Labour Policy

Unemployment and the productivity slowdown

If asked, most observers would likely agree that high and rising unemployment is the number one public-policy problem in Western, industrialized nations. Since the early 1970s, measured rates of unemployment have risen in most industrialized countries. During this period, most major industrial economies have also experienced slower rates of aggregate productivity growth (Romer 1996: ch. 1). While there are signs that productivity may be improving in at least some countries and in certain sectors,21.According to the McKinsey Global Institute, American productivity ranks first in the world and continues to grow rapidly. See The Economist 1996.
21 unemployment remains a problem in nearly every Western jurisdiction with the notable exceptions of the United States of America, New Zealand, and the United Kingdom.

Undoubtedly there are many factors responsible for both the aggregate productivity slowdown and rising unemployment rates. Economists have devoted considerable effort trying to understand these phenomena (Romer 1987; Bailey and Gordon 1988; Griliches 1988; Grey 1987; Bruno 1984; Darby 1984). While no consensus has emerged, there is a growing body of evidence that suggests that structural factors are a major part of the story: labour market rigidities-institutional arrangements, laws, and conventions that prevent the labour market from clearing-may be partly to blame for both rising unemployment and stagnant productivity (Grubel 1988; Daly and MacCharles 1986; OECD 1994c).

Labour: supply and demand

At the heart of the structural explanation of unemployment is the standard supply-and-demand framework that is found in most introductory microeconomics courses (e.g. Gunderson and Riddell 1988). In this framework, labour demand is a decreasing function of the real wage. Optimal behaviour on the part of firms (which, of course, are the source of labour demand) requires that the value of the marginal product of labour equal the real wage. Since, for a given level of capital and other inputs, labour is subject to declining marginal product (i.e. diminishing returns), labour demand must vary negatively with the real wage. This is simply the law of demand applied to the labour market.

In contrast, labour supply is (at least to a point) an increasing function of the real wage. Other things being the same, a higher real wage raises the relative cost of leisure; as a result, workers will be induced to spend more time in the labour force (or perhaps, enter the labour force for the first time) and less time doing other things. This "substitution effect" of moving from leisure into work is simply a rational response on the part of optimizing workers to changing relative prices. Of course, this is not the end of the story. If real wages are sufficiently high, a rational worker might choose to enjoy both more leisure and a higher income. This "income effect" operates in the opposite direction of the "substitution effect" and works to reduce labour supply when the real wage rises (Gunderson and Riddell 1988).

If changes in the real wage induce both substitution and income effects, then why is it that we have argued that labour supply is indeed a positive function of the real wage? -because, for the vast majority of individuals who fall within the middle-income group, higher real wages do induce more labour supply. A "backward-bending" labour supply schedule (i.e. one in which the income effect dominates the substitution effect) is only likely to be the case for workers with very high incomes. In contrast, an upward sloping labour-supply curve (one in which the substitution effect dominates the income effect) is true for most middle-income individuals and is particularly true for lower-income individuals, women, and minority groups (Heckman 1993). Hence, for aggregate purposes, it seems reasonable to assume that higher real wages raise labour supply.

The labour market is said to clear-or achieve equilibrium-at the real wage that equates labour demand and labour supply. Equilibrium in the labour market implies that all those workers who want to find work are able to do so at the given wage rate; it also implies that firms are able to hire all the workers they need at the wage rate. When the labour market is not in equilibrium, the real wage adjusts so as to equate demand and supply. As in all markets, prices-the wage rate in the current context-are the means through which the decentralized actions of individuals and firms are coordinated.

Structural causes of unemployment

Given this partial-equilibrium framework, it is possible to understand how structural rigidities may be responsible for rising unemployment rates. Minimum wage laws that artificially raise the real wage will induce firms to switch from relatively expensive labour to relatively cheap capital; such laws also increase labour supply by raising the price of leisure. Since the minimum wage is fixed by law, it cannot adjust to equate labour supply with labour demand. The result is an excess supply of workers and unemployment for those workers whose productivity is below the minimum wage (The literature on the effects of minimum wages on employment is enormous. For example, see Stigler 1946; Gramlich 1976; Rottemburg 1981; Linneman 1981; Neumark and Wascher 1992; Ernst and Young 1995).

Payroll taxes, employment equity laws, and laws that strengthen union power have a similar impact on the labour market. Payroll taxes and employment equity laws raise the relative price of labour as an input in the production process. (For the effects of payroll taxes on employment, see OECD 1994c; De Matteo and Shannon 1995; Parker 1995; for the effects of employment equity laws, see Block and Walker 1982). Laws that give unions an unfair advantage in the bargaining process will enable unions to bid wages to uncompetitive levels.22.Blanchflower and Freeman 1992. BlanchFlower and Freeman estimate that in the United States and Canada, compensation for unionized workers was between 18 to 20 percent higher than that for nonunionized workers, even after controlling for skilled workers. More findings to this effect are reported in OECD 1994d.
22 In an effort to minimize costs, firms will cut back on their labour demand and direct money into other, cheaper inputs. The result, of course, is a decreased demand for labour at any given real wage. Unemployment results.

