Knowledge that Transforms

THE growing disillusionment with compensatory education and other anti-poverty programs has given new life to an old theme in United States social theory: the poor are poor because they lack mental skills. Their poverty is particularly intractable because it is rooted in the genetic structure inherited from their parents who were also poor and mentally deficient.' An explanation of transmission of economic status from one generation to the next is thus found in the heritability of IQ. The idea is rtot new: an earlier wave of genetic interpretations of economic and ethnic inequality followed in the wake of the failures of the purportedly egalitarian educational reforms of the early 20th century Progressive Era.2 The liberal environmentalist counterattack against these interpretations was highly successful; among social scientists, and in the public eye, the genetic position was largely discredited.3 Since the late 1960's, however, public disillusionment with egalitarian social programs has been enhanced by the dissemination of the heritability research of Burt, Jensen, and others, supporting the scientific claims of the genetic interpretation of racial inequality and intergenerational immobility.4 Further evidence has been found in studies such as the Coleman Report which seemed to indicate that scholastic achievement in schools is not greatly influenced by the level of educational inputs and that differences among children prior to school entry explained most of the nonrandom variance in test scores.5 The version of the genetic argument to which we will address ourselves may be summarized by two propositions: First, that IQ, as measured on standard so-called intelligence tests, is highly heritable, and second, that IQ is a major determinant of income, occupational status, and other dimensions of economic success. If both propositions were correct, it could easily be shown that intergenerational immobility, as measured by the correlation between the economic status of parents and their (adult) children, is attributable in large measure to the genetic inheritance of IQ and its role in determining economic position. The first proposition concerning the heritability of IQ has received careful scrutiny; in fact, the current debate on IQ has been dominated by a concern with IQ's heritability, virtually to the exclusion of questions concerning its economic importance.6 In this paper we Received for publication October 10, 1972. Revision accepted for publication June 26, 1973. * An earlier version of this paper was presented at the Far Eastern Meetings of the Econometric Society in Tokyo, June 1970, and at the workshop sponsored by the Committee on Behavioral Research in Education of the National Academy of Science in Chicago in June 1971. We are grateful to the participants at these meetings for helpful suggestions. Many of the ideas in this paper were worked out jointly with Herbert Gintis. We are grateful to him for his help and to Zvi Griliches, Christopher Jencks, Barbara Roemer, Janice Weiss and the members of the Harvard seminar of the Union of Radical Political Economists. The research presented here was supported financially by the Ford Foundation. 1Jensen (1969) begins his article on the heritability of IQ with: Compensatory education has been tried, and apparently it has failed. The most explicit statement of the genetic interpretation of intergenerational immobility is Herrnstein (1971). For a critical review of Herrnstein's interpretation, see Bowles and Gintis (1973). 2Michael Katz notes the historical tendency of genetic interpretations of social inequality to gain popularity following the failure of educational reform movements (Katz, 1968). On the rise of the genetic interpretation of inequality towards the end of the Progressive Era, see Karier (1972). 3See, for example Hunt (1961). 4See Jensen (1969) and Burt (1958). For a critical review of Jensen's and Burt's estimates, see Light and Smith (1969), Jencks et al. (1972), and Kamin (1973). 5 Coleman et al. (1966). A critique of statistical bases of the Coleman Report can be found in Bowles and Levin (1968 and 1969). See also Mosteller and Moynihan (1972). 6 Information on the economic success or failure of individuals at either extreme of the IQ distribution -such as the data invoked by Herrnstein -tells us virtually nothing about the overall economic importance of IQ as a determinant of an individual's place in the distribution of income or stratification system.

THE assumption that taxes are capitalized plays a central role in public finance theory. It would seem that the taxation of residential property offers a good opportunity to test this assumption empirically. One need simply investigate whether or not, after holding constant housing and land characteristics, a house with higher taxes sells for a lower price. Indeed there have been many attempts in the literature to estimate the extent to which -residential property taxes are capitalized.' Many of these studies have focused on differences in tax rates existing in neighbouring communities, and have attempted to determine whether in such a setting property values are inversely related to tax rates. The major difficulty with this approach, in which tax rates in different communities are compared, is that government expenditures may also differ from one location to another and may also be capitalized in property values. It is therefore necessary to hypothesize that property values depend on both taxes and expenditures, in which case the relationship comes close to being an identity, with average property values related to average tax rates and average levels of government expenditures.2 It is not surprising that tax rates are found in these cases to be negatively, and government expenditures positively, related to property values. However, it is not clear (two-stage least squares notwithstanding) how much of these effects can be attributed to capitalization and how much is due to the tautological nature of the problem. In this paper we focus on individual residential property values in one municipality only, and thus avoid the major problem discussed above since the level of general government services is the same for all property owners.3'4 Further, restriction to one locale does not imply that effective tax rates will be the same on all houses even though the mill rate is, of course, the same. As is the case in most cities there are wide variations in the ratio of assessed value to market value for residential properties, (even within homogeneous housing categories) thus resulting in differences in taxes paid for basically identical housing units.5' 6 Consequently, we hypothesize a relationship of the form

