Perverse incentives in education

There are three types of goods and services in the world.

  • Information goods – these are goods and services where you can discover everything about the good or service in advance by acquiring information.
  • Experience goods – these are  goods and services where you can discover everything about the good or service through the experience of consuming them.
  • Credence goods – these are good and services where even after acquiring information and experiencing them you are still unsure about the the product.

Education is a credence good. We can never be sure that any given individual has benefited from the education they have received as opposed to raw talent. This is a problem because it becomes difficult to measure the value-add of university education.

Education has another interesting property. As a society we have decided that education should not be rationed by price or the ability to pay. Rather we believe that education at lower levels should be zero-price and compulsory. People can, and should, pay more than zero but that is the baseline expectation.  We have chosen education to be rationed by intellectual ability.  This choice has consequences.

  • If we ration by money and the ability to pay that means smart but poor kids receive less education. Human capital is being wasted.
  • If we ration by intellectual ability that means money is being wasted.

The problem here is that money can be measured precisely whereas human capital (or educational potential) cannot be measured precisely (if at all).  This then raises the problem of what is seen and unseen. What should we do about obvious waste?

So keep that idea at the back of your mind and consider another issue. It turns out that people becoming school teachers aren’t as academically talented today as they were some decades ago.  I’m going to suggest two possible reasons for this. First about a generation ago  women were largely excluded from the long-term workforce. Being a teacher, nurse or librarian were “acceptable” professions. Many of the women who today becomes lawyers and doctors etc. in the bad old days became teachers and nurses.  So labour market liberalisation resulted in smarter people gravitating to higher paying professions. Now we can quibble about the social consequences of this (I’m not convinced this is a huge problem) but generally that is how markets work and are supposed to work. The second reason being that the government used to provide scholarships for people to study teaching degrees. That meant that academically smart but poor people went to university and became teachers. As the financial burden of university education has decreased so that incentive structure has changed.

Okay – so why the long story?

Today in the Australian Steven Schwartz floats an idea that keeps reappearing in various guises.

Another way to encourage universities to improve the quality of graduates is to focus on the reason they are willing to accept poorly prepared students in the first place: money.

Students pay tuition fees to the university. These fees are funded by government-backed loans. Universities retain students’ fees regardless of whether graduates ever repay their loans.

Because universities bear none of the repayment risk, they are incentivised to accept poorly prepared students. If these students fail to repay their loans, it is the taxpayers — not the universities — who are stuck with the losses.

Formal examinations, government-mandated ATAR scores and capped places may increase teacher quality, but they all have significant drawbacks. The best way for government to improve the quality of graduates is to require universities to share the repayment risk associated with student loans.

Specifically, each university should be made liable for a portion of its students’ unpaid loans.

So there is a moral hazard problem in education. Okay – that is the price of not having education rationed by price and the ability to pay. That is a feature and not a bug of the current system.

Now there is a whole bunch of stuff in Steven’s proposal.  Ideas that a lot of people would be sympathetic to – may be too many people do go to uni. A lot of people make that argument – yet they quickly go silent when you suggest that they nominate people who should miss out on going.

Here are the important points:

  • Students pay tuition fees to the university. A lot of people forget this. Universities are not charities and not part of the welfare system. Universities sell education services to paying customers.
  •  These fees are funded by government-backed loans. That is the theory and the propaganda that we tell students. It should be a loan but in fact the HECS system works like a tax. I would like to see it actually become a loan scheme.
  •  Universities retain students’ fees regardless of whether graduates ever repay their loans. Well. Duh. Yes. Universities sell a service. Nobody takes their uneaten veggies back to supermarket demanding a refund simply because they didn’t eat them. Lenders assume risk. That is how the market works.
  •  Specifically, each university should be made liable for a portion of its students’ unpaid loans. This is the proposal. Universities should become banks.

I have met many, many university administrators over my career  – some of whom are even smart and competent. Yet I don’t think any of them should be bankers and, to their credit, I doubt any of them want to be bankers.

Banking is a risky business. Universities are notoriously risk averse and, as organisations, conservative. They would not be providing go-go finance but would become quite conservative in their lending decisions.

What might those lending decisions  look like?  I suspect we would see more offers being made to people more likely to repay their students loans. Middle class people and established Australian roots (that is a polite way of saying white Anglo-Celts). Anyone who has been reading Robert Gottliebsen in the Australian complaining about the current credit crunch  would recognise the sort of behaviour that would follow this proposal. Universities would stop taking a punt on people who may have done poorly in high school and then gone on to acquire some life skills or maturity or decided later in life what they wanted and so on.

