governments have begun to get involved. The Obama administration’s Open Government Initiative has created more than 150 challenges, everything from developing new fuel scrubbers for the Air Force to a Healthy App contest sponsored by the surgeon general.

Because they are targeted explicitly at individuals or groups who are not on the government’s payroll, state-funded challenges offer a way around the traditional complaints about government bureaucracy. The problems may be defined by government insiders or politicians, but the solutions arise from the edges of the network, not the center. A prize system widens and diversifies the web of collaboration, encouraging scientists and entrepreneurs to make a contribution, even if they have no direct connection to the authorities in Washington.

So how can this mechanism solve the prescription drug crisis? Either by redirecting research money or appropriating new health care funding, we could offer billions of dollars of prize money for new pharmaceutical innovations. And we could mandate that the prizewinners share their innovations open-source-style, forgoing any attempt to patent their discoveries. Last year, U.S. senator Bernie Sanders of Vermont introduced two bills along these lines: the Medical Innovation Prize Fund Act and the Prize Fund for HIV/AIDS Act. By creating an outlandish award for a successful product—a treatment for HIV/AIDS could win billions of dollars—Sanders seeks to increase the number of organizations attacking the problem. And by mandating that the innovators not block generic versions of their drugs, these laws would allow still more organizations to enhance and refine those discoveries.

Sanders is the most left-wing member of the Senate, but it’s essential to note that his approach breaks from the mirrored alternatives of Big Capitalism and Big Government. The state isn’t trying to come up with breakthrough drugs or even to make direct decisions on which firms to back. Instead, the bills try to use government dollars—and publicity—to widen the network involved in solving these crucial problems and to make it easier to share the solutions that emerge. In our current system, government patents allow marketplace victors to profit for years at others’ expense. A prize-based system would allow everyone to win.

Steven Johnson (@stevenbjohnson) is the author of the new book Future Perfect (Riverhead Books), from which this essay is adapted.