Freedman’s no Friedman on for-profit schools

In a recent blog post, Sam Freedman, former advisor to Education Secretary Michael Gove, announced that he has changed his mind about the viability of for-profit schools. He no longer believes such schools can ‘improve the current education system as it is’. This is for three reasons:

1.     The incentives involved in allowing profit-making schools exist anyway

Freedman is here talking about the dynamic aspects of profits, which would increase incentives to scale up. He points to the fact that about 200 of the new academies have started their own federation, thus displaying that scaling up exists also in the non-profit market.

My first issue with this argument is that the academy chains are not starting new schools but merely incorporating existing ones. This is tantamount to consolidation, which might or might not be beneficial, but it does not increase surplus capacity in the system – which is key to increase bona fide choice and competition. Starting new schools is costly and requires capital, which non-profit organisations cannot access to the same extent as profit-making organisations. This is why for-profit companies now dominate the Swedish schools market.

Perhaps most importantly, even if some non-profit organisations grow, it does not mean that the best ones grow. Evidence from California indicates that there is no relationship between school results and the amount of philanthropic funding they get. And research from Chile shows that whereas for-profit schools grow in size as a result of increasing quality, non-profit schools do not. The reason for this is quite straightforward: there are few incentives for governments and non-profit organisations to back the scaling up of already successful schools. Instead, we witness often futile attempts to support struggling schools. Furthermore, good non-profit organisations do not have the same incentives to scale up as good for-profit schools because of the pecuniary motive. The long queues in popular, and high-performing, non-profit free schools in Sweden are evidence of this: they tend to become selective rather than large.

2.     Allowing for-profit schools wouldn’t increase incentives because it is not a profitable industry

Freedman’s point is that it is difficult to make money out of education. This is because about 80 per cent of schools’ costs are staff, and if you cut back on that you will not get good results. Freedman suggests that there is little evidence of the strategy to cut costs via technology and online learning. This, of course, is partly because such strategies are new in primary/secondary education (and also reflects legal restrictions on such methods). Another way to make money would be to run a lot of schools to exploit scale economies, but Freedman dismisses this entirely (without any real argument).

Neither of the above is a good reason to continue a ban on profit-making owners of academies. Even if we agree with Freedman’s point that the current industry is not profitable at the moment, this is not an argument in favour of a ban on profits. The point is that profit-making entrepreneurs may find new ways to make education cheaper while at the same time providing higher quality (in ways that neither Freedman nor I can know of in advance). By preventing such entrepreneurs from entering the market, we limit the degree of innovation in education. This is clearly undesirable for anyone seeking fundamental progress in the education system.

Second, evidence from Sweden and Chile indicates that Freedman is wrong. The fact that a majority of voucher schools in both countries now operate as for-profit companies strongly suggests that it can be profitable to run schools (although profit margins are rather low: about 5 per cent in Sweden, some of which are returns from their own capital injections). At the same time, as I have shown, there is no good evidence that for-profit schools in either country perform worse than non-profit schools. The schools appear to obtain small profits by running education more efficiently, not by lowering quality.

3.     Allowing for-profit schools would require a complete overhaul of current processes

Here Freedman is talking about the current process to sponsor academies, which is basically procurement without public biddings. If it would allow for-profit companies, the government would be forced to open a public bidding for all sponsored academies (according to a EU law). Sweden gets around this by allowing any provider to start and run free schools, which Freedman doesn’t like because the government would lose control over who can set up a school and where. He also argues that non-profit schools would face a disadvantage because they cannot attract capital to the same extent as for-profit schools, and because the government cannot commit to pay for upfront capital costs for all new schools.

All of this is true of course, but why is it a bad thing to change the situation? A key issue to promote strong competitive incentives in the market is to allow free entry and exit; surplus capacity is essential to ensure that parents have actual choice.  The English model falls short on this account: only 173 free schools have opened in two years. Indeed, as I argue in my book, a major problem in today’s education market has been too restrictive entry requirements. The virtue of the Swedish model is precisely that schools are (relatively) free to start as long as they satisfy the minimum requirements stipulated. Government retains some control by establishing minimum requirements, but then the market is allowed to decide the outcomes.  

When we allow a more liberal establishment regime, the likelihood of orderly failure of poorly performing schools will increase since pupil migration to better schools will be easier. The market would thus weed out the worst performers, rather than the government having to intervene through sponsored academies.

But if the government wants to continue to contract out underperforming schools via sponsored academies, a bidding process would not necessarily be bad. Competition between suppliers wanting to take over poorly performing schools is favourable, since it increases the chances that the government picks a provider that will improve the school, and it also ensures more transparency in the process.

The argument that non-profit schools face a disadvantage is not true; they would compete like everybody else in the market. If they want funding, they would have to seek out philanthropists that provide up-front capital for them. The current government approach is very expensive, and paying for all new free schools and academies means that the increase in supply that is so desperately needed is unlikely to occur. Indeed, this is also why some advisors to the Education Secretary are now apparently pushing for profit-making schools to be allowed. It’s simply too expensive without them.

So, in conclusion, Freedman’s argument against allowing profit-making schools is not particularly convincing. His first two points are not even arguments against allowing them, and the third point is not a good argument for retaining the ban. There is, furthermore, a middle-ground approach to all of this, which should be able to attract broad support: put profits to the test in a large-scale pilot where the new model, including for-profit schools, is tried. When the results are in, we can continue the discussion on whether it would be good to scale it up.

Gabriel H. Sahlgren is Director of Research at the Centre for Market Reform of Education, and Research Fellow at the Institute of Economic Affairs. He is the author of the book Incentivising excellence: school choice and education quality

Michael Gove really does need some better economic advice. All the reasons Freedman cites are red herrings. What is the purpose of profits? Well, one purpose is that they are a signal that the factors of production are being used productively. There is no such signal in academies. You might get the signal in terms of a queue of people waiting to apply, but that is not the same (and it is not what we want - the best bread shops in the Soviet Union had the longest queues no doubt. Secondly his costs argument completely confuses revenue and capital. Profit is a reward for successful entrepreneurship but also provides a return on the capital invested. The fact that a large proportion of the running costs are staff costs is entirely irrelevant to whether a profit can be made. This also treats staff as if they are ipads with fixed prices and a fixed set of services they can provide. Teachers aren't like that - they are human beings with different capabilities that can be deployed in different ways. If you take a school salaries budget of (say) £5m there is an incredible number of way that this can be deployed to provide education services. The most profitable schools will be those who best satisfty parents at lowest cost. If this leads to innovation and reduction in costs across the sector then the government can squeeze it by reducing the per capita spend to everybody's advantage.

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