Solutions to Market Failure in Higher Education


by Samarth Agarwal
This is the second part of a two part series. The first part can be found here.

Government Education to Mitigate Market Failure

As dealt with in the first part, there are certain primary causes of higher education market failure, namely imperfect information, monopoly, positive externalities and public good. Government interventions provide solutions to deal with these specific causes.

1. Solutions to imperfect information- Imperfect information is a situation where the parties to an economic agreement do not have complete information or knowledge regarding the price or the quality of the product. With numerous targeted measures, the problem caused by imperfect information in the higher education markets can be solved. About the uncertain future returns, the government, by offering income-contingent loans, can mitigate the risks of non-payment and therefore attract the students to undertake higher education, making all parties better off. The market failures in credit markets underpin the rationale for governments to provide student finance, in the absence of provision by a private market. There are several grounds on which the government can intervene to deal with the issue of market failure, provided that such a step is either efficient i.e. the benefit outweighs the cost incurred, or it ensures equity i.e. helping the socially and economically vulnerable classes. To resolve the problem of information asymmetry i.e. imbalance of information between the parties that enter into an economic transaction, the government can direct the sellers in the higher education market to properly signal the quality of value of the goods or services. For example, higher education institutions can be asked to signal their govt. ratings and quality control certification. The government can also affix a minimum standard so that the poor quality goods and services are prevented from entering the market and the buyer is assured that he will not get a bad product or service in the higher education market. With regard to addressing the problem of the uneven presence of knowledge between the parties, the government can resolve this through various measures. Firstly, by requiring the firms to disclose all the information they possess. This can be done through consultation, regulation, coordination between the seller and the buyer, and incentivising the sharing of information by the government either positively through inducements and tax relief or negatively through penalties. Secondly, initiating various government programmes to assist the disclosure of information and organising various campaigns to inform the consumers about the product i.e. the higher education and various institutions. Therefore, through these ways, the government can maintain an equilibrium of information available to both the buyers and the sellers.

2. Solutions to monopoly: The problem of monopoly can only be solved with the increase in the number of firms selling the same product i.e. higher education in the market. If there is only one higher education institution, it will have the authority to regulate the price and the quality and quantity to be supplied and act as a price maker. However, if there are a large no. of higher educational institutions, no one single institution will be able to exert influence on the market and will be a mere price taker. There mustn’t exist a barrier restricting a firm to enter or exit a business. The government must ensure that such a situation doesn’t arise where there is only one higher educational institution. The entry of new higher educational institutions increases the competition and the quality of the education provided and also abolishes the concentration of market power in the hands of any single institution. A government can address this problem of monopoly through several measures. Firstly, the government can establish ownership of the institution if the situation of monopoly arises. Secondly, the government can enforce laws preventing the formation of trusts to ensure that the power and the control of the higher education system is not confined in the hands of a few people. Lastly, in cases where the monopoly arises naturally without any barrier to entry and exit of firms, the government can play an important role by encouraging the other higher educational institutions to come up, thus promoting competition.

3. Solutions to positive externalities- The positive externalities, which is one of the primary causes of failure in the higher education market can be addressed by the government intervention through a) introduction of public provisions, b) granting subsidies to those who cannot afford higher education, c) adopting positive advertising campaigns dealing with the importance of higher education to raise awareness and d)  mitigating the transaction costs involved in parties negotiating solutions to externality problems through the creation of institutions. Positive externality exists in various forms in the higher education market. One of its most important forms is network externality which arises when the value of a specific good or service is determined by the no. of other people using it. This can be addressed by the government by providing support for higher education until sufficient subscribers allow a viable private provision such as coordination between the potential private providers.

4. Solutions to public goods- The problem of market failure due to higher education showing traits of a public good can be resolved through government actions. With regard to the problem associated with non-excludability, the government can – a) create tradeable permits, b) define and enforce private property rights and c) provide the good or service directly or indirectly through subsidies to private providers. Next, the problem of non-rivalries can be fixed through various methods. First, encouraging the sustainable use of resources through positive incentives or limiting the use through quotas. Second, motivating and encouraging the community to generate its own and excludable resource solutions. Lastly, providing information and defining private property rights to discourage the over-utilization of resources.

