Academic interest: the free-market case against subsidised student loans

The purpose of markets is to discover the clearing price at which supply and demand balance. Demand is not simply what people want, but what they choose to put their scarce resources towards in preference to alternatives. If demand were not constrained by ability and willingness to pay, we would strip the world bare in no time.

Why, then, do those who favour the funding of higher education through student loans that need never be repaid think that this is somehow extending the free market into higher education? They think they are committed to a decent compromise between efficiency and compassion by supporting a “market” whilst ensuring that no one should be prevented from purchasing in that market by their “ability to pay”.

Sadly, there are many on the right who fall for the delusion that anything is good if you can label it a “market”. Markets are not intrinsically virtuous. If I kidnap your children and then offer to sell them back to you, that is a market, but it is not socially beneficial or ethically defensible. It is not a free market.

In a world of dispersed information and subjective and variable preferences, markets offer benefits over central control if they reveal information that could not be discovered so effectively by other means. They can coordinate activities and the use of resources to satisfy people’s subjective desires as efficiently as can be achieved by imperfect humans immersed in uncertainty.

But they do so only within a suitable institutional framework. One of the necessary features of that institutional framework is that decisions must be taken within the constraints of scarce resources and opportunity costs. Without those constraints, the information revealed is distorted, and the choices taken are misled.

Student loans that are subsidised if the graduate does not earn enough have that effect. Demand is exaggerated, encouraging people to take courses that offer insufficient social benefit to justify their cost. The supply of academics expands to meet the inflated demand. Innovation in provision is reduced. The price of academic qualification is driven up, giving an illusory impression of value to the recipient, as well as an artifically inflated cost to those who have to fund the underwriting, and reward to those who provide the marginal education. The average quality and real value to society of those qualifications is driven down. The supply of people of above-average intelligence into non-academic activities reduces, though they would have been more valuable in those roles. Society is poorer as a result of the intervention.

The socialist who decries the free market and tuition fees may be wrong, but at least he or she is intellectually consistent. The liberal who supports free markets, tuition fees, and student loans that need not be repaid by those on low earnings is intellectually incoherent. If you think that ability and willingness to pay should not constrain access to higher education, you should admit that you do not believe that free markets are a suitable way of allocating resources in this sector of the economy. In which case, don’t try to pretend that tuition fees and student loans have some sort of free-market or efficiency justification.

All your economic points are correct, Bruno. However, I think there are two counterpoints. Many of those who welcomed last week’s announcement saw it as a step in the right direction (as there will be some competition between universities because of the raising of the cap – currently there is really an “entry charge” for higher education but no price competition between institutions). There will also be less of an interest rate subsidy. We should continue to expand the bounds of the politically possible, of course, so that politicians can go further. cont.

On efficiency grounds it is argued that there may not be an efficient student loans market amongst the capital constrained because one cannot use one’s brain as collateral: a government-guaranteed loan system can then be justified. There are other related arguments – a priori, we might wish to diversify investments in human capital across different people but cannot easily do so (eg you and I both agree to go to university and share a proportion of the benefits) because of limits on the enforceability of contracts. Again, having some differential treatment of successful and unsuccessful might deal with this without an iniquitous graduate tax. I do agree, of course, but there are counterpoints.

Surely the primary purpose of markets is to provide a way for two or more parties to exchange goods and services to their mutual benefit. The emergence of a (temporarily) market-clearing price is a by-product.Still, that provocative opening sentence at least induced me to read the rest!I’ve been wondering if the compassionate coalition government should seek (at taxpayers’ expense, naturally) to provide Aston-Martins ‘free’ to those who can’t afford to pay. But I’ve concluded that subsidising wind-farms will probably do more to attract Liberal Democrat votes at the next election.

What of the distorting effect of scholarships? Surely funding scholarships would be a better way to lift the bright poor out of their situation, rather than extending means tested welfare into another sector of life.You win a scholarship. Means tested support for fees are claimed, not earned.

I agree with Tim that scholarships are the way forward regarding ‘access issues’, as long as they are privately funded and not organised via some sort of government scheme. Universities would surely find it relatively easy to raise money from private donors to fund scholarships for less well off students.

If the government is to provide funding it would be better for maintenance than tuition.

