Universities should have skin in the HECS game


With Rohan Pitchford.

The proposed change to HECS made in the recent budget doesn’t seem
to have been well thought out. It is likely that there will be
extensive deliberations, perhaps an enquiry, before major changes
to HECS are implemented. In this post we propose that in any future
HECS type of deferred payment scheme universities (including private
institutions) should share the risk associated with deferred payments
by students. In particular, we propose that universities receive
a share of student repayments when they are made and not before
students pay their HECS debt. So if a student delays a repayment,
full payment to the alma mater is also delayed. In the extreme case
where a student’s lifetime income remains below the repayment
threshold, then the alma mater does not get the full fee for educating
the student.

There are a number of reasons why our ‘skin in the game’ proposal
makes sense. Having `skin in the game’ is likely to make universities
think hard about the courses they offer, about how they educate
students, about what it means to provide good teaching (focusing
on value added rather than the deprecated system of student
evaluations). Having `skin in the game’ will also likely improve
university governance, we shall return to that particular topic in
a future post.

Here we will talk about a framework to think about these advantages. It’s
necessary to go into a little bit of detail about the nature of the
economic problem of human capital acquisition via higher education.
There is a population of high school students of varying abilities
and interests, who are looking to invest in their human capital in
order to reap a return, monetary and personal, throughout their
working life. Then there are educational institutions—call them
universities for want of a better term— which provide instruction
to these students. The student-university pairing can be thought
of as a project team, and the problem that presents itself to society
is how can we fund this project?

A traditional answer to this was purely private funding, i.e. to
let the student fund the project in its entirety. The problem with
this solution is that private lenders are unwilling to provide
finance, because human capital cannot be used as collateral and it
is therefore very difficult for such lenders to extract a return
from their loan. The alternative source of finance—parents—would
be problematic from both an efficiency and an equity perspective
because talented children from low income families would be excluded.
The polar solution of pure tax-payer funded education with no fees
is perhaps even more problematic: children who have the ability to
finish university tend to earn much higher than average salaries.
Distorting taxes paid by those with less income earning potential,
are raised to pay for students with much higher such potential.

Enter the HECS system of deferred payment. It enforces repayment
through the tax system, thus getting around the problem of purely
private funding. This partially alleviates the the cross subsidy
problem of tax-payer funded education; only partially, because it
is subsidised in two ways. One is that those below a certain income
do not have to repay. The other is through a interest subsidy. The
government also capped university fees to ensure that it can contain
universities’ thirst for funds would not blow the budget.

But now the world has changed. The government is planning to remove
the fee cap and open HECS up to private institutions. This creates
a new and very serious issue: How can the government ensure that
educational institutions are delivering the right kind of education?
For the sake of argument, we will take the right kind of education
to mean one that leads to a good job. (Of course, education gives
more than this: there is a consumption component and a social
externality component, but these can be dealt with through subsidy.)

Universities have a particular advantage over students in that we
have intimate knowledge of our courses, we get feedback concerning
student placement in jobs, and we can adjust our curriculum
accordingly. But how can universities be given an incentive to
provide a good education? This is where our notion of skin in the
game is important. Universities are, in a sense, equity partners
of an investment project in student human capital, but Universities
bear only a modest penalty if we fail our end of the bargain, of
providing degrees that lead to good jobs. At the moment this only
happens through student demand for courses. A stronger incentive
is provided by our proposed deferred funding scheme: Universities
receive a share of student repayments, i.e. they obtain funds only
if they have provided an education that results in a “good” job,
meaning one that delivers income above some threshold. If we fall
below this standard, we don’t receive anything.


31 Responses to "Universities should have skin in the HECS game"
    • Exactly – the Norton argument is that some women exit the labour market to become home makers and delay repayment – often permanently. Why shouldn’t uni’s just refuse to accept them.

      It isn’t just women – I would expect to see a lot of statistical discrimination occurring under such a model. Do we really want an education funding model that creates incentives for uni’s to only want to attract white males?

  1. Good point. Perhaps it provides an incentive to universities to discriminate. It also provides an incentive to discriminate based on other characteristics.

    I think that universities have to admit any Australian student who meets the enrolment criteria. I’m not sure if enrolments offices even know a prospective Australian student’s gender, parent’s income, race, medical history etc. I guess anti-discrimination laws are crucial here. So I’m now wondering if a university can develop instruments to get around these laws.

