View source for Government Intervention in the Markets for Education and Health Care: How and Why?

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[[Category:James Poterba]]
[[Category:Education]]
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{{DES | des = Lists 4 major market "imperfections" on page 279.  Points out that they have not been well quantified.  Ignores public goals for education beyond the simply economic. | show=}}
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10.1.1 Market Imperfections with Respect to Education
Many of the classical economists broke with their usual laissez-faire view of the appropriate role of government when confronted with questions of edu- cational policy. In The Wealth of Nations, Adam Smith argued that “[tlhe state derives no inconsiderable advantage from [the education of the common people. If instructed they are] . . . less liable to the delusions of enthusiasm and superstition, which among ignorant nations, frequently occasion the most dreadful disorders” (book 5, part 3, article 2). This reference to societywide externalities associated with the education of each individual is only one of the potential market imperfections that might warrant government intervention in the market for schooling.
The first, and most commonly alleged, source of a market imperfection with respect to education is the presence of externalities from schooling. This argu- ment has been made in many ways; Cohn and Geske (1990) provide an over- view. Some claim that an educated electorate is vital to a successful democratic society, for example, because it permits individuals to keep records, file tax returns, and evaluate campaign material. Others argue that an educated work- force is critical for the adoption of new technologies and for improving, not just an individual’s productivity, but that of his or her coworkers. Yet a third externality argument holds that there is a negative relationship between educa-
280 James M. Poterba
tion and crime, so that widespread education will reduce crime and the associ- ated social disruption.
A related externality argument, that applied with particular force to the nineteenth-century United States, is that education assists in socializing many diverse immigrant groups. This argument is probably specific to public educa- tion: providing the same level of education through various parochial schools might have a smaller effect on social integration. Widespread public education during this period probably helped the “melting pot” to function, and exposed groups from different national backgrounds to the civic structure and related aspects of the United States.
Each of these arguments suggests that private spending on education contri- butes to a public good. If parents ignore the externalities associated with edu- cation in deciding how much to spend on their child’s education, educational spending will fall below the socially efficient level. Public policies designed to increase educational attainment therefore have some prospect for raising social welfare.
A second potential rationale for government intervention arises because mi- nors, who are the usual recipients of education, are not responsible for deciding how much schooling they will obtain. This responsibility falls to their parents, who also bear the costs of education. Since the benefits of education accrue primarily to the children who receive it, the level of spending on education depends critically on the degree of parental altruism. If parents place a low value on improvements in their children’s future earning potential, then they may underinvest in their children, and government intervention might be justi- fied on the ground that it protects children from decisions by their parents.’
One difficulty with this argument is that it could be invoked to justify state intervention in virtually all aspects of child rearing. Can parents be trusted to feed their children properly? To provide the appropriate amount and type of playthings and other stimuli to early development? It is not clear, as West (1970) notes, that the risk of parental underprovision of education is any greater than the risk of underprovision of many other important develop- mental inputs.
A third market imperfection that may be relevant for educational decisions involves capital market constraints. If some households face borrowing con- straints that limit their total access to credit or cause them to face borrowing rates above the economywide marginal product of capital, then even parents whose altruism matched that of the social planner might underinvest in their children. Because loans to obtain education are not backed by tangible collat- eral, they are often difficult to obtain in private credit markets.
1. It is at least possible that some parents may be more concerned with their children than a social planner would be. Parents may also misperceive the value of spending on their children, measured in terms of the corresponding increment to future income or utility, or be concerned primarily with the relative status of their children, as discussed in Frank (chap. 6 in this volume). Any of these factors might lead to overprovision of private education.
281 Government Intervention in Markets for Education and Health Care
A fourth market imperfection, one that applies most strongly in small com- munities with a limited number of children to educate, is the presence of fixed costs in educational production. The marginal cost of adding another student to a classroom is lower than the average cost of each student’s education. Such economy-of-scale arguments, which may also apply to consumption of some types of specialized services in large school districts, provide an efficiency argument for group consumption of educational services. This does not neces- sarily imply that the public sector must provide education.
Although it is relatively easy to construct a list of imperfections in the mar- ket for educational services, it is extremely difficult to p a n r i b their impor- tance. How many parents, for example, would neglect their children’s educa- tion? Moreover, while there are undeniably some externalities associated with education, primary and secondary education also yield very high private re- turns. The central question is therefore whether there are externalities associ- ated with education above the level that parents would choose in a private market. Yet virtually none of the empirical evidence on the economic returns to education, with the notable exception of Lazear (1983), is directed at this issue.
Optimal government policy must balance the gains associated with the par- tial or complete correction of market imperfections against the costs of the policy and its associated distortions. Virtually any government intervention, whether through price subsidies or through public production of services, dis- torts the behavior or private agents. Peltzman (1973) and Sonstelie (1982) are among the small group of studies that have explored the inefficiencies created by the current policy of free public provision of education. Peltzman (1973) shows that free public school can lead some parents who would otherwise have chosen schools better than their local public schools to send their children to those schools. This is because lower-quality, but free, public schools may on balance be more attractive to parents than higher-quality schools for which they must pay tuition. This change in parental behavior can shift the economy from one equilibrium level of educational spending to another equilibrium with lower total spending.
Sonstelie (1982) also concludes that there is a significant efficiency cost to free public schools, but his argument relies heavily on his assumption that private schools are more efficient providers of educational services than their public school counterparts.’ Neither of these studies considers the potential costs associated with public rather than private production of educational ser- vices. Further work on the private demand for education is important for evalu- ating a number of current educational reform proposals, such as those for
2. It is difficult to control for the differences in the attributes of public and private school stu- dents in making such efficiency comparisons.Even if private schools appear to be more efficient when they are educating only a small and self-selected part of the population, they could be no more efficient than existing public schools if their student input was the same. Relatively few studies have developed convincing empirical strategies for correcting for the endogenous selection of students into public and private schools.
282 James M. Poterba
school vouchers and other means of introducing more competition into the
educational marketplace.
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