Morgan Rose

An Education in Market Failure

Morgan Rose*
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The U.S. Supreme Court is currently deliberating Zelman v. Simmons-Harris, a case involving a state-funded school voucher program allowing low-income kids in Cleveland to attend private or parochial schools. A summary of the oral arguments for what may become a landmark case for American education appears in a WashingtonPost.com article from last month, when the oral arguments were presented.1 The case raises a series of economic issues concerning state funding and education, issues ranging from the need for government provision of services in general and education in particular to the most favorable ways to organize government expenditures on education.
The Scope of Public Services

The most fundamental question raised by the school choice controversy is broader than education itself. Before we can confront the subject of the state's role in education, we first ought to address the proper role and justification for government intervention in market activities in general. Most people (although exceptions do exist) believe that there are at least some circumstances in which the state should become involved in economic decision-making, but if we are to get a handle on what the government's role, if any, should be in education, we ought to start by establishing a rationale for government intervention in any arena.

One rationale that economists often use involves externalities and the problems that markets can have in coping with them. It might be clearer to explain what externalities are by first explaining why they sometimes cause problems for markets.

Markets are fantastic at allocating resources well by making sure that if there is a good or a service that a person values more highly than it would cost to produce it, then somebody (maybe the same person, but most likely not) will decide to produce it, a market exchange will take place, and both parties will be better off. If I think an order of chicken wings is worth more than six dollars (which I do) and the restaurant down the street can make them for less than six dollars (which they can), then I can walk there and give them six dollars for an order of chicken wings. If the restaurant could not make the order for less than I think it is worth, then I wouldn't buy it. In different terminology, the private benefit from the chicken wings (the more-than-six dollars of pleasure I receive from them) is greater than the private cost (the less-than-six dollars it costs the restaurant to make them). The net private benefit, which equals the private benefit minus the private cost, is greater than zero, so the chicken wings get produced and consumed.

Markets can be problematic where the net private benefit of a market transaction does not equal the net social benefit, which is the social benefit (the sum of private benefits of all individuals in a society) minus the social cost (the sum of private costs of all individuals in a society). In the chicken wing example, if we assume that nobody in society other than me and the restaurant gets any benefit or incurs any cost as a result of the exchange, so everyone else's private benefits and private costs equal zero, then the net private benefit equals the net social benefit. In such a case, a transaction that is beneficial to the restaurant and me (net private benefit > 0) will be beneficial to society as well (net social benefit > 0).

When net private benefit does not equal net social benefit, individuals can make exchanges that are privately beneficial but socially costly (net private benefit > 0 but net social benefit < 0), or fail to make transactions that would be socially beneficial although privately costly (net social benefit > 0 but net private benefit < 0). Some economists argue that if the government can intervene and bring the private costs and benefits more in line with the social costs and benefits, and so the exchanges that would occur would be on net more socially beneficial, then government intervention would be justified.

 

Ronald Coase asserted that under certain circumstances, people can address externalities without government intervention by reaching mutually beneficial market transactions. (For instance, my neighbor and I might agree that if he pays me a certain amount of money, I won't plant a new tree.) See Coase, Ronald, "The Problem of Social Cost," Journal of Law and Economics 3 (October 1960): pages 1-44, as well as the biography of Ronald Coase in the Concise Encyclopedia of Economics (CEE).

An externality, as defined in Tyler Cowen's CEE essay, "Public Goods and Externalities," occurs when "one person's actions affect another person's well-being and the relevant costs and benefits are not reflected in market prices." Externalities, therefore, cause net social benefit to diverge from net private benefit. For example, if I were to plant a tree in my yard for some shade, that tree might attract some birds that the woman across the street, an avid bird-watcher, would enjoy seeing. In the fall, the tree's leaves might fall into my neighbor's yard, forcing him to rake more. If, when I decide whether or not to buy the tree, I do not consider the benefit she might receive (a positive externality) or the extra cost he might incur (a negative externality), then my decision will only reflect my net private net benefit, not the net social benefit.

It is important to note that simply identifying that private net benefit differs from social net benefit does not automatically justify government intervention. As Cowen wrote, "The imperfections of market solutions to public goods problems must be weighed against the imperfections of government solutions. Governments rely on bureaucracy and have weak incentives to serve consumers. Therefore, they produce inefficiently." With regard to state funding of education, then, unless we have a specific plan for public education, we cannot reach a conclusion about whether that intervention is justifiable on efficiency grounds. We can, however, assert that a minimum necessary condition for state funding of education in general to be economically justifiable is that there are some social net benefits provided by education that are not captured by calculations of private net benefit.

