When More Means Less

This article from the Autumn 2020 edition of the IPA Review is written by former Treasury and Reserve Bank official and Chief Economist in the Prime Minister’s office, Andrew Stone. 

The prevailing approach to education at the federal level, from both major parties, is to focus overwhelmingly on quantities and inputs, with little interest in quality or actual educational outcomes. Even viewed from the narrow, purely economic perspective of boosting productivity and growth, this is madness. Indeed, one of the odd features of the debate about weak productivity growth over the past decade, in Australia and around the developed world, has been the free pass routinely given to school and university systems. At a theoretical level, academic economists continue to emphasise human capital as a central factor in discussions about lifting productivity.  

Yet even as declining standards of school and university education have (rightly) received increasing public scrutiny, researchers seem to have given little systematic consideration to whether these lower educational standards—across many disciplines, since at least the 1990s— might help to account for the disappointing productivity growth outcomes of the past decade, as the hapless victims of these diminished standards have streamed into the workforce. Space does not permit discussion of all the things wrong with Australia’s current higher education system, and the way it affects the broader community.  

Two key flaws of particular importance also happen to be amenable to correction via policy change by the federal government:  

• The misalignment of financial incentives for key agents in the system, especially tertiary education providers;  
• The malign spread of credentialism among employers, with its corrosive effect on the cost-benefit calculation facing young Australians about whether or not to undertake tertiary studies.  

Properly realigning incentives, improving transparency, promoting better teaching standards and tackling credentialism would address not only these two key flaws, but also others that cascade from them. 

The financing is composed of two streams—direct taxpayer support, per student per unit of approved study, through the Commonwealth Grant Scheme (CGS); and course fees paid by students themselves, overwhelmingly on a deferred basis through use of the Higher Education Loan Program (HELP). This latter program automatically allows students to borrow the money required to pay their course fees, from the Commonwealth Government, at a highly subsidised interest rate. This rate is set equal to annual consumer price inflation, so students’ HELP debts do not grow over time in real terms. 

Importantly, repayment of HELP loans is only required on a contingent basis through the tax system. As a result, students need only start to repay their loans, via a modest additional tax impost, once their annual taxable income exceeds a still-generous minimum threshold of just under $46,000. At present, CGS payments (from taxpayers) cover almost 60 per cent of the cost of financing the undergraduate teaching part of Australia’s higher education system, while course fees (overwhelmingly paid via HELP loans) account for just over 40 per cent. 

This overall financing approach has been in place for Australia’s universities for around three decades and has been gradually extended to other parts of the tertiary education system, such as vocational education and training (VET), over this time. 

Most importantly among the strengths of this approach is the scope for deferred and contingent payment of fees via the government paying these fees, with students only required to repay the government in due course. This ensures up-front cost need never be a barrier to entry for capable students from poor backgrounds. At the same time, the requirement for repayment still, appropriately, forces students to make a significant contribution towards the costs of their further study—albeit one many observers assess remains less than the private benefits they receive, on average, from such study (thereby requiring a disproportionate subsidy from taxpayers).  

Despite these strengths, the current financing system also has a number of serious weaknesses. These weaknesses are in urgent need of remedy, to protect taxpayers and students—especially academically marginal ones, for whom the choice to undertake further study is a finely balanced one.  

The most critical of these flaws is the way in which the system misallocates risk in relation to non-repayment of HELP loans, as between students, universities and the federal government. At the moment, far from making money on its HELP loan portfolio, or even simply ‘breaking even’, the Commonwealth books a huge loss of almost 25 per cent in net present value terms over the life of each cohort of loans. 

In part these losses reflect the subsidised nature of HELP loans, compared to the rates at which the Commonwealth must itself borrow the funds used to extend these loans to students—let alone compared to the rates the students would have to pay for such loans in a free market. They also arise from the contingent nature of HELP loan repayments.  

These contingent repayment arrangements mean if a student fails to get a decently paid job, or leaves work to raise a family, or dies before paying off their HELP debts (in which case their debt is simply written off), the Commonwealth ends up bearing the significant loss that results. Universities, by contrast, suffer no loss in these cases, having pocketed up front (and spent) the fees paid via these loans. Likewise students, who in a normal loan market would be charged a risk premium reflective of their actuarial risk of non-repayment or only partial repayment, are let entirely off the hook for these risks, with the general taxpayer left to carry the can.  

