Education: Assessing the costs and benefits

The provision of education services, like health, is one of the things that the state does well. Never mind the fact that both are available in the private sector: The vast majority of us at some point or another rely on the state provision of both. But as is usually the case with such services they have also been used as footballs to satisfy various political ends. Since spending on the NHS is such a large part of government outlays, representing around 16% of total outlays, it is a subject I have covered on previous occasions (here, for example). Education also accounts for a not-insignificant proportion of spending – around 7.5% – and it is thus worth looking at some of the issues surrounding it.

My curiosity in this area was piqued by the announcement last December that the ONS is to apply a new treatment of student loans in the national accounts and public finance statistics which will have some profound effects on the data when the figures are rolled out later this month. The reason for the change is a sensible approach to tackle the fiscal illusions caused by their treatment in the accounts. But first, a bit of explanation is in order.  Student loans were first introduced in 1990 as a means of allowing students to cover their living costs. In 1998, they were extended to include loans to pay tuition fees, but in 2012 universities were permitted to increase the cap on tuition fees from £3,000 per year to £9,000 which raised the amount that students were permitted (required) to borrow. Many students can be expected to graduate with debts of around £50,000. They are expected to repay these loans over the first 30 years of their working lifetime, so long as their annual income exceeds £25,000, with interest charged at a rate of 5.4% (down from 6.3%).

As one who is old enough to have received a public grant to study at university, it strikes me as an egregious example of intergenerational unfairness and is a clear example of the law of unintended consequences. One of the reasons why the cap on tuition fees was bumped up in 2012 was to create a market amongst universities in which they could compete for students on price grounds. However, all universities decided to charge the maximum amount in order that their offerings were not perceived as inferior goods. It thus costs the same to study at Oxford or Cambridge as at Bucks New University.  The model has thus failed. It also does not make sense to me why today’s graduates, who still enjoy a wage premium over their non-university educated peers, should not simply pay higher tax generated by their well-paid jobs to repay the costs of their education as my generation did. I will accept that there may be fewer well-paid jobs about today, but the point still stands. Today’s students are being taxed twice: Once for the direct costs of tuition, where loans are charged at an interest rate 465 points above Bank Rate, and once for the higher wages which a university education (theoretically) generates.

Before coming back to the issue of student loans and public finances, an excellent article in The New Statesman questioned the impact of grade inflation on university education. This is, of course, not to denigrate the hard work that a lot of people put in to obtain their degree. But when 24% of students obtain the highest classification compared to around 7% in the mid-1990s, it is difficult not to be struck by the conclusion that there is some correlation between the need to give the customers what they want (good grades) and the increasingly extortionate amount that they pay (more on this another time). Education has thus become commoditised in a way that was previously unthinkable.

So what does all this have to do with public finances? As it currently stands, student loans are recorded as conventional loans in the national accounts – in other words, they are a public sector asset. But given the amount that students are forced to borrow and the almost usurious interest rate, coupled with the salary threshold, a large proportion of the loans will never be repaid within the 30-year timeframe. The Department of Education reckons that between 60% and 65% of the amount outstanding will have to be written off (other estimates suggest this figure could rise to 80%). Since it was never intended that the full amount of loans be repaid, it is therefore nonsensical to treat them in the public accounts as though they will be.

Accordingly, the statisticians will in future treat part of the amount outstanding as genuine loans whilst the rest will be classified as government expenditure. This will raise annual public borrowing by around £10.5 billion (~0.5% of GDP) and add almost £60 billion, or 4%, to national debt (2.7% of GDP) – see chart. It will therefore be interesting to watch out for comments around 24 September when the new data are released, arguing that the government has somehow been massaging the figures (it hasn't, but the accounting treatment has left something to be desired). However, at a time when the government has recently announced a big increase in public spending, it is clear that forecasts of UK government borrowing will be revised sharply higher in the months ahead. 

Nor is the student debt issue confined only to the UK. A VOX blog post looked at the situation in the US, where the market is far less forgiving, and concluded that high student debt burdens have a major impact on the behaviour of the debtors. Borrowers’ are constrained in their ability to take high-risk/high pay jobs “because they need to pay these loans and prefer more stable income” and find that their mobility is constrained as a result. The research also finds that “borrowers benefiting from debt relief … are also significantly less likely to default on their accounts, above and beyond their student loan accounts.”

The build-up of student debt has major implications for the wider economy and public finances. But to the extent that there are significant social externalities associated with education that have long been recognised but are difficult to measure (better heath, reduced tendency towards crime etc.), there is an argument that the government has an incentive to bear at least part of the costs of provision. In the current system where the cost burden is placed squarely on the consumer of education services, this in effect allows governments a free ride on the positive benefits it generates which is something else today's generation of students have a right to feel aggrieved about.