Uber, but for Regulation

In competitive market economies, prices and profit opportunities signal scarcity and valuable production, and together, they coordinate efficiently the plans of millions of individuals in a decentralized fashion. But ironically, free markets have given rise to the modern corporation, microcosms  of command and control. Famed economist Ronald Coase solved the apparent paradox of the modern corporation by highlighting the importance of transaction costs. If a product has many inputs, negotiating each individual transaction and coordinating them across multiple parties can be extremely costly. Firms emerge to economize on these and other transaction costs, with competitive pressure leading to an optimal mix of outsourcing and insourcing.

The nature of the firm is a useful starting point for thinking about the distinction between government and governance. Both the state and the firm partake in governance by setting and enforcing rules, monitoring compliance, and engaging in rational planning to solve coordination problems in light of transaction costs. Likewise, when a state or a firm fails to practice good governance in the long run it either reforms or it ceases to exist. Reform and ruin occurs most often when the broader institutional setting somehow changes and, in turn, the nature of transaction costs also change. When transaction costs are falling, for example, governance can unbundle, which is what happened in the 1990s when firms began widely outsourcing customer support services to foreign call centers following lower trade barriers and innovations in communication technology. In addition, it is no coincidence that many countries undertook, in tandem, so-called “neoliberal reforms” during the same period. From deregulation to a greater reliance on subcontracting, public governance may be slower and clumsier, but it too is shaped by transaction costs.

Consider the battle raging between Uber and the global taxi industry. Although the current taxi licensing schemes in North America cities are conducive to rent seeking, I believe they reflect genuine efforts at good governance. Licenses are simply a blunt and easily-abused tool that gives customers some expectation of a minimum standard for quality and safety, and regulated prices eliminate the need to haggle with drivers. Uber’s innovation was in developing a multisided platform (MSP) technology that reduces transaction costs for both sides of the market. This platform features a driver and customer rating system and a responsive pricing algorithm that combines with preauthorized payments to remove any need for haggling. And by controlling a bottleneck to market access, Uber acts as a de facto private licensing authority.

To see why MSPs make for agents of good governance consider the market itself. Contract law, property titling, and a system of arbitration represent platform technologies for reducing transaction costs to the benefit of both buyers and sellers. And much like Uber, markets are subject to network externalities. The more sellers in a market, for instance, the more likely that buyers will agree to participate and vice-versa. But as long as there is the possibility of exit, market “regulators” will be driven to maintain a balance between the interests of buyers and sellers that is roughly consistent with minimizing social cost, even if their network effects tend them toward natural monopoly. Therefore, it should be no surprise that some of the earliest modern MSP technologies include marketplaces like eBay and Amazon, neither of which is primarily a retailer. Instead, they represent platforms that help connect independent buyers and sellers from around the world. Technologies like PayPal and services for dispute resolution are all ways to reduce transaction costs and to engage in genuine governance.

Similar to how Uber is disrupting traditional taxi governance, ecommerce is displacing conventional commercial governance. One could even imagine all rental units to eventually list on something akin to AirBnB, effectively rendering local Residential Tenancy Acts as obsolete and archaic as taxi industry regulations. Existing rental markets, for example, often dramatically favour tenant rights over landlord rights or vice-versa, depending on who had the greatest historical influence on the local council. But as Coase famously argued, the dual-sided nature of externalities makes the assignment of rights ambiguous in the abstract. While noise pollution has a social cost, for instance, forcing tenants to quiet themselves imposes a cost as well. If the loud tenant is having an amazing party, he may be more than willing to fully compensate the landlord or the sleepless neighbors. But more often than not, anger and ego are the ultimate barriers to a transaction and such a bargain rarely unfolds. Thus, good and effective laws are ones that approximate the assignment of rights that will minimize social cost on average; however, this attempt often fails because of special interest groups who capture the legislative process.

MSPs are adept at assigning these rights efficiently. Credit card networks, for example, make sellers bear the full cost of processing payments, while customers are often cross-subsidized through rewards and promotions. The only way to supplant an incumbent platform is to adjust the governance structure in such a way that social costs are better compensated by maximizing the bargaining surplus. In other words, MSP technologies are not just a bit better at governance. They potentially meet the economic definition of an ideal “public interest” regulator. Whether this technological revolution translates from local to national governments is not a question of if but when.

Much like the liberalizations of the 1990s, changes to the very nature of transactions have brought all forms of public administration and regulation to the precipice of a new way of reform. Critics will dub it an era of massive deregulation, yet that will be wrong. Less government does not imply less governance. Indeed, there will be exactly as much governance as you can bargain for.

Samuel Hammond is an AIMS on Campus Student Fellow who is pursuing a graduate degree in economics at Carleton University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

Is Higher Education Really a Bubble?

Canada’s alleged housing bubble has returned to the media spotlight with full force in recent months. Falling oil prices have slowed housing sales, which has led to speculation that a bust is drawing closer. Bank of Canada Governor Stephen Poloz did not help matters in December when he was widely quoted as claiming housing could be overvalued by as much as 30 per cent. Less quoted was his repeated assurance that Canadian real estate does not qualify as a bubble about to pop. The perennial fear of collapsing real estate values, at this point, has become a form of mass hysteria.

