Government’s involvement in the formation of human capital, public schooling in particular, has been amply criticized by a number of authors. It is nevertheless true that individuals can enhance their productivity to some degree if they accumulate human capital. But the process of human capital accumulation is costly, as any other investment. 
In this article we intend to extend the criticism to central planned education by focusing on the role education industry plays in the production structure, an issue virtually untouched in previous research.spontaneous order, human capital, public education, capital misallocation

Alina Avrigeanu

Bogdan Glăvan

Flavia Anghel

English

Research Papers in Economics

 
 
17 
PUBLIC EDUCATION, MARKET, AND HUMAN CAPITAL 
FORMATION 
 
Bogdan Glăvan, Flavia Anghel, Alina Avrigeanu
* 
 
Abstract 
Government’s  involvement  in  the  formation  of  human  capital,  public 
schooling in particular, has been amply criticized by a number of authors. It is 
nevertheless true that individuals can enhance their productivity to some degree if 
they accumulate human capital. But the process of human capital accumulation is 
costly, as any other investment.  
In  this  article  we  intend  to  extend  the  criticism  to  central  planned 
education  by  focusing  on  the  role  education  industry  plays  in  the  production 
structure, an issue virtually untouched in previous research. 
 
Keywords:  spontaneous  order,  human  capital,  public  education,  capital 
misallocation 
 
JEL Classification: D20, I21, I28 
 
Introduction 
Government’s  involvement  in  the  formation  of  human  capital,  public 
schooling in particular, has been amply criticized by a number of authors. For 
example,  Marks  (2005)  synthesizes  the  two  main  weaknesses  of  government 
intervention in education: the lower quality of monopolistic services and the bias 
in teaching. For a wider refutation of arguments for public education see Rothbard 
(1999). 
  In  this  article  we  intend  to  extend  the  criticism  to  central  planned 
education  by  focusing  on  the  role  education  industry  plays  in  the  production 
structure, an issue virtually untouched in previous research. We will argue that 
education policy is in fact just an example of industrial policy and that all the 
weaknesses of the latter (Glăvan, 2008b) can be found also in the former. 
 
Public education and the development of human capital 
  The role public education plays in human capital development has been 
analyzed  in  Glăvan  (2008a).  It  is  true  that  individuals  can  enhance  their 
productivity to some degree if they accumulate human capital. But the process of 
human capital accumulation is costly, as any other investment. This cost reflects 
                                                 
* Bogdan Glăvan is Professor of Economics at the Romanian American University in Bucharest. 
E-mail: bogdan.glavan@gmail.com 
   Flavia Anghel is Associate Professor of Risk Management at the Romanian American University 
in Bucharest. E-mail: flavia.anghel@gmail.com 
   Alina Avrigeanu is Associate Professor of Operations Management and Project Management  at 
the Romanian American University in Bucharest. E-mail: alina.avrigeanu@gmail.com  
 
