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.