Education: Excerpt from Economics in Two Lessons

Here’s another excerpt from my book-in-progress, Economics in Two Lessons. As usual, praise is welcome, useful criticism even more so. You can find a draft of the opening sections here.

In the section over the fold, I’m looking at education.

In a modern society, education is the most important single factor determining a person’s life chances. The average who holds a professional or doctoral degree earns more than twice as much as someone without a four-year college degree, and is virtually assured of being employed (at a time of deep depression in 2011, only 2.5 per cent of higher-degree holders were unemployed). In economic terms, the education sector is one of the largest in the economy.

However, this statistical analysis seriously underestimates the economic importance of sector, because it ignores the First Lesson. The true cost of education comprises not just the salaries of teachers and the cost of running schools and universities, but the opportunity cost of the time spent in education by students.

The failure to take proper account of the First Lesson is a big problem in understanding the economics of education. But the failure to understand the Second Lesson has been much more of a problem for policy.

Simple-minded analyses based on a simplistic reading of the First Lesson have driven the irsteducation debate in the US and other English-speaking countries for the last few decades. The dominant idea is that education is a product like any other and that the best guarantee of good education is market competition between providers. The villains in this story are public goods and, especially, teacher unions.

To make education more like a private good, advocates of he First Lesson tried to change the conditions of both supply and demand. On the demand side, the central proposal was that of education ‘vouchers’, put forward most notably by Nobel Prizewinning economist at the University of Chicago, Milton Friedman. The idea was that, rather than funding schools, government should provide funding directly parents in the form of vouchers that could be used at whichever school the parents preferred, and topped up, if necessary by additional fee payments.

As is typically the case, voucher advocates ignored the implications of their proposals for the distribution of income. In large measure, vouchers represent a simply cash transfer, going predominantly from the poor to the rich. The biggest beneficiaries would be those, mostly well-off, who were already sending their children to private schools, for whom the voucher would be a simple cash transfer. Those whose children remained at the same public school as before would gain nothing.

On the supply side, the central idea was the introduction of for-profit schools and colleges to a sector traditionally dominated by public and non-profit educational institutions. For-profit educational institutions had a spectacular rise and fall.

The most notable entrant in the US school sector was Edison Schools. Edison Schools was founded in 1992 and was widely viewed as representing the future of school education. Its plans were drawn up by a committee headed by John Chubb, the co-author of the most influential single critique of public sector education in the United States (Chubb and Moe 1990). For-profit schools were also introduced in Chile and Sweden.

At the university level, for-profit enterprises proliferated with the University of Phoenix was the most notable example. For-profit trade and vocational schools also expanded in the US, and, even more dramatically in Australia, where a poorly-designed subsidy scheme produced a spectacular expansion.

The story was much the same everywhere: an initial burst of enthusiasm and high profits, followed by the exposure of poor practices and outcomes, and finally collapse, with governments being left to pick up the pieces.

Edison Schools, launched on the stockmarket with a flourish in 1999, lost most of its value and was subsequently taken private. At its peak, Edison ran hundreds of schools throughout the US. It has now faded into obscurity under the name EdisonLearning.

Sweden introduced voucher-style reforms in 1992, and opened the market to for-profit schools. Initially favorable assessments were replaced by disillusionment as the performance of the school system as a whole deteriorated. Scores on the international PISA test plummeted and dissatisfaction became general

By 2015, the majority of the public favoured banning for-profit schools. The Minister for Education described the system as a ‘political failure’, Other critics described it in harsher terms.

Although a full analysis has not yet been undertaken, it seems likely that the for-profit schools engaged in ‘cream-skimming’, admitting able and well-behaved students, while pushing more problematic students back into the public system. The rules under which the reform was introduced included ‘safeguards’ to prevent cream-skimming, but such safeguards have historical proved ineffectual in the face of the profits to be made by evading them.

Similar processes took place in Chile, under the influence of the Chicago-trained reformers whose policies were implemented by the Pinochet dictatorship. There were glowing initial reports, but the eventual outcome was to amplify inequality without improving performance. Chile banned for-profit education in 2015

The for-profit university sector followed a similar trajectory. The University of Phoenix epitomised the process. Enrolments peaked at 600 000 in 2010, but had fallen to 142 000 by 2016 as the US government cracked down on shady enrolment practices. Other for-profit universities closed altogether or converted to non-profit status

Perhaps the most spectacular boom and bust took place in my native Australia. From tiny beginnings around 2007, a scheme to provide loans-based funding for vocational training grew into a full-blown educational and budgetary disaster. Even more than in the for-profit US university sector, the companies involved found it profitable to exploit the weaknesses of the funding system, and the fact that students could not judge the quality of education in advance, rather than to do the hard work of providing improved education.

