Why progressives in Europe should learn to love high tuition fees

Timo Idema argues that graduates should pay for their own education – on fairness grounds.

A recent report by the OECD finds that — on average, across OECD countries — a higher educated male’s gross earnings are 300,000 US dollars* higher than those of a lower educated male. Net of direct tuition and other costs (5,000), foregone earnings during studies (40,000), higher taxes and contributions on this income (110,000), this leaves a net individual benefit of about 145,000 dollars for attaining higher education (the equivalent of an annual 11.5 percent return on investment). Figure 1 shows the breakdown for female students across OECD countries. In short, there is a significant private benefit to attaining higher education.

On average, these countries pay about 35,000 dollars in subsidies and foregone taxes (students tend not to pay taxes). States thus subsidise individuals who in turn earn a fantastic private return on this subsidy.

However, some would argue, these individuals also end up paying more income tax (90,000 dollars), social contributions (25,000 dollars), and are less likely to claim unemployment benefits (5,000 dollars, see Figure 2). In short, over a lifetime, the state earns 85,000 dollars on an investment of 35,000 dollars: a pretty good return!

Rightfully, these high private and public returns leads the OECD to conclude that there is room for additional expansion of higher education. The OECD argues that “public investments in education, particularly at the tertiary level, are rational even in the face of running a deficit in public finances.”

Indeed, such high returns on investment suggest that the combined sum of public and private investments is not enough. Not only would expansion increase the overall size of the pie, it would also result in a more equal distribution of the pie.  First, an expansion would reduce the wages of higher educated individuals as they become more abundant. Second, expanding higher education would make lower educated people scarcer in the labour market, which would increase their wages. All in all, the wages of both groups will move closer to each other, at a higher average level.

Given these expected efficiency and equity benefits, I welcome the OECD’s call for expansion. The question is: who should pay for such an expansion? While further public investment would no doubt be profitable, there exists a more equitable and profitable alternative for the state: increasing tuition fees.

After all, for every dollar increase in tuition fees, the state would still reap the same benefits of increased tax revenues from more highly educated citizens. The difference is that taxpayers (a group that includes many lower educated individuals) would no longer need to pay for an investment that provides some individuals with very high private returns. Instead, increasing tuition fees means reducing the 145,000 dollar private net benefit that higher educated individuals currently earn, which means a more equal income distribution. In short, many of these public benefits can be reaped from increasing private investment in education.

However, one risk of higher tuition fees in the absence of other policies concerns unequal access to education. Because the costs of higher education (fees and foregone earnings) are incurred before the expected future benefits of higher income start flowing in, individuals will have to be able to obtain student loans. If student loans at reasonable rates are insufficiently available, the unfortunate outcome will be that only those with enough private (parental) wealth can afford to study.

Unfortunately, the market is unlikely to provide sufficient student loans due to market failures. These emerge because human capital cannot be used as collateral for a loan. When one gets a mortgage for a house, the value of the house serves as collateral for the bank in case one loses one’s job and can no longer pay for the mortgage. However, when borrowing money to invest in one’s human capital, there is no equivalent collateral that can be provided in return. After all, auctioning off human capital in case of insolvency has — for very good reasons — been illegal since the abolition of slavery.

Since there are good reasons – including the above collateral argument – that a private market for student loans will under-provide student loans, there is a strong role for the state in providing such loans. This is where many states fail. They fail to provide loans altogether, and/or they fail to provide sufficient annual amounts.

Still, even if the state provides full student loans, individuals may fear taking a loan on an investment with uncertain future returns. Especially when coming from a poorer background, such concerns may be exacerbated. To address risk aversion, loans need to provide insurance against the risk of low future income – For example, by setting a minimum income at which repayment begins.

The UK’s loan system provides a good example of a solution to this problem. First, one only has to pay back loans at a rate of 9 percent of gross income once annual income exceeds 15,000 pounds. Second, part of the revenues from increased tuition fees are used to make bursaries available for those coming from poor backgrounds. The experience of the UK’s fee increase from 1,000 pounds to 3,000 pounds in 2006 has shown that participation was left unaffected by the introduction of fees.  As long as countries continue to show high private returns to education, there is space for such expansion.

To conclude, the UK’s decision to increase tuition fees to 3,000 pounds (4,500 dollars), and the further increase currently under review, should be applauded by those who care about economic growth and equality. What is more, raising tuition fees merits similar consideration amongst the bulk of other OECD countries that currently have lower or even no tuition fees.

*all figures are rounded to increments of 5,000 and are discounted to net present values (see OECD report for details).

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