Subsidizing STEM Education

C1: Human Capital MarketsHow do we make sure we produce the right amount of most goods? We use capital markets. Money flows wherever it is profitable. The government doesn’t need to determine that cars are valuable and then subsidize them for cars to be produced. The market handles it—through stock offerings and debt sales, capital flows to car producers. Profit and loss signals to investors where capital is most needed. If an industry is very profitable, that sends a signal—that people should invest there. Investors will, and competition drives profit rates down to a normal level. If an industry is losing money, that sends the opposite signal—to take money out of there and put it somewhere else.Why not do this with people? The current system, an artificial low interest rate that’s the same for everyone, makes no sense—just imagine if that’s how businesses were funded. I propose we deregulate human capital markets. Loans would work like corporate loans—the interest rate would be determined by your ability to pay back the loan. Philosophy majors would have high rates, if they got loans at all, and engineering majors would have lower rates. There could even be stock offerings of a sort—cash up-front for school in exchange for X% of the student’s income for life, if a student preferred to pay back their money over a longer period of time, rather than all at the beginning of his working life.If there’s a shortage of engineers, for example, the income of engineers would rise, and stocks in engineering students (the X% of income contract) would become more valuable. Money would then flow to where it is more profitable, fixing the problem. I contend that under this system, saying that there ‘aren’t enough’ engineers being produced is as illegitimate as saying that there aren’t enough cars produced now. The market—that is, the collective wisdom of the millions of individuals investing in capital markets—knows more than any one person standing outside looking in can know.C2: Interfering with Human Capital MarketsThe consequences of interfering in human capital markets are the same as the consequences of interfering with any other market. By distorting the price system, you make things worse.Market prices are not arbitrary—they exist for a good reason. The price system organizes production and exchange—it puts everything in its right place. Prices signal to businesses whether or not something should be produced—if the price goes up, and production of something becomes more profitable, the price signals that businesses should invest more there. Prices going down signal the opposite. High prices signal to consumers that something is scarce, and they should buy less—low prices signal the opposite. Same thing with wages—the price of labor. Low and high wages tell people which professions to leave and enter. The price of time—interest—tells businesses how much to borrow and savers how much to save. Prices are the only way a business can have any idea what to do. What’s a more efficient production process—50 hours of labor, 1 ton of coal and 1 ton of steel, or 20 hours of labor, 2 tons of coal, and 2 tons of steel? It’s impossible to say with just that information. But prices let us compare apples and oranges—we can see which is more costly by looking at the prices of each product. The only way to have real prices is laissez-faire. The subjective desires of consumers create the different demands for different products. The demand for those products creates demand for the different factors of production—raw materials, labor, etc. Competition among entrepreneurs to find the cheapest way to produce the stuff consumers want (50 hours of labor, 1 ton of coal and 1 ton of steel, or 20 hours of labor, 2 tons of coal, and 2 tons of steel?) determines the prices of those factors of production.What happens when this system is distorted? Say, the government subsidizes steel production so much that the price goes down from $10 a ton to $5 a ton. Businesses will make their decisions based on the $5 price. But the most efficient way to do things would the decisions they would have made with a $10 price. Businesses won’t be able to calculate costs correctly, and will make the wrong decisions.The same principle applies to subsidizing education. What costs less—2 hours of skilled labor and 2 hours of unskilled labor, or 6 hours of unskilled labor? The only way to know is to have a free market in human capital.C3: Signaling and Market FailureOf course, the free market system isn’t perfect. The problem is that part of the reason college graduates earn more is signaling. The type of person that goes to college is more productive than the type of person that doesn’t before they take any classes. A college degree signals to employers that a person is reasonably intelligent and conscientious. This means that to the extent that signaling explains a college graduate’s higher income, a college degree has a private return—someone will still earn more because they go to college, but no social return, since they aren’t more productive.This has important implications for human capital markets. For example, imagine if there was no signaling, and the added income from going to college was 100% additional human capital. In this case, an 8% return for an investor in that education means an 8% social return too in the form of additional productivity. If the additional income was 100% from signaling traits the student already had, then the investor would still earn 8%, but the social return would be 0%, since the student isn’t any more productive. Most likely, it’s somewhere in the middle. Perhaps mostly human capital for engineering majors, and mostly signaling for liberal arts majors, but not 100% either way for anyone. Whatever the actual number is, as long as any amount of the additional income students earn is because of signaling, markets will work inefficiently. To get the optimum amount of education, rather than subsidize it, we should tax it. A tax could be levied on investors in proportion to what % of a major is signaling. If engineering majors are only 20% signaling, then a 20% tax would put the private return on investment in line with the social return. For example, if the private return for investors was 8%, with 20% signaling, the social return would be 6.4%. A 20% tax would bring the private return for investors down to 6.4%, which would make sure that the correct amount of education was produced.C4: Why aren’t there ‘enough’ engineers now?If my argument is correct, then it would seem like we should have a surplus of engineers right now, since we subsidize engineering rather than tax it. But it doesn't look like that's the case. One possible reason is that while we subsidize engineering, we also subsidize everything else. In a free market, engineers would get much lower interest rates than liberal arts majors, incentivizing smart people to go into engineering rather than philosophy. Another possible reason is that rather than a shortage of education, we have a shortage of smart people. STEM majors are difficult—not many people are able to complete them. About a 1/3 of students entering college plan on majoring in a STEM field—but most of them either drop out or change majors. [1] If the latter problem is significant, then there will still be too few engineers, but subsidies can’t really do anything about it—we would just have to import engineers from other countries.[1] http://www.heri.ucla.edu...