The results speak for themselves. By the time a conservative government radically restricted the scheme in late 2016, the estimated losses to the budget ran into the billions of dollars, while thousands of students were left with unrepayable debts and worthless qualifications. Meanwhile, the public system of Technical and Further Education, which had worked well for decades had suffered grave and possibly irreparable damage.

The failure of full-scale privatisation left the field open to the main remaining alternative ‘charter’ schools. The idea of charter schools was originally put forward by Albert Shanker, the president of the American Federation of Teachers. His idea was to encourage schools where teachers had more opportunities to try out innovative approaches, and where the student body would be more diverse, both economically and racially.

In the hands of the education reform movement, however, charter schools took on a very different tone and purpose, much closer to that of the for-profit model that failed with Edison. While some independent charter schools have pursued innovation along the lines suggested by Shanker, others are part of chains relying on services like management companies, including for-profits like EdisonLearning.

Charter schools have been, and remain, politically popular with Republicans and Democrats alike. Duncan. The only problem is that, according to the empirical evidence, they don’t work. Charter schools have not failed spectacularly, as for-profits have done, but they have not yielded any significant return for the money and political effort that has been poured into their expansion.

Nationally, there is very little evidence that charter and traditional public schools differ meaningfully in their average impact on students’ standardized test performance.

Moreover, although the evidence is murky it seems that an increasing proportion of charters are being run on a for-profit basis, even in cases where formal structure is non-profit. Given the failure of the for-profit model in general, the prospects for the future are not good.

Why has market-oriented reform of education been such a failure? Every part of the Second Lesson is relevant here. On the ‘production’ side, education is, in many respects similar to other industries. Prices send signals about the cost of providing particular courses of study in particular ways, and of the rewards of one kind of employment or another. Institutions and educators respond to those signals. Students try to weigh the cost and the likely monetary benefits of continuing education, or of seeking employment, along with less tangible costs and benefits, and decide accordingly.

On the other hand, an analysis based on prices falls down badly in the attempt to describe education as a market transaction. All the terms of the Second Lesson are relevant here. Education is characterized by market failure, by potentially inequitable initial allocations and, most importantly, by the fact that the relationship between the education ‘industry’ and its ‘consumers’, that is between educational institutions and teachers on the one hand and students on the other, cannot be reduced to a market transaction.

The critical problem with this simple model is that students, by definition, cannot know in advance what they are going to learn, or make an informed judgement about what they are learning. They have to rely, to a substantial extent, on their teachers to select the right topics of study and to teach them appropriately.

Moreover, any specific course of education is a once-only experience in most cases. Students may judge, in retrospect, that particular teachers, courses or institutions were good or bad, but in either case they are unlikely to return, so that there is no direct market return to high quality performance.

The result is that education does not rely on market competition to any significant extent to sort good teachers and institutions from bad ones. Rather, education depends on a combination of sustained institutional standards and individual professional ethics to maintain their performance.

The implications for education policy are clear, at least at the school level. School education should be publicly funded and provided either by public schools or by non-profits with a clear educational mission, as opposed to corporate ‘school management organisations’.

Post-school education raises more complex problems, regrettably beyond the scope of this book. But the key element should be to make high quality post-school education available, and affordable, for all young people.

21 thoughts on “Education: Excerpt from Economics in Two Lessons

  1. Hi, Professor. On the production side, I suggest there is also a behavioural/identity issue. Teaching is a profession, motivated by ideals and intrinsic rewards. Sometimes extrinsic rewards can (but need not) crowd out intrinsic motivation. Not sure if this is part of Lesson Two or maybe there is a Third Lesson based on psychology and social identity.

  2. A couple of experiments you may want to look at, on the charter school side.

    First, in Texas, some public school districts have lusted after the freedom granted private charter school operators that, for a time anyway, kept the charter schools from having to compete in the devastating “standardized test” schema designed unintentionally to label any school not producing 100% Einsteins as “failing,” and close it. I digress.

    Grand Prairie Independent School District, in Grand Prairie, Texas, between Dallas and Fort Worth, opened up a number of chartered schools on its own, catering to high quality science, arts and literature, and vocational training. Students in the public school system may choose to compete to attend almost any school (the hope is that enough positions are open that no student is denied choice). A couple years into the experiment, state test scores are at least static, and parents seem happier.