18 
the value of workers’ time and effort associated with learning, instructors’ labor 
and knowledge, and the rest of the complementary resources used in the formation 
of human capital. These resources are valuable because they can be employed 
alternatively in the production of other goods demanded by the public. 
The most important question the education system has to answer is what 
type of human capital, in what quantity and for what price it is needed in the 
economy. On the free market, the individual is the sole owner of its human capital 
and  he/she  is  free  to  choose  what  to  do  with  his/her  labor  and  skills.  Each 
individual is interested in accumulating additional human capital as long as he/she 
expect  the  marginal  benefit  will  exceed  the  marginal  cost  of  investing  in  his 
education.  What  is  true  for  the  “consumer”  of  education  is  also  true  for  the 
producer of “education”. Entrepreneurs engage in the production of education and 
start offering specific training programs if they judge individuals’ demand for 
such programs to be sufficiently intense. Competition among private suppliers of 
educational services leads to the efficient use of society’s scarce resources and 
challenges entrepreneurs to provide exactly the services people need in order to 
accumulate  human  capital  in  the  quantity  and  of  the  quality  required  by  the 
market. Of course, it does not mean that the production and distribution of human 
capital will be flawless on a free competitive educational market. Occasionally, 
even private providers of education will fail to anticipate properly the magnitude 
and  composition  of  human  capital  demanded  by  the  public.  Yet  error  is 
inescapable  in  human  affairs.  Competition  among  different  entrepreneurs  will 
eliminate the less able entrepreneurs and keep the number of such errors to a 
minimum. 
  At  the  present,  human  capital  formation  is  not  considered  an  ordinary 
economic  investment.  Because  education  is  considered  a  public  good, 
governments  have  socialized  the  provision  of  education  throughout  the  world. 
State intervention range from issuing compulsory attendance laws and limiting 
entry  into  the  teaching  profession  through  certification  and  other  bureaucratic 
procedures, to supporting public schools and prohibiting any private initiative in 
this field. 
The process runs as follows. Each of us pays taxes. The state uses a part of 
the  money  collected  through  taxation  to  subsidize  education.  In  principle,  the 
system should provide the young generation with the proper human capital for 
increasing  the  productivity,  so  that  to  increase  the  future  income  in  order  to 
remunerate  the  young  specialists  and  the  elderly,  who  originally  financed  the 
whole process. In reality, the system malfunctions are obvious. The inferiority of 
government controlled education results from several problems. 
 
The calculation problem 
  The  fundamental  problem  with  public  education  derives  from  the 
impossibility of calculation in a public property system. Following Mises (1990), 
Rothbard (1970, p. 825-828) pointed out that any puctual decision to socialize 
education  introduces  an  island  of  calculational  chaos  in  the  market  economy.  
 
19 
Under  public  property  of  resources  employed  in  education,  meaningful  prices 
cannot  emerge  and  individuals’  preferences  for  accumulating  human  capital 
cannot be rationally fulfilled. State intervention on education falsifies the true cost 
and return of various educational services. In a socialized system of human capital 
formation,  one  cannot  know  what  precise  investment  in  human  capital  is 
profitable or not. As a consequence, the question in which exact direction human 
capital investments need to be channeled cannot be answered accurately. 
 
  The incentive problem 
  A second problem with public education is that government bureaucracy 
has poor incentives to adjust the provision of education according to the market 
participants’ preferences. Put it differently, this system does not encourage good 
teaching. Innovation and improvement in quality will not be the main priority of 
public  officials.  Rather,  the  directors  of  government-owned  (or  sponsored) 
institutions  will  pursue  their  own  objectives  and  seek  to  satisfy  the  political 
demands of education policymakers. 
Instead, they pursue political, ideological, and personal objectives. 
As a result, the government may provide services to consumers that 
are valued at less than their cost of production and fail to produce 
more highly valued services. The needs of some groups, such as 
the disadvantaged, are easily neglected. (Harrison, 2005, p. 198) 
A further issue is that public investment funding distorts the functioning of 
the capital market and falsifies the time preference of individuals. People will be 
tempted to overinvest in human capital, disregarding the opportunity cost of their 
decision. They will spend more time and energy trying to obtain diplomas and 
various  formal  qualifications  and  less  time  working.  Moreover,  a  process  of 
crowding out will put private (unprivileged) entrepreneurs in the position of being 
unable  to  undertake  investments  necessary  to  provide  consumers  with  the 
education they really desire, because it becomes artificially relative (to the state-
provided education) expensive. 
We should also keep in mind that people lack incentives to conserve or 
increase the value of resources when they do not own (have a private-property 
right over) these resources. Education policy invites corruption and rent seeking. 
Once the government is in the business of providing support to certain schools, 
the incentives change, leading to perverse outcomes. It becomes profitable for 
private actors to withdraw resources from productive educational employment and 
channel them into the competition for political favors. Thus, such an institutional 
setting  leads  to  a  perverse  competition  among  the  providers  of  educational 
services. 
 