    • Of course, once enrolled it provides an incentive to universities to improve the quality of the education of all enrolled students. So all this has a lot to do with avoiding/preventing discrimination in the enrolment process, at the gate-keeper stage.

  2. It’s not clear to me what problem is being resolved by this proposal. Assuming we can get around the perverse incentives – this is effectively the uni’s loaning the money to their own paying customers with the customer having the option to default on the loan.

    • There are a number of issues being resolved. It mitigates the great incentives in universities to provide low quality, low cost, but entertaining education to students; and the massive institutional/administrative frameworks that have evolved in universities around these incentive.

      • Why does this proposal work better than having the students pay more for their own education?

        • First, our proposal doesn’t change the debt experience of the student. Students defer payment in our model.

          More broadly, it does better than simply paying upfront fees by way of university incentives to rip students off educationally. Students are not well informed about the value of the courses they take either ex ante or in the interim. They are badly informed when choosing the course/subject, and can remain so until well after university, until the value added of the course is realised. It takes a few years for them to make an assessment regarding how useful their education was at university.

          They may for instance be entertained in a course, joined that course because their friends said it was entertaining and good, leave thinking they got a good education, move to the workforce and realised that they have been taught nothing.

          Universities are better informed than students, clearly. You have professional (professionals and punters) educators and specialists that have worked for decades on cutting edge research problems in their area. They tend to be better informed about what students should know in their subject.

          • Universities are not unique in offering credence good for sale. In any event I suspect you’re over-selling the problem. After all people have been able to manage their careers and career choices for decades (if not centuries) – so why now is there a unique problen to be solved?

          • I can’t figure out what you are actually saying? What’s unique here is uncapped HECS and the distortions that it is likely to cause. People get government to invest in their human capital, universities get paid the full amount based on a “price” that they set. Sounds like one of those schemes that make investment banks a lot of money.

  3. The scheme doesn’t just penalize fad-style courses, but it also penalizes low earning occupations where the time to get your money back will be longer (almost forever for some things depending on the fees and interest rates). Some of these are vital, and include: nursing, teaching, early childhood education, and all the other occupations you can think of that don’t pay well for a long time. If these were loss making for universities, they would presumably get closed down. In addition to this, some will always be poor paying because they are either a government monopsony or target groups that don’t have any money (e.g., disability studies/therapy — where already it appears a lot of the workforce are from overseas) or both.

    Apart from this, I assume that if the price of teaching gets more expensive for universities, at least at the top end, the universities will simply put their fees up to accommodate this, which is going politically unbearable (Just imagine the headline: $120K for a primary school teaching degree at Melbourne)

    • That’s resolved with lower fees for these courses. The issue was also addressed briefly in the sentence on subsidies.

      Further, with this scheme universities will have an incentive to greatly improve the education of teachers; and I think that the market for teachers will react to that.

      I’ll make the point that the scheme will favour subjects that lead to lower variance in future income (not simply those that are likely to lead to higher expected salaries). Surely, a prospective teacher who is likely to have a steady income would be far more attractive to a university than other professions where variance in income can be very high. So I don’t see any obvious reason why the safe but perhaps low pay professions will necessarily be disadvantaged by all this. It’s all really got to do with risk rather than simply the mean of future income.

      • If you just want to move the subsidy up and down, then I’m not sure how the universities have any skin in the game unless it’s to a very small number of courses (or unless you want to take money away overall).

        Also, maybe you are unaware of this, but things like teaching and especially disability studies (most of which is now agency work) are not stable jobs. Many graduates find it hard to get jobs for years and they are often contracted too. The workforce is also overwhelmingly female (and hence will take further time off), as it is for most of the low-pay jobs you need a university education for. Presumably this is one reason the TERs of teachers are now appalling.

        As noted above, the universities can make their teaching courses as amazing as possible, but that doesn’t solve the government monospony problem. The salaries of teachers (let alone disability works) are, in the large part, paid by the State governments who, for the forseeable future, are not going to be able to afford any large changes to their salary structure (possibly except WA).

        If you want other examples of this, many of the allied health professions are similar.

        • Conrad, presently the funding scheme provides huge incentives to universities to not educate Australian students. There is a financial incentive to fill universities with foreign fee paying students. Should the changes to HECS actually be implemented (I greatly doubt it will happen without more thinking about the issues), the market for Australian students will be the new game in town. If universities had their way over the last decade, I don’t think that they would have been keen on admitting any HECS funded Australian student nor keen on providing courses like teaching and special education. But somehow they were compelled to do this.

