Following on from yesterday’s blog about Human Capital Theory, I thought it would be worth talking a little more broadly about financial barriers to higher education and what we mean by that term.  Because there are at least three different phenomena at work, and much too much policy confuses the three.

The first type of possible financial barrier is the one we encountered yesterday: the “value for money” barrier, (or alternatively, the “is it worth it” barrier).   A free master’s program in data journalism sounds acceptable, but the 12-month, $105,000 (US) program in data journalism offered by Columbia University is likely going to put people off because it’s not clear anyone’s ever going to earn that much extra money as a result of taking it.  Because different degrees produce graduates with different types of earning power, the tuition rate at which people start to say “this degree isn’t worth it” is going to be different: this is why there is an awfully good case for differential tuition and why we should be particularly concerned about fees in programs which tend to lead to lower-paying jobs (for example, Early Childhood Education).

With public subsidies, most degrees/diplomas in Canada pass the “is it worth it” tests.  But just because something is a good deal doesn’t mean we can always afford it.  It might be crazy to pass up a $150,000 Mercedes going for just $100,000, but that’s not an amount of money many people have just lying around for purchases.  Taking advantage of good deals still implies a need for liquidity.  Many, many students need liquidity.

You can see where I am going with this – different problems require different policy tools.  If you think there are accessibility barriers, you deal with them by lowering costs – that is, either by subsidising the institution to reduce prices to students, or by reducing net tuition through grants (targeted or otherwise).  Grants tend to be more effective with lower-income students because they often systematically over-estimate costs and underestimate returns, meaning (if you recall yesterday’s Human Capital discussion) that poorer students will be systematically less likely to attend any program because of the way they conceptualize the payoff.  But for students with liquidity problems, the correct tool is student loans.  Those students don’t need to have the net price lowered in order to convince them to go; they just need some money to tide them over.   It is therefore cheaper and much more efficient to improve liquidity through loans.

Ah, you say, but what about debt aversion?  This is the third type of financial barrier and it is by far the trickiest, the least understood, and the one that really messes up student aid policy.

If one wanted to get all homo economicus about this, one could argue debt aversion does not exist.  Think about it for a minute: if a student says, “I want to study program X but I don’t want to borrow more than $Y”, is the student actually saying the program is not worth more than $Y?  That would imply the real problem isn’t debt per se, but value for money, a subject we have already covered (if true, it would explain why debt aversion is associated with poorer students – because we know their valuation of the cost and benefits of education makes them less likely to attend).

[the_ad id=”12598″]

Well, hold on, you say.  Maybe that’s not true.  Maybe people think a program is probably worth it, but are worried about the risk.  That is, they like the 80% chance that this program leads to a good future but are terrified about that 20% chance that their career never really starts, and that money is wasted and then they are in debt to someone.  Fair point.  But note that the solution to this problem is not necessarily to reduce lending, but to reduce the risk of lending.  Income-contingent lending programs, which allow people to suspend their payments when income is low, are an important potential tool here.

There is a final type of debt aversion that probably needs to be addressed, and that is debt aversion that stems from cultural biases.  To the extent that evidence of actual debt aversion has ever been found (see back here), it has not been connected to income, which makes complete sense because experimental evidence tends to find that because low-income individuals don’t get extended credit all that often, they take what they can get when offered.  To the extent it is associated with anything, it is probably cultural background, such as some Islamic cultures which dislike the idea of interest-bearing debt.  This particular aversion can be overstated; a few years ago I had reason to commission research on attitudes to debt in Indonesia and though many said they wouldn’t take out student debt, fewer than 10% of students in the world’s largest Islamic country had genuine opposition to borrowing which could be said to stem from cultural reasons rather than risk-related ones (a high proportion of individuals who said they would not borrow for education were quite happy to borrow for houses, vehicles and other goods where the asset was tangible). Because aversion is not tied to income, this is a difficult problem to target; however, some countries have had quite a bit of success using Shariah-compliant student loans.  The UK, for instance, has recently introduced such a scheme and of course Malaysia has a loan program that gets around the problem of interest-bearing loans quite neatly.

To conclude: the golden rules of dealing with financial barriers are: i) Grants are most effective when targeted on income and/or on programs with lower payoffs.  ii) liquidity is a big deal, but it’s best dealt with through loans, iii) reduce risk in repayment, preferably through income-contingency and iv) for very hard-core issues of cultural debt aversion, consider something like a shariah-compliant student loan.