School Choice Markets Work--If the Rules Are Right

There is more to a market than buying or selling.  Armchair economists and parlor libertarians often act as if all you need to make a market is to remove the government barriers to trade.  This can be true (ag subsidies, I'm looking at you!), but in many places it's nowhere near enough.  You need the social norms that support market trade, and you need to set good rules by which trade happens.  What we did to Russia is a good example of why the "get government out of the way" theory is not sufficient.

Matt Yglesias has a post on school choice that makes this point very well, I think, citing a paper by McLeod and Urquiola:

Friedman (1962) argued that a free market in which schools compete based upon their reputation would lead to an efficient supply of educational services. This paper explores this issue by building a tractable model in which rational individuals go to school and accumulate skill valued in a perfectly competitive labor market. To this it adds one ingredient: school reputation in the spirit of Holmstrom (1982). The first result is that if schools cannot select students based upon their ability, then a free market is indeed efficient and encourages entry by high productivity schools. However, if schools are allowed to select on ability, then competition leads to stratification by parental income, increased transmission of income inequality, and reduced student effort--in some cases lowering the accumulation of skill. The model accounts for several (sometimes puzzling) findings in the educational literature, and implies that national standardized testing can play a key role in enhancing learning.

The rules surrounding markets matter a lot--and the reason we don't know this is that the rules that work have disappeared into the background, faded out of our consciousness, become part of the miasma of "the market".  For example, I recall a web debate years ago in which someone made the standard point that cartels are very difficult to hold together, which means anti-trust rules about this sort of thing have dubious utility.  I believe it was Eugene Volokh who pointed out that this was true . . . but only because courts refused to enforce cartel agreements.  If courts did enforce them, cartels would work pretty well--which is why we still have professional sports leagues.

Luckily, this is the sort of rule that most voucher programs enforce--and because I find this paper pretty convincing, I'd say they should continue to.