There is a large body of empirical evidence that shows that labour-market rigidities of the sort outlined above have a detrimental impact on both employment and productivity growth. It is a well established fact that excessively high minimum wages are a cause of unemployment, particularly among young and unskilled workers (Stigler 1946; Gramlich 1976; Rottemburg 1981; Linneman 1981; Neumark and Wascher 1992; Ernst and Young 1995). For instance, economists Shannon and Beach found that the 1991 increase in Ontario's minimum wage reduced the number of jobs, and disproportionately hurt young and part-time workers in retail sales and hotel and food services (1995). In a recent survey article, labour economist Barry Hirsh reviews the empirical evidence on the effects of unionization on economic performance (1997). The general findings from this literature suggest that excessive union power erodes productivity and profits and reduces investment and employment growth. The literature on the effects of payroll taxes suggests a similar conclusion: payroll taxes "kill" jobs. Estimates using Canadian data suggest that payroll tax increases are a major cause of rising national unemployment rates.23.De Matteo and Shannon (1995) estimate that a 1 percent increase in payroll taxes raises real wage costs to employers by 0.56 percent and reduces employment by 0.32 percent. Parker (1995) estimates that increases in payroll taxes from 1991 to 1994 may have reduced employment by 1 percent.
23 Finally, employment equity laws do very little to reduce discrimination and introduce many job-destroying rigidities into the labour market (Block and Walker 1982). Indeed, the work of Nobel Laureate Gary Becker is most instructive in this regard: in a competitive market, "arbitrary discrimination"24.Discrimination not based on differences in productivity (i.e. non-economic discrimination)
24 on the part of employers is unlikely to persist since it is costly for firms to practice such discrimination. In other words, the forces of the market work to penalize those employers who discriminate arbitrarily.25.Becker 1957; for a very readable summary of Becker's work on discrimination, see Chiswick 1995
25 Employment equity laws may not only be harmful; they may also be unnecessary.

Hence, the overall lesson for labour policy to be drawn here is as follows. The optimal labour market policy-that most likely to be consistent with low unemployment and rising productivity growth-is that which introduces the fewest rigidities into the labour market. International comparisons are instructive in this regard. The United States of America, with the most flexible labour market of all major industrial economies, has among the lowest unemployment rates and highest productivity growth rates in the world.26.According to a study by the McKinsey Global Institute (1993), America's labour productivity exceeds Germany and Japan's in several industries.
26 In contrast, the European Union, which has one of the most highly regulated and rigid labour markets, stagnates with double digit unemployment rates and very sluggish rates of productivity growth.27.OECD 1994c. Economist Charles Hanson captures the European experience quite succinctly: "What can we learn from the EU? That unduly high wages and work benefits coupled with an excess of regulation can severely damage the labour market and create mass unemployment." Hanson 1996: 16.
27 While a flexible labour market policy alone may be insufficient to explain the gap between American and European unemployment rates, it is clear that a flexible labour market policy is a necessary condition for sustained job growth and productivity improvements.

Labour policy in Ontario

Since taking office in the spring of 1995, the Harris government has pursued a number of labour market reforms that will increase the flexibility of the Ontario labour market; these changes will, in turn, reduce the structural unemployment problem that is so pervasive among Western economies. Some of the major labour market reforms introduced by the Harris government are as follows:

•       Repeal of the 1993 Employment Equity Act (Globe and Mail 1997h: A4B). As noted earlier, employment equity laws are not an effective means of reducing discrimination in the workplace. The natural forces of competition are the best way to induce employers to stop discriminating along arbitrary lines (Sowell 1981; Chiswick 1995). Imposition of legislated guidelines on the hiring decisions of employers can only serve to raise the costs of hiring and cause economic misallocation. Furthermore, such laws violate the fundamental freedom of employers to make their own decisions regarding the operation of their enterprises (Epstein 1992).

•       Freeze of the minimum wage (Ontario, Ministry of Labour 1995). At $6.85 per hour, Ontario has one of the highest minimum wages in North America. The Harris government's decision to freeze the minimum wage indefinitely must be applauded since it is well known that minimum wage laws reduce employment growth and are detrimental to the job prospects of the most vulnerable members of the labour force.

