Who’s wrong? The Government or the Economists?

Where should we draw the boundaries of the state? When should Government take responsibility for providing or funding services? And when should it be left to the market to sort out? One characteristic of the current government is that it has destabilised well-established understandings of where the boundaries lie. Most prominently we have the debate over higher education funding. But there are a range of other fields – including social care, rail pricing, school sports, arts funding and library provision – where central or local government is stepping back from funding and/or provision. While the financial crisis is typically invoked as the trigger for this, there is more than a suspicion that this can act as a handy pretext for furthering an agenda of state retrenchment, leaving more to the market, the voluntary sector or informal provision.

From the point of view of economists interested in social policy and social problems this is intriguing. Many economists who concern themselves with such matters tend to operate from a social liberal or social democratic position – they tend to favour a mixed economy and acknowledge a significant role for the state, if only in funding rather than provision. This is in part because they are a self-selecting group. The dyed-in-the-wool market fundamentalists don’t tend to spend too much time thinking about the role of the state. Rather, they tend to assume that Milton and the Public Choice boys have put that particular question to bed – the state should keep well away from just about everything.

But those of us who do spend a bit of time thinking about the role of the state tend to frame it in terms of technical and political factors shaping the appropriate boundary with the market. In fact, at more sophisticated level, it is recognised that this is largely a false opposition. The “free” market, unencumbered by state intervention, is a creature of the textbooks that cannot exist in the wild. Real markets do not float independent of extensive state action. Similarly, apart from the command economies of the twentieth century – and typically not even there – state provision is interwoven with market relations of various types.

Anyway, I’m going to leave the political arguments around state action – arguments primarily associated with a concern for equity – for now. That is a whole other story. When we consider the technical dimension of the issue there is a concern for market failure, on the one hand, and government failure, on the other. Even when pure market provision is identified as problematic this doesn’t lead automatically to the conclusion that government should step in. Only if the risks associated the government failure are not too severe is it likely that government provision will enhance welfare. Also, with the rise of behavioural economics and “nudge” policy, individual failure is increasingly entering the discussion alongside market and government failure. These discussions are fundamentally comparative. It is not that there is a perfect solution to most problems of provision. It is a question of assessing which institutional arrangement – the market or the state or some hybrid – is comparatively advantageous.

Technical arguments for state action rest on the identification of market failure, which can arise for a number of reasons. The sources of market failure are usually categorised something like: externalities, information failures, failures of competition, public goods, missing markets, and systemic risks. It can also be helpful to draw ideas such as transaction costs or principal-agent theory from industrial economics to explain why certain activities are better performed through hierarchical organisations of significant size, while others can safely be left to markets. It is largely a question of relative efficiency and appropriate incentives.

If we take the example of higher education funding, a typical justification for rejecting a reliance on pure market provision rests on some combination of externalities (some of the benefits of higher education accrue to society in general not just the person being educated) and capital market failures (people for whom higher education would deliver a net benefit may not be deemed an appropriate risk by private lenders – lenders won’t rely upon unsecured assurances of increases in future income contingent upon completing higher education – and so students cannot finance their studies). There can also be arguments about information failures – those whose parents or friends have not experienced higher education will have less understanding of what it entails and are less likely to risk incurring large debts to find out. Occasionally there might be arguments about rationality, although those tend to apply more forcefully to students at earlier ages.

These arguments lead to the conclusion that it is appropriate for the state to at least partially fund higher education through prices, student maintenance or both. That is the case pretty much everywhere in the developed world.

Except, apparently, Britain in 2010. In fact, it isn’t even the whole of Britain because the Welsh have now announced that they are not planning to follow the path laid out by Cable and Willetts. Policy is withdrawing state support for teaching and passing pretty much all the cost to the consumers studying most subjects. It would appear to be intent not only on throwing the whole system into reverse, but also, in the process, to challenge our very understandings of who benefits from higher education and the capabilities of markets to ensure that those who can benefit from higher education are able to benefit.

