Deferring higher education fees without relying on contributions from non-students

Abstract

The benefits of deferring the payment of higher-education costs are increasingly acknowledged as a way to overcome student-borrowing constraints. Since higher education is a risky investment and students are generally risk averse, the repayment arrangements proposed in the literature frequently include some insurance. In a competitive environment, preventing adverse selection may require coercion to join the scheme or the use of public funds (i.e. contributions from non-students) to make the scheme attractive to all students. Alternatively, when the number of higher-ability students is low, students can be given the option to choose among arrangements that include different degrees of insurance.

JEL classification:

• I22
• 128

Keywords:

• risk aversion
• adverse selection
• optimal education finance

Acknowledgements

I gratefully acknowledge financial support from the Spanish Ministry of Science and Innovation through Research Grant ECO2010-16353 and the Autonomous Government of Catalonia through Research Grant 2009SGR-189 and XREPP. I am indebted to two anonymous referees for their insightful comments. Any remaining errors are my sole responsibility.

Notes

On 15 July 2010, Vince Cable, the UK Secretary of State for Business, Innovation, and Skills, announced a graduate tax plan.

The reason why I consider the government among the competitive funding institutions is that such arrangements do not exist currently on a broad basis and need to be driven by the authorities. Also, an equilibrium does not always exist. In this case, it can be useful to resort to a government that, unlike market institutions, can use its coercive power to force students to join a particular scheme. In turn, we should not neglect that, even if the government takes the initiative, existing banks can react to the emergence of profitable alternatives.

Del Rey and Racionero (2010) show that this scheme does not, however, yield optimal participation unless students are compensated for their forgone earnings while studying. The graduate tax proposal in Lincoln and Walker (1993) also includes an annual maintenance grant. We will come back to this point shortly.

Insurance can also induce moral hazard. This should be taken into account in further research.