Financing Education Sustainably – There is a Way

Recently, less recently, even less recently, and on many other occasions has the financing of education been an issue. Costs have grown too high, now after decades of expanding welfare states a structural economic recession seems to have set in. In many countries tuition fees have been raised and students are entitled to less and smaller allowances from the government. This raises an issue of equity: children of poorer families might have smaller and fewer opportunities to enjoy a good education. It also raises an issue of underinvestment in education: too many might decide not to enroll in schools because of the massive debts they would accumulate.

Last year on LSE I have been taught welfare economics by Nicholas Barr. He proposed a, well, solution to the whole issue that is surprisingly simple. Honestly, I have no idea why it has not been implemented yet. The idea is as follows. Yes, students should pay for a larger share of their own education, but education should be free at the point of use, so that it does not (really) matter how large your budget is. The trick is to not require students to pay for their education before or while they are enjoying it, but after. They should pay a certain percentage of their income, until the costs of the enjoyed study are paid back, perhaps plus a small premium. Arrangements can be made fairly easily to accommodate some freedom of choice, e.g. to allow for quicker repayments. This way, those who enjoyed education pay for it (instead of the general tax-payer), which relieves the financing burden of education systems for governments. But also, if you don’t have the money to pay back your education costs, you don’t have to. You pay when you can. This way, scarily large student debts will not deter those who want to from enrolling in a desired university.

A simplified depiction of an expected life cycle of consumption and saving

It also makes sense, looking at the graph above. The great majority of potential students is expected to earn plenty of income – most of their lives they will earn more than they will spend. Only during their teens and early twenties are they expected to spend more than they will earn. With governments becoming less and less willing to subsidise education, students will have to get the money from other sources – not all of them have wealthy parents who are willing to step in. Banks are only reluctantly willing to give out loans, since they face an information problem: they don’t know whether the student, who is often too young to have built up a track record of credibility, will live up to the terms of the loan. Moreover, there is often no collateral. Student loans will therefore either not be given, or at high interest rates to compensate for the risks, which would greatly enlarge the risk of personal bankruptcy. Using a system as described above, all these problems disappear. When graduates start earning, they have plenty of income that can taxed by a personalised “education tax”.

One may raise the argument that there might be students who just start studying because they need not pay it back anyway, and who will fail to pay back the entire amount. Although it is a legitimate argument, I find it weak. I don’t believe that a significant share of talented students will not try to find a decent job if they can. Moreover, the percentage of the income that is taken out for paying back the study expenditures should, at default, be kept relatively low (definitely not higher than 5%), so that incentives are only minimally distorted (if at all).

The catch for governments may be one of information and discipline. Firstly, a funding gap should not be allowed to develop by exploding education costs – when current educational expenditures are much higher than current repayments. Moreover, universities must somehow determine what the costs of its programmes actually are. And they don’t like to do that, since university closets may house some skeletons. This is a major, extra advantage of such a system: it would impose credible and serious discipline on universities, which in the past have been notably opaque and ill-disciplined with regard to reporting how they spend their budgets.

This plan addresses yet another issue, which Barr does not mention, and surprisingly few others do (I am not aware of anyone who does or did, but I am sure that they are out there). In the Netherlands and several other European countries tuition fees are, basically, equal across studies. Whether you study economics, math, or medicine, you pay the same yearly tuition fee (provided that you have not delayed your studies too much). I have always found this strange, because one of the main reasons education is subsidised is that it results in positive externalities: a better educated population will be characterised by higher welfare levels, especially when considering future welfare levels, since education is believed to be a crucial ingredient to sustained economic growth.

Increased education thus leads to increased wealth. From the point of view of the student, this increased wealth can be decomposed in two parts: a public and a private part. The public part is that part that truly benefits (the rest of) society. These externalities are, theoretically, not taken into account by the individual who enjoys the additional education, because he or she cannot charge society for the additional wealth. But there is also a private part; this is the part that benefits the individual, most notably because of higher wages. At least theoretically, government need should not subsidise education because of private ‘externalities’, but only to the extent to which it leads to positive public externalities.

Recalling that tuition fees are basically equal, is it the case that, for instance, those studying to become a doctor, a teacher, or a business consultant will yield an equal amount of positive externalities for society? I don’t know the exact numbers, but I am pretty sure that those studying anything related to business will, for instance, have a higher expected wage level, whereas I wonder whether the public externalities are very large. In any case, it seems right that those earning more because of larger expected private ‘externalities’ will contribute more as well, perhaps to a certain limit equal to the (estimated) costs of the study he or she enjoyed plus a small premium. The plan roughly outlined above could be easily adapted to incorporate this, since those who particularly enjoy private ‘externalities’ have the income to pay (back) for their education.

There is however (at least) one catch to this plan. How do we treat those who enjoy education in one country, and leave at some point after graduation, before the costs have been paid back? The plan might prove to be an incentive for educated people to leave the country. Whatever the goal of government policies, it cannot be to chase away the educated! Firstly, public support may exist to prevent a race-to-the-bottom (see for instance the problem that the Belgian government pays for the education of Dutch students, who come to Belgium because of lower tuition fees), and thus to facilitate that those who moved still pay back for the education expenditures. Secondly, a contractual agreement may be signed, that is honoured internationally. So, moving graduates need not be a problem.

Perhaps I am missing out on some subtleties, or some not-so-subtle subtleties, and if so, please let me know. As the title suggests, there is a way to let students enjoy a good education (without bankrupting them), which, after all, is key to a bright future.

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