Universities need skin in the game

Derided at the time (and by many today) the Conservative-Liberal Democrat decision to treble tuition fees is signicantly underrated. As I pointed out, Jeremy Corbyn was wrong to state that £9k fees had put working class applicants off a University education. In fact, high tuition England has done better than tuition free Scotland at getting disadvantaged students to apply.

But the system is far from optimal.

Applicants often make poor degree choices, let down by poor quality information on employability. Indeed, there are 23 universities where graduates actually earn less than non-grads.

But that’s not the only problem. Income contingent loans mean that higher earners pay back more than lower earners. This is what makes this system ‘progressive’. Student Loans are underwritten by the taxpayer and in four fifths of cases the taxpayer ends up writing off some debt. The IFS estimates that around 43% of the total debt goes unpaid.

And there’s a massive difference between the winners and losers. If you end up in the bottom 20% of graduate earners it’s likely that on average you’ll never make an annual repayment of more than £500. Meanwhile the top 20% of graduate earners can expect pay as much as £5,000 in a single year in their 40s.

This creates a dangerous moral hazard. By reducing the risk to graduates whose degree choices fail to pay off and shrinking the reward to the graduates who chose wisely, income contingent loans create an implicit subsidy to courses that offer lower economic returns.

This is not just a problem with the student’s incentives. From the perspective of a university £9k a year from a Media Studies student who’ll graduate to earn less than £21k a year is worth just as much as £9k a year from a Physics and Engineering graduate who’ll go on to found the next Tesla. In fact, because science courses on average cost more to run than humanities courses, the Media Studies student is actually a more profitable option for the university.

IFS data shows that while average university funding is up by 25%, there’s a big divergence in where it’s going. The highest cost courses have seen only a modest 6% increase, while lower cost courses have seen a 47% increase. The Government can and does mitigate this effect with funding grants, but those grants have shrunk across the board since tuition fees were trebled.

As student numbers are no longer capped, the unintended consequence of a progressive repayment system is that universities are incentivised to push low-cost, low-return arts courses at the expense of high-cost, high-return STEM courses.

Beyond alumni donations and looking good in league tables, universities fail to capture the upside of investing in the employability of their students. This needs to change.

One suggestion from Ryan Bourne resurrects a relatively untried proposal from Milton Friedman. Rather than students taking out loans, universities would buy shares in a student’s future income. If you’re a bright student with 3 A Stars at A-Level then Cambridge might offer to provide a full education in return for a 3% stake in your future earnings. Cambridge could then tap into that income stream right away by selling it on the open market.

In some ways, this model already exists. App Academy, a 12-week intensive coding bootcamp, doesn’t charge fees but instead requires that students pay App Academy 22% of their salary for the 12 months after graduating (provided they get a job as a software engineer). This gives them a strong incentive to link up with employers, assist in the job search and most importantly, teach coding well.

Moving to the App Academy model aligns the incentives of graduates, taxpayers, and universities. It would disincentivise institutions from admitting students to low-return courses and incentivise investment in more expensive STEM courses provided they paid off for graduates.

Data like the IFS’s that simply compares large blocs of people doesn’t take account of their pre-existing skills and abilities: perhaps they would have done better if they’d never gone to university at all. This system would give students an incentive to only do degrees that enhance their earning power—since they will have to tithe to their institution.

Unfortunately, this policy may be too radical; too big of a change overnight. But discussing and studying the ideal is useful because it can reveal the direction in which policy should move in the short-term.

Here’s a more modest step.

Students should make payments direct to universities not the Student Loan Company.

Under the status quo student loan repayments end up going to the same place, regardless of whether a student went to Oxford or London Metropolitan. In effect it means that once you graduate universities have no stake in you succeeding or failing.

We should change that. Rather than each graduate making repayments to the Student Loan Company, they should pay the university directly under the same repayment terms. Universities should then be allowed to sell off that future income stream for cash today.

This would make a difference for two reasons.

First, it’d create a strong market incentive to accurately estimate graduate earnings. In order to maximise revenue from selling off the rights to future repayments, the university will need to provide accurate, evidence-based estimates of graduate earnings. Similarly, financial institutions will rigorously test each university's numbers, ensuring that they’re accurate.

Second, it would give universities skin in the game: incentivising them to invest in employability, shut down courses that don’t deliver for students, and shift resources to high-payoff STEM courses.

The 'loan' could still be written off after 30 years, but it would be the university not the government writing it off. This would amount to a cut in funding for universities, but importantly it would be a cut that hit the least useful courses and institutions hardest and incentivised expanding the courses that pay off the most. Cutting university funding would be no bad thing either. Subsidised tuition encourages universities to over-invest in new infrastructure and prevents them from making the same efficiency savings that other similar sized organisations might make.

For instance, there’s no incentive to introduce shorter courses; university terms are still based on pre-industrial revolution agricultural seasons.

There is a risk that the courses cut will be disproportionately ones that attract pupils from disadvantaged backgrounds. But we shouldn’t be focused on inputs (i.e. number of disadvantaged students attending university) but outputs (i.e. will they get a good graduate job). The courses that get cut will look good if you simply measure inputs but bad if you measure outputs. There's nothing progressive about saddling a young person with massive debts to pay for a university education that does little to nothing to improve their life chances.

By shifting the burden of funding university tuition fully onto universities and students, it will free up additional public money that can be used to address educational inequalities earlier on - an approach that could be more fruitful.

If we want universities to serve their students better, they need to have skin in the game.