A similar story could be told in a number of other policy sectors where the government appears intent on shifting the burden of costs away from taxation and on to the individual user, and to encourage or enforce the withdrawal of the state from provision.

So is the government right to ask these big questions? Has there been a cosy and relatively unquestioning consensus on these points among economists of social policy? Because some of the policies currently being pursued fly in the face of well-established arguments as to why you can’t leave these things to the market and expect a socially optimal outcome. If policy persists in this direction then you’ll just end up with some sort of undesirable outcome. The result could be no provision, under-provision, widely differing levels of provision over space as a function of things like population density or income profile, and social advantage or divisions being further entrenched.

Or, on the other hand, have the economists got it right? If so then the government is heading from some fairly disastrous social outcomes if it carries on with some of the policies it is seeking to pursue, precisely as the theory would predict.

Another way to approach this issue is to ask why an activity is being provided by the state in the first place. Productive activities end up in the state sector for all sorts of reasons.

In some cases a company is failing and the state takes it over to stop it going under. That was part of the story of nationalisation in Britain in the 1960s and 1970s. It is most recently part of the story of the fallout from the credit crunch. In this situation there is no technical economic reason why the activity could not be in the private sector – it is just a question of a private firm having got into difficulty either because it was not competitive or made bad decisions resulted in poor performance. And the government of the day felt it could not ignore the situation.

Other activities are in the state sector precisely because without state provision there would be no uniformity of coverage and services were, typically, only available to the rich. That is the pre-history of the National Health Service. If the trigger for state provision was a failure of the market to provide adequately then an incautious return to the market, or to the voluntary sector or civil society, is likely to be accompanied by a re-emergence of the problems that led to state involvement in the first place.

Another example of where these arguments are likely to play out in practice again is public libraries. It appears that many local authorities are considering swingeing cuts in their library provision. This is accompanied in some cases by arguments about communities who really want to see continued library provision in their area being willing to self-organise to ensure future provision. These are arguments that are pretty much untested, at least since earlier in the twentieth century. Part of the reason why local government got involved in library provision in the first place was a recognition that the reliance on private philanthropy was not sufficient to deliver widespread access, and a recognition that there are considerable social benefits to a literate population with access to appropriate written material. That is, this is a service with a positive external effect that the market will never be able to capture adequately. A loss of social welfare results from leaving it to the market or community self-organisation.

Personally I suspect that the body of thinking underpinning the economists’ position is rather more extensive and rather more rigorous than the thought that has been applied to some of the Government’s current policy directions. So my money is on the economists. Of course, the negative effects that the economists might predict from some of the policies currently being pursued can always be given a different spin by labelling them the benefits of localism, rather than the products of patchwork market provision. But that is a rather different type of argument.

On the other hand, it is clear that the body of knowledge economists work with evolves over time. A good illustration of that is the way in which Nicholas Barr, in his standard textbook on the economics of the welfare state, dropped the chapter on housing policy between the 3rd and 4th editions. He felt that there was no longer any strong arguments for assuming that markets-plus-income redistribution couldn’t deal adequately with housing problems. So perhaps the Government is on to something.

There are a whole host of bigger questions that could be pursued here, but now isn’t the time. One such question is whether the premise is right. Is the decision whether to use markets or public provision primarily a technical matter, which has no subtle and not so subtle transformational effects? That is the standard economic position. Decide on your objectives and then look at which institutional arrangement is best able to meet it. It is also a characteristic of many liberal political positions. It is strongly evident in the famous Orange Book. Some economists are becoming rather more sceptical about the argument that different provision systems are simply neutral technologies for achieving policy goals. Anyone interested in pursuing that argument might like to dig out a copy of Stephen Marglin’s book The dismal science: how thinking like an economist undermines community. This position starts to bring economics close to the position of critics of the economization of policy such as David Marquand. But that’s a topic for another day.

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  1. These arguments lead to the conclusion that it is appropriate for the state to at least partially fund higher education through prices, student maintenance or both. That is the case pretty much everywhere in the developed world.

