Tuesday, August 23, 2005

Visible Improvements Beat Invisible Hand Metaphors

It is unfortunate that when someone is arguing a good case for something that Adam Smith would have been a sympathetic supporter, that the author of the excellent ideas quotes from Smith incorrectly. This creates a small dilemma for Lost Legacy:

Should we let the incorrect attribution to Smith go by without comments, or should we treat it in exactly the same way as we would if the author had been arguing for non-Smithian ideas?
The best way to help address the dilemma is to present the case and let you decide for yourself. My answer is given in what I say below.

I refer to an article in the Financial Express, Mumbai, India, 23 August: “Let all professional colleges set own fee structures: institutional subsidy can be given to those who cannot afford” by Parth J Shah, President, Centre for Civil Society, Delhi.

In the course of his argument for the right of colleges to charge appropriate fees, and not to be told what fees to charge by government, which a recent court case in India has decided in favour of the freedom of colleges to charge, the author says:

“The power of Adam Smith’s ‘Invisible Hand’ is finally understood. A proper framework rules of the game is necessary for the Invisible Hand to work. As Smith demonstrated, the institutions of private property and free competition are sufficient to align individuals pursuit of self-interest with social interest. Once fair and transparent rules are instituted, the Invisible Hand would work in the education sector also.”

Now, as regular readers will know that is not what Adam Smith said in relation to the invisible hand. He meant no general statement about markets, or self interest, or even that the metaphor of the invisible hand applied in all situations.

The metaphor of the invisible hand was used by Smith only three times (he took it from Shakespeare: Macbeth: Act 3, scene 2: ‘thy bloody and invisible hand’). His first use was in reference to pagan superstition (the ‘invisible hand of Jupiter’, the pagan god, Jove, not the planet); his second was in relation to the Feudal Lords being led by an invisible to supply their retainers and serfs, upon which their power rested, in roughly the same proportion to what they would have received from their own plots of land if they had had any from the land being divided equally; and lastly, in the preference of traders and manufacturers being led to locate their business locally rather than abroad, which led to the faster growth of national income.

In no case were these uses directed at markets, or at the self interest of individuals always being benign; it could lead to malign outcomes too, as when ‘merchants and manufacturers’ were led by their self interest to erect monopolies, impose restrictions and raise monopoly prices against consumers.

Smith believed that he best antidote to monopoly price fixing is not government regulations and interference in pricing decisions, but legislation to promote competition. Hence, if a college charges higher fees than another (neither being subsidized) than it has to produce a better quality of education to continue in business.

That Parth J Shah understands this is clear from his article. He should stick to making that point and not bringing in the invisible hand which refers to something else.

In my first teaching job on leaving University as an economics graduate was in a college which among other things delivered a non-degree course, the Diploma in Management Studies (DMS). The state fixed course fees. The DMS programme in the region was set at a low fee of few pounds per term, and it was a very popular programme. The college I taught at raised the DMS fee to £30 a term (with permission from the authorities who took the view that the College was going to find no takers when they could get the DMS course elsewhere at a third of the price).

The outcome? The College soon had the largest DMS programme in the region, with attendees from the whole region and not just from the local town. Why? Quality counts. It had fulltime teachers on the programme; it brought in guest lecturers from regional employers; it had clear rooms and proper chairs and desks; and carpets on the floors, with pictures on the walls. And the large surpluses earned from the courses went to funding other courses, and, eventually, the rent of a large building with large grounds that was furnished to a high standard. Most of the other DMS courses at low fees at other colleges continued.

Allowing local colleges to set their own fees, arrange their own scholarships and bursaries, and to compete on quality would do wonders for college education in India. It only requires the freedom to do so; no invisible hand is needed. Just visible good marketing sense, without unnecessary government interference.

That way, students, and their employers, signal what they approve of and poor schools go out of business - or, better still, improve themselves without requiring money from taxpayers.


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