    The second is puzzling, vexing and encouraging perhaps. One of the largest charter operators in the U.S. is a well-knit group operated by followers of the Turkish religious leader, Fethulah Gulen. There are troubling issues of school governance — every principal is from Turkey, and Turkish immigrants get all the contracts to build the schools, and Turks make more money in the same positions than other nationalities, etc. — but the schools tend not to discriminate against handicapped, gifted or troubled students as other charters do. The actual classroom work seems close to top-of-the-line. In other words, it’s the charter school idea in an actually-working incarnation. Gulen schools seem to work at least as well as non-charter public schools, better than almost all other charter schools. What do they do that distinguishes them from other charters? Will those actions change if Trump agrees to extradite Gulen to Turkey?

  3. There is one other parameter in US school funding, as I heard it (and I am not sure of the facts here…perhaps Ed Darrell could add more information), and that is that schools are significantly funded from local rates, therefore the degree of public funding can be highly variable.

    From the Wiki..

    “Funding comes from the state, local, and federal government”

    For instance the house where I was briefly staying in Hinsdale Chicago had rates of $27,000, (again as I was told). The high cost of the rates was substantially due to the amount of money spent on the schools in the council area. The local High School boasted to having educated the highest number of national leaders for all high schools in the country, so the more money applied to education from that would indicate a higher degree of successful outcomes.

    I’m not sure how this impacts on the pressure to create charter schools or on their chance of success, but from a residential point of view it meant a steady turnover of properties in the area as people moved in to give their children a better educational choice, and later to move out to reduce their exposure to the high cost of property ownership.

  4. I see from Ed Darrel’s blog that “post truth” began in the US at least 99 years ago

    …and from Wikipaedia

    “On December 28, 1917, an article titled “A Neglected Anniversary” by H. L. Mencken was published in the New York Evening Mail.[1] It claimed that the bathtub had been introduced into the United States as recently as 1842, the first ones having been made of mahogany lined with lead”

  5. It’s rather long for a straightforward argument, compared to other sections on more complex issues.

    Digression: I wonder if we should see the private education policy debate as an exercise in distraction? The private-school crowd have managed to shift the debate from a real and intractable problem, inequality of opportunity, to a largely imaginary one, parental choice. Modern public education systems do an adequate job in reproducing the workforce of an advanced economy, and in allocating resources and life-chances fairly efficiently in narrow productivity terms. This is why the private education agenda is the province of a handful of cranks, zealots and grifters, and is not seriously pushed by big business interests.

    Where public education has failed is in levelling the playing-field and offering genuinely equal opportunity to children of equal natural talents but different parental resources. Instead, they reproduce existing inequalities, through mechanisms like housing differentiation. IIRC the Nordics do the least bad job here, and achieve the highest intergenerational mobility. They just spend a lot of money on their public schools and universities.

  6. “Moreover, although the evidence is murky it seems that an increasing proportion of charters are being run on a for-profit basis, even in cases where formal structure is non-profit.”

    This sentence could use a footnote that points to evidence supporting what it asserts.

  7. @BilB
    Right. Most public schools are significantly funded from local property taxes, which means schools in wealthy school districts typically have more money than schools in poor districts. These differences are magnified/multiplied by the other advantages that come from rich people having money — those kids travel more, have better places to study, have more books in the home, etc., etc.

    Not sure how many states, but Texas for one example is under state court orders to equalize funding, which has produced a law known in Texas as Robin Hood, which requires rich districts to contribute to a state pool of money used to equalize spending per student, to some degree. This law helped some, but not enough — and it has become a campaign point against any local campaign to raise tax rates for school improvement.

    In the US schools are governed by 15,000 school boards in local districts, about 99% locally-elected, and the rest locally-appointed. There is great diversity in funding due to this governance, in addition to great income differences.

    As you might imagine, charter schools hammer poorer school districts harder than rich districts.

    $27,000 as the annual tax on any property sounds excessive, except for the largest and most extravagant homes. Not saying it’s not so, but it’s far above average. Here in Dallas the average assessment is generally around $2,000 annually, split between schools, hospital districts and a few other uses.

  8. “it seems likely that the for-profit schools engaged in ‘cream-skimming’, admitting able and well-behaved students”

    This seems unlikely, because if they really were cream-skimming to any great extent (and could actually do it), you would expect them to do better than public schools (like for example the private schools do here). I think in Sweden, as far as I’m aware, the basic problems were similar to what happens at our universities, where you take more or less anyone, tell them they are all smart so everyone is happy in the short term but actually teach them less and less. You enforce this with standard management tactics that you probably get to put up with at UQ that are designed to encourage people to game the system for outcomes with poor validity.