This wouldn’t be rationing by price and ability to pay – easily observed, but rather ability to repay. Not so easily observed but likely to result in outcomes that are highly correlated with class and ethnicity. A more honest approach to rationing by ability to repay would be to let the actual banks run an actual loan scheme.

So while a lot of sensible people would be nodding their heads and agreeing with Steven – I suspect the actual outcomes of such a policy would not be palatable to the broader community.

Yes there are quality problems in the university system – those problems should be fixed through improved university governance not poor regulation.

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25 Responses to Perverse incentives in education

  1. AH

    How about abolish compulsory education, deregulate the curriculum and make primary and secondary school no longer free?

    Then all schools become private schools.

    Due to the absence of current “crowding-out” effect, there would emerge much greater variety of schools, catering to all manner of student needs and price points.

    Teachers would be much more subject to market demands. This would in turn create demand for more useful teacher training than is currently offered.

    People who choose teaching simply because the university entrance requirements are low would no longer find it to be a profitable career.

  2. Tim Neilson

    may be too many people do go to uni. A lot of people make that argument – yet they quickly go silent when you suggest that they nominate people who should miss out on going.

    Step 1 – people who are academically below average, unless they’re prepared to pay full cost recovery fees up front.
    People with ATARs below 50 are being accepted into unis and presumably getting HECS.
    That shouldn’t happen.

    Once we’ve got that into place we can discuss any further steps.

  3. Tim Neilson

    How about abolish compulsory education, deregulate the curriculum and make primary and secondary school no longer free?

    Then all schools become private schools.

    I was going to say that that would create a permanent multi-generation underclass of illiterate innumerate unemployables.

    But then I stopped to think about what’s already happening.

  4. Gibbo

    I can condense your concerns down a bit for you Sinclair.

    “Wasting Government money is terrible unless it’s on something that benefits me, then it’s just fine & dandy.” and “There is too much Government interference in Australia except for Education, where more Governance would fix things.”

    What’s that old saying about “always back the horse called self-interest”? This is exactly how we got the AGW scam. A great big bunch of folks who are happy to waste other folks’ money simply because it benefits them.

  5. HGS

    Hat AH said above. And it is all that really needs to be said.

  6. Lilliana

    “people who are academically below average, unless they’re prepared to pay full cost recovery fees up front.”
    Agree 100%
    Also all PC nonsense courses eg. women’s studies should be full fee up front and no HECS. If you are really keen then find the cash or a scholarship. I’m sick of paying for unemployable bleeding hearts.

    “create a permanent multi-generation underclass of illiterate innumerate unemployables”

    Too late – we are already there. Can’t do basic maths without a calculator and can’t write a coherent sentence – hell some of them can’t even speak their native language!

  7. Sinclair Davidson

    Gibbo – yes, yes. I’ve been telling people for years that I hope nobody finds out what a rort higher education is until I retire.

    More seriously – I’m setting out the arguments not my preferences. My preference is that students pay fees and finance their own education. University governance does need repair and again I’ve been saying for years that councils should be elected by alumni.

  8. Fisky

    Teachers would be much more subject to market demands. This would in turn create demand for more useful teacher training than is currently offered.

    Sounds great, but the worst edu-fads tend to originate in private consultancies flogging nonsense like “brain gym” and “21st century skills”, not in public schools or the education department.

  9. Fisky

    I should add – initial teacher training academics in the universities are also substantially to blame for imposing low-impact constructivist teaching fads. But schools and unions often outsource their training to private consultancies, who get paid huge $$$ to tell teachers:
    -Not to explain things clearly, but instead to “facilitate” learning
    -To do groupwork even when its completely irrelevant to the task
    -To avoid explicit teaching of knowledge and instead focus on content-free “skills”
    -To differentiate classes according to “learning styles”

    This is being pushed substantially by private educationalists, not the public sector.

  10. I have enjoyed the tertiary experience with many non-Australian, non-Anglo-Celtic ‘roots’ over the years – Chinese, Malaysian, Indonesian, German and Dutch et al. Wonderful stuff and not to be sneered at.