I have wondered lately whether higher education fits that mold. Theories of a “higher education bubble” exist, but mainstream economists almost universally scoff at them, which is understandable because calling student debt a “bubble” is highly misleading as anything more than a metaphor. Yet, it is also worth acknowledging that those who deny the possibility the loudest tend to belong to a knowledge-based class predisposed to uphold the value of university education. The question is not whether higher education has value, though. Rather, the question is whether underlying incentives have caused a misallocation of credit to leverage the wrong kinds of education in the wrong quantities.

The first symptom of a bubble to consider is rapidly rising prices. It is well known that tuition costs have grown significantly above the average inflation rate in both Canada and the United States. In the five academic years from 2010/11 to 2014/15, for example, the average tuition rate in Canada climbed from $5,146 to $5,959, which is roughly 3 per cent annually. During the same period, inflation averaged 1.5 per cent, indicating that tuition increased 1.5 per cent in real terms. Whether this trend is “good” or “bad,” it is not accelerating out of control. In comparison, however, real estate values appreciated by 80 per cent or more between 2001 and 2006 in seven American metropolitan areas. Now that is a bubble!

Student debt, too, is less of an issue and recent graduates are faring much better than is widely believed. The widely-reported number is that students graduate with around $25,000 in debt, but this figure is misleading. In 2012, for example, Simon Fraser University conducted a survey that revealed student debt levels to be roughly $24,600, yet, what is often missed is that this average excludes those who graduate debt free. The average drops to $14,500 when debt-free students are included as part of the analysis.

Bubbles are not just fast growing prices or debt loads, however, but prices that are not connected to market fundamentals. In Canada, rising tuition fees clearly reflect three fundamental forces: 1) demand rising faster than supply (the ratio of students to faculty has increased from 17 :1 to 25:1); 2) higher administrative costs; and 3) a shift in the balance of cost-sharing. Government funding, for example, once comprised more than 80 per cent of Canadian university operating revenues in 1990, but is today closer to 57 per cent percent on average.

Perhaps, then, Canada’s postsecondary education is less like the US housing bubble and more like our own “overvalued”–but not out of control–real estate. The analogy matches quite well. Rather than being driven by easy credit and speculation, our real estate boom is mostly confined to regional markets where the supply of housing is constrained and immigration is high. Low interest rates might have caused some overleveraging and modest mismatching, but it has not been enough for a big bust. In the same way, Canada’s model of postsecondary education leads to modest malinvestments in human capital: too many people with arts degrees, too few in vocational programs. These malinvestments almost surely decrease productivity and lead to labour market mismatches, but they do not portend a catastrophic implosion.

One final possibility is that our public model of university funding transfers the risk to taxpayers, which would mean that our student debt, while not at bubble proportions, is also not the full story. A substantial share of public debt must be considered as well. If that is the case, the question is not one of student solvency but provincial solvency. That, however, is a debate for another time.

Samuel Hammond is an AIMS on Campus Student Fellow who is pursuing a graduate degree in economics at Carleton University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies

Competition and Choice in Education: A Brief Opinion

The most erroneous assumption is to the effect that the aim of public education is to fill the young of the species with knowledge and awaken their intelligence, and so make them fit to discharge the duties of citizenship in an enlightened and independent manner. Nothing could be further from the truth. The aim of public education is not to spread enlightenment at all; it is simply to reduce as many individuals as possible to the same safe level, to breed and train a standardized citizenry, to put down dissent and originality – H.L. Mencken 

If there is one word that summarizes P-12 education in Nova Scotia, it’s mediocrity. The newest nationwide assessments place Nova Scotia’s junior high school students below average in every subject, with particularly large gaps in mathematics and reading comprehension. For those parents who are vigilant about their children’s educationfor example, those who sang in the chorus of dissatisfaction within the 2014 Education Reviewthese rankings will not come as a surprise.

The review calls for major education reforms that “disrupt the status quo.” Outside of these consultations, however, students and their parents have limited power to shape the nature of that disruption. In addition, many potentially helpful reforms, from abolishing school boards to rewriting curricula standards, will ultimately create a new status quo with its own inherent inertia. A more effective system would be one with a set of broad objectives that encourages grassroots innovation and adaptationone that ultimately meets the demands of students and their parents. Introducing competition into Nova Scotia’s public education system, i.e. “school choice,” would help unleash a discovery process for best practice measures in such a way that could satisfy diverse learning needs and respond to varying learning abilities.

As a product of Nova Scotia’s public education system, I have firsthand experience with extraordinarily capable students who became the victim of “leveling down” under the oppressive weight of Nova Scotia’s school boards and teacher unions. Fortunately, from grades 7 to 9, I endured French Immersion and I later earned an International Baccalaureate (IB) certificate in high school. It’s an open secret that the primary benefit of French Immersion and IB certification in Nova Scotia is the separation it provides from typically classrooms in the province. Essentially, it is as if an unofficial second-tier exists for a privy minority to self-segregate into, less to upgrade than to avoid the chaos and frivolity of the academic track. In addition to being more rigorous, these programs often have smaller classroom sizes and more external scrutiny that proxy a market test.

All in all, Nova Scotia’s public education system has many victims, but so long as it’s content on being average, those in the tails of the distribution are harmed the most: namely, gifted and special needs students. Indeed, their needs are not just distinct, but in constant flux. The pseudo-second-tier classrooms may be an oasis in terms of limiting disruption, but teacher control of the classroom ought to be a baseline expectation, rather than a luxury scattered arbitrarily across the province.

Samuel Hammond is an AIMS on Campus Student Fellow who is pursuing a graduate degree in economics at Carleton University. The views expressed are the opinion of the author and not necessarily that of the Atlantic Institute for Market Studies