The Indian Economy Blog

May 31, 2007

The Indian Education System — Part 5

Filed under: Education — Atanu Dey @ 6:45 am

One underhanded way to scare a neoclassical economist out of his wits is to creep up on him and shout “monopoly power.” Economists regard monopolies with the same mixture of dread, contempt and fascination as biologists regard cancer. They recognize the awesome virulent power of monopolies to wreak havoc on their world of mutually beneficial voluntary exchanges. Monopolies, whether public or private, lead to social welfare losses. At the other extreme, perfect competition leads to maximization of social welfare, subject to some reasonable conditions often approximated in the real world.

In a competitive market, a large number of firms compete amongst themselves to supply the stuff that consumers demand. Each firm strives to reduce its own costs to increase profits, while at the same time reducing prices to lure buyers away from its competitors, and in the resultant shuffle, prices are bid down to the level of costs, thus competing all profits away. Unlike in a competitive market where firms make no economic profits (they make only accounting profits), a monopolist makes economic profits because it is able to dictate the price by controlling the quantity it supplies. By sufficiently restricting supply, a monopoly can charge prices that are way above costs, and thus extract what is called “rents,” or economic profits.

One feature of the Darwinian world we live in is that there is always competition. It is good to be the king because the king has power. But the more power the king has, the greater is the competition to be the king. Sure, the monopolist is the king in the market, extracting rents and imposing social welfare losses. But somewhere along the way, the monopolist has to pay the king-makers. There is a competition for the market as if to compensate for the lack of competition within the market. The competition for the market leads to welfare losses, a sort of negative image of the social welfare gains from competition within the market.

One parsimonious explanation for not allowing free entry into the market for education is that by retaining monopoly control of the education sector, the government acts as a monopolist. By requiring licensing from the government, and by restricting the licenses, the government encourages competition for the right to serve the market and thus reduces the competition within the market. Restricting the licenses increases their “price.” Bribes, in other words. This is the rent collected by the government, or more accurately, the agents that represent the government such as bureaucrats and politicians.

The licensed firms (schools and colleges) have to recover the costs incurred in obtaining the licenses. They in turn, given the legal protection from reduced competition, have the means to dictate price and the outcome is predictably low quantities (shortages abound), high prices, and rampant corruption.

This is purely anecdotal but is useful in clothing the bare outlines of what I conjectured above. Some institution wants to start a medical college somewhere in India. It applies for a license and is told off the record that the price is Rs 20 lakhs (approximately US$ 50,000) per seat. For the 200-seat license applied for the price is Rs 4,000 lakhs, to be delivered in unmarked bills in a large plain brown envelope. That “fee” is routed through the licensing bureaucracy with appropriate payoffs to different people—the lion’s share ending up in the appropriate political hands. After all, securing top positions at the bureaucracy is not cheap; and running elections is a costly business.

The firm having paid the whopping fee to operate a medical college, now has to recover its costs. Perhaps its actual cost of training a medical student is Rs 5 lakhs per year. It adds on a “special college entry fee” of say Rs 10 lakhs (remember to bring in unmarked bills in a plain brown envelope) to the normal tuition fees. The hapless students are forced to pay because seats are limited. The four year medical training which should have cost only Rs 20 lakhs if free entry were allowed into the field now has to pay Rs 30 lakhs, and perhaps gets substandard training. Further down the line, doctors are in short supply and therefore they command some market power and thus are able to recover their costs. The patients suffer but that is why they are patients—they suffer.

What needs to be done will occupy our attention the next time.

[Previous post: Part 4. Continued in Part 6.]

13 Comments »

  1. I think the article is far too confused.

    Conflating a ‘monopoly’ and ‘corruption’ and claiming that a ‘monopoly’ naturally causes corruption is *highly* illogical.

    Examples where a monopoly actually works – health care system in Canada, Cuba, et al. Education is also a highly regulated industry in all western nations. You really think the institutions there pay these bribes?

