Financing education on Wall Street?

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Low education rates due to lack of financing (primary, secondary and tertiary) really bother me. And it’s not only because they perpetuate poverty, both domestic and international. It’s because it really doesn’t have to be that way.

Why?

Because the individual monetary returns on education (in increased future wages) usually far exceed the costs of providing the education. Toss aside any desire for social good and there is still profit to be made by financing education.

What’s implicit here is a challenge to whether education financing should be provided by the state at all. I would suggest that the private markets could step in and do a bang-up job. What they need is the right vehicle.

The right vehicle is this: Financing tuition with payback amounts based on the student’s future income. If you are a student, this could mean selling equity in your future income stream (on the extreme end). This may sound manipulative and predatory, but if you think about it, it’s really not. Low future earnings would mean that the loans are forgiven (or substantially reduced). High future income means you are subsidizing the low performers. It fundamentally operates the same way as progressive tax brackets.

Now there are questions of adverse selection and moral hazard (same sort of situation as microfinance) . But the investor, the student and society are all pretty well aligned on this. Harder study means higher wages for the student and greater returns for the investment and (directionally) more societal contribution. Artists might get a free ride on the back of the i-bankers — but maybe that’s the way it should be.

The role of the government in this system would be regulation, consumer protection and being the lender of last resort. Education is a human right. A system like the one above would be able to provide it to most. The state would need to provide for the rest.

Couple advantageous to consider
1) Increased competitive pressure would improve schools. Not only would schools be forced to compete for student tuition, but their ability to provide an education that lead to future high-income will be rewarded with higher tuition.
2) You can imagine this trickling down to our woefully underpaid teachers. Their ability to educate well means feedback in more demand for spots at a particular school, higher tuition and (hopefully) higher salaries to retain those teachers.
3) The market is allocating the resource, not government planners with imperfect information and perverse incentives. No more or less is spent on education than should be.

This approach has been tried a few times on a small scale — none have been too successful or replicated but I think it’s a matter of execution, not concept. MyRichUncle.com originally offered college loan interest rates based on future income, Yale Law School offered income-based loans payback with their Tuition Postponement Program. These models have all been either entirely or partially abandoned. (NB: The Australian Higher Education Contribution Scheme prices courses based on income grids, which is a form of this concept.)

Am I crazy here or does this make some sense? What do you think?

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2 Responses to “Financing education on Wall Street?”

  1. Catherine Says:

    Why is this better than having the government do it? Over here, the government cuts you a check (part scholarship, part loan that you pay back at very low interest rates after you graduate. If you don’t pass enough classes, the scholarship becomes a loan too.). You then decide what school to spend it at. The playing field is leveled at every generation. You get into the best university programs because you are smart–not because daddy can pay–and everyone can afford it if they get in.

    Also, unless you are VERY careful in designing this system (not sure how you could be careful enough) you would be penalized in some way for chosing a low income profession–not to mention that you would never tell the bank when getting the loan that you wanted to be an artist, or a social worker. Do we really want a world full of I-bankers and lawyers? And do we need to glorify them any more?

    Also I disagree that this could work at all at pre-university levels. You don’t (the majority of people, anyway) get to pick your elementary school or teacher based on quality, you go because it’s the only one near you, so you don’t really create a market incentive for teachers to improve. And it is pre-university education that is the real problem in the US.

  2. phil Says:

    Response to Catherine:

    But first a disclaimer: This post was meant to be provocative. I know little about education and don’t understand any of the complications associated with a system like this, but the fact that returns on education far exceed its costs seems to scream for a market (rather than government planned) solution.

    First paragraph Catherine questions whether this would provide a level playing field, which I take to mean will it be progressive or regressive.

    Think a privately funded system would end up being more progressive for this reason: In a privately funded system the tuition money chases the student, not the other way around. Everyone who is not sufficiently educated is a profit opportunity! Therefore investors are going to track the students down. This matters most in families/communities without strong cultures of education. A previously non-existent market incentive would exist to pluck children of advantageous environments out (to complement the obvious social incentive) Government loans are great, but only when they are fully understood and sought out.

    You raise an interesting quesiton about whether the wealthy would be advantaged in a system like this. Two elements of this:

    1) Would those from wealthy families secure loans on better terms?
    2) Would those who are wealthy in the future (those that want to become I-bankers/lawyers) be better off in the system?

    The wealthy will still have daddy pay for education and the not-as-wealthy would still rely on loans/grants — no different than today. The relevant question is whether children from comparatively wealthier backgrounds would be able to secure loans on better terms. It’s an actuarial question — just like health insurance. Are future incomes of those from wealthy families (holding everyone thing constant!) more than those from non-wealthy families? I don’t know the answer. Does anyone? My guess is that other factors will determine loan terms more than financial background.

    The second question. Are we encouraging more Ibankers? No! First of all, Ibankers are actually worse off in this system. Their cost of education is higher than it used to be because they are footing the education bill for others (essentially a income-bracket based tax). True — there would be pressure for lenders to encourage more lucrative professions, but this is probably not significant in comparison to the already existing individual pressure to do so based on wages. Moreover labor markets are markets! Excess supply drives down prices (wages). Encouragement to be in one profession will make that profession less attractive when the wages fall. The market allocates labor correctly — lenders will not be able to trump individual and market desires.

    Another unrelated comment:

    Everyone who I’ve discussed this post with has US tertiary education in mind when responding . I was actually dreaming of developing world secondary education when writing the post. India, in particular, is experiencing a shortage in publicly funded school capacity and increasingly turning to the private sector. Should parents fund their children’s education for a microloan? I think a) they should and b) a more sophisticated and targeted lending market should be developed to support this.

    Check out this paper for more on private schools at the BOP in India.

    http://www.nextbillion.net/blogs/2008/04/28/harnessing-indias-human-capital-through-educational-opportunities

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