Making Education “Free”!

I recently came across this article discussing Chile’s move to make higher education “free”. From the article:

“In March 2016 we will start with free higher education now that we have the resources,” said Rodrigo Peñailillo, Chile’s Minister of Interior in early December following approval of a corporate tax hike that will generate $8.2 billion in new revenue.

What I find interesting about these types of discussions is that they only seem to focus on the cost of the service in question. In reality, when a consumer is making a decision about a product or service she generally has to weigh two things: cost and quality.

The hidden assumption in these discussions is that no matter what we do to the cost side of the equation, the quality side of the equation will remain the same, or at least stay on its current course. In our day-to-day lives, however, we instinctively know this to not be true. We weigh cost against quality every day when we decide what to eat, which mode of transportation to use, which phone to buy, etc., and yet our public discourses on changing the cost of certain services through government intervention largely ignores the potential impact on quality. I think its worth investigating this hidden assumption on quality a little further.

Quality

I know that I can spend more money to get higher quality, grass-fed beef, but I don’t always do it. Sometimes the cost is just not worth it to me. Other times it may be. Some people think I’ll be healthier if I eat only grass-fed beef, and others think its a waste of money and doesn’t make a difference.

But what would happen if we all decided that grass-fed beef was healthier for us, and that getting more people to eat grass-fed beef would increase our vitality, and longevity. In order to help increase our health and quality of life, we decide that our government should tax corporations to make grass-fed beef “free” for everyone, so that we can all enjoy the wonderful health benefits and live happier lives.

Of course, we all know that nothing is really free, and that under this scheme, the beef will just be paid for by corporations instead of directly by the consumers. Fundamentally, this is a massive change in the pricing mechanism of the grass-fed beef market. What would the effects of such a drastic shift in the pricing mechanism be, not just on the grass-fed beef market, but on the economy as a whole?

First off, it’s highly likely that demand for grass-fed beef would skyrocket. Who would buy grain-fed beef, when the grass-fed variety is free? This would be a boon for grass-fed beef producers, and a depression for grain-fed beef producers (who would likely begin restructuring their business to provide grass-fed beef). One issue, however, is that the grass-fed producers could not immediately meet the surge in demand, so there would be shortages in grass-fed beef. Previously, anyone who wanted to pay for the luxury of grass-fed beef could get it it, but now almost no one can. This would, of course, lead to a black-market, where those with money could buy grass-fed beef, since the store shelves would be empty of it. It would also incent people to pick up as much grass-fed beef as they can when its available so they can sell it on the black market to those who really want it.

So far, the quality of the beef hasn’t really been affected, but the availability has been greatly affected. For those buying on the black-market, the price has also increased compared to what they used to pay. Next, let’s think about how the grass-fed beef producers are getting paid.

Since grass-fed beef can’t be produced for free, the producers still need to at least have their costs met for raising cows and producing grass-fed beef, or they will stop making it and go out of business. As we said earlier, they will be paid by a tax on corporations. As the demand surges for the “free” grass-fed product, however, do the corporate tax revenues surge in lock-step? Obviously not.

Not only that, but corporations will have all sorts of new and different incentives to avoid this new tax. Corporations have a knack for getting pretty creative when it comes to limiting their costs, and taxes are one of their bigger costs. They may decide to invest more in marketing and R&D to reduce their bottom line (on paper, at least), so that their tax burden doesn’t really change at all. Corporations may also decide that they need to lay people off in an effort to reduce costs to keep their post-tax profits and margins at similar levels as before. This will likely reduce the quality of their products or services, which may put downward price pressure on their goods.

So we see that the demand for the grass-fed product goes up since the price is now $0, and we see that the tax income to pay for the product is completely disconnected from this demand surge. So how can we actually pay for the production needed to meet the new demand?

We might now need to tell the grass-fed beef producers that we only have $X amount of money coming in as tax revenue for this program, so they will be paid accordingly, based on our ability to pay. As we said before, however, the tax revenue from a different sector of the economy is in no way linked to the demand for grass-fed beef, so the $X amount of money collected will not be sufficient to pay the producers for their actual costs of producing the beef.

