Students are not ideal borrowers. With low or no income and few assets, they struggle to put up collateral and have historically not been serviced well by the finance industry. And as the cost of education has risen over the years, the state has stepped in and provided students with loans to cover the rising fees. Over time, the volume of outstanding student debt has risen to staggering totals. 45 million American graduates and undergraduates owe USD 1.6 trillion. In the UK, the total debt is a more modest £120 billion and is growing by around £16 billion each year. The average British student graduates with more than £50,000 in debt, though not all of that is provided via government.
Of course, how much notional debt you have is actually irrelevant. What counts is how much you have to repay. And under the UK system, debt repayment is linked to future income. At the moment, repayments are taken out of any earnings above roughly £26,000 a year at a rate of 9% until the debt is paid off. After 30 years, any remaining debt is written off.
This resembles an Income Share Agreement (ISA), a private contract where an investor funds a student’s education against a claim on a part of the future income post graduation. This is the approach suggested by Milton Friedman in his 1955 essay ‘The Role of Government in Education’, and Several US colleges already facilitates ISA programmes.
As an ISA does not provide the lender with a fixed income, it can be compared to an equity investment in the student, who sells part of his future work efforts against an upfront cash amount. Of course, private investors will expect a return. Under an ISA, students in fields with lower expected earnings cannot expect the same terms as students who expect higher salaries upon graduation. At Purdue University, who runs an ISA programme, students pay the investor a fixed percentage of post-graduation salary for 112 months. The higher your expected earnings, the more you can borrow. This is a major and important distinction from government programmes. A public education system (like in the UK) extends loans to all students, irrespective of future earnings potential. This creates a problem: those who chose a degree leading to a low-earning career pay less for their education than those who chose one leading to a high-earning one. In other words, education that improves productivity is more expensive than education that doesn’t. This means an overdemand for some of the more exotic humanities or arts studies but it also allows for inferior quality education for flourish. This is evident in the UK, where not only Oxford and Cambridge, but many other less prestigious institutions charge the maximum $9,250 a year. Students who cannot get into a top university may be less price sensitive when choosing a 2nd best option than an investor would be. Allowing a free market for education would flush out the underperforming institutions who provide degrees that fail to deliver in the jobs market.
Today, the overwhelming consensus is that government plays a crucial role in facilitating equitable access to higher education and that a private market would make it available only to the privileged few. But the case against government involvement in education is strong. We have previously described how government education has led to an over consumption of education and a damaging ‘qualification inflation’ which perversely hurts those at the bottom rung of the social ladder. We have also described how government guarantees has ignited the explosion in student debt. Add to that the perverse incentives as described above: uncritical state funding of education guides students to degrees that fail to improve productivity. ISAs are not a blanket solution to a complex issue, but coupled with alumni donations, scholarships, grants and corporate sponsorships they provide an alternative to the government system. Private money always seek the best returns. Allowing businesses and private investors to guide resources to the degrees that are in demand and provides the highest salaries would create a market for education with a focus on delivering value for money for both students and those who fund them.