From the magazine: The economics of education

What is economics? What bearing does it have on school management? Ithe June/July issue of Education Executive, Stephen Mitchell, chief operating officer at the Spencer Academies Trust, Nottingham, explored economics, demonstrating its relevance to the SBL role and how to apply it to advantage

It inspires dread in most and gives rise to many jokes. One of my best friends has made it the basis of their career; it has an impact on each one of us. What is it? Correct, it’s economics! Is it relevant? You bet your life it is but, is it interesting? Well, for some it will be; for others watching paint dry will be preferable.

This RIB takes a quick sojourn through how economics impacts us, considers some of the challenges the government faces when managing education budgets and ends with a challenge in relation to how we should embrace it.

Economics as knowledge

“Economics is the science which studies human behaviour as a relationship between ends and scarce means which have alternative uses,” said famous British economist LC Robbins. Economics can be used to define and describe how the world works and to explain some deep-rooted truths about how the market works. More importantly, for those of us working in schools, it can be used to understand why the Education and Skills Funding Agency acts the way it does or, indeed, give us a theoretical base from which to challenge the department on their policies, rather than relying on the, ‘but it’s not fair’ argument.

Moral hazard

In traditional businesses there is much academic research regarding a phenomenon called ‘moral hazard’ – the concept that individuals alter their behaviour when their risk-taking is borne by others – and the impact that differing objectives may have on business performance. This is less so in the education sector. Traditional economic theory says that managers should act in accordance with their shareholders’ objectives – for example, making the most profit possible. The moral hazard emerges when management is motivated to act in their own interest – e.g. growth for bonus, rather than growth for shareholder dividends – which means they’re not acting in the company’s best interests.

The basic economic principles of supply and demand dictate where and how we allocate our resources

In the not-for-profit sector we have a different priority; we’re focused on the ‘social good’ of our services – this requires a different understanding of how the cost-revenue model works. However, the concept of moral hazard holds true; do we see examples of school leaders driving growth for reasons of ego, personal salary increments, or other things – rather than delivering an organisation that ensures students receive the best education possible?

The obsession with eternal growth

We don’t need to trust our own anecdotes to answer this. Leading research by American economist William Baumol illustrates that managers will, generally, seek to grow an organisation beyond its optimal size because we place an undue sense of importance on size of income – there’s a desire to be bigger and a belief that bigger is good. Society holds a general view that a drop in income is a bad thing, viewing it as a sign that an organisation is suffering. For example, recently there was news that the motor industry had dropped 17% in a year and that the sector was in freefall. The untold story of those March 2018 figures was that it was the fourth highest month for sales – ever. The figures are actually pretty robust.

The unhealthy obsession with forever growing income figures is nicely summed up by the somewhat pithy phrase, “Top line is vanity, bottom line is sanity.” In these times of education funding cuts, we all have a healthy focus on our bottom line figures.

Bringing economics to school

So, how does all this make economics relevant to your role? I refer to my earlier point about moral hazard. Take remuneration as an example; we must ensure that the pay polices we set across our schools are focused on ensuring the best outcomes for our organisations, and are not skewed by anything that acts against those interests. So, if pay progression is linked solely to performance in exams and progress figures, does the school inadvertently assume a policy of trying to off-roll those students who are not going to help the league table positions? Or do leaders chase growth of the trust at the expense of ensuring that progress and school improvement are secured at the original schools?

Managing the risk of moral hazard has been part of the reason for the growth of the various corporate codes of governance that the country now has. Figure 1 (Financial Reporting Council, 2010) summarises the key aspects of our country’s regulations.

 Figure 1

The key aspects of corporate governance in the UK

A single board collectively responsible for the sustainable success of the company.

Checks and balances including:

  • separate chairman and chief executive;
  • a balance of executive and independent, non-executive directors;
  • strong, independent audit and remuneration committees;
  • annual evaluation of its performance by the board.

Transparency on appointments and remuneration.

Effective rights for shareholders who are encouraged to engage with the companies in which they invest.

These principles are clearly intended to ensure that actions undertaken by staff are controlled so as to avoid moral hazard, to protect organisations and the staff working within them.

Within education, we’ve gone further. We have the Academies Financial Handbook and regulated funding agreements, which are designed to constrain and control managerial behaviour. They complement the Companies Act, charities’ SORP, etc., as part of wide-reaching governance controls. In addition, and particularly topical at present, CEO salaries must be disclosed in financial statements on named basis and others over £60,000 must also be identified. There have been many news reports about the level of CEO salaries in the academy sector; whether or not they are justified is not for this column but, one thing is for certain, the scrutiny surrounding them is helping to control the potential for moral hazard.

Origins of the national funding formula

It’s also worth noting that the fundamentals of our maintained schools system are based in the failure of a free market to determine itself in line with societal preferences. If we assume that we exist in a completely free market, and the laws of supply and demand are in play, then education would be provided at a cost by private sectors whereby all those wanting to get an education could afford to do so. The quality might vary, depending on price, but supply would equal demand at all price points. This would be a socially optimum outcome, according to theory.

We must ensure that the pay polices we set across our schools are focused on ensuring the best outcomes for our organisations

However, this clearly isn’t the case. Society dictates that we want all children to receive an outstanding education at no cost to parents (unless they choose to go to independent schools) and, in the absence of the market providing this, the government has stepped in and provided an intervention, which – as an aside – gives all of us the jobs that we enjoy today. To fund this, the government must use economic calculations to ascertain the ‘social benefit’ of providing the service – i.e. how much does it need to spend to achieve the outcomes it wants and, therefore, how much does it need to invest. The national funding formula is the result of these calculations and indicates how they want to share their resources to achieve that benefit. However, clearly, money doesn’t grow on trees, so the government needs to identify where it gets this money from. To do this, it taxes incomes and other activities which produce a social negativity, i.e. smoking, or the new ‘sugar tax’.

Economics in practice – not just in theory

Economics is all around us. We can thank economics for our jobs because society has deemed it vital that education is provided to our children and that society will pay that cost. We receive taxpayer pounds to help deliver that social benefit and we struggle daily with the balance between what society wants and how much it is prepared to pay for it, through our ongoing funding challenges – hence our responsibility to public spending.

The basic economic principles of supply and demand dictate where and how we allocate our resources – we’re constantly making judgement calls about what to buy, at what quality and what price. Understanding how these tensions are interlinked is key if we are to maximise financial efficiencies and, most importantly, student outcomes.

Lessons from an MBA

This Really Important Bits article is a brief review of some tools which can be used to help manage your workforce. The concepts in the series are being explored in more detail at www.stephenmitchell.info/RIBs and are available for you to freely download and use.

This article featured in the June/July issue of Education ExecutiveSubscribe now to keep up-to-date with the latest in school business management and leadership.

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