In terms of incentives, these financing arrangements create perverse pressures for students and for universities, especially. In both cases they encourage more people to undertake study than rationally should.  

In the case of students, the Commonwealth is effectively providing them with a significant subsidy to undertake further study, through the structure of HELP loans and through the Commonwealth Grant Scheme (with its overprovision of general taxpayer funding relative to the typical share of public-versus-private benefits which tertiary education provides). Goods and services whose purchase is subsidised get over consumed, and this is as true of higher education as of any other product. Indeed, it is magnified in the case of higher education by the persistent messaging from government (and the tertiary education sector) that further study is inherently ‘a good thing’, which anyone who can do should do. The result is more students drawn into tertiary study than otherwise would undertake it.  

Even more importantly, this pressure towards overexpansion of the higher education system is dramatically magnified by financial incentives created for tertiary institutions themselves. These incentives strongly reward institutions for taking on academically marginal students who may be ill-suited for tertiary training, or lack the necessary intellectual foundations to succeed. They also encourage institutions to actively try to retain struggling students—including via lowering academic standards if need be— even if those students are not coping with or benefitting from their studies. 

Institutions receive substantial direct CGS funding for these students, as well as HELP-financed student fees. This funding is received regardless of whether the tertiary training it pays for is equipping students with valuable or marketable skills and knowledge. In the event it isn’t, it is the students (through accumulated HELP debts) along with taxpayers who are left bearing the burden, while the universities get off scot-free.  

The current financing system:  

• promotes overengagement in higher education by young Australians, via subsidising this and via blunting the price signal which would otherwise concentrate their minds more carefully on the cost-benefit trade-off around undertaking further study; and  
• even more importantly, corrupts the traditional gatekeepers of the system and of its academic standards, the tertiary institutions. It does this by giving them a large financial incentive to enrol students who, academically, ought not be there, and by failing to impose any accountability for whether or not these students actually receive any benefit from their studies, in terms of knowledge gained that might lift their future earning power.  

The upshot is too many people undertaking tertiary study, at significant cost to taxpayers and to many of those individuals—with this damaging outcome driven in part by unscrupulous providers who disguise their greed under a veneer of rhetoric about ‘social justice’ and ‘empowerment’.  

So what should a sensible higher education reform package look like—one that promotes a genuinely better educated, more skilful and more productive nation, while more rigorously safeguarding taxpayers’ interests? Given the problems outlined earlier, and the failings of recent reform efforts, it should have three main components. 

The first essential element should be measures to better align the financial incentives in the higher education system, so as to simultaneously provide a fairer deal for taxpayers and remove the encouragement for tertiary institutions to exploit marginal students in the pursuit of a fast buck.  

Universities currently have no ‘skin in the game’ in relation to the subsidised HELP loan funding provided by taxpayers to enable students to pay their course fees.  

To correct this misalignment of incentives, a vital reform the system requires is to change HELP so tertiary institutions bear some cost, going forward, if students from whom they take fees, paid for via HELP loans, fail to repay those loans (or take an inordinately long time to do so).  

Introducing a suitably calibrated cost would immediately force universities to think harder before recklessly taking on students who are not properly equipped for further study. It would also make universities think twice about callously encouraging students who aren’t coping with their studies to continue them, at substantial direct and opportunity cost to those individuals.  

Finally, such a change would force universities to pay much more regard to the extent to which their course offerings are actually imparting useful skills—as opposed to wasting students’ time—by exposing institutions to ongoing cost in the event they’re actually doing the latter.  

So how should the objective of forcing tertiary institutions to have ‘skin in the game’, in relation to their students’ HELP debts, be achieved? A simple mechanism would be to make HELP loans into joint contingent loans. Students’ repayment obligations would remain unchanged from those applying currently, but institutions would now also be required to pay an annual interest charge on any HELP debts of their students that remain unpaid, once a suitable grace period has elapsed. The Pyne and Birmingham reform packages both sought to alter the ratio of funding of undergraduate education between taxpayers and students from a current percentage split of almost 60:40 to one somewhat more even: roughly 50:50 under the Pyne reforms, or 54:46 under the replacement Birmingham package.  