    Perfect competition can NEVER exist. It’s as ideal a situation as *perfect communism*. Both are equally unattainable.

    In your definition of monopoly the FDA of the US, or the CDA of India are also monopolies. And they ‘raise’ the cost of creating and selling new drugs, killing millions of people a year. But what’s reality? Without such a ‘monopoly’ billions of people would be dying due to fake drugs and useless drugs. There’d also be people selling whatever they please as cures for any disease – note that the FDA was actually started in these circumstances.

    The ills of our education system certainly include corruption and high costs/prices. But to say that is because the industry is regulated by the govt. is short-sighted and naive.

    Comment by Prasanna — May 31, 2007 @ 10:24 am

  2. “Conflating a ‘monopoly’ and ‘corruption’ and claiming that a ‘monopoly’ naturally causes corruption is *highly* illogical.”

    I see.

    The next time you get medicare from Cuba, you might see the reason why its easier to pay-off the attendant for a bed rather than sleep outside.

    there doesn’t need to be perfect competition, *any* competition is better than none.

    As for Perfect Communism, lets leave that in the last century.

    Comment by ColomboUnbound — May 31, 2007 @ 3:08 pm

  3. Prasanna wrote: \”Without such a ‘monopoly’ billions of people would be dying due to fake drugs and useless drugs.\”

    You mean trillions, don\’t you? Trillions will die every month if the FDA did not stop the evil drug companies. Yeah, that must be it.

    [EDITED BY ADMIN]

    Comment by Anonymous — May 31, 2007 @ 9:40 pm

  4. Prasanna wrote “The ills of our education system certainly include corruption and high costs/prices. But to say that is because the industry is regulated by the govt. is short-sighted and naive”.

    How naive you have to be to write so. Do you think, Govt. regulation ahs no hand in the corruption in education sector

    Comment by Rishav — May 31, 2007 @ 10:55 pm

  5. If (primary) education is so important for the country, why is it rarely an election issue? I can understand it doesn’t matter to urban middle class. But even the rural poor seem to care more about caste, water, jobs than primary education. Maybe there’s a message in that?…

    Comment by Pramod Biligiri — June 1, 2007 @ 1:01 am

  6. Pramod wrote “If (primary) education is so important for the country, why is it rarely an election issue? I can understand it doesn’t matter to urban middle class. But even the rural poor seem to care more about caste, water, jobs than primary education. Maybe there’s a message in that?”

    Its because there is positive externality from universal primary education (eg the community benefit-cost will be higher than the individual benefi-cost ratio)..thts y govt needs to enter..as a provider and maybe regulator…how to do that…Atanu is doing a great job of it..

    Comment by Rishav — June 1, 2007 @ 10:27 am

  7. Pramod asks why (primary) education is not an election issue? That is an interesting question worth pondering.

    My guess is this. About 80 percent of India is reported to subsist on less than US$2 a day and around 50 percent on less than half that. When you are very poor, your planning horizon is necessarily very limited. Education, and especially primary education, has long pay-back periods and people struggling under credit contraints cannot accord very high priority to education. They have more immediate and pressing concerns. The politicians know this and in a contest where one candidate promises primary schools and the other promises free electricity or Rs 2 per kg rice, the result is foretold.

    Middle-class people in India, even if they voted, are powerless compared to the power the poor have in influencing national policies. I would not discount the concerns of the poor but as a constituency the poor actually are party to the creation of the policies that doom the poor to continued poverty. It is all karma, neh?

    Comment by Atanu Dey — June 1, 2007 @ 10:38 am

  8. [...] June 1, 2007 « The Indian Education System — Part 5 [...]

    Pingback by The Indian Economy Blog » The Indian Education System — Part 6 — June 1, 2007 @ 11:08 am

  9. Rishav wrote:
    “How naive you have to be to write so. Do you think, Govt. regulation ahs no hand in the corruption in education sector.”

