Education Spending

This is a follow up to the post on Indian spending on education abroad.

The actual spending may not be $13 billion annually but the argument does not change even if the figure was much lower. What matters is that it is indicative of a problem and we should be concerned about it. It should be noted that this spending is an outflow of resources. That in itself is not a bad thing, however. We need to ask if this is a net outflow in the education sector. That is, what is difference between the inflow and outflow.

Suppose that the outflow were $13 billion a year but the inflow were $20 billion. The net outflow then would be -$7 billion. That just means that there is a trade surplus in favor of India to that extent. In an increasingly integrated world, cross-border trade in services is a good thing. It indicates a healthy system since it implies that there are comparative advantages among the trading partners and therefore trade is welfare enhancing for each party engaged in trade.

I will briefly touch on the benefits of having a large domestic market for education. Large domestic markets allow an economy to achieve scale economies, and efficiencies through learning-by-doing, and therefore gain comparative advantage. India has a potentially very large domestic market in education. It is only potential and not actual because the supply is deliberately not allowed to expand to meet the demand. As I have touched upon the reasons for this elsewhere on this blog, I will not repeat them here. Here I will only note that if free entry were allowed into the sector, it would reduce costs and therefore reduce prices, while raising quality, and inducing efficiency in the sector.

Competition for the market and in the market

Let me take a brief digression into markets and competition. Entities — individuals, firms, groups, whatever — compete against others for gaining something that they value. This drive is hard-coded even at the most basic level of existence. Genes compete in making copies of themselves. This induces competition for resources. At the broadest level of analysis, we see nations compete for resources such as land, water, and energy. They go to wars for this. Competition cannot be avoided given finite resources.

It is generally true that economic agents (individuals or firms) compete in the marketplace for profits. As profits are the difference between costs and prices, there are two avenues for increasing profits: reducing costs and increasing prices. You would do both if you could but in most cases where you have little power to dictate prices, you have to reduce costs. If even after doing your best in reducing costs, you still cannot make a profit at the prevailing market prices, you exit the business. Other low cost producers survive and the game continues.

Memorize this line: competition IN the market leads to the elimination of the high-cost producers until such time that only the remaining (that is, the lower cost) producers are able to meet the demand.

That line appears to be trite. But there is a reason for memorizing it. Competition in the market is a cut-throat business and no one would like to face competition. If only you could somehow have a captive market, you would not have to deal with pesky competitors. Is there a way out? Yes, there is. Here’s what you do: you carve out a space in the market where you do not allow others to intrude into. In other words, you become the sole supplier, the monopolist. Then you can set the price by determining the profit-maximizing quantity, and only supply that quantity.

Excellent idea, that one. But wait. Others would also like to have that deal, wouldn’t they? So that gets us to the other line which is worth memorizing.

You can reduce competition IN the market by competing FOR the market.

That’s the truth: you cannot escape competition. You can merely move it elsewhere. For reducing competition in the market, you need to move up the hierarchy and compete for the market.

Where there is free entry into the market, competition within the market essentially guarantees that there are no huge profits to be made. So how much is it worth to you to be the monopolist in that market? How much would you pay to compete for the market? The maximum you would be willing to pay is the maximum profits you can make as the monopolist. If every year you could make $1 billion, well then that is the maximum. If you can buy the right to be the sole supplier to that market for anything less, that is money in your bank.

It’s competition all the way up

This idea of competition for markets can be generalized. Here’s how. Let’s take a concrete example. Imagine free entry into the mobile space of a certain region. Suppose you could only make $1 million a year profit when you face competition in that market, but you could make $100 million a year if you were the sole supplier. So, if there is someone, let’s call him Big Guy, who can guarantee you monopoly control, you would be willing to pay him up to $99 million (your excess profit.)

Now it is a game between you and the Big Guy. You tell him that you are willing to pay $10 million a year as a “license fee.” You negotiate back and forth and finally settle at $20 million. The Big Guy could have made the same deal with your competitor, however. So, you sweeten the deal for him. You say you will give him $2 million on the side into his personal Swiss bank account. But so is your competitor. So negotiations go on till your competitor has dropped out in the competition for the market. Finally, you pay the license fee of $20 million to the Big Guy above the table, and below the table you wire $10 million to the Big Guy’s swiss account. Then you go into the market, provide mobile service, charge the price that maximizes profits, thus recover the license fees and the bribe, and all is well. Note, however, that the consumers eventually pay a price that is higher than what they would have paid if there had been free entry into the market (that is, no license fees) rather than the competition for the market which involved a license fee.

So let’s go up one level, the level of the Big Guy. At some point, he was not the Big Guy. He had to compete with others who also wanted to be the Big Guy. So how did he become the Big Guy? He bought the right to be the Big Guy. And how much did he pay? First, he estimated how much his personal Swiss bank account will grow by if he were to become the Big Guy. And then he paid something less than that to become the Big Guy. Suppose he estimated that his wealth would go up by $100 million, he took a gamble and spent say $50 million on his election campaign to become the Big Guy.

The moral of the story: the more there is at stake, the more you are willing to pay to be the Big Guy.