DRM: “Purpose” was perhaps a little strong. “Major benefit” might have been better. But it may be defensible: you describe the purpose of *free* markets; I merely describe the purpose of markets. My example of a market in kidnapped children is a market, but not a free market. For better or worse, it establishes a clearing price (or the absence of one). It is not clearly to the mutual benefit of all parties, because property rights have not been observed. One could think of other, less-draconian examples, of markets where the outcomes are not necessarily to the mutual benefit of all parties because participation was not entirely voluntary. Cont…

Philip: Imagine a similar choice in my sector. Which would be better:1. The government decides how much renewable heat is “socially optimal” and funds it, or2. The government creates a market for renewable heat in which there is competition between suppliers, but demand is inflated by the provision of finance to all who want it, on terms that do not require repayment until household income is above a certain level?I hate (1) (effectively the default position of the intellectuals), but (2) is even worse – not for me (I will sell a lot of pellets at nice high prices, and so will my competitors) but for society. We should insist on an option 3, not kid ourselves that 2 is better than 1.

Philip: As it has been reported, there will be more of an interest-rate subsidy, not less. It’s a “progressive” policy, apparently. The income level at which repayments will start has been raised. The interest charged to low earners has been reduced, at the cost of higher interest rates for higher earners. It is a disincentive to those who expect to contribute most to the economy as a consequence of their education, and an enticement for those who expect to contribute little. It doesn’t take an economics genius to work out that we will get more people with limited potential and fewer people with substantial potential as a result. Sociology departments should do well.

Your brain can be “monetised” if you are prepared (and allowed) to contract its output at the right price for a sufficient period in the future to make it an attractive investment opportunity; i.e. student sponsorships. There are two problems:1. Our silly attitude to “human capital”. We expect people who do not have property rights in that “capital” to pay for its development. Lease-purchase would be the best option.2. The low value of many students’ short-term cranial potential on graduation. But that, of course, is the point.

A teenage entrepreneur has no more cognitive collateral than a teenage student. They both have a hypothetical forward revenue stream. Arguably, there is at least as much social justification for investing in the entrepreneur’s potential as in the student’s. Should the government provide guaranteed loans for all teenagers who want to start businesses as well? Or should loans only be made to those whose capabilities and plans offer a realistic prospect of a return, according to the judgment of those who would be risking the money?

Why do we assume that we must facilitate the entry into full-time higher education of as many students as would like, as soon as they have finished school? Why not work, save up and then go into higher education? What about part-time education? Young people’s strengths are often underestimated, but experience is not one of them. For the humanities and social sciences, experience of life should be an essential qualification. Youthful characteristics like energy, imagination, restlessness, and egalitarianism, untempered by experience, would be better matured in the workplace than in academia, where they may be harnessed and corrupted by the sheltered theoreticians who dominate the faculties.

Bruno – I agree with much of what you say but I think that, overall, the proposal is better than the current system. But, I agree, freedom of contract in the labour market would help solve some of these problems and privately provided scholarships (whether through potential employers or universities themselves can help with the risk sharing issue). It is always difficult to decide whether something is a move in the right direction and sometimes the judgement is based on how easy it is to move further. Releasing the fee cap is the difficult thing politically, if the government caps the salary at which payback starts in nominal terms it could unsensationally deal with the problems you identify

Philip: Do you think the public-choice incentives will actually work that way, or in the opposite direction? If demand is greatly exaggerated, a genuine correction would result in fewer school-leavers going to university. I can’t see that being regarded as unsensational, unless the idea that it is desirable for almost half our school-leavers to go to university had been successfully challenged. It is the same point as with the cuts. The narrative is that these things are ideally desirable but currently unaffordable. If the Government could do as much as it ever did, but at lower cost, it would. The argument should be about the undesirability, not the unaffordability, of many govt. actions.

By amusing coincidence, a propos of the question of whether economists should support something that is wrong but perhaps with potential to be better than the current system, or whether they should simply stand up for what they believe is right, I just received an email notification about a new edition of W.H. Hutt’s Politically Impossible, “co-published by the Mises Institute and the Institute of Economic Affairs” (http://mises.org/store/Politically-Impossible-P10421.aspx). Looks like similar ground to Hayek’s stuff on the intellectuals. I can see the argument for teasing policy along, but I’m instinctively with Hutt and Hayek. Maybe it needs both approaches (good cop, bad cop).

With such issues, there are always two questions. Given the choice between a new policy and doing nothing, what would you do? And then, if we remove the bounds of the politically possible, what would you do? I was trying to answer the first question – questions that we generally do not like answering at the IEA! But it cannot always be the case that just because a policy is wrong-headed, continuing with the status quo must have been better.Overall, I think that public choice problems surrounding young people are not very significant. It is older people that are the problem in a public choice context.

I just signed up to your blogs rss feed. Will you post more on this subject?

[...] I have a feeling that, in higher education, it is better to have no market than a skewed market. [...]

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