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May 1, 2011

Why Choice Should Not Be Stifled in Schools or Markets

The lottery ball drops from its cage and rolls to a stop. A number is called out. One young mother leaps with joy, while another holds her head in despair. The recent documentaries Waiting for Superman and The Lottery covered agonizing selection scenes where a few lucky kids win the prize of going to a charter school. The rest will end up languishingin the failing local school, waiting in vain for someone to come rescue them.

 But Superman is unlikely to save the day, due to a successful decades-long campaign by teacher unions to oppose competition and parent choice at all costs. Since the truth would not make for great union protest chants ("Raise my pension plan, not your kid's attention span!"), teacher unions instead make two basic arguments: (1) that charter schools are not as good as they claim to be, and (2) that they are bad for society because they divert students and dollars away from the core public schools.

Fighting choice is always tough politically, but if you have a weaker product, sometimes it's your only hope. And so I wasn't all that surprised when several exchanges across the globe began calling for the demise of dark pools in the wake of the "flash crash," using eerily similar logic to the unions arguing against charter schools.

Dark pools are in many ways the charter schools of the trading world-innovative niche venues aimed at those seeking an alternative to the default markets. In the U.S., Rosenblatt Securities estimates that 13 percent of trading has migrated to dark pools, up from only 4 percent three years ago. Like parents fleeing public schools, investors are increasingly choosing to flee public markets. Opponents of alternative markets make almost identical arguments to those of the teacher unions as they watch their customers increasingly heading for the hills: (1) that dark pools are not as good as they claim to be, and (2) that dark pools are bad for society because they divert liquidity away from the core public markets.

Imagine for a moment that we lived in a world where the party that was losing customers, whether public schools or public markets, took a long hard look in the mirror, rather than seeking a regulatory solution to shut their competition down. In this imaginary world, the teacher unions would realize their policies sometimes don't cater to the needs of the children, and the exchanges would realize their policies sometimes don't cater to the needs of long-term investors.

The underlying problem driving customers away is a culture that doesn't reward quality. Teacher unions violently oppose merit pay, and so the schools have evolved into egalitarian paradises where no one need fear discrimination based on their lack of teaching ability. Similarly, at most of the world's exchanges, no attempt is made to evaluate or incentivize based on the quality of order flow.

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