Over the years, I have concluded that one of the reasons policy debate can be so stifling is we’re usually debating options within existing policy parameters: that is, “fixes” to existing policy.  It’s pretty rare that anyone talks about “greenfield” policies in areas where no policy ever existed.  This is kind of a shame, because it means people don’t really understand the process of trade-offs that go into original policy-making.

So, just for fun, I am going to spend this week talking about how to create a student aid program from scratch – what decisions have to be made, in what sequence, etc.  Of course, not many countries really do this truly from scratch anymore: a few in Africa and Asia and that’s about it (Russia is probably the largest country without a functioning national student loan plan).  But let’s put ourselves in the position of a country that is just starting out in the whole student aid business, with levels of technology that are not quite Canada 2019.  And see where this leads us.

Ready? OK, let’s go.

We’ll start by assuming that if this country is new to the whole business of student assistance, it’s probably not all that wealthy.  If it wants a student aid program, it’s probably because it wants to expand access to higher education and become a richer country.  The problem in this situation is that higher education is always relatively more expensive in poor countries than in rich ones, mainly because of labour costs.  Because professors are somewhat internationally mobile, they need to be paid on a scale high enough to keep them from decamping to another country where academics are better paid.  This can lead to professors being paid quite highly, relative to the average national income, which in turn makes higher education difficult to support publicly, particularly in countries where the tax take is not a very high proportion of the economy (common in both Africa and Asia – and indeed was also the case in North America prior to WWII).  In order to expand, universities need fees, but in order to pay fees, many (most?) students need some assistance. And that’s where this exercise comes in.

We can take it for granted in this situation that the government cannot afford to provide everyone with grants sufficient to cover both fees and living expenses.  Even in places like Scandinavia, non-repayable aid doesn’t cover everything; there is always some mix of grants and loans.  So, the default policy position is going to be loans plus grants with the mix to be determined by some combination of financial circumstances and politics.  I will come back to the loan/grant balance in a couple of days, but for now let’s stick to the loans part.

The very first question to ask is “where is the loan money going to come from”?  There are really only two choices here: it can come from government current accounts or it can come from banks; if the latter, government can either guarantee the loans (which is how student loans started in North America), or they can pay the bank a fee for every dollar loaned (which is how it works in China and in Canada from 1995-2001).  There are no other choices, really.  So which option should a government choose?

(Some governments have tried to get cute and tried to use public-but-non-governmental sources of funding instead.  In the 1990s, Ghana, for instance, tried running its student aid system using the one of the state pension funds as a source of capital.  Let’s just say that the rioting which followed the news of substantial fund losses was not entirely unforeseeable).

For a whole bunch of reasons, the loan guarantee option makes an enormous amount of sense to most governments, because banks have something most governments do not: a functioning system of loan recovery.  This matters a lot: the ability to lend money depends crucially on how much money ends up getting repaid.  A country with 90% loan repayment is going to be able to be a lot more generous with loans than a country with 10% repayment (at that point, you might as well just stick with grants).  Plus, the cost of a guarantee lies far in the future – under a guarantee system, you can get the first four or five years of a program basically for free.  The costs pile up later, sure, but if you’re a government which tends not to think about the long term this is neither here nor there.

So why don’t all governments go that route?  You might think it’s because it’s cheaper in the long run, but this is usually not the case.  Yes, it’s true that a government’s cost of capital is lower than a bank’s cost of capital, but the relevant question is actually whether government cost (capital + loan recovery) is lower than bank cost (capital + loan recovery), and you have to have a pretty deep level of financialization of the economy and/or a very efficient tax system to make that work.  Most OECD countries can do it; most non-OECD countries can’t. 

No, the more common reason is that banks turn governments down because they don’t believe in the government guarantee.  This is particularly the case in parts of Africa or Australasia where the there is no indigenous banking sector and the financial sector is in the hands of transnational agents (South African, French, Australian, British or Nigerian as the case may be).  Basically, if you are Standard Chartered or ANZ or a similar institution, do you actually believe that the government of Madagascar (or the Solomon Islands, or wherever) will live up to its guarantee commitment?  If not, you’re not going to put your shareholders’ money at risk.

As you can have probably gathered from the foregoing, this “choice” may not always be a choice – circumstance may force a government into one option or the other.  And the nature of this “choice” may in fact constrain the amount of credit a government can extend to students.  But even were this not the case, governments do tend to have to pick and choose between students when it come to aid.  How they decide to ration aid is therefore the subject of tomorrow’s blog: see you then.