Last month a gathering of British students, organised by the far left (did anybody count the number of Socialist Worker posters on display), trashed much of Westminster, London. In a rare admission by some of their lecturers that ‘incentives matter,’ some of the students had been ‘encouraged’ to attend the event with promises that coursework deadlines might be extended for those involved.

In a further recognition of the importance of incentives, one of the most common arguments that the participants advance is the notion that education is a ‘public good’ with ‘positive externalities.’  Since ‘society’ benefits from students’ receipt of education – a better educated workforce generates more and better paying jobs for the general population – students should be subsidised to attend university even though they are likely to secure higher incomes on average than taxpayers as a whole. Absent the incentive provided by public subsidy education might be ‘under-produced’ relative to some social optimum.

Recourse to this argument in an educational context is widespread yet it rests on a failure to understand a distinction originally made by Buchanan and Stubblebine between policy-relevant and policy irrelevant externalities. Externalities are policy relevant when the ‘supply’ of a positive external effect is determined by the ability or inability to charge for the relevant units. Thus, a ‘landscape entrepreneur’ may not invest in constructing a public park if she is unable to profit by charging for access to the grounds. Externalities are policy irrelevant when the externality is supplied irrespective of the capacity to exclude non-payers. The decision of a householder to provide a rose-garden for her personal enjoymentmay not, for example, be affected by the capacity to charge onlookers for ‘viewing rights’. The distinction between policy relevance and irrelevance here depends on whether the externalities are infra-marginal. This scenario refers to externalities that exist, as in the case of the rose garden, but where interventions would not produce marginal improvements to the level of supply. Thus, if the government subsidises gardeners to increase the production of roses the externality is infra-marginal when the subsidy exceeds any value placed on the additional roses by passing members of the public who may not register the existence of a few extra flowers. In other words, the externality is infra-marginal because for purely private reasons the gardener is already taking into account (albeit unintentionally) the interests of external beneficiaries.

Buchanan and Stubblebine’s analysis suggests that owing to the social nature of life externalities are ubiquitous but most of them are irrelevant from a policy perspective.  Purely private decisions to adopt a rigorous skin care regime or to attend fitness classes to maintain the interest of one’s spouse may, for example, generate positive externalities for others who appreciate the beauty of the human form and may benefit ‘society’ as whole by improving the aesthetic ambience in which we all live. It is unlikely, however, that a more satisfactory level of supply could be induced by government encouraging people to spend additional resources on their appearance. Indeed, to do so might be to transfer resources away from what are potentially more valued uses.

Seen in this context, there is little reason to suppose that education generates policy relevant external effects. First, it is not clear that benefits generated by private decisions are uncompensated or that they might not readily be internalised via private mechanisms. The fact that an educated person may raise the productivity of others with whom they interact is likely to be reflected in that person commanding a higher wage or salary than a less educated person. One would expect profit-seeking firms to pay more for workers who raise the productivity of their co-workers.

Second, insofar as decisions over education do generate uncompensated effects these seem likely to be infra-marginal and thus policy irrelevant. Given that people have purely private inducements to invest in literacy and numeracy– such as the greater likelihood of finding a job – it is not clear why governmental efforts to encourage additional investment would be worthwhile. A similar analysis applies to private decisions to invest in more sophisticated training such as higher education. In general, the expectation of commanding a higher wage or salary will itself be sufficient to induce the supply of any relevant spill-overs, irrespective of whether these are compensated directly by ‘society’…

Read the full article on the Pileus blog.

Mark Pennington’s new book, Robust Political Economy: Classical Liberalism and the Future of Public Policy, will be launched at the IEA on Thursday 20 January 2011. Click here for details of the event.