Private and Social Net Benefits of Education

Having laid out a potential justification of state funding in education, we turn now to the writings of past economists for their views of the social benefits to be attributed to education. As we will see, some, but not all, of the views given were consistent with Alfred Marshall's comment in Book I, Chapter IV, paragraph 28 of his classic textbook Principles of Economics (1920, first pub. 1890), that "living economists with one consent maintain that such expenditure [on the education of the masses of the people] is a true economy, and that to refuse it is both wrong and bad business from a national point of view." It may be surprising that some of the descriptions these economists gave of the social costs and benefits involving education and state funding lay more in the realms of political and moral philosophy than of economics.

Adam Smith laid out his arguments regarding education in Chapter I of Book V of An Inquiry into the Nature and Causes of the Wealth of Nations (1904, first pub. 1776). In his view, education of the masses was a means of promoting domestic tranquillity and improving the overall judgment of a society. In paragraph 189, he wrote that

An instructed and intelligent people, besides, are always more decent and orderly than an ignorant and stupid one. They feel themselves, each individually, more respectable and more likely to obtain the respect of their lawful superiors, and they are therefore more disposed to respect those superiors. They are more disposed to examine, and more capable of seeing through, the interested complaints of faction and sedition, and they are, upon that account, less apt to be misled into any wanton or unnecessary opposition to the measures of government. In free countries, where the safety of government depends very much upon the favourable judgment which the people may form of its conduct, it must surely be of the highest importance that they should not be disposed to judge rashly or capriciously concerning it.

For Smith, then, education brought about an improved temperament in its recipients, which would be beneficial to the orderly and measured operation of a society, particularly in democratic nations in which the masses were participants in government. Essentially, basic education made for better citizens. With such social benefits resulting from widespread education, it is no wonder that Smith believed, as he asserted in paragraph 239, that "The expence of the institutions for education [are], no doubt, beneficial to the whole society, and may, therefore, without injustice, be defrayed by the general contribution of the whole society." In short, Smith supported state involvement in at least the financing of education.

French economist Frederic Bastiat, far from emphasizing the social benefits of education as a justification for public expenditure, in fact focused on the social costs of public expenditure as a justification for keeping government out of education, as well as most other endeavors. In Chapter 17, titled "Public and Private Services," of Economic Harmonies (1850), wrote of the moral and intellectual decay that results when the state attempts to satisfy a human want through services rendered publicly rather than privately:

When the satisfaction of a want becomes the object of a public service, it is in large part removed from the sphere of individual freedom and responsibility. The individual... ceases to exercise free control over the satisfaction of his own wants, and, no longer having any responsibility for satisfying them, he naturally ceases to concern himself with doing so. Foresight becomes as useless to him as experience. He becomes less his own master; he has lost, to some extent, his free will; he has less initiative for self-improvement; he is less of a man. Not only does he no longer judge for himself in a given case, but he loses the habit of judging for himself. This moral torpor, which takes possession of him, likewise takes possession of his fellow citizens, and we have seen entire nations fall in this way into disastrous inertia.

Although this dark perspective is not about social costs attendant on education specifically, it is a broad rebuttal to those, like Smith, who support government intervention as a means of generating social net benefits, particularly benefits regarding what might be called national character.

 

For a discussion of education as an investment in people's personal resources, see Gary S. Becker's CEE essay, "Human Capital."

Not all analyses of the social net benefits of education and state funding delved into the human condition. Some were more economic in nature, stressing the effects of education on national wealth. Returning to Marshall, most of his discussion of education came in Book IV, Chapter VI. This chapter is entitled "Industrial Training," but the arguments made there are quite applicable to general education as well. In paragraph 17, he asserted that "There is no extravagance more prejudicial to the growth of national wealth than that wasteful negligence which allows genius that happens to be born of lowly parentage to expend itself in lowly work. No change would conduce so much to a rapid increase of material wealth as an improvement in our schools." Expanding on the theme in paragraph 26, he wrote,

We may then conclude that the wisdom of expending public and private funds on education is not to be measured by its direct fruits alone. It will be profitable as a mere investment, to give the masses of the people much greater opportunities than they can generally avail themselves of. For by this means many, who would have died unknown, are enabled to get the start needed for bringing out their latent abilities. And the economic value of one great industrial genius is sufficient to cover the expenses of the education of a whole town.

 

In Book I, Chapter V, paragraph 3, Bastable noted three difficulties that had risen in France's state-funded primary school system of his day. Compare the difficulties he mentions, those concerning religious instruction, the effect of private fees on the poor, and measuring achievement, with points addressed in the WashingtonPost.com article and in John E. Chubb's CEE essay, "Public Schools." It appears that some of the education controversies present today have quite a long history.

So Marshall's support of state funding for education comes from the straightforward belief that general schooling would allow more people of exceptional talent and vigor to become productive, and that the additional innovation and productivity would more than pay for the public expense of education.