•       Curbing the excessive influence of unions. Through Bill 7, the Ontario government has amended the Labour Relations Act so that employers can now hire replacement workers in the event of a strike (Ontario, Ministry of Labour 1995). This is undoubtedly a positive development as it will give firms greater flexibility to continue operations in the event of a work stoppage. Since the Ontario economy operates within a global environment, work stoppages and other supply bottlenecks reduce the competitiveness of firms operating in Ontario. Furthermore, the amendments to the Labour Relations Act requiring a secret ballot for votes on strikes, ratification, certification, and decertification will reduce the coercive influence of union leaders over their constituents (Ontario, Ministry of Labour 1995). If unions are to be truly democratic institutions, union members must be free to express their preferences without being subject to undue influence from union bosses. The Ontario government deserves credit for taking measures to protect the right of unionized workers to express their interests in a less coercive environment.

Policy analysis

Both theory and evidence suggest that economies with less rigid labour markets produce more jobs and experience greater productivity gains than economies with more rigid labour markets. The Ontario government must be applauded for taking steps to reduce job-destroying labour-market rigidities. However, it still has a long way to go. Towards this end, we recommend that the Ontario government adopt the following proposals:

•       Eliminate the minimum wage. Since it is a well established fact that minimum wages do more harm than good, why have one in the first place? If the labour market is to clear, there should be no impediments to the natural adjustment of real wages to changing conditions of demand and supply. If the young, less productive, and most vulnerable members of the labour force are to improve their lot, they must be able to find employment. We do no justice to these individuals by outpricing them in an already competitive labour market.

•       Repeal the Labour Relations Act and pass Right-to-Work (RTW) legislation. If the Ontario government is truly to liberate the labour market from the shackles of excessive regulation, it must eliminate the monopoly power over labour supply that unions currently have in certain industries. Under a RTW law, all unions are forced to become voluntary organizations because such legislation allows employees to negotiate contracts with employers or seek other representation on an individual basis. This would introduce greater flexibility into the workplace and would force unions to become more responsive to the interests of their members. Furthermore, there is a large body of evidence which shows that jurisdictions with RTW laws experience faster economic growth and lower unemployment rates precisely because RTW laws increase the flexibility of the workplace (Mihlar 1997). If Ontario is to remain competitive on the world stage, it should implement a RTW law.

•       Reform the Workers Compensation Board of Ontario (WCB). With unfunded liabilities totaling $10.9 billion, the WCB of Ontario is in serious financial trouble and is the most severely underfunded WCB in Canada (Business Council of British Columbia 1996). Efforts must be made to put the WCB of Ontario on a more secure financial basis. Furthermore, significant reforms must be introduced in order to improve the efficiency of the WCB. In particular, premiums (which are a tax on labour, and hence, on jobs) must be reduced, benefit levels must be cut, and provisions aiding workers to return to work must be strengthened. At the moment, the Ontario government is studying reform options for the WCB. Definitive action is required here.

Conclusion

Although much more work needs to be done, we must acknowledge that the Ontario government is heading in the right direction with respect to its labour-market policies.28.The recent decision by the Ontario government not to impose a temporary ban on the right of public-sector employees to strike is commendable. The freedom to strike is an integral part of the right to collective bargaining. It is important, however, to note that the recent changes to the labour code allowing employers to hire replacement workers in the event of a strike or lock-out do not apply to the public sector. Given that the public sector has a monopoly over many of the services it supplies, the government should have the ability to hire replacement workers so that public services supplied to taxpayers will not be disrupted. Hence, we suggest that the option to have replacement workers be extended to public-sector employers as well.
28 The reforms implemented by the Ontario government to date will definitely help alleviate the structurally induced unemployment problem in Ontario. However, if these gains are to be maximized, the Ontario government must adopt the proposals outlined above. We award the Ontario government a B+ for its labour-market policies.


Health Policy

Economics and health care

Economics is the science of how individuals make choices in the presence of scarce resources and unlimited wants. Choices about health care-how it should be delivered and financed-are necessarily economic choices since health care involves the use of resources that carry a positive opportunity cost. Unfortunately, in the Canadian context, economic principles-principles that, if applied, would improve the efficiency and effectiveness of our health-care system-have been ignored in the debate over health care. Instead, the focus of the debate has been ideologically driven, and issues relating to cost and efficiency have been little considered.