          Smart universities have to now start thinking about the local student market. In all honestly I don’t think that many university administrators have come to terms with this (they’re still exclusively thinking about emerging student markets like Brazil and India). Well I expect that eventually, whatever happens with the proposal in the budget, there will be a new focus on the Australian market for students. From a welfare view point this raises new issues that we have not seen for four decades; if universities are going to make a bulk of their money from Australian students, then we need to do some hard thinking on welfare, agency issues, market failure, and the governance of universities. HECS is a complicated financial security and we simply don’t understand its effects on universities should it be uncapped.

          One issue is quality of education, which is closely related to university governance. I think that having universities share in the risk associated with the HECS-financial-derivative will be beneficial. If they don’t share in this risk, the fear is that basically we will get a generation of Australian students whose HECS debt funds bad universities with an administrative structure focused on taking advantage of the information asymmetry between students and universities: at best what I call investment-universities at worst snake-oil universities. (my conclusion about the present state of affairs with the administration of universities is that basically these have evolved into firms seeking to realise opportunities that arise from the differential information between students and universities regarding quality of education.)

          PS. My mother was a special education teacher for decades (in Australia). My impression growing up was she had a safe but low paying job. Have things changed?

  4. I don’t disagree with what you’re saying here about quality of education and so on, but I am just less confident about whether it would really change things enough such that it is going to be worth the problems it will cause. Things like accrediting societies have a vastly stronger position in terms of quality management (much tougher than TESQUA and the government paper-trail making ones). We are lucky in my area because we have these guys which forces us to have a reasonable standard, and the quality of students we get that take our courses from other areas without any such bodies can be truly appalling. So I realize how bad it can get.

    One can go through the types of degrees and have a think about this, including what happens now:

    First, Australian universities already compete for Australian students in postgraduate courses, but the information asymmetry already means that the actual quality of the courses doesn’t matter much (this is no surprise because it’s well known to be the biggest factor in undergraduate choice is research prestige). I can think of huge differences for the same course in my area — I’m sure they must exist in economics too, but they all get jobs anyway. For another large chunk of undergraduate degrees, it doesn’t really matter where you go or how bad the education standard is, for the same reason. For example, for a long time, Monash had exceptionally good computer science courses, and Melbourne had especially average ones (this may have changed now as I’ve been out of the area for years). But that made no difference, and nor would your changes make any difference because students from both places will inevitably get decent jobs because a lot of the variance is attributable to the student and not the course, and most of the students are male anyway so they won’t be taking much time off for kids or anything like that either.

    So this leaves us with fad-courses, which I agree would be good to kill off. But since these can usually be made very cheap to run (why not just run some really crappy versions online?) and marketed at 18 year olds who clearly don’t think through their life choices well, presumably many universities would still take students and just take the risk of some proportion of students being unemployed for a long time. But some may of these courses be taken over by bottom-feeding providers that are least cheaper. So some good outcomes may occur here. Students will waste less money.

    It also leaves more general degrees that are cheap to run, which you might get some benefit out of depending on the function between how much it costs to make them more employable (poorer universities would probably just take the hit). Would it be worth the cost of improving teaching to make business studies graduates more employable? Beats me, but it might me.

    It also leaves the courses I’m complaining will get hammered, because they are more expensive to run because they require organized work placements, labs and so forth, and because they also attract people likely to have more patchy work lives (e.g., females), and people you wouldn’t want at all because they are too old to pay HECs back (e.g., people wanting to change into teaching over the age of, say, 40 — one of the groups the government tries to attract for impossible to staff areas, like physics teachers).

    As for special education teachers — I’m not sure what the current conditions are for them in particular. But there are certainly more problems for normal teachers now, particularly starting off. If the TER scores are indicative of the likely long term work prospects, then I imagine they are pretty bad. For the other groups, some proportion of disability workers usually have stable jobs if they work in the government sector (50%? at a guess), and the rest seem to work through agencies. It’s not clear to me how good or bad it is for other allied health-care workers in terms of security. It’s not homogenous, but the pay is pretty average (but not terrible like disability workers).

  5. Theoretically, the scheme looks clever and incentive-aligning indeed. But … it seems to require that those who make decisions today bear the consequences of those decisions tomorrow. I don’t see that happening any time soon. We do not have the reliable kpis for admin people it would take and the reconfiguration of governance seems impossible given the present state of affairs.

