Higher education

Higher education: returns are high but we need to fund it better

This week I was invited to speak at The Economist’s Higher Education Forum in New York to share my thoughts on how higher education can be expanded. I believe that we need a fair and sustainable cost-recovery model at the university level using future earnings to finance current education.

Over the past two decades, there has been a tremendous increase in the number of university students and graduates worldwide, which should have led to decrease in the rate of return to investment to higher education – if supply outpaced demand, of course. While there has been some decrease in overall rates of return, investment in education is still a highly profitable investment. Global demand for high levels skills such as working with new information and problem-solving has kept the returns to schooling high in even the poorest countries of the world. In fact, the returns to higher education are higher in lower-income countries – except in the Middle East and North Africa due to rigid labor market regulations.

There are significant wage returns associated with investments in education.  Yes, this is the case, even though the benefits of higher education are hotly debated.  Private returns to schooling has many benefits:

  • The global average private rate of return to schooling is 10 percent per year of schooling (with the highest returns in Sub-Saharan Africa!); 
  • The returns to schooling are higher for women; and
  • The private returns to university education are now higher than the returns to primary schooling.

However, these are private returns. For society’s well-being, one should calculate the ‘social rates’ of return, which include benefits accruing to the country beyond the individual’s wages and corrected for the substantial public cost of providing education. Typically, social rates of return to higher education are much lower (as a result of high public costs) and the returns to primary are higher (given lower public costs). (See, for example, Psacharopoulos and Patrinos 2004 | Montenegro and Patrinos 2014).

High private returns signal that tertiary education is a good private investment. The public priority, however, should not be a blanket subsidy for all. High returns to tertiary education may be the result of increased regressive funding, whereby the poorer finance the education of the rich. For society, it is much better to improve cost-recovery and use future earnings to finance current higher education.
Source: Montenegro and Patrinos 2014

Given an environment of high returns to university education, any lowering of the private cost of university actually implies that the general taxpayer (average income) pays for the education of the rich (above average income). In fact, the same (zero) price for all is inequitable. Most of the benefits of a higher education degree are appropriated by the graduate. In other words, higher education is not a public good.

Society still needs higher education graduates. Before increasing university funding, we need to plant incentives for the efficient and equitable use of funds. For efficiency, start with user selective fees near the social cost of higher education. For efficiency and equity, institute sustainable student loans; but different from those that have typically been used.

Given the increasing demand for higher education, the high private returns, the scarcity and injustice of increasing public funding, then we need to use future earnings to finance current education.  Typical student loans are unsustainable and penalize graduates too much. The current student debt in the United States is $1.4 trillion, with the average graduate owing $33,000.

It’s much more efficient to use ‘income contingent’ loan payments. Income contingent loans, which are available in countries like Australia, require payments based on income until the loan is repaid. Payments are sensitive to the student’s ability to pay through an adjustable repayment period. The return for the investor is fixed, but it can fall below the initial value of the loan if income is not enough to repay the loan during a long period of time.

A more private sector approach might involve human capital contracts – or income share agreements(see Lumni and Upstart), where payments depend on income until the repayment period ends.  Human capital contracts are a means of financing education through which investors finance students’ expenses in exchange for a percentage of students’ future earnings.  Lumni already provides such contracts for 7,000 students in Chile, Colombia, Mexico and Peru. The percentage of income and duration of payments is based on students’ expected earnings.  Upon graduation, each student will then pay X% of income for Y years for each $100 of support received.

Follow Harry Anthony Patrinos on Twitter at @hpatrinos

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