Markets versus government

Most economists would argue that, under certain conditions, the market is the "best" mechanism by which society can allocate resources (Gwartney and Stroup 1993). Markets produce a system of relative prices, and the price-system is an extremely efficient way of coordinating the actions of decentralized economic agents (Hayek 1945). Certainly the market does not always give us the first-best outcome from the perspective of economic efficiency. Sometimes, prices do not always completely convey costs and benefits.29.When prices do not fully convey costs and benefits, we say that there exists an "externality." This constitutes a "market failure." For a classic presentation of this argument, see Bator 1958.
29 On other occasions, uncertainty and incomplete information can cause inefficiencies.30.Optimality also requires complete information on the part of all economic agents. Incomplete information is also a source of market failure (Bator 1958).
30 The fact that markets are imperfect, however, does not constitute a sufficient argument for command and control methods of allocation. That the market does not always guarantee a first-best outcome does not mean that the government can.31.The inability of governments to correct market failures, or for that matter, to behave in a manner consistent with overall economic efficiency is known as "government failure." For a discussion of the problems of government failure, see Wolf 1993; Mitchell and Simmons 1994.
31

The provision and financing of health care in Canada is skewed away from markets and towards government command and control. If the extent to which the market guides the allocation of resources can be approximated by the presence of prices, it is clear that the determination of how resources are allocated in the Canadian health-care sector is largely in the hands of government, as there are very few prices charged for health care services. Under the Canada Health Act, health care in Canada is a single-payer, fee-per-service system. Since the single payer is the state, consumers are not charged for their consumption of most health care services. Suppliers of medical services-physicians, physiotherapists, optometrists, and so on-bill the government for each service rendered at a rate fixed by the government. Hence, market prices do not emerge as a mechanism for resource allocation.

Since consumers in Canada are not, in general, charged a price for their consumption of medical care, there is no incentive on the part of individuals to curtail their use of medical goods. However, since health-care budgets are finite and set by governments, it is obviously impossible to satisfy this demand for health care. As a result, governments have been forced gradually to de-list many medical procedures and long queues have emerged for many elective procedures.32.Ramsay and Walker 1997. Ramsay and Walker estimate that the average time that patients in Ontario waited for an appointment with a specialist (after having seen a GP) was 4.7 weeks in 1996. The average time waited for treatment after an appointment with a specialist was 5.6 weeks.
32 Rationing by waiting is now the unofficial, de facto allocative instrument in the Canadian system of universal health care.

Demand curves slope downwards

The emergence of waiting lists should not come as a surprise to anyone familiar with economic theory. A fundamental principle of economics is the "law of demand," which tells us that, all other things held constant, the quantity demanded of a particular good rises as the price of that good falls. This well established fact applies with equal force to the market for health care: as the relative price of health care falls, people consume more of it. Hence, if the price of health care is extremely small, we would expect the demand for health care to be extremely large.

That the "law of demand" should apply to health care is not only intuitively obvious; it also receives a great deal of empirical support. Perhaps the most decisive empirical test of this proposition was provided by the RAND Corporation in its famous Health Insurance Experiment (HIE) (Newhouse and the Health Insurance Group 1994). Researchers at RAND observed the behaviour of families who received varying degrees of health insurance over several years. Some families received complete insurance for routine medical expenses; these families paid essentially a zero price for health care. Other families received partial coverage for their health care expenses; these co-insured households paid a positive price for their health care expenses. What researchers at RAND found was that families that received more health insurance consumed more health care. In other words, as the price for routine medical expenses rises, people consume less health care. Moving households from full insurance to co-insurance has the effect of reducing consumption of health care services. In other words, the demand curve for health care slopes downwards.

That this should be the case is not, in itself, surprising. Incentives matter and it is not clear why the incentives that apply to every other market should not apply to health care. The more interesting finding of the RAND Health Insurance Experiment was that, with a few exceptions, individuals' consumption of routine medical expenses was unrelated to their health (Newhouse et al. 1994). In other words, individuals who were charged positive prices for health care did not experience significantly worse health than individuals who received "free" health care. Positive prices for routine medical expenses do not induce most individuals to "under-consume" health care services.33.Newhouse et al. 1994. The only groups that suffered adverse health as a result of co-insurance were the very poor, the mentally disabled, and the chronically ill. Combined, these groups make up a very small percentage of the total population. Clearly, co-insurance is a viable option for the vast majority of individuals.
33 Charging prices for medical services is therefore not inconsistent with good health for the population at large.

Lessons for Canada

The RAND experiment and other health care studies from abroad suggest the following broad lessons for health care policy makers in Canada:

•Co-insurance for routine medical services is a viable way to improve the efficiency of health care demand without adverse effects on health (Newhouse et al. 1994).

•Competition among suppliers of health care tends to reduce costs and raise production efficiencies. In other words, government monopoly in health-care supply is likely to be inefficient; and competition between government suppliers of health care and private suppliers is likely to improve standards of care and reduce costs (Ramsay, McArthur, and Walker 1996). This lesson is true for virtually every other market; why should it not apply with equal force to health care? Indeed, liberalizing the supply of medical services would not only improve allocative efficiency but, over time, it would also enable the health-care sector to become an engine of economic growth.

