Funding universities

Guest Column in The Korean Times, 25 October 2015

By Harry Anthony Patrinos

There has been a tremendous increase in the number of university students and graduates.  This should have led to decrease in the rate of return to investment to higher education.  The returns to higher education are higher in most lower-income countries than they are in high income countries.  Global demand for high levels skills has kept the returns to schooling high in even the poorest countries of the world.

But there are significant salary increases associated with investments in education, especially higher education, in all regions of the world.  In fact, the global average private rate of return to schooling is 10 percent per year of schooling.  The returns are highest in Sub-Saharan Africa.  The returns to schooling are higher for women than for men, at all levels of schooling.  In a stunning reversal from previous patterns, the private returns to university education are now higher than the returns to primary schooling.  Again, these are private returns; what the graduate will realize net of any personal cost associated with attending school.  For society’s well-being, one should calculate “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 ― calculated using social costs since social benefits are much more difficult to come by ― are much lower (as a result of high public costs) and the returns to primary are higher (given relatively lower public costs).

High private returns signal that tertiary education is a good private investment.  The public priority, however, is not a blanket subsidy for all.  High returns to tertiary may be the result of increased regressive funding as much as an increase in the demand for high order skills.  For society, it is much better to improve cost-recovery and use future earnings to finance current higher education.

The implications of any funding change should be assessed based on efficiency and equity.  It is clear from many studies that education raises productivity.  But most of the gains are realized by individuals.  It is an assumption that high returns to schooling should result in increased public funding of universities and that this would lead to increased well-being. To maximize social welfare, one needs to take a more holistic approach.  That is, one needs to consider funding changes at the margin and to distinguish between public and private sources of finance.

Given an environment of high returns to university education, any lowering of the private cost of university actually implies that the general taxpayer (people with average incomes) pays for the education of the rich (people with above average incomes).  Inequity is the result of regressive public financing, whereby the poor finance the education of the rich.  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.

But society does need higher education graduates.  But 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 that what has 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. Current student debt in the United States of America, for example, is $1.4 trillion, with the average graduate owing $33,000).  It is much more efficient to use income contingent repayments.  Income contingent programs (used today in Australia, England, Ethiopia, Hungary, Korea, New Zealand, South Africa and the United States) 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, where payments depend on income until the repayment period ends.  Payments are sensitive to student’s ability to pay by adjusting the total amount paid by the student.  Investors participate in the good fortune of highly successful students that offset the low payments from low-income earners.  Human Capital Contracts are a means of financing education through which investors finance students’ expenses in exchange for a percentage of students’ future earnings.  The percentage of income and duration of payments is based on students’ expected earnings.  Upon graduation, each student will pay a percentage of their income for a specified number of years for the amount of support received.

Higher education should be expanded.  High returns to tertiary signal that university is a good private investment.  Therefore, we need a fair and sustainable cost-recovery model at the university level based on the principle of using future earnings to finance current education.

Harry Anthony Patrinos is a practice manager, education at the World Bank.