Why the Government is Applying Banking Mistakes to Education and Health

Jan 22nd, 2011 | Filed under Politics

The recent restructurings of higher education costs and NHS funding have one key thing in common – they both operate on the assumption that introducing a free market environment will lower running costs and improve performance, because that’s what free markets do. It’s a typical viewpoint held by the economic right, which assumes that just about anything can be improved by introducing a market.

And the thing is, they’re almost right. Lower costs and improved quality are natural consequences of a correctly functioning market environment. But as an approach, it’s a sort of economic Darwinism that assumes that value for money is the single most important factor in long term viability – a belief that doesn’t necessarily fit with areas such as health and education, where there are quite obviously higher social goals that are of key importance.

In the case of health, I would rather save 105 people at £10 per head than 100 people at £5 per head. Now, whether or not you hold that view yourself (that you should spend twice as much to save 5% more), you’d have to admit that strict value for money is not at the very top of the priority hierarchy.

But this is academic, because it would only apply correctly in the scenario in which we have a correctly functioning market in health care. The truth is that the market won’t work, for a very simple reason. A market can only operate correctly if all participants in that market have all the relevant information required to make their choices. Specifically, information on quality must not be significantly harder to discern than information on price. That will not be the case.

The case of universities is a good example of this. By charging variable amounts, the government’s assumption is that you will be able to pay more for a better education at a better institution. However, consider the practicalities. The following steps illustrate how the market will operate:

  1. To start with, universities with the best reputation will charge the most, because supply and demand dictates that you can charge more for that which is more sought after
  2. These “high reputation” universities will then produce graduates with a “higher value” degree, thus turning an untested qualitative measure into an untested quantitative measure
  3. Employers will assume that, grades being equal, the standard of education will be higher for a graduate from a more expensive institution. They won’t have an objective measure of relative quality, because their intake will not provide a statistically significant sample with which to test the output of the universities, and league tables showing the distribution of grades gives no indication as to the relative quality of education of two people with the same grade.
  4. This correlation between the cost of a degree and the probability of being hired as a graduate will further justify the prices as they have been originally set, and will reinforce the status quo

At no point in this process does the quality of education that has been received enter into any of the decisions, because it’s so much easier to use cost as a proxy.

The same is true of the health service. Establishing an objective measure of “quality” to drive the market is difficult, but using price is easy – you assume that you roughly “get what you pay for”, and that therefore higher cost must mean higher quality. The market cannot operate where information on quality is missing.

And this is exactly how the banking crisis unfolded. Information about quality (in this case, the risk of debt) was absent, and the market relied on cost in order to make decisions. We all know how that ended up – the market failed because people misjudged the quality of what they were buying and lost a whole lot of money in doing so.

It’s all very well for the government to talk about the lessons from the banking crisis, but they’ve missed the biggest one – free markets work indiscriminately towards “good value for money” as their primary goal, and can only achieve that if all participants have access to good information. Neither education nor health are appropriate areas to employ markets, and if/when they fail, the bail-out won’t be as simple as throwing money at some banks. People’s health and education will be at stake.

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