  9. “In a modern society, education is the most important single factor determining a person’s life chances.” To which I agree wholeheartedly, we (should) never stop learning. However, the medium for this is debatable and depends greatly on the circumstances surrounding a persons situation although access to tertiary education has improved over the past 50 years.

    The biggest problem with education at present is that education like many other facets of society is that it has been commodified by the neoliberals and as such if it doesn’t make a quid it’s not successful. What we really need to do, if we’ve got the intestinal fortitude, is to decommodify education. Only when we do this will we all (most) Australians receive an equal opportunity of receiving a quality education.

    The commodification of public goods has been most spectacular in that it has been abject failure! Whether the public good has been education, transport, water or whatever the public good it is not in good health, will continue to be neither your arse nor your elbow until we put the horse in front of the cart.

    Life education can be formal or informal, I personally received a good education at primary, secondary and trade school, but I chose to move to Wyuna (Wai-oo-na in Bangerang) when I was 28 and the next 5 or 6 years were the greatest learning experience of my life – agriculturally, socially, culturally, historically, morally, perceptively, etc. However, I’m not everyone and we must provide a formal education that will cater everybody without fear or favour unlike the current policy!


    “When the industrial revolution hit in the 1800s, countries with large disparities in wealth, low property ownership, deficient democracies and disparate education systems were left behind.”

    This means that under neoliberalism we are heading in exactly the wrong direction. If we don’t change direction soon we will collapse like the US is doing.

    Read “How America will collapse (by 2025)” in Salon. It’s a real chance though maybe not quite that soon.

  11. @Ikonoclast

    This means that under neoliberalism we are heading in exactly the wrong direction. If we don’t change direction soon we will collapse like the US is doing.
    Read “How America will collapse (by 2025)” in Salon. It’s a real chance though maybe not quite that soon.

    The speculative scenarios described for the US in that article have no applicability to Australia.

  12. @J-D

    Is the possibility of a decline in technological innovation not applicable to Australia? Is the possibility of the education system falling behind its competitors not applicable to Australia? Would Australia be immune to an oil shock when it produces a much lower percentage of its oil needs than the US? Do we have a good track record of avoiding joining in US led military misadventures? Are we less vulnerable to cyber attack than the US?

  13. @Ikonoclast

    Those aren’t the scenarios the article identifies as constituting ‘collapse’. I don’t know what you think ‘collapse’ means, but I do know what the article thinks ‘collapse’ means.

  14. “In a modern society, education is the most important single factor determining a person’s life chances.”

    David Gillespie takes a look at how Aussie schools stack up;

  15. My reading of the Swedish story is more Conrad’s than John’s. It was more like the VET failure – big incentives for managerial ‘slash costs and do the bare minimum to get the money’ rather than for cream skimming. Of course if you attempt to get around this by ‘pay for performance’ schemes then you will get cream skimming (and its much nastier corollary “sink schools”).

    Which is the point about privatisation of education (and human services generally, but its more obvious in education than most other sectors because of the market characteristics John describes). You have an agency problem which you deal with by creating incentives – the performance management system. But that system has to be exactly pitched right because you are steering between Scylla and Charybdis. Too lax, no performance and the money’s wasted. Too tight and you get cream skimming and sink schools.

    But if the regulators were so competent and had sufficient information to get their regulation just right then they would clearly be the party best placed to DELIVER the service – so what have you gained by introducing the agency problem?

    The other point you might want to nod to is the longer run political economy of vouchers rather than the immediate agency problems. When the middle class get vouchers which they can top up then they will vote for inadequate vouchers in return for tax cuts. They won’t care about sink schools because their kids won’t attend them – indeed, that their children get a big head start on the hoi polloi is a feature not a bug. In time this will radically undermine support for the idea of free universal education. This was clearly understood in the late 19th century when debates over government provided public schooling versus government funded private (church) schooling took place – there’s no reason to think humans have changed much since then.

  16. A simpler way of linking at this is to SDK: who is education for? Privatisation advocates assume that it’s for the parents, liberals that it’s for the children. Behind privatisation is a desire to return to the patriarchal family in which children have no independent rights, and conflicts between their interests and those of parents are ignored.

  17. For a fascinating angle on the ‘education’ side of this consideration, read ‘Learning from Shanghai’ by Charlene Tan. The world’s current #1 public school system has a lot to teach Friedmanites…

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