When a conclusion appears as an assumption (or more dubious arguments for university funding)

Funded by Universities Australia, KPMG have produced a report modelling the economic effects of increased investment in higher education. As an exercise in persuading Treasury, it is almost certain to fail.

Perhaps because of the way Universities Australia specified the project, the report assumes that this increased investment comes from the government. But this is not an assumption that can simply be built into an economic model. It is a highly contentious conclusion that never receives the arguments it needs.

The obvious alternative assumption is that students pay some or all of the increased investment. Under current HELP loan scheme arrangements this would still cost taxpayers, because of bad debts and interest subsidies, but not as much as direct subsidies.

Indeed, even setting aside the interests of taxpayers, it is highly likely that there would be more efficient investment and higher return if investment is determined privately rather than publicly.

For example, there is a discussion in the KPMG paper on whether lower student-staff ratios would improve returns to education. Possibly they would, on average – though the evidence produced establishes this as a plausible hypothesis rather than a firm finding. But students vary considerably in their need for small classes or contact with staff. Any across-the-board funding increase to reduce class sizes is likely to leave us with classes which are inefficiently small for some students and too large for others. In a market, each person can match their own preferences to the courses on offer.

This implicit assumption that students are homogenous pervades the report, but it is wrong. The efficient level of investment for a bright, hardworking young man (men being more likely to work full-time throughout their careers) is likely to be massively higher than for a middle-aged women of average intelligence filling in time after the kids have left home (helpful as these students are to tutors in actually doing the reading). Yet under the government investment scenario, each will have the same amount invested in their studies if they enrol in the same broad field of study.

Salvaging the government investment assumption needs some evidence that there will be under-investment if the task of increasing investment is left to the market. Yet the only evidence relevant to this point provided in the report, high private returns to investment (40% earnings premium compared to no post-school qualification), is strong evidence against the report’s assumption that government investment is needed. In specific cases where labour market premiums are lower, such as teaching and nursing, there may be a case for government paying some or all the extra investment. But on these average returns there is no general market failure and no general case for public subsidy.

So the Universities Australia/KPMG proposal involves efficiency losses in higher education investment and an unwarranted transfer of wealth from taxapayers generally to students and graduates. I trust Treasury will send it straight to the recycling bin.

KPMG’s report reminds again that no matter how impressive the econometrics in an economic model, the conclusions are only as good as the original assumptions.

17 Responses to “When a conclusion appears as an assumption (or more dubious arguments for university funding)

  • 1
    Jacques Chester
    April 22nd, 2009 21:55

    Thoughtcrime!

  • 2
    Rajat Sood
    April 22nd, 2009 23:12

    I agree with you on the lack of a demonstrated market failure, Andrew, but I still think its a legitimate question to ask whether given current policy settings (including a limit on student contributions), an increase in government investment would be net beneficial. You or I might not think its the best question to ask, but it is not without value in an environment where governments are determined to spend money. Having said that, Treasury officials reading this report may well draw the sensible inference that if more government spending is good, allowing more private spending would be even better.

  • 3
    charles
    April 23rd, 2009 07:28

    “Indeed, even setting aside the interests of taxpayers, it is highly likely that there would be more efficient investment and higher return if investment is determined privately rather than publicly.”

    And this is based on the assumption that markets work, that they create something other than boom and bust.

  • 4
    conrad
    April 23rd, 2009 07:55

    “In a market, each person can match their own preferences to the courses on offer”
    .
    “on offer” being the optimal word here. It seems rather unlikely to me that anyone is going to offer low staff-student ratio courses — they’re simply too expensive for most Australians ( or more honestly, Australians are too cheap to pay for them). So in case you’re one of the few people that want and want to pay for them, it is unlikely they are going to exist anyway, excluding a few very contentious areas which generally require other public input (i.e., training in public organizations) that would no doubt get blocked for that reason.
    .
    It’s worthwhile noting here that you can see this outcome already — there are already many accrediting organizations that could accept people without public university degrees, but there are simply no courses on offer where this occurs in Australia (unlike the US, where there are such organizations because people are willing to pay the cost). The only area I can think of where such accreditation and training organizations exist in Australia is IT — but there has never been anything to stop other private training organizations trying to take over other areas, like engineering, health etc. It just hasn’t happened. So the market has already failed (possibly due to government subsidies of public organizations) in these areas for people that want private training in everything excluding IT.

  • 5
    Andrew Norton
    April 23rd, 2009 07:58

    Rajat – Yes, it is a legitimate question, but not one asked by this report which simply assumed it as the answer.

    Charles – We are always taking about alternative systems, neither of which can predict the future with certainty. We can be 100% sure that mistakes will be made in both. The question is which over the long-term gets more right. The main advantages of a market system are that a) it can use massive amounts of information currently ignored in student preferences for courses, teaching methods, career commitment, etc., b) lets different higher education providers take multiple bets on the future, so spreading risk; and c) creates strong incentives to respond to information about student and labour market demand, while under the current system universities are strongly contained by regulation and have weak incentives.

    I have a paper coming out from NCVER which argues all this in detail, which I am sure you will read carefully due to your genuine interest in good public policy:)

  • 6
    Andrew Norton
    April 23rd, 2009 08:10

    Conrad – Bond has flourished since FEE-HELP, charging very high fees for low student:staff ratios among other things. I am sure U of M would like to go in this direction if it was not so constrained on fees.