Developing a Proper System of Institutions

When the market failure in higher education is present and is confined to a specific place, it implies that the problem is specific. Institutional arrangements involve coordination of various economic factors, such as the sellers of higher education i.e. educational institutions, processing, materials flow, finance, information, knowledge, customers i.e. the students, finished products and governments. However, widespread failure of higher education markets reveals that there exists a systematic problem in the institutions. Thus, it is becoming necessary to identify the failure in the institutions and strengthen their foundations. However, this cannot be done by the market forces and would require different organisations to intervene. The system of institutions can be corrected in two ways, namely adopting new norms, values, rules and conventions and changing the basic structure of the organisations. 

International Pressure to Reform Markets

International institutions such as the World Bank and the IMF (International Monetary Fund) exert a significant influence and pressure on the countries to reform their markets and mitigate any failure. In recent years, the importance of higher education has been stressed upon a lot by the international organisations. Although, in early times, these institutions did not pay enough attention to the social and institutional arrangements in different markets in a country, in modern times, it cannot be denied that these international pressures are constantly playing out in the international diplomatic arena. This has led to a significant improvement and has brought about several reforms in certain markets including that of higher education. The reforms which the members states in the European Union were compelled to implement is a good example of such international pressure.

Evolution and Technology

There are various instances where the markets evolve and the failure in the market is mitigated by the eventual balancing of the demand and supply. However, with the complete knowledge of the actors, a market system can be developed easily.

Sometimes it just takes time for markets to evolve and for supply and demand to find the right products at the right prices. But it is possible to use the knowledge of the actors in the market to accelerate the development of a specific market system. Economists such as Rodrik contend that institutions for high-quality growth can be developed by implementing a bottom-up participatory approach that elicits and aggregates local information to create institutions and builds on the arguments of Adam Smith that the participants are the closest to the demand and supply constraints in the market. Likewise, the market of higher education can evolve from the grass-root level through various developments and innovations of the market participants. In order to ensure the right performance of the market, it is important that there exist the right enablers. In cases where there doesn’t exist a well-defined mechanism, market players invent their own localised solutions like informal contract enforcement. Similarly, technology can play an overwhelming role in overcoming market failures in higher education. It has truly changed the way markets function and has allowed a consumer to find whatever information he/she needs about the product (in this case higher education). It also prevents the seller from taking undue advantage of the consumer.

Role of Market Forces

The market forces i.e. the seller and the buyer also play a significant role in eliminating market failure. In higher education too, market forces may mitigate market failure without depending upon state intervention. In cases where a monopoly exists, the other sellers enter the market for earning profits and hence the control of the market goes away from the earlier existing sole seller. In the case of higher education, when sellers observe the monopoly of one institution, they also set up educational institutions to earn profits. No. of institutions rises till the sellers’ yield exception profits. After that point, there doesn’t exist an incentive for new sellers to come into this market. Thus, this is how market forces solve the problem of monopoly. Next, the problem of information asymmetry can be dealt with by the market forces through various Consumer advocacy groups and informed buyers. These consumer advocacy groups and informed individuals enhance the process of demanding and disclosing information regarding higher education and its institutions. With respect to the network externalities, the private market may start privately led initiatives to coordinate firms into providing the higher education goods or services with a network externality. The problem of non-exclusion can be resolved by the market forces if they somehow manage to make the particular product of the higher education exclusion. Thus, the overall problem of market failure of higher education due to it showing traits of the public good can be dealt with through a partnership between the public and the private sector where exclusion can be enforced and prices can be managed through mutual cooperation.

Economists have always been interested in applying the economic principles in various fields including higher education. However, it is evident that for a market to succeed, there need to exist State intervention as the competitive behaviour of the free market relies highly on it.

Views are personal.

Image credits: Meltwater


Samarth Agarwal is currently pursuing law at National Law University Jodhpur.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s