One of the less-anticipated outcomes of the COVID pandemic is the return of inflation at levels not seen in nearly thirty years.  It is not yet clear if this inflation is something transitory, or something more long-term.  The supply-chain snarls of mid-2021 have been followed by inflationary spikes due to rising oil prices and now – with the invasion of Ukraine – major spikes in food prices world-wide.  In theory, each of these things is a one-off.  But as wages rise to compensate, the risk grows of a lasting inflationary cycle.  If that happens – what happens to higher education?

Let’s start with institutions.  The basic problem is wages: across higher education, over 65% of all expenditures are on compensation.  If inflation rises, unions will seek wage rises to compensate.  At 5% inflation a year, a three-year wage settlement that covers inflation will see overall wage costs rise 16% a year in nominal terms.  If you assume “normal” inflation in non-salary items, that implies that overall institutional costs would rise by just under 13% in nominal terms.  Can afford this?  Well, thanks to inflation-indexed tax brackets (in most provinces at least), nominal government income is unlikely to rise anywhere near as quickly as this, which in turn means institutions are going to be left to cover a lot of this increase on their own.  Therefore, paying for these kinds of pay rises is going to mean some combination of domestic tuition rises (hard to imagine in a period when family budgets are being squeezed), international student enrolment increases, and cuts in staffing or services. 

Or, of course, pay could fall in real terms, which is I suspect where we will end up.  For example, all those deals recently collective agreements signed in Alberta?  Those pay scales are all going to be eroded by 5-8% in real terms over the next couple of years.  I doubt that will be the norm elsewhere but my guess would be that some salary erosion is likely.  A period of greater labour strife is even likelier. 

But I think this is not where we are going to see the biggest effect of inflation.  For that, we need to turn to the Canada Student Loans Program, which due to a combination of inflation and some deeply unwise promises made by the Liberals in the last federal election, is suddenly in deep, deep financial trouble.

Until quite recently, federal student loans worked like this: zero interest (that is, negative real interest after inflation) was charged while the student was in school and then afterwards students were charged interest at a rate of prime plus 250 basis points.  If we assume inflation at about 1.5% and a prime rate of about 3% (about average over the decade prior to covid), then someone who borrows $6000/year for four years and then repays steadily over ten years would have ended up paying back about $2800 more than they borrowed in net present value terms.  It is from calculations like this that we got irritating nonsense from the NDP about how governments were “profiting” from student loans without considering that a) it’s a minority of students who pay consistently from day 1 and b) there are losses inherent in a loan system with no effective credit checks and no collateral that need to be covered somehow. 

But now, let’s see how this system works if we change some of those assumptions.  Let’s raise inflation to five percent, and drop interest rates to zero, as per the Liberals’ pledge.  Now, it turns out, even for students who pay immediately upon graduation and never miss a payment, the elimination of all interest means that the government loses will lose one-third of the face value of the loan due to inflation. 

But it gets worse, because in truth very few graduates are apt to pay anything their loans on-time thanks to another significant change promised in the last election, which was the raising of the loan repayment threshold.  Effectively, under the new policy, what this means is that with annual incomes of $50,000 or lower, graduates will not pay a cent on their loans.  Above that, graduates need to start paying one dollar towards their loans for every five dollars owned, so that a graduate with a debt of, say, $24,000 and repaying $200/month would keep getting at least some subsidy. 

If you want to get a sense of how many students will benefit from this repayment system, consult some of the figures in this 2018 report from the University of Ottawa’s Education Policy Research Initiative entitled Earnings of Post-Secondary Education Graduates by Department: A tax Linkage Approach. Figure 2 on page 26 shows that the median humanities graduate would be unlikely to have crossed the repayment threshold until 4 years into repayment, and would still be receiving some assistance in Year 7 after graduation.  The outcomes for college graduates (figure 16, page 40) suggest that something on the order of three-quarters of all college graduates outside of engineering fields would not start paying loans back for four years and a similar percentage would still only be making partial payments after 7 years.  And that’s before we get to the cost of the promised five-year repayment holiday for any borrowers-in-repayment who have kids. 

I don’t have access to the kind of microsimulation modelling that would allow me to work out the exact levels of subsidies involved in all of this.  But in an inflationary environment, every delay in repayment means that the outstanding debt shrinks in real terms.  At 5% inflation, the debt of a student who does not start repayment until 4 years after graduation – which, recall, is what will be the case for the median Arts graduate and 75% of all college graduates – will have lost about 40% of its value before a single dollar is repaid.  The combination of high inflation and extremely generous repayment terms therefore likely means between half and two-thirds of the real value of every dollar loaned will be lost.  And since the federal side, we are talking about 3.5 billion of loans every year, that’s an implicit subsidy on the order of $2 billion per year.

That’s a lot of money.  It could fund a lot of student grants, which are proven to have at least some effect on access.  Instead, it’s going to go to people who already have finished their studies: some of whom certainly need some help making payments as they get themselves established, but for the most part this is a windfall gain to the more upwardly-mobile end of the under-35 population. 

Now, I suspect things won’t actually be that bad, because I don’t think inflation is really all that likely to stay at 5% for 15 years.  But the exercise above is still a useful one because it shows how inflation really messes with some basic assumptions about how programs work and where subsidies get directed.  Forewarned is forearmed.