Health policy in Ontario

Ontario's health care policy is not so much a health care policy as a "cost control" policy. In the 1996 budget, the Ontario government froze health care spending at $17.4 billion for 5 years, promising to improve the efficiency of each dollar spent on health care by reducing overlap and duplication.34.Ontario, Ministry of Finance 1996b. Note that the government of Ontario raised spending on health care in the 1997 budget to $17.8 billion.
34 Under Bill 26, the Savings and Restructuring Act, the Ontario government set up a Health Services Restructuring Commission that has broad powers to restructure hospitals and root out inefficiencies in the health care system. Towards this end, the Commission has proposed the closure or merger of several hospitals and has redirected funds within the health budget towards community care, dialysis, breast cancer screening and other procedures.35.Ontario, Ministry of Health 1995. The Ontario government plans to close down 24 hospitals in total (Maclean's 1997b).
35 It is hoped that these changes will enable the government of Ontario to provide better health care for less.

The Ontario government deserves some credit for pursuing this strategy. Clearly, there are inefficiencies within the health care system that can be eliminated by such restructuring. For instance, it has been estimated that as much as one-third of hospital capacity in Ontario is unused. Over the past decade, nearly 9,000 hospital beds were eliminated in Ontario but not a single hospital was shut down (Ontario, Ministry of Health 1995). Indeed, within Metro Toronto alone, there are 40 percent fewer acute-care beds today than 10 years ago but no fewer hospitals (Globe and Mail 1997c). By closing down and merging several hospitals, the Health Services Restructuring Commission is acting in the best interests of Ontario taxpayers. It makes no sense for the taxpayer to continue funding bricks and mortar that have no measurable impact on the health of the population.

Fundamental change is wanting

Unfortunately, cutting costs by reducing overlap and duplication is only window dressing and does little to solve the underlying problems inherent in our present medical system. Closing down a hospital and redirecting funds from less utilized services to more utilized services may result in some short-term savings. However, in the long run, it does not address the fundamental problem with the Canadian system of universal health care: the absence of prices and competition.

If prices are not allowed to signal how resources are to be allocated in the health care sector, then government fiat becomes the allocative instrument. Unfortunately, government fiat is an extremely inefficient way to determine the allocation of resources because government lacks the information necessary for "rational economic calculation" (Hayek 1945) and is subject to political forces that undermine its best efforts to spend wisely.36.This is the problem of "government failure." See Wolf 1993 and Mitchell and Simmons 1994.
36 Because of demographic factors37.As is well known, Canada's population is aging. Since consumption of health care generally rises with age, an increase in the average of the population will likely result in higher total health costs.
37 and the absence of proper incentives, the natural tendency is for health costs to rise dramatically. In their efforts to contain these costs, governments will seek to impose further controls on the health care sector. Viewed from this perspective, the Hospital Services Restructuring Commission and the various proposals being floated in Ontario to control where new physicians can practice (Globe and Mail 1996a) are more a symptom of than a cure for the health care dilemma.

Policy proposals

It is only by liberating the health care market that the Ontario government will be able to achieve its real objective of improving the quality of health care at a reasonable price. Given the current situation, controls are necessary, but there is nothing inevitable or inescapable about the status quo. If the government of Ontario truly wishes to improve health care, it should allow prices to play a larger role in the allocation of health care resources. Furthermore, it should permit greater competition among health-care providers. The evidence suggests that the presence of prices and competition in the health-care sector will inject a much needed dosage of economic rationality into the allocative process without compromising standards of care or the health of the population. Indeed, the experience of the United Kingdom and New Zealand with respect to health-care reform is most instructive in this regard (Ramsey, McArthur and Walker 1996). Until quite recently, both countries had health-care systems very similar to Canada's.38.Indeed, it is worth noting that Canada's system of universal health care was fashioned after the UK's National Health Service.
38 Faced with escalating costs, long waiting lists, and declining service quality, both the United Kingdom and New Zealand liberalized their health-care sectors by allowing private market forces to play a greater role. Today, government and the private sector compete to provide health-care services in both countries.39.In fact, according to Tim Evans of the Independent Healthcare Association in the United Kingdom, roughly 17 percent of the British population has some kind of private medical or health insurance. See Pollard and Evans 1996.
39 Health-care budgets have become more manageable, service quality and choice have improved, and waiting lists have been shortened. Thus, there is empirical evidence that greater competition can only benefit the health care sector.

