Monday, October 11, 2010

Markets for Education

Today in the NYT, Jeremy Dehn, who teaches film and video production at the University of Denver, the Art Institute of Colorado and the University of Colorado at Denver, makes a pretty convincing case that adding a "gainful employment" rule that prevents for-profit colleges from earning revenue without delivering improvements in economic outcomes for students is a good and necessary thing.

He won't find any disagreement here. Instead, I'll expand on some of his commentary to discuss how markets help and hurt in education. I'm sure a knee-jerk reaction to this issue in the "smaller, less, weaker government" circles is that the government is getting what it deserves for meddling in the market for education. This would be the wrong conclusion.

An important thing to realize about education is that it is usually not a component of consumption. In most cases, education is an investment, not different from an upgrade of physical capital that makes a factory more productive. Of course, some people take courses for fun and don't apply their learning in the workplace, but this is surely an exception.

Consumption vs. Investment is an important distinction to make because generally speaking private markets for consumption goods function well - people know what they want, value it appropriately, and private parties are able to profit from serving these needs. Alternatively, markets for investment and risk do not always function well. Short-sightedness and risk-aversion dominate individual preferences in these markets, so the collective outcome that can be expected from private markets is suboptimal.

Fully factoring the costs of education, many individuals would not be willing to take the risk of financing education, and most investors would be reluctant to offer financing on affordable terms. Who, other than a good parent, would be willing to finance the education of a five year old, who wouldn't be able to pay back any loans for at least 10 or 15 years? And even at the age of 18, many students who would benefit from increased education will avoid school because the costs are too high. This is the basis for subsidies at all levels of education.

Now of course if the government subsidizes something, and there are private markets that expand to take advantage of those subsidies, things quickly get out of control. Look at the housing and health care markets for a recent and ongoing example, respectively. All the capital that as been privately directed to expanding schools, building homes, and advancing the medical industry is used for these purposes because the government has signaled quite clearly that it intends to pay for these things for more people. The government platform for decades has been expanded access to health care, home ownership and affordable education. We have completely overstimulated these sectors, because appropriate balancing mechanisms were not put in place, and policies were poorly designed.

The issue with education is actually quite similar to the health care problem in many respects. Our well intentioned and necessary market intervention to expand access is in no way tailored to the purpose we are really seeking. We pay private providers for education and health care services regardless of outcome. So their incentive is simply to maximize revenue and reduce costs. Quality and outcomes are not direct financial motivators, so we rely on altruism on the part of doctors and teachers to achieve the actual effect we are seeking - be it healthier or smarter people. I might even argue that doctors and teachers are some of the most altruistic professionals, but even still, with all individual and structural incentives directed at market expansion, the subsidy overstimulates, drives up costs, and quickly appears unaffordable and not worthwhile.

So I conclude with a fairly banal point - we can and should privately organize to deliver goods and services that are publicly financed and subsidized, but we must reform the subsidies in all cases to direct profit making activities towards the ultimate purposes of our policies.

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