    Are we arguing that correlation is causation here? In India there is corruption in *everything*. Saying that Government regulation causes corruption flies in the face of any example I can quote to you from the US, or Europe.

    And I’m not saying that Government regulation has *no role* in corruption. Just that it can’t be the root cause! Because if it were, then the US and Europe would be just as corrupt, and their education sectors just as bad!

    And Anonymous, billions of people would have died without the FDA and food and drug regulation. You think private concerns are pious and ethical of their own free will? For every example that you can quote of an ethical company, I can probably dig up tens of unethical and immoral activities done by companies.

    ColomboUnbound:
    Regulated competition will certainly be beneficial for customers. The example of Cuba was to merely show that *regulation* or a *monopoly* does not cause corruption or inefficiency, in and of itself.
    Second, while Cuba is not the best example, you have nothing to say for Canada, and the rest of Europe? Which do have a ‘monopoly’ of state-supported medicine?

    Comment by Prasanna — June 1, 2007 @ 12:30 pm

  10. I think it is difficult to evaluate public service in the same way as consumer goods. Education is not an entirely commercial enterprise. If some one started a school only to make money, I am pretty sure that he or she is on the wrong track. It is true that private institutions have to make ends meet but they also have other goals, hopefully. The public school system works fine for the whole world except in corrupt countries- so education is a sector that can be run efficiently by a democratically elected uncorrupt govt.

    Comment by Revathi — June 1, 2007 @ 5:27 pm

  11. Where is this democratically elected uncorrupted government which makes public schooling ‘work’ ?

    Comment by Deane — June 1, 2007 @ 9:14 pm

  12. Thanks to Rishav and Atanu for thoughtful replies. I’m skeptical of schemes launched by bureaucracy without political will.
    Of course allowing market forces into education is a different issue and makes sense.

    A couple of requests for future coverage: 1) Are you going to talk about the voucher system? 2) How did a State like Kerala get it right despite being mostly anti-market? Are cultural factors important?

