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In Germany, for Creative Writing, I have written a persuasive essay about the financing of Higher Education.
Redefining the Role of Government in University Funding
Higher education is going through a phase of change across the developed world. While in the US students struggle to pay back their loans, budget restraints force Europe to undo the paths that led it to have "free" education. As policies change, the dilemma between tuition fees and tax-financed education comes back to life. I will explain why any of the extremes is undesirable, and how a mixed solution brings the bests results in terms of efficiency, funding, and fairness.
Before dealing with the dilemma, it is better to clarify what tuition fees are. I will call tuition fees all payments students have to make to their university in order to study in it, either as they are studying or after they have completed their studies. The difference between fees that have to be paid every semester and those which are paid after completing studies is crucial. We will call the former upfront fees, and the latter deferred fees, following the terminology used in recent literature.
In order to answer the main question of the essay, we must first understand what the criteria for choosing between public or private financing of goods is. Nobel Laureate Paul Samuelson determined it already in 1954: goods whose benefits spill over entirely to society should be paid by the State. If the good benefits only the person who consumes it, it should be privately financed.
Under free competition, prices reflect the costs of production, and if there are no spillover effects, these costs in turn reflect cost for society as a whole. Making a good "free" would make consumers face a price lower than the real one, and overconsume.
With spillover effects, cost for society is the cost for producers minus the spillover effect. Therefore market prices, which equal costs of production, are above the real cost, leading to underconsumption. For example, if we made people pay for vaccines themselves, some would choose not to take them because they think infection is unlikely. They ignore the benefit the rest of society has, that is, that they can't pass their disease on someone else. They would choose the best solution for themselves but not for everyone.
This raises the question: Who profits from higher education? It is clear that society as a whole profits from having well-educated masses. However, graduates themselves also profit from it because they get higher wages. Therefore theory itself tells us that the government should pay a part of the costs, neither all nor none of them.
Those in favor of a tax-financed system have come to believe that it is a fairer system, because the lack of tuition fees helps the poor go to college. Yet a sober analysis of the matter reveals that this cannot be further from the truth. The reason is that even in countries where no tuition fees are charged, students mostly come from middle and upper-middle class families. According to a recent study by the Education and Skills Select Committee in the UK, 81% of the children from professional background go into higher education, far more than the 15% figure corresponding to children from unskilled backgrounds. However, everyone pays taxes. This implies that the poorer families end up paying for the education of wealthier students. A system with no tuition fees fosters social inequality.
But tuition in the form of upfront fees also has problems. It is also unequal. Wealthy families can simply pay them in cash. Middle class families can get a loan at a reasonable rate by using their homes as collateral. Poor families are left out.
A system fully funded by taxes has a practical problem as well. The State has several services to provide, but it has limited resources. Higher education is rarely among its priorities. Moreover, as higher education becomes more complex and more massive, the resources required to keep it running increase. These are the reasons countries which have relied only on taxes to finance their higher education have seen a steady decline in real funding per student, as in the UK and Australia. Canada and Sweden are not poorer than the US, but their universities are far worse-off economically. A system funded only by taxes is an underfunded system.
A system based on upfront fees also underfunds the system, because it leaves people out.
For most people it does not make sense to pay for their degree while they are studying. It would be much better to focus on studying and postpone the payment until after graduation, to have deferred fees. As graduates they would make more money and be able to pay the fees more easily. Poorer students could take loans to cover living expenses as well, making the demand for these loans even larger. But if there is this huge demand, where is the supply? There is none.
The failure in the student loan market was studied by another Nobel Laureate, Milton Friedman, back in 1962. The problem lies in the fact that if a graduate defaults his debt, the lender can simply do nothing. In a mortgage, if the lender does not pay the bank gets the house, but if a graduate defaults, the bank cannot get his education back and sell it to someone else. This makes the loan much riskier, and this risk premium makes the interest banks would have to charge much larger, making repayment almost impossible.
The State can fix this; it can provide the loans itself and deduct the payments from the graduates' paycheck every year. The costs of running this loan agency are mostly fixed, so it makes sense to have one single credit agency, since having two would double the cost per student.
But loans can turn out to be a burden in the future, as the experience of the US and lately Chile shows. This problem is easily avoidable and was provided by Friedman in his 1962 paper: Income-contingent loans. Friedman then realized that if the bank cannot resale the graduates' education, then why not take the additional income provided by their degrees. And that is how income contingent loans work: you pay back depending on how high your income is. It is like a "graduate tax" but one that ends when your pay back everything you owe. Graduates with low earnings would pay little of their income, and might even end up not paying back their loan in full during their lifetime. Graduates with higher incomes would face higher payments.
The application of the solution to international students is not straightforward. A distinction must be made for the international students who will not use what they have learned in the home country, but will work and live in a foreign nation. Their situation is different in two ways. Firstly, the latter do not make the home society profit from their education, or at least not as much as home student. The second difference regards the enforcement of the loan system: the German government will find it much more difficult to make a student working in Malaysia pay back her student loan as one living in Heilbronn.
The first problem would require the home state to pay a smaller proportion of the costs of education, since it does not get all the spillover effects. The second problem would lead the State to charge a higher interest rate reflecting the higher risk of the loans to compensate for risk.
The first-best solution for both problems would be for the foreign nation to have a system identical as the one in the home nation. The foreign nation would pay a part of the fees to compensate for the spillover effects in its society, and would provide the income-contingent loans. There would be financial transactions between the states, and the student would have to worry about nothing. This can be set up can easily among European nations, which already have a similar system for social security. Second-best solutions such as making the student pay for most of the tuition fees upfront will have to be taken for nations with which the home country has not signed a coordination agreement.
If the international student decides to work and live in the home country, then these problems do not arise. There is no reason why they shouldn't be a part of the system for national students.
This arrangement is efficient; it makes students face the real cost of education by making taxpayers pay for the spillover effects. This arrangement keeps the system well-funded; the burden is made lighter by distributing it among graduates and taxpayers. This arrangement is fair; it allows those with no current income to take a loan for all their expenses and makes the wealthier graduates pay more. This arrangement is a first-best solution.
As the attentive reader surely has noticed, the theory behind it has existed for decades: The private and public nature of higher education dates back to the 1950s, income-contingent loans to the 1960s. The only explanation for the delay in its application lies in misunderstandings of the problem, most notably the misguided belief that tax-based financing provides equal opportunity, making any changes on the financing of higher education politically costly. A minister from a Nordic country even used the word "taboo" to describe the discussion of tuition fees. Thankfully, policy makers around the world, for example the 2003 UK White Paper on Higher education, are finally seeing past slogans and are enacting the proposals included in this paper. It is only a matter of time until the rest of the world follows suit.