  11. Anthony

    I have met many, many university administrators over my career – some of whom are even smart and competent. Yet I don’t think any of them should be bankers and, to their credit, I doubt any of them want to be bankers.

    Banking is a risky business. Universities are notoriously risk averse and, as organisations, conservative. They would not be providing go-go finance but would become quite conservative in their lending decisions.

    Indeed. It may also lead to a more US-style education system in some ways. People who are more educated are more likely to repay a loan. But it’s a catch-22, you don’t earn that status until you get a degree the Uni won’t lend you money to study at. So, you go to a cheaper community college (or TAFE etc) to get another post-grad qualification. Then the Uni is willing to lend you money to complete the degree.

    There are other ways to encourage some skin in the game. Universities with their links to business and existing alumni networks might be better placed to be job placement agents rather than bankers. So, we could make government funding for future students dependent on the employability of their graduates.

    Another option that myself (and other commentators here) have suggested is that the ratio of HECS/HELP to Government (free) contribution varies according to employer demand for graduates. So, if 90% of Law students can’t find a job within 12 months of graduation the government contribution might fall to 5% and the other 95% is on HECS. Whereas say 100% of Medical graduates get a job then the government funds 50% of their course.

    All that aside, the logical option that is completely outside the Overton window is deregulation and let Universities set their own fees. The Commonwealth already has lifetime HECS caps of IIRC $100k for most courses and $150k for medicine. So, $200k degrees would result in students needing a bank loan. However, given there are 43 Universities in this country. Surely that is enough to keep fees down and most students could get a degree at a decent University for under $40k quite easily.

  12. Fisky

    Yes there are quality in the university system – those problems should be fixed through improved university governance not poor regulation.

    Banning immigration would do more for university quality than any other measure.

  13. I think we’re in furious agreement about a reform that has no chance of ever being legislated.

    Only competition will will present an alternative and some industries are do this by providing a managed career stream with a smaller component of university study.

    I have an acquaintance who’s son has got a job with an industrial developer who works full time and doing a part time uni degree in building construction management. He’s about to buy his first investment property. He’s a decade ahead of where I was at his age.

    Any industry that doesn’t want its future put into the hands of a bunch of pampered townie hipsters beholden to the trade union party might like to look at similar initiatives.

  14. Fisky

    Competition will not save the universities. What are they competing over? Larger shares of the international student market, for whom higher quality (i.e. more rigourous) courses would be an impediment to their real objective – getting PR.

    We should stop pretending to care about university quality under the current ponzi population model. Immigration or quality. Pick one.

  15. AH>>

    Due to the absence of current “crowding-out” effect, there would emerge much greater variety of schools, catering to all manner of student needs and price points.

    Teachers would be much more subject to market demands. This would in turn create demand for more useful teacher training than is currently offered.

    That’s the old fantasy of an infinite variety of schools being established within easy reach of everyone. Doesn’t happen. Nor do teacher training institutions set up new courses to cater for them. Can’t and won’t.

    The whole system would be improved, though, if there was a mechanism to eliminate teaching fads before they took root.

    Most people have forgotten – if they ever knew about – the report to the Whitlam Government by Peter Karmel, which is where the first big Commonwealth investment in education began. Look back on Karmel’s recommendations now and we see programs for “teacher improvement” courses, which, in the hands of the state bureaucracies and the unions, just meant extra short holidays from the classroom, and “innovations” at school level. There was a monster fleet of mini-buses running around Australia, every one of them an “innovation” in the eyes of the then Schools Commission.

    The only difference is that teachers and administrators were more competent than they are now, which tells you all you need to know.

  16. 2dogs

    Specifically, each university should be made liable for a portion of its students’ unpaid loans.

    Instead, fund places in courses in proportion to the rate of HECS repayment. If Engineering courses have 95% payback, increase engineering places. If basket weaving has 15% repayment, decrease basket weaving places.

  17. Tel

    Education is a credence good. We can never be sure that any given individual has benefited from the education they have received as opposed to raw talent.

    I disagree. On an individual basis, each individual can figure out whether he/she/they felt ripped off by the university experience. On both an individual and a group basis we can see whether the loans are getting paid back. That’s sufficient to classify as an “Experience good” by your subdivision and over time reputation handles the rest (although a university can liquidate it’s reputation if a bad actor gets into power but that’s a separate discussion).

    These fees are funded by government-backed loans. Universities retain students’ fees regardless of whether graduates ever repay their loans.