A corollary: the more stuff you can control, the more stuff you have the power to license, the more you are able to tilt the game from being a competition in the market to a competition for the market. The more competition for the market, the more money you can make. So it should come as no surprise that Big Guys want to get into the game of License-Control-Quota-Permit business. That’s where the moolah is.

Government control of the economy allows the functionaries of the government (politicians and bureaucrats) to reap private benefits. That is why they have in incentive to increase the scope of the government.

Back to education

Education is heavily controlled because the ones who do the control make out like bandits. If all license requirements were to be entirely eliminated, then suddenly the profits will disappear because it will mean competition in the market. The market will guarantee that the inefficient suppliers will exit the market.

What about quality? The quality is guaranteed in a competitive marketplace for the simple reason that if a supplier does not meet the consumers’ expectations, no one will buy from that supplier.

I have noted previously that there is a role for the government in a liberalized education sector. But I will write more the next time.

6 thoughts on “Education Spending

  1. lurker Thursday March 20, 2008 / 9:21 pm

    Indian School of Business (ISB), Hyderabad is a relatively recent entrant and it has managed to get ranked among top 20 business schools (according to economic times, 08 rankings). But i am not too familiar with its model and whether it can be emulated. A worthwhile case study…

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  2. tarang_72 Friday March 21, 2008 / 6:24 pm

    I am not sure who should enter in the business of education? Looking at the number of new engg/medical colleges opened in the last few years, if any industrialist wants to open a school/college, i am sure s/he can easily do so by involving one politician as trustee (to get the govt work done).

    Other thing i dont know is whether indian industrialists openly prefer free markets? In the past, we have seen these big industrial houses not to prefer that because they are sort of big boy. Even today, i am sure indian business environment is controlled by 20-25 industrial families who can get anything from govt they want (!!) and they would want that number limited.

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  3. lurker Friday March 21, 2008 / 6:58 pm

    I have always found it difficult to understand. Go to any city in India and you can see private schools and colleges set up by every tom, dick and harry. There is a joke in Maharashtra that you do not have to worry if you cannot get admission in an engineering college because you can always open one. All you need is a one room building and a B.Tech. guy as a teacher/principal. Of course it helps if you get government accreditation for your college. However, even if you do not get it you will still be raking in students (& moolah).

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  4. vakibs Friday March 21, 2008 / 8:04 pm

    Hi Atanu

    Both my parents are dedicated teachers in government run schools. They teach in classrooms of over 100 students. The students are mostly from backward castes and poor families. Needless to say, their families are uneducated, have hardly enough food to eat and possess no disposable income. Several students sell their government subsidized textbooks on black market. The rate of school dropout is alarming. 10% drop out of school every passing year, during the 5 years of secondary school education. Several girls get married in their teens and my parents receive invitation cards to their weddings.

    As teachers in charge, my parents get a lot of flak for the low performance of their students in public exams. The inspectors routinely compare the school’s output with that of the 100% results of private schools. Beneath this discrepency however are hidden some facts (a) their students come from rich, land owning families (b) the parents have a lot of disposable income (c) the classrooms have 20 students or even lesser.

    The real reason for the discrepency in the results is easy to see. The per capita investment on each student (money+teachers+motivation) is 1000 times higher in the private schools than in the government schools.

    Now, why did my highly intelligent parents opt for employment in government schools than in private schools ? Not because of any reason to serve the society but more mundane reasons of higher pay. Yes, government teachers get paid about 5 times as high as private school teachers. In private schools, the management corners all the profits and pays awfully low to the teachers. Why is this strategy succeeding ? Because of the high level of unemployment in our country, there is no real shortage of talented young men and women.

    Inspite of their higher pay, the challenges faced by my parents as government teachers are far higher. (a) They have to teach 10 times as many students as the private teachers. (b) They have to deal with the bottom rung of indian society, in terms of both economic and social status. (c) They have to do a thousand other odd jobs as government employees – correcting 1000 times as many examination scripts as private teachers, officiating at elections and other state paraphernalia .. (d) They have to deal with politically-connected absentee teachers who dump their workload over other teachers.

    Now, when you advocate privatizing the Indian education industry, what would happen to teachers like my parents ? They would see an immediate cut in their salaries (as high as 90% of their income). Do they deserve it ? In 20 years of their service, each of my parents can lay claims to bringing education to atleast 10,000 Indian citizens – mostly from poor and backward families. Does the nation reward them now by cutting 90% of their salaries, and putting that money into the pockets of the education-contractors ?

    Would this act benifit any of the poor and backward caste children that they are teaching ? Would we see a dramatic increase in their education output ? What is the guarentee that this move would not lead to further seggregation of children – special private schools catering to poor, backward caste children & clique schools such as the Delhi public school catering only to the children of the rich and the powerful ? In the USA, the black people had to wage a bitter war to end this type of seggregation in the school. How can we ensure that this privatization would not be a retrograde step in India ?

    How can we truly educate and transform the entire Indian population.. because each single child matters the most to the development of the country ?

    My story is coming from the rich and fertile Godavari delta region of Andhra Pradesh. The region has a strong liberal history, and practically zero communal problems. And it still has 30% illiteracy. Amongst the so called literate, hardly 10% of the students are eligible for ready employment in either service or manufacturing sectors.

    We agree that we massively screwed up in the 60 years of independence. But how can we redeem the situation ?

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