Welcome back to this little series.  On Monday and Tuesday we looked at loans – how to pay for them and how to design repayment systems.  Today, I want to introduce grants into the mix (to be clear, I’m only talking about grants where need is the primary criterion – there’s a whole other set of policy considerations about merit-based aid, which I’m going to leave to one side during this discussion).

Theoretically, the grants vs. loans debate is one of the most important and most fraught in the design of a student aid system.  It is not really a matter of “generosity” unless you assume away the problem of scarcity.  Loans and grants actually address quite different problems and don’t always need to be integrated into the same program.  Here’s why:

Though we speak of “financial barriers” to higher education, these actually come in two quite distinct varieties.  The first is what you might call the “rate of return barrier”: that is, where a program is so expensive, many people do not want to take it because they believe the costs outweigh the benefits.  The current poster-child for this kind of program is the new Columbia J-school degree in data journalism which is retailing at $106,000 US.  Given that this mostly gives graduates an entrée into a profession which is widely viewed as ailing if not failing, it seems unlikely many people will want to attend.   Lending people money in this situation really does no good – you need grants to reduce the price.

Now, to be clear, just because a program has an expensive list price is not a particularly good reason to subsidize students; if a program genuinely generates negative private returns, there is no real reason to publicly subsidize it.  But now imagine that large numbers of people start to think that moderately-priced programs which actually have reasonably good rates of return are “too expensive”. What then?

As it turns out, students from lower-income backgrounds tend both to overestimate the costs of higher education programs and underestimate the long-term benefits, relative to students from higher-income ones.  This is likely one reason (there are others) why low-income students have a systematically lower propensity to opt into higher education.  It’s also a problem that can be solved with targeted grants.

The more common financial barrier in higher education, though, is the liquidity barrier.  That is to say, people want to go to higher education, they think it’s a good deal, but they don’t have enough money both to pay fees (remember, in this scenario we’re assuming the existence of fees) and keep body and soul together.  They don’t need a grant to be convinced to go: they need a loan to tide them over until the end of their studies. 

(To be clear: you could achieve the same thing with grants – it’s just more expensive.  How much more?  As we discussed a bit yesterday, it depends on how efficient your loan repayment systems are.  If you’re recouping 90 cents on the dollar after losses, interest subsidies and administration, then a dollar in grants costs ten times a dollar in loans.  If you’re only recouping 50 cents on the dollar, then a dollar in grants costs twice a dollar in loans.  This is one of the many, many reasons why repayment rates matter)

Now, it’s not quite as simple as “grants to reduce prices where necessary” and “loans to solve liquidity problems”.  Almost, but not quite.  The third issue is debt, which is actually fiendishly complicated from a policy perspective.

Many people will claim that too much debt is itself a third type of barrier.  There is some evidence for this (I wrote about it here), but it seems like a relatively small phenomenon.  Most of what people mean when they say some students are debt averse is actually “this course’s benefits are perceived to outweigh the costs”.  Now you may want to deal with this problem through grants, as suggested above – but it’s not a separate problem.

Even if debt aversion isn’t (much of) a thing, debt management is.  Borrowers who start their working careers with very high debt-to-disposable income ratios tend not to have very good outcomes (it’s the ratio rather than debt per se that’s the problem: medical students tend to graduate with a lot of debt but usually pay it off fine, whereas drop outs with low levels of debt often default).  There are a variety of ways to handle this problem.  One approach is just to make default impossible by adjusting the rules (i.e. impose income-contingency), another is to extend the length of the loan so as to make a given debt load more bearable.  But another set of approaches involve grants in one of three forms:

• grants at the time of enrolment, such that the amount of loan given in any year is not excessive (which is what we tend to do in Canada);
• grants at the end of studies to reduce accumulated debt to a manageable level (in Germany, for instance)
• subsidies during the repayment period to make loads more manageable (in Canada, this could mean things like the Repayment Assistance Program, and in the UK it could be massive debt forgiveness as in their current ICR system).

In an idealized, rational public policy system, a government would have some sense of various students’ price sensitivities and liquidity constraints, give out loans and grants accordingly and then, maybe, provide some non-repayable aid debt management grants.  In reality, no government in the world operates this way.  Instead, rules for loans and grants either get made separately with little account for balance (for instance, in the United States, or Australia), or someone goes in with a hard-and-fast rule about loan:grant ratios (50:50 in Germany, 70:30 in Sweden, etc.) and then makes the overall provision of aid as generous as the overall budgetary picture allows.  And all the while, student groups are arguing for more grant money because hey, who wouldn’t want to pay less when the alternative is paying more? 

At the end of the day, the loan/grant mix is 100% about politics and macro-budgetary priorities.  There’s very little that’s “rational” about it.  When it comes to deliberate policy making, the rational aspects tend to be less on the overall mix, and more on the specifics of how both loans and grants are rationed.  Which will be the subject of our fourth and final blog on this topic tomorrow.