Universities should have skin in the HECS game [May 30, 2014]

By Rabee Tourky On May 30, 2014 · 29 Comments

NOTES: This is a post written by Pitchford and Tourky 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.

Rohan Pitchford and Rabee Tourky

The proposed change to HECS made in the recent budget doesn’t seem
to have been well thought out. It is likely that there will be
extensive deliberations, perhaps an enquiry, before major changes
to HECS are implemented. In this post we propose that in any future
HECS type of deferred payment scheme universities (including private
institutions) should share the risk associated with deferred payments
by students. In particular, we propose that universities receive
a share of student repayments when they are made and not before
students pay their HECS debt. So if a student delays a repayment,
full payment to the alma mater is also delayed. In the extreme case
where a student’s lifetime income remains below the repayment
threshold, then the alma mater does not get the full fee for educating
the student.

There are a number of reasons why our ‘skin in the game’ proposal
makes sense. Having `skin in the game’ is likely to make universities
think hard about the courses they offer, about how they educate
students, about what it means to provide good teaching (focusing
on value added rather than the deprecated system of student
evaluations). Having `skin in the game’ will also likely improve
university governance, we shall return to that particular topic in
a future post.

Here we will talk about a framework to think about these advantages. It’s
necessary to go into a little bit of detail about the nature of the
economic problem of human capital acquisition via higher education.
There is a population of high school students of varying abilities
and interests, who are looking to invest in their human capital in
order to reap a return, monetary and personal, throughout their
working life. Then there are educational institutions — call them
universities for want of a better term — which provide instruction
to these students. The student-university pairing can be thought
of as a project team, and the problem that presents itself to society
is how can we fund this project?

A traditional answer to this was purely private funding, i.e. to
let the student fund the project in its entirety. The problem with
this solution is that private lenders are unwilling to provide
finance, because human capital cannot be used as collateral and it
is therefore very difficult for such lenders to extract a return
from their loan. The alternative source of finance — parents — would
be problematic from both an efficiency and an equity perspective
because talented children from low income families would be excluded.
The polar solution of pure tax-payer funded education with no fees
is perhaps even more problematic: children who have the ability to
finish university tend to earn much higher than average salaries.
Distorting taxes paid by those with less income earning potential,
are raised to pay for students with much higher such potential.

Enter the HECS system of deferred payment. It enforces repayment
through the tax system, thus getting around the problem of purely
private funding. This partially alleviates the the cross subsidy
problem of tax-payer funded education; only partially, because it
is subsidised in two ways. One is that those below a certain income
do not have to repay. The other is through a interest subsidy. The
government also capped university fees to ensure that it can contain
universities’ thirst for funds would not blow the budget.

But now the world has changed. The government is planning to remove
the fee cap and open HECS up to private institutions. This creates
a new and very serious issue: How can the government ensure that
educational institutions are delivering the right kind of education?
For the sake of argument, we will take the right kind of education
to mean one that leads to a good job. (Of course, education gives
more than this: there is a consumption component and a social
externality component, but these can be dealt with through subsidy.)

Universities have a particular advantage over students in that we
have intimate knowledge of our courses, we get feedback concerning
student placement in jobs, and we can adjust our curriculum
accordingly. But how can universities be given an incentive to
provide a good education? This is where our notion of skin in the
game is important. Universities are, in a sense, equity partners
of an investment project in student human capital, but Universities
bear only a modest penalty if we fail our end of the bargain, of
providing degrees that lead to good jobs. At the moment this only
happens through student demand for courses. A stronger incentive
is provided by our proposed deferred funding scheme: Universities
receive a share of student repayments, i.e. they obtain funds only
if they have provided an education that results in a “good” job,
meaning one that delivers income above some threshold. If we fall
below this standard, we don’t receive anything.