Economics of the war on Australian undergraduates [Sept 2015]

BY RABEE TOURKY ON SEPTEMBER 17, 2015 · 24 COMMENTS

NOTES: This is a post written following the 2014 federal budget announcement, we opposed the budgetary measure for the higher education sector, which was aimed at maintaining the income contingent loan scheme for student fees (paid by students and government) and at the same time have universities set the fees. We anticipated that this will incentivise universities in bad ways. Thankfully, the scheme proposed by the government and supported by universities was not implemented.

An issue that has perplexed me over the last few weeks is why do the top universities in Australia continue teaching Australian undergraduates when the fees they get from these undergraduates are far lower than foreign fees. Further, there is no doubt in my mind that given the intense competition for hugely expensive research prestige; top Australian universities will be focused on maximising profit in their undergraduate production activity.

Let’s look at some (simplifying) features of the market for undergraduate education:

1. Australian universities are essentially price takers when it comes to the fees they charge international undergraduate students. So we are in a classical small open economy setting, which we may reasonably assume is perfectly competitive.
2. The international price for undergraduate degrees is higher than the equilibrium local price that would emerge in the counterfactual closed economy setting. So education is an export market.
3. All Australian undergraduate fees are channeled through the HECS income contingent scheme. This tells us that local demand for undergraduate degrees is not price sensitive and can in the (relevant region) be taken to be perfectly price inelastic. An important feature of income contingent schemes.
4. The supply curve for undergraduate education is strictly upward sloping. Indicating increasing marginal cost of educating undergraduates (basically this is not a capacity constraints model with perfectly elastic supply or perfectly inelastic supply). I’d venture the view that supply is presently in the inelastic region.

I’ll look at three situations, two of which compete in my mind for models representing what we presently have (which of the two fits better is one of those rare empirical questions that embarrassingly rear their heads in economics because of indeterminacy of modelling).

A. Deregulated HECS fees (Pyne May 2014)

A world with deregulated fees can be described by the following demand-supply diagram that appears in various contexts in first year economics classes (outside the US I guess, because I don’t think that anyone there is interested in small open economies):

• In a setting where HECS fees are unregulated Australian students pay the same as international students for their degrees, and that price is set by international markets. All demand by Australian students is met, and the number of international students is determined by the marginal cost of educating them and world prices.

B. Demand driven system with capped fees (one version of the status-quo since 2012)

Here the government caps fees charged to local students. The government imposes a price ceiling for domestic prices, which at present can be around one fourth of international prices. This is similar to the kinds of price ceilings in Venezuela on the domestic prices of exportable goods such as petrol and toilet paper. As in Venezuela the expectation is that local suppliers will want to shift all supply to the export market.

• One anticipates that Universities will want to reduce the number of low-fee paying domestic places and specialise exclusively in international student education. So like Venezuela we are likely to see acute shortage in undergraduate education for local students.

C. Demand driven system with capped fees and forced supply (second version of the status-quo since 2012)

As mentioned above, there is no explicit minimum quota on the number of Australian undergraduates that a university must educate. So a university can, thinking hypothetically, reduce the number of Australian undergraduate place to zero (unlike the situation of a public hospital that may wish to specialise in providing care to private patients).

So imagine for now a move to force universities to educate Australian undergraduates. That is force universities to supply Australian undergraduate education at the same level as they would have had they been able to increase local fees to international levels. This is illustrated below in our diagram:

• With forced supply the university teaches the same number of local and international students as it would have in a deregulated market. Further, because the local demand curve is perfectly inelastic (due to HECS), forced supply results in a subsidy to local students (indicated by area A) and no deadweight loss (no efficiency loss).

For an economist the most alluring feature of the income contingent loan system is precisely the price insensitivity of demand under HECS. This allows subsidies (as above) that are not associated with efficiency losses (yuck).

A source of forced supply

Unfortunately, there is no explicit minimum quota for the number of Australian undergraduate places in Australian universities. Thus, I am perplexed. What is the mechanism of forced supply in our system? The only indirect mechanism that I am aware of is the following rule, which appears to be a social contract between Universities and the Australian public:

• A University must admit an Australian undergraduate if their high school score is higher than the high school score (equivalent score) of an admitted international student.

Thus, if a university prevents an Australian undergraduate from enrolling in a degree, it must prevent any less qualified international undergraduate from enrolling.

The obvious corollary is that a senior university administrator seeking to shift university education to more lucrative markets has one of two choices:

1. Break the nexus between the quality of the marginal international undergraduate student and the marginal Australian undergraduate. That is, admit lower quality international students and demand higher quality Australian students.
2. Shift education at the University away from undergraduate degrees placing an emphasis on fee paying masters degrees. Thus undermining our decades old free education system.