The information problem 
Under  public  provision  there  are  no  price  signals  to  elicit  and 
confirm consumer preferences and provide the incentive to meet 
them. Further, there are no direct feedback mechanisms to show  
 
20 
whether decisions are correct or to improve performance. Often the 
government never finds out whether it provided the right types and 
amount of education. (Harrison, 2005, p. 198) 
It  is  vain  to  offset  this  informational  insufficiency  by  using  various 
surrogates  such  as  asking  students  to  deliver  information  about  the  quality  of 
teaching, etc. Without a market test it is difficult to interpret properly the data 
contained by statistical research. Only through voluntary buying and selling on the 
market,  that  is,  through  demonstrated  preferences,  is  possible  to  find  the 
importance students (or their parents) attach to different aspects of education. 
In  practice,  public  education  lead  to  excessive  costs,  overuse  of 
educational resources and misallocation of human capital. Too many of society’s 
resources are allocated to schooling and general training. In a state-sponsored high 
education system (which is supposed to provide individuals with more specific 
human capital), the opportunity cost of engaging in education is also artificially 
lower.  As  a  consequence,  too  many  individuals  are  stimulated  to  become 
“specialists”  or  “experts”  in  some  field  or  another.  The  state  interference  in 
education  induce  individuals  to  invest  more  heavily  in  the  accumulation  of 
subsidized human capital. This process has nothing in common with economic 
efficiency  and  welfare  maximization,  because,  as  Rothbard  (1970,  p.  820) 
observed, “since there is no pricing, and therefore no exclusion of submarginal 
uses, there is no way that the government, even if it wanted to, could allocate its 
services to their most important uses and to the most eager buyers. All buyers, al 
uses, are artificially kept on the same plane. As a result, the most important uses 
will be slighted”. 
Given that policymakers are not omniscient, they cannot know ex ante the 
optimal pattern of investments, and they consequently cannot improve the market 
outcome.  As  a  popular  and  condensed  adage  strongly  supported  by  empirical 
evidence tells us, the “government cannot pick winners.” Indeed, the history of 
interventionism and dirigiste policy is replete with wrong decisions that wasted 
resources  in  bad  investment  projects,  creating  inefficient  industries  and  social 
unrest. In the human capital production system, government intervention may lead 
to  the  development  of  wrong  educational  programs,  qualification,  even 
universities. 
 
The (dis)order of human capital on the (not so) free market 
The capital structure consists of various capital resources arranged in such 
a  manner  so  to  produce  an  income.  This  structure  continuously  shifts  as  the 
market demand changes. 
A change in the preferences of consumers triggers a reconsideration of the 
position  of  certain  capital  goods  within  the  production  structure.  This 
reconsideration is based upon economic calculation, in an attempt to anticipate 
future revenues relative to different uses of respective capital inputs. Obviously, 
as a result of changing preferences, the new expected income will be different 
from  the  income  anticipated  at  the  moment  when  these  capital  goods  were  
 