In light of the evidence presented above, we suggest that the Ontario government adopt the following policy proposals:

•       Ignore the Canada Health Act. As a result of the Canada Health Act, the federal government is able to punish financially provinces that deviate from the federal vision of health care as a single-payer system controlled and operated by government. Ontario need not worry too much about such sanctions because (1) Ontario receives less per resident than most other provinces (with the exception of Alberta) in federal transfers for health care (Ontario, Ministry of Finance 1997a), and (2) the trend towards greater decentralization will result in greater reductions in federal spending (particularly for the wealthier provinces) on health care.40.See Boessenkool 1996. Boessenkool estimates that by fiscal year 2002/03, Ontario will receive $43 less per capita below the equal transfers per-capita benchmark for a total cash loss of over $500 million.
40 If the federal government is no longer paying for health care, why should it be able to determine how the health-care system should be run? Unthinking obedience to the principles of the Canada Health Act may be politically expedient in the short run but, in the long run, it compromises the best interests of Ontarians.

•       Set up a system of Medical Premium Accounts (MPA).41.For more details on how MPAs work, see Goodman. and Musgrave 1992.
41 The results from the RAND Corporation's Health Insurance Experiment suggest that co-insurance for basic medical procedures is the best way to improve the efficiency of health-care demand without compromising health. One way to implement a system of co-insurance is for the government to allot all funds for health care to the consumer directly through an MPA. Under such a system, each individual has an MPA that is divided into two parts. One part is used to fund a catastrophic insurance plan, the other is used to pay for routine medical expenses (i.e. trips to the general practitioner, chiropractor, pharmaceutical expenses, etc.) for which consumers will be charged prices. Under such a system, competitive forces can play a role in providing health care. Consumers will have the option to use the MPA wherever they like, improving service quality and efficiency since the presence of competition and prices will make the costs of health care more apparent to both producers and consumers. Finally, the provision of government-funded catastrophic insurance will ensure that no one is bankrupted by major illnesses.

Conclusion

The ideology of health care in Canada is this. Government can and must provide health care at a zero price to consumers. If market forces are allowed to determine the allocation of health-care resources in Canada, the poor and defenceless will be outpriced and will not be able to afford high quality health care. As a result, the health of many Canadians would be compromised.

The reality of health care is as follows. The individual's consumption of health care is sensitive to price; higher prices discourage demand. However, the empirical evidence does not suggest that lower demand will cause health to deteriorate. Most individuals do not "under-consume" health care when charged a price for it. Hence, the emergence of prices and market forces need not be inconsistent with good health for the public at large.

If prices are not charged, rationing and government control become the allocative instrument. The evidence from around the world suggests that government control is not an efficient way to determine the allocation of real economic resources In the end, government control is self defeating-it begets more controls that, in turn, reduce efficiency and result in an even greater need for controls. "Restructuring commissions" with wide sweeping powers should be viewed as a symptom of rather than a cure for this deeper problem.

The Ontario government deserves some credit for trying to improve the efficiency of tax dollars devoted to health care. However, its overall approach to health care is misguided. For failing to address the real problems that plague the Canadian system of universal health care, the Harris government deserves a C for its health care policy.


Education Policy

Economics of education

Most economists would agree that government has a role to play in the market for education. Education-in particular, primary and secondary schooling-is an activity in which social benefits are likely to exceed private benefits. Certainly each of us benefits privately from being more educated; higher levels of education may improve one's skills and enable one to earn a higher income and enjoy a higher standard of living. A convincing case can be made, however, that society as a whole also benefits when each individual has a basic level of education. A more literate society may be a more law-abiding and civil society. We are all better off when our neighbours are "better citizens." Hence, because education confers benefits that accrue not only to the person being educated but also to society at large, society has an interest in ensuring that each person receives at least a basic level of education.42.This is not likely to be the case for higher levels of education as the returns to a university education are almost entirely captured as higher future income by the person being educated. Hence, the rationale for government intervention in the market for higher education is much weaker. See Constantos and West 1991.
42

Another way of stating this proposition is as follows: the social rates of return on basic schooling exceed the private rates of return (Easton 1988). In a free market, economic actors will undertake an activity until private marginal benefits equal private marginal costs. Efficiency, however, requires that social marginal benefits and social marginal costs be equated. Since the social benefits of basic schooling exceed the private benefits, a free market in basic education may result in too little schooling taking place (i.e. an under-investment in education). The existence of such "external benefits" may provide a (partial) rationale for government intervention in the market for basic education.43.In the jargon of economists, basic levels of education generate positive "externalities." The presence of externalities constitutes a "market failure" and this has traditionally been used as a justification for government intervention. See Baumol 1965 and Bator 1958.
43