    Lack of skin in the game. Easy to identify.

    So there is a moral hazard problem in education. Okay – that is the price of not having education rationed by price and the ability to pay. That is a feature and not a bug of the current system.

    No that’s not the correct diagnosis. Lack of quality control in deliverables and risk falling on a third party (in this case the taxpayers) is the problem.

    Lenders assume risk. That is how the market works.

    Let’s see … you get a loan from the bank and you buy a car. Turns out the car has a major design defect and the accelerator gets stuck which kills people. So you go to the bank and say, “Hey you took the risk, I’m not paying my loan because this car is shit.”

    How about this one … you want to try your hand as a racehorse owner so you borrow from the bank and buy a horse, then you hire a trainer who trains the horse but it never wins any races … so that’s the bank’s fault obviously, couldn’t be a bad trainer.

    Or from the government’s perspective … you take you 16 year old civil slave (ohhh errr I mean “citizen”) and you hand he/she/they over to a university along with a wad of money and you say, “Here! Make me a taxpayer.” At age 21 the university hands said “citizen” back and say, “One taxpayer delivered, signed off with credentials.” Then no tax comes. Hmmmm, but all the paperwork is in place, what could have gone wrong.

    https://www.thebalancesmb.com/clawback-provisions-in-business-contracts-398185

    Read that, then we hand the word over to Infidel Tiger to have a play with.

    Clawback” ohhh that’s a fun word. Tiggers like Clawback best of all!

  18. Squirrel

    This taxpayer will be more relaxed about the very substantial (and likely to be somewhat more so after the next federal election) public resources devoted to post-secondary education when we stop hearing the constant refrain about skills shortages (usually as a prelude to/explanation for importing “scarce” skills) at the same time as we have a less than brilliant rate of unemployment and under-employment.

  19. Just Interested

    University governance does need repair and again I’ve been saying for years that councils should be elected by alumni.

    To the blog owner: agree that university governance requires repair but why would alumni be particularly better placed to determine councillors?

    Some people may get warm lumpy feelings about where they went to Uni but for the most part people couldn’t really much care about their uni once they have their quals,

    There is also no Australian tradition of people directly contributing to their alma mater and so there is an absence of even the little incentive of ensuring that their ‘investment’ isn’t being wasted through taking the time to vote for appropriate councillors.

    Just dunno that attending a uni somewhere once gives you an especial insight about the skill set necessary to set that university’s policy.

  20. Anthony

    why would alumni be particularly better placed to determine councillors?

    Because if the University produces bad graduates it devalues its reputation now and anyone holding a degree earned previously suffers that loss of reputation. Also, vice versa.

  21. Anthony

    To add to above comment. So, Alumni have skin in the game for the University leadership to be good.

  22. bespoke

    Alumni have skin in the game for the University leadership to be good.

    How is that working out for US University’s. Brick and mortar universities are becoming antiquated anyway with the internet.

  23. You don’t get to live in a fancy suburb unless there is available supply of housing and you can afford it.
    A university education should be no different.
    We are educating muppets in course with no societal value but purely to keep the statistics humming.
    And let’s not forget the enormous international student cash gravy train that is the modern Australian university.
    What are all these sheltered workshops going to do when courses are fully online so some third world donkey shepherd can do a Melbourne Uni yartz degree from his yurt?
    No need to attend a physical location at all.
    Everyone gets to play… it’s the ultimate in education equality.

  24. max

    it is time to close the universities and to abolish compulsory education.

    they are socialist institutions

  25. Kneel

    “We are educating muppets in course with no societal value…”

    It’s a self-fullfilling prophecy – a university degree gets you a better job, therefore I need to go to Uni and get that better job. If I can’t get into the medicine or law courses, I’m still better off with a degree, even if it IS in native basket weaving techniques – after all, if I don’t make use of my degree to get a better job, I don’t have to pay back the loan!

    Keeps the unemployment numbers lower too.

    The funny part is, that being a qualified tradie is probably going to pay more than what a PhD in womens studies can get in the real world, but the tradie will pay less for her education – hell, she’ll even be paid while she learns! Of course, it’ll be beneath many to talk to the tradie, them being not university edumacated and all, so they must be dumb, right? Just don’t look too closely at what they get paid…

    If you have kids of the age to be concerned, tell them to get a job as a sparkie or a plumber, is my advice – there’s a shortage and it’s getting worse. Good, honest work too.

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