Profit in Education

In "Not Welcome Sign = No R&D" EdReformer Tom Vander Ark relates the hostility of public sector employee organizations toward parent choice in education to the slow pace of innovation in the education industry. Vander Ark quotes an Oregon statute:...
All materials would become the property of the OVSD and the State of Oregon. OVSD would run all logistics for maintenance of this program (contracting, rate-setting, procurement, etc.).
The impact on incentives should be clear. Why would investors support the development of effective instructional methods if the State will steal them and deprive investors of any chance to recoup? One might draw an analogy to the disincentives to minerals exploration in countries where the State claims all sub-surface resources.

Joanne Jacobs noticed the Vander Ark article. A visitor (ceolaf) asked about the role of profit in the education industry and Harriet left a comment, with a botched link (the Joel Fried article, repaired in the expanded and revised comment below).

Thomas Sowell (Knowledge and Decisions) and Milton Friedman (Capitalism and Freedom) discuss, in abstract, the role of markets in allocating resources to meet human wants. Myron Lieberman (Privatization and Educational Choice) discusses the role of market incentives in the education industry in particular. Friedrich Hayek addresses the role of markets (freedom, really) in generating information on human wants and resource availability, here. Please make time to read Hayek's brief essay.

“Profit” is a bookkeeping term, the difference between total revenues and total costs. An organization which has no line in its balance sheet for profit must attribute all revenues to costs. This says nothing about the motives of people in the organization.

Joel Fried
Pots and Kettles: Governance Practices of the Ontario Securities Commission, part 2 The Government’s Principal – Agent Problem.
2. The Government’s Principal – Agent Problem
The principal-agent problem for the private sector is well known: the owner/principal delegates to a manager/agent the responsibility to provide some services for the principal. The problem is one of structuring contracts and institutions to insure that, in carrying out her duties, the agent acts in the principal’s interest rather than her own.

Citizens of a country also face a principal – agent problem. Citizens “own” the machinery of government and employ bureaucrats to act as their agents in running this machinery. To reduce the costs of monitoring, the principals choose a legislature/board of directors to oversee the agents. Monitoring mechanisms are similar to those in the private sector: there are financial accounting standards that are met for each budgetary unit, and an external auditor checks these internal accounts. Transparency is maintained, in part, through freedom of information regulations. Compliance with procedures and other regulations are met both through internal monitoring and checks by units external to the bureau. Finally, contracts are structured, at least in a limited manner, to align the incentives for agents with those of the principals.

There is, however, an additional problem in the public sector that does not exist for private firms. The firm has a well defined objective function – the maximization of profits – whereas the apparent objective for the government is the maximization of some index of a (weighted) level of welfare of the electorate. An unambiguous index of social welfare has been impossible to construct (bold mine, HT) and, in its absence, monitoring the public sector is further complicated because data is generally lacking on whether or not the objective was actually approached and/or achieved and what the costs are that are linked to any specific objective. In effect, because of distribution issues and public goods, the cash flows measured with traditional accounting procedures will be, at best, only superficially correlated with that objective. Thus, looking at cash flows will provide the principals an extremely poor method of monitoring their public sector agents.
[As an aside, this last point: "...looking at cash flows will provide...an extremely poor method of monitoring...public sector agents" is why Harriet expects only marginal results from the popular "audit the DOE" imperative. As Harriet explained here, the difference between the demands which public-sector providers of education services make on taxpayers and students, on the one hand, and the tuition charged by schools in competitive markets, on the other, firmly establish the existence of gross waste and fraud in the US State-monopoly school system.]

Governments do not need to recognize “profit”; they could tax every dollar-denominated transaction. Markets do not need “profit”; contracts with investors could promise a percentage of receipts or a percentage of the amount lent (like a bond). Accounting rules which recognize “profit” allow a business to shield some revenue from taxation by deduction of research costs or capital expansion costs.

A market economy (a legal system which protects title to property and, by extension, enforces contracts) calibrates the rewards for the solution to resource allocation questions to the magnitude of the resources at issue and to the urgency of the question. “What do you want to eat for lunch?” is a question which becomes more urgent with every hour that passes since your last meal and which involves, over a nation of 300 million people, hundreds of millions of dollars worth of food and prep time. A marginally better answer, such that several thousand people will spend an additional dime on lunch, or which saves a dime for each meal served to several thousand people, can make the person who finds that answer wealthy.

“What History (or Math, or poetry, etc.) should thirteen year-olds study?” is as inappropriate a question for citizens to pose to a State (government, generally) bureaucracy as “What size shoes should thirteen year-olds wear?” would be, as becomes obvious when one rephrases the question: “What Math material should my neighbor’s 13 year-old daughter study?” (what size shoes should she wear?). Remote authorities do not know this child. There is no good argument for taking from her mother the power to answer this question. Even if her mother needs help finding the answer, there is no good argument for restricting her choice of advisers to State (government, generally) employees.

As Harriet has written many times before, the US taxpayers' $555 billion+ per year age 5-18 education subsidy ($2.9 billion, Hawaii) significantly understates the cost of the current US State-monopoly school system.

The cost of the US State-monopoly school system includes the opportunity cost to students of the time they spend in school. It does not take 12 years to teach a normal child to read and compute. Most vocational training occurs more effectively on the job than in a classroom. This opportunity cost appears as lost productivity in two forms: absent child labor and less practiced adult labor. Just as few adults will exhibit native fluency in language without early experience, "fluency" in carpentry, masonry, machine tool use, or other vocational skill depends on early experience.

The cost of the State-monopoly school system includes the cost of prison for the children of poor and minority parents who are ill-served by a school system designed by and for academics.

In support of the bureaucratic imperative to regulate and in the name of "equality" and "standards" the US State-monopoly school system imposes a uniformity of treatment upon an enormously diverse student population with a wide range of interests and aptitudes. Obvious costs include apathetic scholarship and perfunctory effort as adult workers. The cost of the US State-monopoly system also includes the opportunity cost to society of the lost innovation in instructional methods and individualization of curriculum which a competitive education industry would generate.

We walk over the Comstock Lode every day, unaware of the wealth beneath our feet.

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