Separate from the issue of the overall level of aggregate CGS funding to universities, however, a related issue is whether this funding is being well directed towards courses with serious intellectual or skills content, as opposed to flaky or politicised offerings which may be popular with students precisely because they lack material that is challenging and opens minds.  

In determining appropriate levels of funding support for different units, one consideration for the Commonwealth is, naturally, the cost of course provision. However, this is very far from the only, or even the most important, consideration— and it is unclear why (for example) taxpayers should currently be providing around $23,600 per unit for Environmental Studies, but only around $10,600 per unit for Mathematics or Computer Science; or why a unit of Media Studies should attract more than $13,000 of funding per student, but a unit of English Literature just $6,000 and a unit of Economics less than $2,200.  

Accordingly, the current funding clusters under the Commonwealth Grant Scheme should be rejigged—but in a more thoughtful and politically savvy way than was proposed in the Coalition’s 2014-15 Reform Package. Such a rearrangement should redirect funding away from vacuous or highly politicised courses and towards those of clearer intellectual value, that develop broad critical thinking and analytical skills— especially Science, Technology, Engineering and Mathematics (STEM) subjects.  

The proposed emphasis here on STEM courses primarily reflects the intellectually demanding nature of such subjects (owing to the maintenance of objective standards in these disciplines), and the versatile character of the skills they provide (which ensures they represent a good investment for students and the nation). For these reasons, increased financial support for the study of STEM courses should be a key objective of higher education reform.  

Finally, the third crucial leg of sensible higher education reform should be to:  

• tackle the blight of credentialism, in a structurally sustainable way that cannot swiftly be co-opted or corrupted by the tertiary education system; and  
• implement some form of independent check on the academic standards of Australian universities—to help slow, and ultimately reverse, the damaging deterioration which has occurred in many disciplines, across most institutions, over the past 30 to 40 years.  

Happily, to achieve these twin goals, it should be possible to kill both birds with one stone. Consider credentialism first. Many employers seek a simple threshold mechanism for assessing applicants’ literacy and numeracy skills. A better approach would be to provide what employers are seeking directly— independent of the tertiary education system—by offering a widely recognised, cheap, nationally available testing mechanism for reading, writing and numerical skills. Such tests could be offered (say) twice a year, providing a well understood means for any Australian who wishes to do so to establish they have these skills, and at what level.  

Such a system would also provide an independent mechanism for benchmarking the academic standards of Australian universities, including the consistency of standards applied between foreign and domestic students. Universities could be required to have a quota of randomly selected final year students take national reading, writing and numerical skills tests each year, at a suitably high level, in addition to their university assessments. The grades awarded to these students by their institutions could then be calibrated against their performance on these benchmark tests, with suitably aggregated results released publicly.  

This would allow students, employers and the general public to observe whether there are any glaring discrepancies between, say:  

• the grades awarded by particular institutions and the level of core skills competencies displayed by their students (for example, does institution X routinely give As and Bs to students whose literacy and numeracy skills are actually low?); and/or  
• the average grading standards applied by different institutions (for students with a given level of core literacy and numeracy skills, does institution Y tend to give much higher grades on average than institution Z?).  

These reforms represent a key policy lever available to the federal government for lifting the quality of education in Australia, and for refocusing education on the provision of skills and knowledge of genuine value— intellectually and from a work perspective. They are not about trying, as a nation, to churn yet more students through universities so as to hit meaningless and counterproductive targets for the proportion of tertiary degree holders in the workforce.  

To the contrary, there is a strong case Australia already has too many young people attending university, when judged by the return they and the nation receive relative to the time they spend studying, and the substantial costs they and taxpayers incur for them to do so. It is important to understand the perverse incentives which society, and successive governments, have progressively built into Australia’s tertiary education sector—affecting both the behaviour of tertiary institutions, and the choices individuals make about whether or not to go on to post-school education.  

Understanding these incentives, and the damaging intellectual and economic impacts they are having, illuminates how the system ought to be reformed so as to correct these incentive structures. Better aligning these incentives offers the prospect of substantial long-term benefits for productivity growth and, even more importantly, the healthy functioning of society as a whole.
This article is an edited version of a chapter in Andrew Stone’s new book, “Restoring Hope: practical policies to revitalize the Australian economy.” Order your copy here.