Economics for Edu-pundits Part III

(Part II is here)

Fixing the problems we see in the present public education system is easy, but in the short term highly disruptive.  But, that’s only because the present system is so screwed up and the interests within the system have gotten so comfortably entrenched and skilled at gaming the political forces by which the system is controlled.

The solution is simple – the system needs an injection of both profits AND losses.  The losses part is the critical component.

Businesses are only interested only in the profit half. If they can avoid losses by getting government subsidies, tariffs and other restrictions against imports, or domestic laws that stifle competition, they will do so. Losses, however, are essential to the process that shifts resources to those who are providing what consumers want at the lowest prices—and away from those who are not.

Here’s a good example of profits and losses in action in the airline industry from Thomas Sowell’s Basic Ecomonics from which I’m stealing a large part of this discussion.  (I’m not providing proper quotations for readability purposes; just assume the well-written parts are his and the poorly written ones are mine)

Between the last year of federal regulation in 1977 and twenty years later in 1997, the average air fare dropped by 40 percent and the average percentage of seats filled on planes rose from 56 percent to 69 percent, while more passengers than ever were carried more safely than ever. Meanwhile, many airlines went bankrupt. That was the cost of greater efficiency. It has been estimated that, during the era of federal regulation, government intervention in the market had caused costs and fares to be 50 percent higher than they would have been in a free market. When the protection of federal regulation was removed, those airlines which could not survive with lower fares and rising fuel costs went out of business.

In 2010, the inefficiencies are still being sucked out of the system and it remains a painful process, especially for inefficient airlines.  we haven’t reached airline travel mecca yet, but consumers have it better than ever.  Bad airlines still remain and you fly with them at your peril.  The situation is the same with bad charter schools.  But, the system as a whole is far better off.

People often have a knee-jerk reaction to “profits.” They think it is a valid criticism that business are “just in business to make profits.”  Schools  shouldn’t be in it for profit, but for more altruistic reasons.  By this kind of reasoning, it could be argued that teachers are just working to earn their pay.  What matters is not the motivation but the results.

To understand why profits and losses are so important, we need to examine what is needed for a business, such as a school, to turn a profit.

One precondition is that profit-seeking businesses cannot squander scarce resources like schools currently do. Businesses operating in a market economy have to pay for all their inputs—whether labor, raw materials, or electricity—and they have to pay as much as others are willing to bid for them. Then they have to sell their own end product or service at a price as low as their competitors are charging. If they fail to do both, they fail to make a profit. And if they keep on failing to make a profit, either the management will be replaced or the whole business will be replaced by some competitor who is more efficient.

In this case failure is a good thing.  if you don’t want children attending bad schools, you have to let them fail and allow the resources to shift to better schools.

Some people, like Downes, charge is made that profits are short-run gains, with implication that they come at the expense of longer-term considerations. Sowell deals with this argument handily:

But future values are reflected in the present value of a business' assets. A factory that runs full blast to make a profit today, while neglecting the maintenance and repair of its machinery will immediately see a decline in the value of property and of its stockholders' stock. It is in the absence of a profit-and-loss economy that there are few incentives to maintain the long-run productivity of an industrial enterprise or a collective farm, as in the Soviet Union.  What happens to the enterprise after the current management's tenure is over is of little concern in a system where there are no profits and no present values to influence decisions.

Ever notice how decrepit inner city schools are.  This explains why. It certainly isn’t for lack of funding.

Couldn’t we achieve the same results by running schools as non-profits?  We’ll see the problems of non-profits in the next post.