Over the summer holidays, we are revisiting some of our favourite articles from The Australian TAFE Teacher magazine.

At the request of the Council of Australian Governments, the Productivity Commission (PC) recently undertook an examination of the publicly funded VET system and VET workforce. The draft report made many recommendations that, if followed, will dramatically alter the funding mechanisms for VET, the working conditions of its employees and the economic incentives affecting teachers, TAFEs and private VET providers.

The key economic issues are first, the PC endorsement of current moves to extend competitive tendering of publicly funded VET and, second, the shift to an ‘outcomes’ based funding model.

These changes are based on a fundamentally flawed understanding of the economics of publicly funded VET. They will arguably result in reduced quality of training provision, more costly and burdensome VET regulation, and taxpayer exposure to significant financial risk.

The central problem with the PC endorsement of competitive tendering of publicly funded VET is that the two minimum conditions required for efficient contracting out do not exist.

Efficient market pricing relies on accurate information on the characteristics of the good or service being transacted and the quantities demanded and supplied. The PC’s own analysis in the draft report explicitly states that there are, as yet, no robust measures of “productivity, efficiency, effectiveness and quality” in publicly funded VET services available either in Australia or globally. The PC notes economists and statisticians have over the last 50 years failed to develop such metrics for intangible services such as ‘education’. (It recommends ‘more work’ be done to develop these indicators.)

This problem is compounded by the fact that there are multiple and, indeed, conflicting objectives imposed on the publicly funded VET system.

This makes it impossible to precisely relate VET inputs to VET outputs.

According to the PC the publicly funded VET system has three objectives: provide workforce skills, encourage maximum participation of the population in training, and promote social inclusion. Surely it is simple to assess whether the VET system is meeting workforce skills and for government to pay private providers to meet these skills? Not so. The PC notes that only 30 per cent of VET graduates are employed in an occupation directly related to their qualification. Is this evidence of skills mismatch or broadly skilled, flexible workers? Without precisely specifying the quantities of VET outputs and their quality, there is simply no basis – in economic theory or empirically – for arguing that contracting-out publicly funded VET will result in better or more efficient training provision.

The simplest way to cut through these profound theoretical and empirical barriers is to ignore them. The PC does this by proposing to shift from the present system of publicly funded VET, based on payment for hours of teaching delivered, to “outcomes based funding”. Payments are to be made for module or course completions or “number of students passed or firms serviced”.

The use of such crude metrics of VET system performance will create perverse incentives for teachers and training providers, both public and private. The PC notes that this funding model “could lead to some reduction in VET standards, if successful completions are paramount”. These perverse incentives will be intensified by the PC recommendation to introduce performance based pay for VET teachers. In the absence of productivity and quality metrics, VET teacher “performance” is likely to be measured by reductions in unit cost of delivery and increases in student graduations. Both can undermine quality.

There are many high quality and ethical private VET providers but there are also many stark examples of market and ethical failure in private VET provision. These include the recent foreign student debacle and the malfeasance on a grand scale revealed by NSW Independent Commission Against Corruption (ICAC) investigations into private VET training provision for construction equipment operators, residential house builders, structural engineers and the security industry. The ICAC noted corruption had become so extensive as to undermine the integrity of the VET system in the specific fields of training. Because they could not compete against corrupt providers who would guarantee an “outcome”, ethical operators were driven out of the industries.

Deregistration of VET providers by state training regulators are focussed overwhelmingly on private providers. Corruption and malfeasance, of course, do occur in public VET provision but the publicly available evidence suggests these problems reside primarily in private provision. The economics of VET explain why this is so. Many private VET providers are sole operators or have only a few employees, resulting in fewer internal controls and checks. There can be very low barriers to entry and low exit costs for operators. Qualification requirements for operators and teachers are either low or easily circumvented. And quality in VET provision is impossible to measure.

Contracts for private providers to deliver publicly funded VET are very short term with no certainty of renewal. This encourages opportunism and reduces the incentive to invest in the business. Deregistered providers can reappear as ‘phoenix’ operators. And as Bruce Baird observed in his review of the foreign student college debacle, “where profit is a key outcome from delivering education services, the quality of the service will at some point and for some providers come under pressure”.

The risks in extending competitive tendering of publicly funded VET can be reduced to some extent by more intrusive regulation of public and private VET providers. But this is the system chasing its tail – increasing the scale of publicly funded private provision requires imposing ever more stringent controls. The rising cost of regulation undermines the case for contracting-out, and as the PC states, form-filling associated with such monitoring is one of the reasons teachers leave the VET system.

In outsourcing delivery of essential services, such as workforce training, government cannot dissociate itself from the need to guarantee continuity of service supply or from bearing other costs arising from the financial failure of a private supplier. There are many Australian examples of these risks being realised, such as ABC Learning and the ‘renationalisation’ of privatised public transport systems and toll roads. Private agents contracted to supply essential services are aware of this implicit government guarantee. This creates a moral hazard or an incentive for the private agents to increase their risk preference – increasing the probability, and possibly scale, of the liabilities for which government may be responsible.

Publicly funded VET does not meet the minimum conditions required for efficient, competitive tendering. There is profound uncertainty about the quantity and quality of the goods and services being contracted out, and there are significant risks to the quality of the future workforce and public purse.

-Dr Phillip Toner is a senior research fellow with the Centre for Industry and Innovation Studies at the University of Western Sydney.

This article was originally published in the 22 March 2011 edition of Campus Review