Thoughts on economics and liberty

A liberal policy position on higher education

This article was published in the September 2009 issue of Freedom First.

Liberals generally agree that a government has little justification to deal with matters beyond its (first-order) core functions of defence, police and justice. However, most liberals do make a provision for a government to provide infrastructure and reasonable equal opportunity (second-order core functions), subject to the government doing only to the minimal extent necessary to achieve basic objectives in these areas.

If we agree that these areas establish the boundaries of the role of a government, then there is no scope for government funding of higher education, apart from regulating the sector to prevent fraud. Indeed, tertiary education institutions are fishing nets to ‘catch’ the society’s most talented. Students attending these institutions will, almost invariably, become wealthier than the average taxpayer. Subsidising them would amount to deliberately increasing inequality in society. And there are no natural rights for anyone to be provided higher education by the state, just as no one can demand that every tennis player should be given an ‘equal opportunity’ to play in the Wimbledon.

Privatisation, but good regulation

The government must therefore completely exit higher education. Institutions owned by government should be sold off broadly on the pattern of school privatisation discussed in the July 2009 issue of Freedom First, and converted into for-profit corporations with their shares traded on the stock market. With that, the tax revenues saved from higher education could be diverted to the maintenance of law and order and provision of good school education: areas which are in deplorable condition in India today.

But selling off IITs, IIMs, medical colleges and other government-owned tertiary institutes (including vocational) does not mean de-regulation. Apart from accreditation to prevent fraud, some steps must be taken to assure standards (but not to set standards – a task that must be left to the sector to resolve). Such accredited tertiary education institutions would have full operational independence, with the ability to set their own salary and scholarship structures to attract distinguished academics and talented students. They would set their own fees and determine the type, quality and mix of courses to offer. As a result, only that much higher education will be provided as the market needs and is willing to bear.

What about meritorious but poor students?

The issue of funding poor, meritorious students to attend these courses can be easily managed on the pattern of the HECS scheme in Australia (noting that HECS has imperfections that will need to be overcome). Under this model, any Indian citizen admitted to an accredited institution could apply for and get a low interest loan from the government for an amount sufficient to pay their fees as well as cost of living and books. This low interest rate loan (at a rate about one per cent higher than the variable Reserve Bank rate to meet transaction costs) would be repayable over, say, 15 years. Repayment would be through the income tax system after the concerned student gets a job and starts earning an amount greater than, say, three times the poverty line.

As a result, all meritorious students in India could easily pursue higher education and repay the fees when they start earning a sufficient income. Much of this can be outsourced to the private sector, and private competition in the loans market can be encouraged, thus ultimately allowing the government to exit this area completely.

Preventing non-repayment of loans

What if upon completing their studies some students leave India permanently, not repaying the loan? (In a way this has already happened with engineering and medical students who have simply left India. A comparable education in USA would have cost $100,000 at least). The way out of this would be two fold. One, agreements could be made with countries with similar schemes, to ensure that these educational loans are repaid.

At the least, a system to monitor departing students can be established whereby students leaving India even temporarily would need to furnish a bank guarantee equivalent to the amount of their outstanding loan plus the present value of costs incurred by taxpayers on their school education. Such a bank guarantee would be forfeited should they fail to return within a stipulated time. Students not carrying proof of such a guarantee would be turned back at the immigration check. Of course, this will require linking the loan system with the tax and immigration systems through a well-organised national ID and database.

Raising funds for these loans

How should the government raise the funds needed to issue these student loans? In brief, from the market. This is not as hard as it may sound, since most tertiary-educated workers will earn well, making it relatively easy to recover loans through the tax system. A rolling debt model would be followed. Government-guaranteed bonds (underpinned by these future tax system repayments) can be issued for the amount of student loans expected to be made. Prudent investors and banks will readily buy these risk-free bonds.

These bonds can be retired after ten years using repayments from students most of whom would by then have started working. Not all bond repayments will be met from student loan repayments alone, given potential mismatches of timing between student earnings and the redemption of the bonds and so some fine-tuning of the loan cycles would be needed. In addition, the residual costs of administering this programme, including the difference in interest costs between the effective rate of bonds and the

Bank rate, and a write-off for defaults, will need to be charged to the taxpayer, amounting to a (small) subsidy for higher education. This subsidy can be arguably justified as an unavoidable cost to fund meritorious poor to study as well as – for those who take a utilitarian approach and believe that higher education generates positive externalities – to facilitate innovation in society. But these arguments are vague and problematic, and the government should endeavour to get out of this as soon as practicable.

Common objections to such a system

Won’t this system lead to astronomical fee levels? No, because of competition in the sector. Students will generally prefer quality education at the lowest possible cost, forcing the fees down. Even the best universities will need to attract high quality students to retain their reputation, and they will have to bid for them through discounts. Will the liberal arts be ousted from the teaching agenda in this free market? Not really. Good private sector corporations recognize the commercial value of a liberal education. Arts graduates often do better in modern businesses than technical graduates because innovation, entrepreneurship, leadership, people management and strategic thinking have little to do with technical skills. Therefore the market won’t kill off philosophy, noting that there will be increasing opportunities for philanthropists to fund such disciplines.

I believe that if such a system is implemented, India will get at least a hundred universities of the standard of Harvard University in a few decades.

Freedom Team of India

The Freedom Team of India (http://freedomteam.in/), now registered as a Trust, would have opened its bank account by the time this article is published, allowing you to contribute to its efforts even if you can’t join it as a member. [Note: this bank account has not yet been opened] In a few months the member category called Freedom Partner will be operationalised. Watch this space!

ADDENDUM

Barun Mitra's article on education First.

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