Tuesday, May 20, 2008

Economist's Notebook: Doing it Now or Later

My background is in policy and economics, but though it seems a natural intersection, it can often be a frustrating place to spend time. The reason for this, for me at least, is the fact that policy is informed and influenced by politics as much as (or often much more than) economics. And politics and economics are not always happy bedfellows.

I was thinking of this when I read of the huge backlog of deferred maintenance projects in the Portland Public School system and my own trials and travails at OSU: Heat blasting on 97 degree days and absent on 30 degree days, a ventilation fan that disrupts class about 10 times a lecture and has been that way for at least two years, a leaky roof dripping on the Chair's desk, etc., etc., etc.

As an economist, intertemporal problems are routine. You have to weigh the present value of the costs and benefits when taking a decision about fixing something today versus letting it go a while longer. This would seem a fairly easy problem for an institution like PPS (though it is in no way an answer to the overriding problem of resource constraints). But the reality is that parents have a time horizon that is much shorter than the school district itself. If a parent knows their child will be in a school for only 5 years, the present discounted value of deferred maintenance cost is much smaller than for PPS itself which is thinking of school buildings lasting for 50 more years. This is true in many aspects of government business - it is often hard to get the public to be far-sighted (especially true when you talk about very long time horizons and add some uncertainty like in global warming).

It seems like an appropriate response would be to put some welfare weights on the current concerns of parents and the concerns of future parents and be explicit/transparent about it. Simply deferring maintenance and hoping for better times in the future seems like a fool's errand. It is likely to never happen and often you end up having to pay a much higher price when systems fail like the heating system at Cleveland. Once we decide how to weight the concerns of the current generation and future generations, we can then start to allocate resources systematically. Why is this a good idea? Because it is often very hard to resist fulfilling urges today - people tend to place undue weight on current needs and desires. Ex post, however, they often regret not having exercised more self-control. This idea has been popularized recently by Richard Thaler and Cass Sunstein in their book 'Nudge.' In the parlance of the book, my welfare weights idea would be introducing 'architecture' to the choices made by the PPS. This architecture acts as a commitment device and will ensure that we are not shortchanging future kids for the sake of the current ones. Instead what we have is a bunch of discretionary decisions that add uncertainty and inefficiency into the system which serves no one well.

And, by the way, the title of this post comes from a theoretical examination of this issue by Matt Rabin and Ted O'Donoghue (whom I was lucky enough to get to know when I was a grad student).

Quiz: Name the PPS school pictured above.


Fred Thompson said...

Great set of blogs.

But this one really got my attention. The deferred maintenance issue is one I have wondered about for a long time. Granted human decision making is both myopic and tunnel visioned. We see that everywhere. Perhaps, most prominently in the case of climate change. However, most organizations get the maintenance problem right. As you note, it is a fairly straightforward capital budgeting problem: minimize the present value cost of the sum of asset replacement cost and maintenance cost, where the life of the asset is a function of the level of maintenance.

The organizations that seem to have the most problems getting this one right are state and local governments. Since not all organizations are equally culpable, I think it makes more sense to look at differences in information costs, design elements – authority (decision/property rights), responsibility (targets), accounts (rules for measuring performance in terms of targets), and payoffs (specified algorithms for allocating payoffs contingent upon measured performance) – and their complementarity for an explanation, rather than some fundamental characteristic of the human condition.

In this instance, I am inclined to focus on design elements. Local governments in the US have separate capital budgets, which are often subject to fewer constraints than their operating budgets (lower opportunity costs). Acquisition of plant and equipment can come from the capital budget; maintenance must come from the operating budget. Hence, they tend to underinvest in maintenance and over invest plant.

One of the reasons I think this is likely to be the efficient cause of the phenomenon of deferred maintenance at the state and local level in the US is that governments that practice cash budgeting and accounting (no distinction between capital and operating budgets) like the the US federal government or sub-national governments elsewhere appear to have precisely the opposite bias, they tend to underinvest in productive assets, but try to make them last forever.

Patrick Emerson said...


This is a really interesting comment, and one I am going to have to chew over for a while. But I think you have really hit on something I have not fully appreciated. Hmmm.....

Fred Thompson said...

Thanks. As I said, this issue has been going around in my head for a long time, but I have never figured out a good way to test it. However, I noted the under-investment behavior consulting for both the DODand in Eastern Europe.

Some of the works that influenced my thinking on the issue are:

Harvey Averch and Leland L. Johnson. Behavior of the Firm Under Regulatory Constraint. The American Economic Review, Vol. 52, No. 5 (Dec., 1962), pp. 1052-1069

William J. Baumol and Alvin K. Klevorick, Input Choices and Rate-of-Return Regulation: An Overview of the Discussion. The Bell Journal of Economics and Management Science, Vol. 1, No. 2 (Autumn, 1970), pp. 162-190.

W. Mark Crain and Asghar Zardkoohi. A Test of the Property-Rights Theory of the Firm: Water Utilities in the United States. Journal of Law and Economics, Vol. 21, No. 2 (Oct., 1978), pp. 395-40.

Patricia M. Dechow. Accounting earnings and cash flows as measures of firm performance: The role of accounting accruals. Journal of Accounting and Economics 18 (1994) 3-42

Howard Frant. Reconsidering the Determinants of Public Authority Use. Journal of Public Administration Research and Theory: J-PART, Vol. 7, No. 4 (Oct., 1997), pp. 571-590.

I also recall that Earl Thompson wrote an article about VA hospitals some time during the 1970s, which showed that they exhibited behavior that is consistent with my interpretation -- efficient in visible, easy to monitor ways, inefficient in doing things that were less visible and harder to monitor. I thought the article was in JPE. But I cannot find such an article, although I would swear that it profoundly influenced my thinking about this issue.

Fred Thompson said...

It wasn't Earl Thompson, after all, but another member of UCLA's economics department (then) COTTON MATHER LINDSAY. The publication was Veterans Administration hospitals: an economic analysis of Government enterprise (Washington : American Enterprise Institute for Public Policy Research, 1975).