ECONOMISTS have been alternately fascinated and frustrated with industry or market concentration ratios ever since they were first calculated from census data for the Temporary National Economic Committee for 1937. They are fascinated because concentration ratios are the single best available index of the degree of oligopoly. The frustration stems from the absence of precise coincidence between the Standard Industrial Classification System (SIC) used by the Bureau of the Census and economically relevant markets. Yet, when all is said and done, most industrial organization economists agree that concentration ratios based on SIC industries not only are the best available, but provide useful measures of one dimension of the extent of oligopoly in American industry.1 This is not to imply, of course, that market concentration is the only index of oligopoly or market power. Economic theory suggests and empirical studies verify that entry barriers, product differentiation, firm conglomeration, among others, also may influence firm conduct and industrial performance. But changes in industrial concentration are uniquely significant because often they reflect, at least partially, changes in other structural variables as well. For example, if entry barriers are declining, because of growing markets or whatever, this tends to become reflected in lower concentration ratios. Hence changes in market concentration may also reflect what is happening to other structural variables affecting the discretionary power of sellers. We shall not here argue the question of whether or not concentration ratios are meaningful indices of market structure or whether they are causally related to industrial performance. Those assuming that the answer to both questions is yes, gain aid and comfort from the most comprehensive review of the empirical evidence on the subject.2

T HE dominant type of health insurance contract in the United States contains a formula providing partial reimbursement to the consumer for expenditures on selected goods and services. The consumer pays a predetermined amount per period, the premium. At the beginning of the period specified in the insurance contract, the consumer is uncertain about many future developments. The occurrence of various illnesses, the amount of medical services consumed, and the out-of-pocket (direct) monetary loss cannot be perfectly foretold. When a consumer chooses health insurance from a set of alternative contracts, he may reveal information of a general nature about preferences for avoiding risk. This paper suggests a model of the choice among health insurance options which permits quantitative inference about risk aversion from revealed choices. The model is based on the theory of expected utility maximization, and more recent development in Arrow (1963), Pauly (1968), and Zeckhauser (1970). The analysis is only exploratory, since several limiting assumptions and functional representations have been adopted. The model will be seen, however, to have useful application to the Federal Health Benefits Program in which federal employees choose health insurance from a wide range of options. The premium cost to the employee for any option depends on the average experience of all those selecting the option. This program has been in existence since 1960, and has generated important information on the frequency distributions of total and direct expense for various types of consumer unit under various types of insurance. The Expected Utility Model

THIS paper attempts to analyze and measure the relationships among leverage, market structure, risk and profitability. It develops a theoretical model relating these variables and then tests the model using cross-section data on 228 United States manufacturing firms. An additional test is made using data from 85 industries with both tests covering the 1960's. Recently numerous studies have tested the relationship between market structure and rate of return (Hall and Weiss, 1967; Samuels and Smyth, 1968; Fisher and Hall, 1969; Shepherd 1971, 1972; Stigler, 1963; Kilpatrick, 1968; Collins and Preston, 1969; and Gale, 1972). Several of these authors have included a risk variable or a financial structure variable or both in a linear regression model. They have commonly represented the degree of risk by the variability of profits over time (hereafter denoted o).'More recently, Gale (1972) has used financial structure (measured as the equity to assets ratio) to represent risk. Still other economists suggest that leverage may have an independent influence on the rate of return, unrelated to risk (Stigler, 1963; Scherer, 1970; Jean, 1970). At this point a more general test may resolve the alternative hypotheses. This paper will test both the Gale hypothesis and the Stigler, et al. hypotheses using a simultaneous 3-equation model.

T I HE effect of coinsurance on the demand for medical services has been debated for many years. Some assert that it helps control total expenditures by giving consumers a stake in how much medical care is purchased. Others assert that coinsurance is irrelevant to choice, since the physician makes the decisions about using medical services for his patients. Persons attempting to predict expenditures under various national health insurance plans are naturally interested in how coinsurance affects demand for services. The evidence we present in this paper decisively rejects the assertion that coinsurance is irrelevant to choice; coinsurance clearly does affect the demand for services. Moreover, as we shall show, the impact of coinsurance varies across medical services in a systematic fashion depending upon the time price of the service. In a longer,more detailedversion of this paper (Phelps and Newhouse 1973) we have derived expressions relating the responsiveness of demand for medical care services to coinsurance, market prices for medical care, and time costs. In the remainder of this section we sketch the assumptions underlying those derivations. We assume that consumers maximize a utility function in other goods (x) and health status (H) subject to a budget constraint. Medical care (h) is a homogeneous commodity that can be purchased in the market at a price of p per unit, and x can be purchased at a price of one per unit. There is a production function for H which uses h and time inputs (t). Denote the opportunity cost for time as w per unit of time, and let T be the amount of productive time available to the person. T To-th, where To is total time available and is fixed. The consumer's level of health is considered random. This induces him to purchase insurance. The insurance contract specifies a coinsurance rate -the consumer pays C per cent and the insurer pays (100-C) per cent of all incurred expenses during the period. We are not concerned here with the selection of C (Phelps 1973), but how the consumer reacts to a random loss, given his insurance policy. Assume that C has been previously chosen, or is imposed; in either event, C is fixed, and the premium (or tax) is prepaid. The total price is then the sum of the money price per unit C p and the time-price w t per unit