The role of government in education

That government may have a role to play in the market for education, however, does not establish precisely what that role should be. In theory, there are many ways governments can intervene in the education market.44.See Easton 1988 for an overview of the Canadian experience.
44 It can simply finance education, giving money or vouchers to parents with children and allow parents to choose among private-sector suppliers. Or, it can finance and provide education through a system of schools owned and operated by the government. Or, it can allow some mix of private and public provision and financing. In Ontario, the second approach to primary and secondary schooling has dominated educational policy. The Ontario government finances and provides schooling for the majority of students in Ontario. In other words, the public sector has a virtual monopoly in the provision of basic schooling.45.This is not, of course, strictly the case. There are private schools in Ontario, most of which charge tuition. Further, school taxes can be directed towards the Catholic public schools as well as the secular public schools. The public sector, however, has a near monopoly over schooling since public-sector schools do not charge tuition and have greater access to government funds than do private institutions. Parents who send their children to private schools must pay tuition in addition to school property taxes.
45

Unfortunately, this approach to schooling has proven to be both costly and ineffective. Ontario taxpayers pay more per student than the average of the 9 other provinces-$644 more per student-and, although the ratio of students to teacher are lower in Ontario than in any other Canadian province (Ontario, Office of the Premier 1996a), this additional spending has not been reflected in the education received by students. For instance, test results from the Third International Math and Science Study show that Ontario students are below the Canadian average in math and science skills (Maclean's 1997a). Clearly, Ontario's education dollars are not being well spent.

The failure of schooling financed and operated by the state is not unique to Ontario. State-controlled education dominates educational policies in most Canadian provinces and the results are usually the same: government-run schools are expensive and do not serve the interests of students and parents well. There is widespread dissatisfaction across Canada with the public-school system and provincial governments across the country are under pressure to change the status quo.

Monopoly: the cause of failure

The failure of the public-school system has its roots in its monopolistic position (Gardner 1996; Raham 1996). The monopoly enjoyed by the public-school system in Ontario makes it unresponsive to change. When educational policy is standardized by public-sector officials in Toronto, a one-size-fits-all approach to schooling tends to emerge since this approach is easier to administer from a bureaucratic perspective. Clearly, however, no single approach to education will be appropriate for all students, given the diversity in talents and endowments present in the population at large. The result, unfortunately, is that few students will receive the type of schooling they need and deserve. A one-size-fits-all approach to schooling stifles the experimentation and diversity that would make schooling more responsive to the needs of individual students. Choice and competition are compromised for the sake of bureaucratic ease.

Furthermore, when government has a monopoly over the provision of schools, the school system ceases to be accountable to its customers, the parents and students. In the absence of choice and competition, educational policy can be set without the approval of parents. Whole programs and pedagogies can appear or disappear at the whim of administrators without the consent of parents.46.Consider, for instance, British Columbia's experiment with "child-centered" learning.
46 In addition, since there are no published statistics on how well students are taught in different schools, parents have no way of knowing which schools are better and which are worse, with the result that supply becomes detached from demand: the suppliers of education produce a product and the demanders of that product must buy whether they like it or not.

Ontario's education policy

Since taking office in 1995, the Ontario government's education policy has been a "cost control" policy. As noted earlier, Ontario spends more per student for primary and secondary schooling than most Canadian provinces with no appreciable improvement in the education of its students. During the decade from 1985 to 1995, school enrollment rose by 16 percent but the real value of school property taxes increased by over 80 percent (Harris 1997). While part of this increase can be accounted for by lower student-to teacher ratios, much of it is due to a large and inefficient educational bureaucracy of school board trustees, administrators, and so on.

In an effort to contain these costs, the Ontario government is taking aim at the educational bureaucracy. In particular, it is cutting the number of school boards from 166 to 66, capping school trustee salaries at $5,000, reducing the total number of school trustees by two-thirds, and pursuing a number of other measures to root out overlap, duplication, and other inefficiencies (Ontario, Ministry of Municipal Affairs and Housing 1997a). These are positive initiatives as they will ensure that more education dollars go to classrooms as opposed to bureaucrats and administrators. Furthermore, responsibility for funding the school system will be transferred from municipalities to the provincial government. This will curb the upward spiral in school property taxes.

The Harris government has also implemented a number of reforms that will improve the accountability of the school system. Every school will be required to have an advisory school council. Annual reports will be published by the Ministry of Education, which will enable parents to monitor the performance of local school boards (Ontario, Ministry of Municipal Affairs and Housing 1997a). In addition, the Ontario government will be the first in Canada to introduce comprehensive testing of students (PCPO 1996). The move towards comprehensive testing is a welcome development since it will facilitate monitoring of basic educational standards.

Policy analysis

Cost control is necessary but, in itself, will not solve the problems inherent in the school system. If the Ontario government is truly interested in improving the quality and efficiency of the Ontario school system, it must liberate the market for education and end the virtual monopoly enjoyed by public schools. It is only through choice and competition that the diverse needs of different students can be met. And the only way to introduce competition and choice into the educational system is to enable other types of schools to enter into the educational market.