    And that’s what the new deal says if you care to read it. You may not agree with the balance of it but there seems to be a misunderstanding about that balance. If you don’t either decrease the amount of funded courses you have to tax those that haven’t been to university (and likely never will) ie a fork lift truck driver in Manchester. Why should he subsidise some uppity lecturer on 40 – 50k in London?

    That’s what I don’t understand about the SLFers – they seem to think like Socialists that money grows on trees – everything has a consequence for other people – it’s not whether you can sell it to those uppity middle class types – it’s whether the skilled working class are willing to fund it!

    • If you don’t either decrease the amount of funded courses you have to tax those that haven’t been to university (and likely never will) ie a fork lift truck driver in Manchester. Why should he subsidise some uppity lecturer on 40 – 50k in London?

      Because the economy relies on a mix of skills, and if the economy does badly, we all do badly. What little productive industry we have left is down to the fact that our universities punch way above their weight given the size of the population. We are 2% of the world pharma market but 10% of pharma manufacturing is done here. We might not make many cars any more, but we do design them. Destroy our universities, or bequeath them as playgrounds for the idle sons of the idle rich, and what does our economy have left to work with? A few incompetent bankers who will emigrate (or get a proper job) once all the capital has relocated to ASEAN?

      There are massive problems with inequality of access to higher education and massive problems with income inequality. But these are not problems you can tackle by making higher education a privilege that only the rich can afford.

      The argument is much the same as for universal benefits. Means testing is pointlessly expensive, demeaning, and leads to those in need not applying for monies they are entitled to. And by ‘entitled’, I mean that the societal benefit of helping them is considered, by society, to be greater than the direct financial cost of doing so. It makes more sense to give everyone the benefit and adjust the income tax structure so that those on above average incomes pay back more in tax than they receive in benefits. That’s what a proper progressive tax structure is all about (not that we have one of those, either – it’s scandalous that unearned income is taxed at a lower rate than earned income).

      You chose a poor example too. Very few lecturers are on that kind of money – £50k is the starting point for a professor. and many skilled manual workers earn more than many academics (more than any public sector employee apart from doctors and the police, in fact). My bus driver earns more than almost all of the graduates I know, apart from a couple that sold their souls to the City. But then, he’s lucky enough to live in a city where there is still a strong manufacturing industry and the bus companies can’t just rely on the job centre sending them people to work for minimum wage.

  2. @John – Thanks for your comment.

    I wasn’t intending this post to be about higher education specifically. That was just the example I took because it is currently in the news. My point was that there are technical arguments about the nature of the “good” that is higher education and the limits of what can be achieved through a market which lead economists to consider that leaving it to the market is not necessarily a good idea.

    The point is not political. It is accepted by many economists who would definitely not consider themselves socialist. Similar arguments can be made about the provision of health care, which is why that is not left to the market in developed countries. So I was pointing out that there are perfectly respectable – in fact relatively conventional – economic arguments that this is one area in which there is a case for the state to act to ensure equality of opportunity, rather than access to higher education based upon social class and family resources. That seems to me to be an entirely liberal position to take.

    Your argument about who pays is, of course, an important one. I’d only make a couple of comments.

    If you look at the issue over time rather than at a single point in time then graduates will tend to pay more tax over their lifecourse anyway, so the argument that they are paying for their higher education already is credible. It is just that they are paying for it through subsequent taxation so it has less impact upon their decision at the point of choosing whether or not to study. The question is whether you call it a loan and tie it to the individual or take it as a higher rate of tax on higher earners.

    The report by the OBR produced earlier this week indicated that the government’s policy of removing direct support for Universities’ teaching costs and moving it all to student tuition fees will not save money in the short term. In fact it is going to cost more than £10bn. That is just logic. If the students won’t start paying back until after they graduate then there is going to be an extended period of transition during which someone (the government) is going to have to be loaning out money, while the repayments are only going to start arriving some years later (if ever). This policy is not, in my view, primarily about saving public money.