Tuesday, October 19, 2010

Rethinking college tuition and student loans

Britain and Ireland currently go through much soul searching on how to reform the financing of higher education. As for health care, education is becoming more expensive as it is a service, which we do not know yet to scale well, while manufacturing has benefited from tremendous improvements in mass-production and can be relocated to where it is the most efficient. If higher education is becoming more expensive, who should pay for it? Obviously, there is a large private benefit to getting an university degree. Thus the student should also pay a large share. There is a social benefit as well, as a well educated workforce brings all sorts of positive externalities, which means that society should subsidize higher education as well. But not too much, as these subsidies are regressive: while rich people pay more taxes, they benefits even more from higher education subsidies, as their children are more likely to attend university and stay there longer. But if university tuition is so expensive, what to do with those students who are credit constrained? Should they get subsidies, loans, or just deal with it?

Neil Shephard suggests a complete overhaul of the system. Here are its components:

  1. Students are charged the full cost of their education by universities.
  2. They get an explicit scholarship from the government for part of this tuition. This makes is visible that the state is helping.
  3. Students have the option of deferring the payments to the universities. As the universities are taking the risk when a student could default or make little money, they will make sure students will get a good education (and not admit students who should not go to college).
  4. This means that universities will make loans to their students. These loans should also cover living expenses.

I think this is a very good programme. It essentially boils down to students borrowing against future income, and seeing how the return to education is vastly superior to the financial cost, they should want to take this opportunity as long as there is a market. Universities are the ones providing this market and they are incentivized to provide a good educational product.

The suggestion is in fact very similar to the credit products that MyRichUncle offered before the financial crisis in the United States: it gave loans to students against a share of future income for a set time. The loan amount was determined by student performance and major, thus taking into account the expected value of a university degree. With the Shephard proposal, it is up to the university to provide this value.

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