Whenever people criticize government provision of a product, clever analysts often demur that private suppliers who compete with government have exactly the same problems. Part of Helland and Tabarrok‘s case for the Baumol effect in education, for example, is that prices have risen at the same rate in both the public and private sectors:
Prices are much lower at public than at private institutions. The vertical scale is a ratio scale, so equal slopes mean equal rates of growth. Thus, although prices are lower at public institutions, the rate of growth in prices has been similar at private and public institutions. Between 1980 and 2015, real prices more than doubled.
OK, let’s step back. Picture a typical government service. The price: gratis. The quality: mediocre. Private competition, however, remains legal. Should we expect the private part of the market to look just as it would under laissez-faire?
No way. Unless the government rations the free mediocre product, consumers have virtually no reason to ever pay for products of mediocre or lower quality out of their own pockets. At minimum, then, government’s gratis products kill private production of all products of equal or lower quality – a textbook case of predatory pricing.
That’s not all. Gratis production also effectively kills private provision of products of moderately higher-than-mediocre quality. After all, if you can get a C+ product for free, who wants to pay full price for a B- alternative? With gratis public provision, private providers must convince consumers that the marginal quality improvement is worth the total price of the product. A tall order.
What does this mean? Well, if public schools add more low-value services, private schools must keep pace in order to compete. If public schools add more sports, more specialized teachers, or more courses, private schools that fail to keep up will lose their customers. The first rule of private competition against gratis government is: Always keep your product quality well above the government’s. This remains true even if the government adds services that consumers value well below cost. If you can get them for free from the government, why pay extra for a private school that refuses to offer them?
The lesson: When government supplies free (or highly subsidized) products, we should expect private suppliers to supply gold-plated versions of the standard government-issue. As a result, their prices and costs will be closely synced.
There are admittedly some exceptions: If government is spending money for no gain at all, private competitors needn’t bother. If government supplies numerous expensive low-value services, private competitors might decide to just outshine the government on other dimensions. Most realistically, if government refuses to provide some cheap, highly-valued options (such as religious education), then private competitors can win customers by filling the gap.
Yet overall, when there is a dominant public sector with a private fringe, we should expect the Helland-Tabarrok pattern – without or without a Baumol effect. Given the pathologies of the public sector, it’s nice to have a private option, but don’t get too excited. The private options will generally be extravagant, because gratis government strangles budget-friendly alternatives. Tragically, this in turn sustains the illusion that in the absence of government, only the rich would be able to afford whatever the government now provides.
P.S. Another reason to expect public and private education to closely resemble each other is that both are almost always non-profit. Morally, yes, there is a major difference between public and private non-profits. Economically, however, they’re very much alike, because both give managers flimsy incentives to raise value or cut costs.
READER COMMENTS
John Alcorn
Jun 12 2019 at 10:03am
This blogpost is Bryan Caplan’s 2nd critique of Helland’s and Tabarrok’s thesis, that the Baumol mechanism accounts for most of the d*mn high prices phenomenon in education and health care.
As I noted in a comment to Bryan’s 1st critique, Arnold Kling has a pithy, incisive mini-essay, “What Gets Expensive, and Why” which identifies four causes of expensive education and health care:
1) The Baumol effect
2) Category creep
3) Demand de-linked from outcomes
4) Subsidize demand, restrict supply
No. 4 actually comprises two causes: 4.a) Subsidies and 4.b) Regulatory restrictions on supply.
In light of Bryan’s 2nd critique, we may add still another mechanism to Arnold’s list:
5) Government supply (production of the output)
Bryan’s 1st critique highlighted mechanism no. 4.b, the impact of regulations on prices in education and health care.
In this blogpost, Bryan focusses instead on the conjunction of mechanism no. 4.a, Taxpayer subsidies, and mechanism no. 5 Government supply (public schools), to explain d*mn high prices in education.
Meanwhile, over at Marginal Revolution, Alex Tabarrok has replied to Bryan’s 1st critique, about the impact of regulations.
Dr. Tabarrok casts himself as an empirical economist, and Bryan as an armchair economist.
However, Bryan’s hypothesis in this blogpost (Bryan’s 2nd critique) seems like a testable hypothesis:
Ben Y
Jun 12 2019 at 10:10am
To buttress your point: in most Orthodox communities, private tuition cost far less than the public’s cost per student in public school.
This is because religious people won’t send their children to public school, this eliminating the free competition.
robc
Jun 13 2019 at 12:05pm
And it is quite possible the the level of education received qualifies it as “gold-plated” despite the low tuition cost.
Note: I know nothing about the Orthodox communities education. But I have seen the same in other religious schools.
robc
Jun 13 2019 at 12:10pm
Example: KY spends $9863 per student (some recent year, found via google search). Louisville’s Highlands Latin School has a tuition of $7975 for middle and HS students (lower for elementary) and has an average ACT score for graduates of 31.
It is a religious school, but not in any kind of exclusive way. That is gold plated results for a very good price, although I think there is clearly some selection bias involved.
Craig
Jun 13 2019 at 4:53pm
Great article.
Phil H
Jun 13 2019 at 10:17pm
“Yet overall, when there is a dominant public sector with a private fringe, we should expect the Helland-Tabarrok pattern – without or without a Baumol effect.”
I’ll bite on this. The test case should be the security industry. Security is another major public good that the government supplies. If you want more security you can go private. I guess the Baumol effect will apply a bit, because a bodyguard is a bodyguard is a bodyguard, but security is one area where you can also use technology to be more efficient. So have security costs exploded in the same way as education and healthcare costs?
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