    • Indeed, as you know one governance advantage is that it provides an incentive to appoint regular academics to lead administrative positions. My view is that best practice requires that Deans, presidents, chancellors, are offices to which university academics volunteer. People with longterm contracts with the university who know that when they finish being administrators they return to the “prison yard’ and have to live with the consequences of their management. I think that should our proposal be implemented, it will lead to quick changes in university governance.

  6. Thanks for this article and the informed comments that debate substantive incentive issues in this highly artificial market. I hope these nuances do get picked up by the government as the fee proposal is refined.

    I have been reading articles in The Conversation of the HECs issue and have just about exploded with the ill informed commentary on equally ill informed articles. What a disappointment that forum has proven to be

  7. hmmm. I would expect universities to sell off their future HECS income streams on the financial markets if this proposal came up. I cannot imagine university hierarchies waiting 50 years for all the money they are owed. And Andreas is right: the present governance structure is too short-term oriented and too little concerned about the long-term reputation of teaching for your proposal to have the desired effect. From a short-run perspective your proposal would mean the end of implicit subsidies to women and international human capital: universities would then increase the price of studies that lead to jobs abroad or that attract large groups of women, since those reduce the payoff of these courses. you get closer to a user-pay system in terms of incentives. Not clear that that is what you want.

    So if the real point of the proposal is not the effect it would have within the current arrangements, but more the change of governance you foresee arising from it, then it is the change of governance you really expect to have beneficial effects.

    • Hi Paul, How will the market value these future HECS income streams? By expected income of students I guess. The emphasis will once again be on the value-added of the courses that universities provide. I think that the present governance structures at universities evolved from the distorted student demand led incentives. Things will get worse with the HECS regime proposed in the budget, universities will turn into Investment-Universities and will remain demand driven, rather than education-quality value-added driven. I think that the governance structure at universities is not simply fad driven it is incentives driven.

  8. Some of my colleagues express doubt that the current Hecs-plans will get through the senate, so this discussion might be moot. Nevertheless, there is some merit in thinking over the issues with market liberalisation and the market imperfections in the current system that one has to be wary of: without a change that addresses the most important ones at the same time, one is likely to have reforms hijacked by the remaining major market imperfections.

    Apart from the governance issue, one mayor market distortion in the current market for tertiary education is that the existing universities control public property worth billions: the inner-city campuses were endowed by the public to universities who dont pay rent for their premises. Those assets are a huge prize and are the first things a true market-oriented owner of a university would simply sell off: there is a lot more money in simply selling off the whole campus to property developers and take the money to Switserland than to maintain in the education business!

    If you hence are keen on more competition but dont want a liberalisation to lead to theft of public property by current hierarchies, then you would have to take back the property into public hands: separate the ownership of the current lands and business from the education business operating on it. One could put the land in a public institution that simply auctions off leases to use the lands for educational purposes, effectively charging the current universities for the right to stay where they are. Then there would be a level playing field for newcomers.

    • The idea that it will not get through the senate even with changes is not all together reasonable. Some aspects of the plan will get through. I’m expecting a cut in compound interest rates on HECS as to be the compromise that get’s the rest past the senate. But what I am truly hoping for, regardless, is a senate enquiry on university liberalisation that engages professional (i.e., academic) economists.

      • I have the same prediction as you as to what will happen with the HECS changes.

        However, I think it’s a bit late for a senate enquiry. At a guess, most universities will be getting < 25% of their revenue from the government after these changes (probably a lot less in a few years given that the student subsidy will be linked to the CPI and not real costs, and student fees will presumably go through the roof), so no matter what people might want to say about them, given that even now they are essentially corporate businesses, surely the answer is they will do anything they more or less feel like no matter what would come out of that (especially because no-one is going to come up with the money to de-liberalise them).

        Perhaps the best the government can do now is really just fiddling around the edges, trying to keep individual courses alive that might well close but are necessary for the workforce (e.g., many of the health-sciences that are expensive to run like dentistry and physiotherapy, or are moderately priced but have low demand, like podiatry).

  9. An alternate way of implementing this proposal would be to pay Universities a financial bonus each year depending on how much their alumni’s HECS repayments outperformed the average. The advantage to this over direct coupling is that you can apply demographic weightings and test alumni repayment performance on a course-by-course basis (so that the repayment of BEs is only compared against other BEs, etc). Demographic weightings should eliminate the perverse incentives to discriminate on a demographic basis.

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