A similar argument was presented by Charles F. Bastable concerning government intervention in technical education for various trades. In Book I, Chapter V of Public Finance (1917, first pub. 1892), after noting the economic gains that could be made from widespread technical instruction, Bastable made a fairly explicit appeal to the idea of social and private net benefit discrepancies concerning technical education: "Expenditure on such an object is productive even in a financial point of view, and it may further be argued that individual or family interest will not suffice to accomplish the end desired." Bastable went on to note drawbacks to government intervention in technical education, but repeats that "public outlay may be of advantage in promoting industrial training."

 

Readers interested in a more advanced treatment of public funding of education, and collective action in general, should see The Calculus of Consent by James M. Buchanan and Gordon Tullock. See in particular Chapter 5, par. 29 and Chapter 8, par. 36.

Taking these all of these past views together, there does appear to be a consensus that education does impart social benefits not captured by private calculations, although there were a variety of opinions on exactly what those benefits are. Confronting this consensus is a view that the means of potentially realizing the social benefits, government intervention, generates its own social costs, suggesting, at least to Bastiat, that the cure is worse than the disease.

Adam Smith for School Choice?

If we accept the view of Smith, Bastable, and Marshall, that there are social net benefits to education that justifies government intervention, is there anything in their writings that allow us to discern how they would view today's debate over school choice in America? While one does not presume to write with authority on how these men would have viewed the specifics of Zelman v. Simmons-Harris, there are strong indications, particularly in Smith's Wealth of Nations, that he would welcome the introduction of additional competition into American education.

Smith believed that when teachers are paid a fixed salary by the schools in which they work, rather than being paid fees by each student they teach, their have no incentive toward diligence in their duties. Paragraphs 134 and 136 of Book V, Chapter I, explain that

The endowments of schools and colleges have necessarily diminished more or less the necessity of application in the teachers. Their subsistence, so far as it arises from their salaries, is evidently derived from a fund altogether independent of their success and reputation in their particular professions....

In other universities the teacher is prohibited from receiving any honorary or fee from his pupils, and his salary constitutes the whole of the revenue which he derives from his office. His interest is, in this case, set as directly in opposition to his duty as it is possible to set it. It is the interest of every man to live as much at his ease as he can; and if his emoluments are to be precisely the same, whether he does or does not perform some very laborious duty, it is certainly his interest, at least as interest is vulgarly understood, either to neglect it altogether, or, if he is subject to some authority which will not suffer him to do this, to perform it in as careless and slovenly a manner as that authority will permit. If he is naturally active and a lover of labour, it is his interest to employ that activity in any way from which he can derive some advantage, rather than in the performance of his duty, from which he can derive none.

Teachers, then, who are not directly beholden to those they teach for their pay, have no reason to take an active interest in their duties.

In addition to this lethargy on the part of publicly-funded teachers, publicly-funded universities are also lethargic, in the sense that they are not quickly responsive to changing information and systems of thought and have little incentive to stay abreast of the latest intellectual developments. In paragraph 174, Smith wrote:

Were there no public institutions for education, no system, no science would be taught for which there was not some demand, or which the circumstances of the times did not render it either necessary, or convenient, or at least fashionable, to learn. A private teacher could never find his account in teaching either an exploded and antiquated system of a science acknowledged to be useful, or a science universally believed to be a mere useless and pedantic heap of sophistry and nonsense. Such systems, such sciences, can subsist no-where, but in those incorporated societies for education whose prosperity and revenue are in a great measure independent of their reputation and altogether independent of their industry.

Although these passages decrying the insulation of institutions that receive fixed payments from the state (or endowments) are suggestive of Smith's possible views toward school choice, paragraph 140 is much more directly applicable to the issues of competition and performance (note that in Smith's day, emulation referred to an ambition or attempt to equal or excel over others):

The charitable foundations of scholarships, exhibitions, bursaries, &c. necessarily attach a certain number of students to certain colleges, independent altogether of the merit of those particular colleges. Were the students upon such charitable foundations left free to choose what college they liked best, such liberty might perhaps contribute to excite some emulation among different colleges. A regulation, on the contrary, which prohibited even the independent members of every particular college from leaving it and going to any other, without leave first asked and obtained of that which they meant to abandon, would tend very much to extinguish that emulation.

In the light of this statement, it seems reasonable to conclude that Smith would at least be sympathetic toward the principle of school choice, or at least toward the premise that allowing student to choose (or in the case of young students, allowing their parents for them) which school they will attend will improve outcomes by giving schools greater incentives to perform well. Education would still be state-funded, aligning private net benefits with social net benefits, but the competition for students would preserve many of the benefits of markets.


Footnotes
1.

Michael A. Fletcher, "Justices Indicate Choice Crucial in Vouchers Case," WashingtonPost.com, 20 February 2002.


*Morgan Rose is a Ph.D. candidate in economics at Washington University in St. Louis, with research interests in industrial organization, corporate governance and economic history.

For more articles by Morgan Rose see the Archive.
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