On Public Funding of Colleges and Towards a General Theory of Public Options.

Via Aaron Bady, here is Colleen Lye and Chris Newfield, from “The Struggle for Public Education in California” (in the South Atlantic Quarterly, Spring 2011).  If we want to wonder why public education is becoming expensive it is in part because we aren’t supporting it as much as we were in the past. I need to file the second paragraph below as a great observation on some of the consequences of “pity-charity liberalism.”  Quote (my bold):

California, one of the world’s wealthiest places, has seen one of the world’s most astonishing declines in college achievement. The state’s continuation rate, the proportion of students starting college who complete it, fell from 66 percentto 44 percent in just eight years (1996–2004). California’s rank among states in investment in higher education declined during the same period,from fifth to forty-seventh,according to Tom Mortenson, a higher education policy analyst.The state has cut its investment in higher education by close to 50 percent since 1980, forcing tuition increases like the 60 percent rise at the University of California from 2004 to 2008, which was followed by a 32 percent rise between 2009 and 2011. Meanwhile, half of California’s students (kindergarten through grade twelve) are now eligible for thefederal school lunch program, up from one-third in 1989. As Mortenson notes, these students will have no personal resources to cover the costs ofattending college, which at UC is nearly $30,000 per year.

Throughout this period, the Democratic opposition came to accept the description of the public infrastructure as a “safety net”—something remedial, for society’s alleged losers. Higher education by its very nature falsified this idea, since it was a public investment that created and constructed new technology and new ideas, new craft knowledge, new andmore effective economic and sociocultural systems. Specialists were well aware that public funding was the only source of support for the early development of scientific and cultural knowledge, for fundamental experimentation, for breakthrough creativity. And yet even progressive politicians seemed unable to learn a basic concept like “market failure” that had been part of economics since the 1950s. They accepted the premise that public outlays could and should be replaced by private funding wherever a higher education manager expressed an eagerness to try.

Lots of people are talking about the financing of public universities and the current student debt crisis. Yglesias notes “The current incentive structure points toward always reinvesting excess money into moving up the prestige hierarchy rather than toward lowering prices to broaden the customer base” while responding to Freddie DeBoer. But how can Yglesias’ description happen in a competitive market? We have to look at a situation where a producer of a good has some monopoly pricing power combined with a strong inelasticity of demand on the part of consumers.

One of the general principles of a neoliberal approach to providing goods is that it is better to give people cash to spend among private providers of a good rather than the government provide these goods themselves at a discount. Giving people cash fosters competition, innovation and choice, while the government providing goods directly at a discount will likely lead to stagnation, dependency and wasted resources.

But that’s in a perfectly competitive market. What happens when we have producers with pricing power and where demand for a good – say because education is the main source of socio-economic mobility in this country – is inelastic? What if we decide to give people cash instead of directly providing a good at a discount? We can expect incumbent institutions to simply capture that money as a rent.  Is replacing public provisioning of colleges with pell grants and student loans actually helping students with college costs or is it simply increasing tuitions?

I encourage you to read JW Mason’s post Public Options: The General Case, which fleshes this case out.  It’s one of my favorite posts on the internet. Mason (my bold):

Under what conditions does public spending on higher ed increase the number of people in college, and under what conditions does it just enrich Kaplan and the Harvard endowment? More broadly, it seems to me that the price effect of subsidies is a neglected argument for direct provision of public goods.

Formally, a subsidy is just a negative tax, and like a tax, its incidence depends on the relative elasticities of supply and demand. If supply is less elastic than demand, most of the cost (of a tax) or benefit (of a subsidy) will fall on the producer; if demand is more elastic, most will fall on the consumer….

The interesting question is what happens when we generalize this logic to other areas, like higher education. Imagine a state that’s considering a choice between spending, let’s say, $1 million either subsidizing its public university system, enabling it to keep tuition down, or as grants to college students to help them pay tuition. On the face of it, you might think there’s no first-order difference in the effect on access to higher ed — students will spend $1 million less on tuition either way. The choice then comes down to the grants giving students more choice, fostering competition among schools, and being more easily targeted to lower-income households; versus whatever nebulous value one places on the idea of public institutions as such. Not surprisingly, the grant approach tends to win out, with an increasing share of public support for higher education going to students rather than institutions.

But what happens when you bring price effects in? Suppose that higher education is supplied inelastically, or in other words that there are rents that go to incumbent institutions. Then some fraction of the grant goes to raise tuition for existing college spots, rather than to increase the total number of spots. (Note that this must be true to at least some extent, since it’s precisely the increased tuition that induces colleges to increase capacity.) In the extreme case — which may be nearly reached at the elite end — where enrollment is fixed, the entire net subsidy ends up as increased tuition; whatever benefit those getting the grants get, is at the expense of other students who didn’t get them.

Conversely, when public funds are used to reduce tuition at a public university, they don’t just lower costs for students at that particular university. They also lower costs at unsubsidized universities by forcing them to hold down tuition to compete. So while each dollar spent on grants to students reduces final tuition costs less than one for one, each dollar spent on subsidies to public institutions reduces tuition costs by more.

The same logic applies to public subsidies for any good or service where producers enjoy significant monopoly power: Direct provision of public goods has market forces on its side, while subsidies for private purchases work against the market. Call it progressive supply-side policy. Call it the general case for public options. The fundamental point is that, in the presence of inelastic supply curves, demand-side subsidies face a headwind of adverse price effects, while direct public provision gets a tail wind of favorable price effects. And these effects can be quite large.

This argument seems straightforward and logical, and has some empirical backing. But it’s only very rarely made in support of direct provision of public goods. One can speculate why that might be. But the important thing is those of us seeking an incremental de-marketization of society, should recognize that the logic of the market is often on our side.

There’s more at the post, including a critique of the EITC using the same model. I like the idea of a progressive supply-side along these terms, where the government is in the business of fostering opportunities for its citizens rather than bribing incumbent institutions while further extending and entrenching their monopoly powers.