The "way ahead" is to end the monopoly of the public-school system. The state should stop providing universal primary and secondary schooling and restrict its role to that of a financier, letting parents, community groups, churches, teachers-in short, the private sector-provide the education. The state should certainly provide some minimum curriculum standards, and testing should be used where possible to ensure that these standards are met, particularly in core subjects such as math, science, and language instruction. Furthermore, performance statistics should be made readily available to parents so as to enhance accountability and, in doing so, enable parents to make informed choices as to which schools are best for their children. However, within this broad framework, there should be no limit as to what sort of schools could emerge. Competition and choice will act to ensure that the diverse needs and interests of individuals are better served.

A voucher system is perhaps the best way to liberate the market for schooling.47.The voucher system was first proposed by Friedman (1962). In the United States, vouchers are sometimes called "educational opportunity scholarships." For details on American experiments with school vouchers, see Hanks 1997.
47 Under a voucher system, the government finances education by giving all parents a voucher for the education of their children. Parents are free to take this voucher to the educational institution of their choice. The provision of education is then left to the private sector, which will offer schooling in exchange for vouchers (which the school can then redeem for cash from the provincial government). Schools are free to charge fees greater or less than the voucher value. Parents must make up the difference if total fees exceed the value of the voucher. Competition for students among private suppliers of education-associations of like-minded teachers and parents, churches, community groups-will ensure that a wide variety of educational products is available. This will improve the match between supply and demand.

Charter schools provide another way to liberate the market for schooling (Raham 1996; Freedman 1996). Interested groups can apply for a government charter to establish their own schools. Such chartered schools receive from the province a subsidy per student roughly equal to that paid to public schools. Parents are free to send their children either to public schools or to charter schools. Since private-sector groups run these charter schools, a wider range of school types will emerge, and a degree of choice and competition is introduced into the market for education as the charter schools will have to innovate in order to attract students.

Evidence from around the world suggests that choice among schools-either through school vouchers or charter schools-is the most effective way to improve educational outcomes and reduce costs. Charter schools compete with public schools in both New Zealand and the United Kingdom. Test scores suggest that students in charter schools perform better in standardized exams than their cohorts in public schools. Furthermore, charter schools can often revitalize schooling in poor regions; charter schools in several American inner cities have much lower drop-out rates and boast higher academic achievement records than public inner city schools (Raham 1996: 13-14). Finally, the data also suggest that school choice reduces educational costs; data from various jurisdictions suggest that charter schools are more efficiently run than public schools (Raham 1996; Freedman 1996). Clearly, the way to revitalize schooling is to end the public-school monopoly and give parents the right to choose where their children go to school.

Policy proposals

Given the benefits of choice in schools, we recommend that the Ontario government adopt the following policy proposals.

•Redirect all spending on education directly to parents through a system of vouchers as the best way to liberate the supply of education while at the same time ensuring that all students have access to education. Competition and choice among schools will raise educational achievements, improve student and parent satisfaction with the school system, and allow innovation and diversity to flourish.

•Alternatively, the Ontario government can pass charter-school legislation allowing interested groups to set up their own schools and receive funding from the government per student at levels equal to that received by public schools. The introduction of charter schools will stimulate innovation and diversity within the school system since charter schools must compete with public schools for students. Charter schools, however, do not offer the same flexibility as vouchers since, with a voucher system, schools can charge fees in excess of the value of the voucher. This allows for greater product diversity since not all types of programs will cost the same. In contrast, charter schools are not allowed to charge fees and hence, may be more restricted in terms of their ability to develop new programs. Still, the introduction of charter schools would be a vast improvement over the status quo, as it would enable parents a greater degree of choice than the current system.

•       In order to maximize the benefits of either a voucher system or a charter school system, the closed-shop union privileges of the Ontario Teachers Federation (OTF) must be eliminated. All teachers in possession of a teaching certificate from an accredited institution should be eligible to teach; membership in the OTF must not be a barrier to entry into the teaching profession. Furthermore, the monopoly power of the OTF over the supply of teachers must be curbed in order to allow more flexible hiring and promotion-under the OTF, teachers are rewarded on the basis of seniority, not teaching performance. Allowing schools to experiment with different methods of determining salaries-for instance, performance-based pay-will introduce greater flexibility and efficiency into the system by improving the incentives faced by teachers.

Conclusion

The Ontario government deserves credit for trying to improve the effectiveness of tax dollars spent on education. School choice-either through a voucher system or the introduction of charter schools-is the next step. There is still much to be done. Nonetheless, for having the courage to take on the educational bureaucracy, reduce spiraling costs, and improve the accountability of the public school system, the Ontario government deserves a C for its educational policies.

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Last Modified: Wednesday, October 20, 1999.