21 
integrated in the production structure. Therefore, capital goods should be removed 
from their old employment places into new uses. But one of the fundamental 
features of capital is complementarity. A capital good is able to produce income 
only if it is employed with other inputs according to a production plan. As a result, 
shifting  the  position  of  a  particular  capita  good  will  be  accompanied  by  a 
reevaluation of complementary inputs. 
Investing in human capital is a very difficult decision, because the fruits of 
this  investment  will  not  come  soon,  in  most  cases.  Time  is  a  very  important 
variable in the equation. During the period which elapses from the moment of 
deciding to accumulate a certain category of human capital to the time when this 
capital will be integrated in the overall economic structure and its services will 
begin to bring income to its owner, one can witness significant changes in the 
consumption  preferences.  To  the  extent  that  these  changes  are  not  properly 
anticipated, they will generate painful shifts in the economy. Some capital goods 
will depreciate in value, and this will trigger a similar development in the realm of 
human capital (which is complementary to physical capital). The fall in the value 
of human capital can be drastic, in some cases, given its high specificity. A good 
explanation of the disorder that may affect human capital structure can be found in 
Rogojanu (2000). As the author argues, we can explain this phenomenon in more 
detail by assuming the existence of two types of human capital: productive (P) and 
educative  (E).  The  latter  is  a  higher  order  input,  because  it  participate  to  the 
formation of the former. If the value of P human capital declines (because of, let’s 
say, a shift in public preferences to more leisure), the value of E human capital 
falls also.   
This phenomenon is illustrated by the situation of Romania. In the ‘70-’80, 
the  economy  was  oriented  toward  heavy  industry  –  constructions  and  steel 
manufacturing  –  which  prompted  the  education  system  to  produce  to  a  larger 
extent  specialized  human  capital  in  this  field  (engineers  of  various 
qualifications).
1 At  the  beginning  of  the  next  decade,  consumer  preferences 
revealed, through a now liberalized price system, an increasing appreciation for 
consumer goods. Inevitably, some industrial complexes went into bankruptcy and 
the value of associated human capital P declined. The falling value of human 
capital P will affect the value of human capital E. Because of internal rigidities, 
the  real  importance  of  various  branches  of  E  industry  has  remained  hidden. 
Eventually, the weaknesses of the relative distribution of human capital became 
obvious.  This  prompted  the  reorientation  of  the  education  system  in  order  to 
produce more human capital P specialized in business and law.
2 Of course, the 
new shape of the education industry is far from being perfect. The problem is, 
though, if the E Industry can be organized in such a manner to react promptly to 
any future changes in the public’s preferences. 
 
                                                 
1 During these years, universities became popularly known as “engineers factories”. 
2 The magnitude of this shift has prompted some people to call the impressing number of emerging 
law schools “lawyers factories”.  
 
22 
Conclusion 
The state intervention in human capital formation is just a particular case 
of  industrial  policy.  It  leads  to  a  broad  range  of  negative  outcomes: 
standardization  and  lack  of  variety  in  educational  services,  political-induced 
discrimination  (that  may  take  the  form  of  affirmative  action,  for  instance), 
monopoly prices for education – often paid via taxes etc. Calculation problems, 
informational failures and incentives issues prevent the state from allocating the 
human capital efficiently. In order to have a rapid adjustment of the education 
system  to  the  requirements  of  different  industries,  we  need  to  have  a  free 
competitive, private property-based education sector. 
 
References 
Glăvan, Bogdan. 2008a.  “Brain Drain – A Management or Property Problem?”, 
American Journal of Economics and Sociology 67(2). 
Glăvan, Bogdan. 2008b. Coordination Economics, Poverty Traps, and the Market 
Process A New Case for Industrial Policy? Independent Review 13(2) 
Harrison, Mark. 2005. “Public Problems, Private Solutions: School Choice and its 
Consequences”, Cato Journal 25(2): 197-215. 
Marks,  Benjamin,  2005,  Archipelagos  of  Educational  Chaos”,  Journal  of 
Libertarian Studies 19(2): 87-102. 
Mises, Ludwig von. 1990. Economic Calculationin the Socialist Commonwealth,  
Auburn, Ludwig von Mises Institute 
Rogojanu,  Cosmin.  2000.  “Distorsiunile  temporale  ale  alocării  relative  a 
capitalului uman”, in Relansarea creşterii economice în România, pp. 348-350. 
Rothbard,  Murray.  1970.  Man,  Economy,  and  State:  A  Treatise  on  Economic 
Principles. Los Angeles 
Nash Rothbard, Murray. 1999. Education. Free and Compulsory.  
Auburn: Ludwig von Mises Institute. 
 
 
 
 
   

Brain Drain – A Management or Property Problem?”,

Coordination Economics, Poverty Traps, and the Market Process A New Case for Industrial Policy?

Economic Calculationin the Socialist Commonwealth, Auburn, Ludwig von Mises Institute Rogojanu, Cosmin.

State: A Treatise on Economic Principles.

PUBLIC EDUCATION, MARKET, AND HUMAN CAPITAL FORMATION

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