This means the grass-feed beef producers will have to either go out of business and shut down, lower their costs, or convince us that we need to pay them more.

None of these solutions are good. If they shut down, nobody gets any grass-fed beef, and we’ve failed at our goal to make us all healthier and live longer. Now, in fact, if the original hypothesis for this program is correct, we’ll all be forced to live less healthy lives, as nobody can get grass-fed beef! This is the worst case outcome for the the quality of grass-fed beef…it’s now completely non-available. (In reality, however, this scenario would lead to a black-market for grass-fed beef that ‘illegal’ producers would sell goods on to those who still want grass-fed beef anyway, and the prices would, ironically, be higher).

If the producers decide to lower their costs, this directly impacts the quality of the end product. They will need to find creative ways to cheapen the cost of producing “grass-fed” beef, which will ultimately alter the definition of what “grass-fed” beef really means. Do they add in some grain-feeding to lower their costs? Do they find cheaper ways to grow and fertilize their grass? Do they buy lower quality soil? They probably do some combination of all of these things, because somehow, they have to lower their costs to stay in business!

Maybe the producers convince us that we really just have to find a way to pay them more, or else the quality of our grass-fed beef will suffer, and so will our health. We decide that we just have to raise taxes somewhere else in the economy to pay for the beef quality that we know we deserve. Now this vicious cycle happens all over again, because the revenue from this newly taxed sector will also not change in lock-step with the (virtually unlimited) demand for “free” grass-fed beef. In addition to this problem, we’re now deciding to make more and more sectors of the of the economy less healthy to provide us with our coveted grass-fed beef. Is this worth it?

Is this what we want?

I’ve focused above on a simple analogy with grass-fed beef, but I think its easy to see how this same logic would apply to anything else, be it education, health care, or internet service. When we play with the nobs of the cost structure for a good or service, the quality will necessarily be affected, very likely in a negative manner.

We’ve seen this very clearly over the last 40+ years with healthcare in America. Ironically, our policies that focused on keeping costs low have not only had a negative impact on quality, but they’ve simultaneously caused costs to soar! While an argument can be made that the quality of healthcare has gone up over this time, I think this is largely due to the amazing march of technological innovation. Clearly, the increase in quality is not commensurate to the increase in cost! (For more on this topic with regards to healthcare, check out Catastrophic Care)

I argue that by shifting the cost of a good or service away from the consumers of that good or service, we create a malfunctioning price system that necessarily raises costs and lowers quality. Is that really what we want to see in the long term for our education system?

What do we really want?

I think what we all really want is a decreasing cost of education coupled with a rising quality of that education. A properly function price system provides exactly this over the long term. On the other hand, I believe I’ve outline why government schemes to provide ‘free’ education (or any other service) will actually have the exact opposite effect in the long run.

In marketplaces with function price systems we tend to see aggressive and competitive battles to raise the quality of goods while simultaneously decreasing the costs of those goods. By far the best example of this process is in the technology sector. Looking at the cost of smartphones, or computers over time, we see incredible decreases in cost and simultaneous increases in quality. This has the effect of bringing higher quality products and services to more and more people over time in an incredible march towards a higher standard of living for all.

We see exactly this with the explosion of smartphone adoption in the third world and emerging markets. Smartphones were initially toys for the rich in the first world, but will soon be within reach of almost everyone. This wonderful fact will rapidly increase the standard of living for billions around the world, and is not the result of a tax scheme to provide free pocket computers to everyone. It is the result of a long, steady, and continuous march of a market with a functioning price system that has driven down costs while driving up quality over several decades.

Making education better and more available

Ultimately, I’d love to see education get better and more available to as many people as possible. This is precisely why I don’t support tax schemes to disconnect consumers and producers from the price mechanism of the education market. Doing this may be a temporary boon (as it was for the grass-fed producers), but is clearly worse for the long run.

We already have lots of problems with the current price mechanism in education due to student loan schemes and subsidies, but I will leave that for another post. Anything that makes the costs more, rather than less, transparent will, I think, strengthen the pricing mechanism, and the long term out look for quality education for everyone.