Reforming student loans

bruce chapman
dung doan

While the circumstances concerning higher education financing vary across countries, they reach unanimity on one point: they all have poorly designed loan schemes for students, CBE economists Bruce Chapman and Dung Doan write. 

Climate change, poverty and inequality would have to be on just about everyone’s list of major economic problems, but right up there for a lot of us would be higher education financing as well. The evidence is clear that the majority of countries are in, or are soon facing the prospect of, significant difficulties associated with student loan default, emerging shortfalls for governments of loan revenues and an apparent incapacity of policy to find the right formula to ensure that poor prospective students are not being denied access to higher education.

The US student loans system is a powerful example of what can go wrong. The current level of unpaid student debt is close to USD 1.6 trillion; this figure exceeds both the current US credit card debt as well as the Australian annual GDP, the latter by well over 20 per cent. Moreover, student loan indebtedness in the US is expanding rapidly, by around USD 100 billion. These huge figures don’t really matter, so long as the system is designed such that most of the debts can be repaid. Sadly, this is not the case.

Unpaid student debts are a burden for all taxpayers; the negative implications for budgets are profound.

A large proportion of US college debtors (at least 20 per cent) default on their loans. This has grave consequences because default damages credit reputation, making it extremely difficult for the defaulted debtors to obtain other loans in the future – currently over 9 million Americans are in this category. Further, unpaid debts are a burden for all taxpayers; the negative implications for the budget are profound.

Why is the US system working so poorly? The key problem is that US student loans, like a mortgage, must be repaid within a fixed period of time regardless of whether borrowers can afford it or not. As a result many debtors, such as those unemployed or earning low income, experience severe financial hardships even in the absence of default. Solving this problem has been a prominent topic of debate in US presidential campaigns.

The situation in the US, however, is not unique. Countries like Brazil, Colombia, Malaysia, and Thailand also face similar challenges that arise from excessive repayment burdens for graduates and substantial losses of revenue to the government. While the circumstances vary across countries, they reach unanimity on one point: they all have poorly designed loan schemes.

Fitting squarely into policy debates

The recent Special Issue of the Economics of Education Review on “Higher Education Financing: Student Loans”, co-edited by CBE economists Bruce Chapman and Dung Doan, is dedicated to address this international problem. It offers authoritative and original analyses on higher education financing and fits squarely into the policy debates on reforming student loan systems in a wide range of countries.

The first proposition put forward in the Issue is the (seemingly counter-intuitive) inequitable nature of free higher education and the desirability of government-provided income-contingent student loans such as Australia’s HECS. Whilst the existence of tuition fees is hardly questioned in Australia, political resistance to the continuation of tuition is powerful (e.g. in the case of New Zealand). The Issue offers conceptual and theoretical arguments, supported by empirical evidence from England, that introducing and even increasing tuition fees, when coupled with a carefully designed Income Contingent Loan (ICL), can boost both the growth of and access of the poor to universities. More importantly, about half of the authors of this issue have actively brought these insights into dialogues with governmental partners in Brazil, Colombia, Japan, Ireland, Malaysia, and the US.

Be careful, however. This does not mean that there exists a one-size-fits-all panacea since country-specific context really matters.

Proposing to replace a free higher education system or a mortgage-like loan with an ICL is only the start of the endeavour. The next and equally important question is, what should an ICL look like? Readers of the Issue will find a design “blueprint” that details parameters and desirable characteristics of an equitable and financially sustainable ICL.

Be careful, however. This does not mean that there exists a one-size-fits-all panacea since country-specific context really matters.

The Issue features case studies for five countries – Brazil, China, Ireland, Japan and the USA – and illustrates how an ICL could be customised to best suit a country’s specific labour market characteristics and idiosyncratic fiscal and administrative circumstances.

The US was put under the microscope in two papers in the Special Issue. One examines the effects of its mortgage-like loan system in comparison with the consequences of ICLs in Australia and England. The other provides a detailed examination of the US so-called repayment crisis, in which over the last two decades repayment rates have slowed down, loan size and proportion of borrowers with large balances have surged, and the profile of distressed debtors has evolved.

The proposed ICLs for Brazil and Japan, notably, have been welcomed at high-level discussions between the authors and the respective Ministry of Education and stayed on their policy radar. This experience is becoming common-place in other countries.

Another highlight of this Issue involves methodological novelty in projecting how much a graduate would earn over her/his lifetime, which is crucial for predicting loan impacts and performance. Of interest is that the new projection method has been introduced to and adopted by the Malaysian Ministry of Education as they attempt to reform their student loan system in 2018. Two contributors to the issue, Chapman and Lorraine Dearden (UCL), spearheaded this outreach effort as part of a DFAT engagement with Malaysia. Yes, academics make major policy impacts!

The Special Issue is the fruit of the intellectual interaction between 21 international researchers, 12 of whom are CBE researchers and visitors.

The launch of the Economics of Education Review Special Issue on “Higher Education Financing: Student Loans” will be held on 15 August in the Fred Gruen Seminar Room. Click here to register for the event.