    Comment by Pramod Biligiri — June 2, 2007 @ 1:57 am

  13. Education in India (and elsewhere)
    There has been a lot of discussion lately about the quality of some higher education institutions in India such as the IITs and the IIMs, some of it from the US media. While it is true that some of these graduates have done well in the information technology sector and, to a lesser extent, in other parts of the corporate world, as well as in entrepreneurial activities, the key questions are whether they truly represent value in India’s growth equation, and whether they are truly the product of meritocracy. I would make the following observations:
    1. The biggest public gains from a public welfare standpoint to any society is in primary and secondary, rather than in higher education. Since there are more private gains for every additional year of higher education, this is best left to private capital to manage at market prices. Affordability and access to such higher education institutions should not be an issue as long as tax policy and access to private funding is encouraged (bank loans, etc.) since the key underwriting question will be the net present value of future earnings from such education; the “sheepskin effect”. I would venture to suggest that institutions such as the IITs should be sold to private entreprenuers (and even such institutions such as JNU whose current contribution to public welfare relative to tax spending is questionable) in order to release substantial efficiencies. The AICTE and other regulatory bodies, on the other hand, should be considerably strengthened in order to provide quality-control and oversight over privately funded institutions. Government expenditures in higher education should focus on niche areas relevant to economic growth such as biotechnology or alternative fuels research that may not attract short-term focused private funding, but even here, TATA (as in BP solar) or Suzlon and Biocon should be encouraged to fund their own future requirements in manpower and R&D (tax breaks). Also, fees in IITs should be increased substantially to reflect the true cost of education, mitigated appropriately by scholarships and loans to provide access to less-privileged students.
    2. Although there is a strong myth about the competitive nature of IIT and IIM entrance examinations, and the focus on meritocracy, there is a considerable skew towards prospects from urban, english-language schools. Go to any IIT campus, and you will see that the proportion of students from such schools is much higher than the underlying proportion of such schools in the overall geography of India. My point is not to argue that those schools have an unfair advantage since they offer better educational facilities and preparation for IIT entrance examinations, but to suggest that kids from rural schools or government schools in general have a disadvantage when it comes to understanding the real relevance of IITs and other elite institutions in their future lifetime earnings. When one looks at other publicly funded “institutions of national importance” such as the ISIs (Indian Statistical Institutes) the skew is even more pathological; why is there an overwhelming overrepresentation of Bengalis in the ISIs, is it because they are genetically predisposed to be statistical in their thinking, or is it because the ISI entrance examination notices appear next to tender notices in many national newspapers, and is more heavily advertised in Bengal newspapers? The answer is that fees (and scholarships) need to be raised in these insitutions and specific funds need to be applied to advertising and coaching for students in rural and vernacular schools. Then you will see a real meritocracy, not just meritocracy among the children of the Indian professional elite. Think of the quality of IIT graduates then!
    3. Despite the appearance of academic quality, there is a dearth of good faculty at these institutions and this is primarily due to the lack of pay but also due to the lack of quality control in faculty hiring and promotions. A lot of these issues are due to lack of autonomy and interference from government agencies, and the fact that the existing faculty and administrative bureaucracies at these institutions haave taken shelter under the pretense of lack of autonomy to subsidise large-scale inefficiencies. The lack of merit in teaching and research related income streams clearly will have downstream effects on the quality of graduates coming out of these institutions. These facts are often hidden from the taxpayers who fund these institutions, creating a classic “moral hazard” from a public welfare standpoint. The central universities, in particular, where an increasing share of taxpayer funding is diverted, are places where this kind of pathology is rampant — JNU, Jamia, AMU, Pondicherry are all excellent (!) examples.
    4. When it comes to primary and secondary education, there needs to be a sea-change in taxpayer funding, focussing large funds on rural schools, in teaching as well as in infrastructure, but also in the local control of these fund expenditures. Give local taxpayers control over schools and their governing bodies and you will see better visibility in their functioning.
    One little known fact is the skew in public tax-based funding of Kendriya Vidyalayas, which subsidise inefficiencies and restrict access to these “better” schools through the tariff barriers of admission criteria. Let me expalin this tax scandal which has been going on in India for the past half-century, which neither our media, nor tax-paying citizens have chose to make visible. Kendriya Vidyalayas are, like many other publicly funded institutions, primarily paid for by corporations and private-sector employees. However, the children of private-sector employees in effect have almost no access to these schools, who have a stated policy of discriminating in favor of government and public-sector employees as well as defence personnel. Why hasn’t someone moved the courts against such an obvious flouting of equal treatment constitutional principles? Again, taxpayers in private-sector jobs probably have written this off as yet another cess and in any case have access to other private-sector primary/secondary education options, but what about access and scholarships for children of day laborers in the unorganized sector???
    Perhaps the left leaning ideologues at JNU would wish to comment on this dictatorship of the proletariat! Why are there so many of these Vidyalayas in urban areas or in public industrial towns or in district headquarters towns rather than in far-flung rural areas?
    Enough said.
    By the way, educational access and skewness against the underprivileged is not just an Indian problem. Just see how asymmetries and inequalities are reinforced in other educational models; in the UK, how many Oxford and Cambridge graduates come from working Cockney families in relation to their proportion in the population? In the US, how are Harvard and Stanford admissions criteria different for children of alumni and donors, as opposed to the general population?
    India has a tremendous focus on education (I have benefitted) but I would argue much of it is familial and societal culture; the specific question to honestly answer is how much the government has done to unleash procutive human potential through illiteracy eradication. How much of India’s education policies are simply a function of the need to provide quality education enclaves for the children of bureaucrats, the successors of the British collectors? Are we democratic in our education policies? Think about this the next time you vote.

    Comment by Svaha — September 16, 2007 @ 5:20 pm

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