    I’m not sure what you are getting at in your second paragraph. Yes, relatively few private higher education institutions have directly taken on the public universities, as it is a very unlevel playing field. However there are several dozen with FEE-HELP and about 35,000 students in mostly niche markets.

    There is a massive private vocational education system – a poorly researched one, but what we have suggests that it has more students than the TAFEs, though a lower ‘load’ because a larger proportion are doing short courses.

    Similarly, as noted many times in this blog, there is a large and growing private school sector, which at the upper end promote their small classes.

    What practice shows is that even when the market is rigged by regulation and government subsidy, we see private education markets emerging and meeting demand the public sector fails to meet.

  • 7
    Rajat Sood
    April 23rd, 2009 09:48

    Andrew, I’m not sure what you mean by saying that the report “assumed the answer”. Certainly the report assumes that the extra spending comes from government and not students, and it ignores deregulation or extra student contributions as an alternative option. So you could say the report asked the wrong question. But the report does not begin by assuming that extra spending (by government) will be net beneficial. It compares a scenario of increased government spending with a status quo baseline, in which government spending on higher ed remains at 1.6% of GDP. The report then purports to show that for an extra 0.6% of GDP in taxes or debt, as well as the time during which the additional students are out of the labour force to study, the payoffs are a net increase in GDP of 5.9%, etc.

  • 8
    conrad
    April 23rd, 2009 10:16

    Andrew,

    I’m just saying that for the bulk of H.Ed (I agree with you on lower level vocational courses), I find it difficult to imagine that you will ever have any great percentage of Australians being trained with a low staff-studio ratio, no matter how free universities are to charge whatever they want. Bond, for example, has around 3000 students, of which over half are OS students. Moreover, even if Melbourne reduced it’s ratio 30%, it would still only be medium (the top universities in the US often have ratios of less that 10:1). There’s simply no big market for courses made expensive via low student-staff ratios, even when such a situation could conceivable offer better training. If there really was a market for it, and the training was better, I don’t see why we haven’t already seen private suppliers pop-up like we have in IT. It is also the reason why post-graduate courses, where universities can charge whatever they want, still remain comparatively cheap in Australia.

  • 9
    Andrew Norton
    April 23rd, 2009 10:24

    Rajat – Fair point. They did not assume that (whatever the funding source) that returns from added investment would be positive. But the spin UA is putting on it is that it justified extra government spending, but that requires an additional argument that the public rather than private sector should pay.

    Conrad – That may be the case, but if so it is a sign that most people don’t really believe that low student:staff ratios are worth the cost. In which case we should have my system, in which those who do want them pay extra, and the rest save money. As always, the test of these things should not be what I think or you think or KPMG thinks or the government thinks but what entrepreneurs find by testing the market.

  • 10
    Fred Argy
    April 23rd, 2009 16:20

    Andrew, I note that, in the later discussion, you have outlined the three advantages of a market system. That’s fair enough – and it requires us to look at the alternatives.

    But this would simply confirm that it is “highly likely” that a superior investment (from an efficiency viewpoint) might be better provided privately rather than publicly?

    But does it satisfy your later conclusions that “the Universities Australian/KPMG proposal would necessarily “involve efficiency losses” and an “unwarranted transfer of wealth from taxpayers to students and graduates” and that it should be “send it straight to the recycling bin”? This may or may not be true and it requires a separate cost-benefit exercise.

  • 11
    charles
    April 23rd, 2009 19:10

    Andrew I will indeed read it with interest, I may question some of what you write but that doesn’t mean I am not interested. My point is simple, the days when the statement ‘efficient markets’ can go unchallenged are gone. If you going to challenge the assumptions of others, take care to examine your own.

  • 12
    Rajat Sood
    April 23rd, 2009 19:32

    Charles, whatever one thinks about the causes of the GFC, what we’re talking about here with higher ed is whether, at a very basic level, governments are better at allocating resources than individuals. If you really think government is likely to do a better job at allocating university places than a market, why not allow the government to decide what the shops down the street can sell or which house you can live in or what you can eat for dinner. We wouldn’t accept such heavy-handed interventions in these other parts of our lives, so why are they allowed to remain in higher ed?

  • 13
    charles
    April 23rd, 2009 21:02

    Rajat

    I tend to agree with the thrust of Andrew’s arguments probable for different reasons. I have very little faith in markets, they assume a free flow of information and the equal power of all participants. These two assumptions are not close to reality and as a result the value of markets is reduced.

    I personally think that the goal of all universities seems to be “research” and they have lost the plot. A little bit of competition may force them to focus on the product they are supposed to deliver; education.

  • 14
    Andrew Norton
    April 23rd, 2009 22:20

    Fred – Another frustrating aspect of the KPMG report is that is has nothing about how these extra resources are to be allocated, which ought to be a crucial issue. For the NCVER paper I mention at comment 5 I had to do a lot of work on vocational as well as higher education – it is a comparative piece on the allocative mechanisms in each system – and there as well I could not find any clear theoretical case for a centralised allocative system, though overall the quality of discussion in the voc ed sector is much better than higher ed. The government’s new Skills Australia body is a serious attempt at gathering industry and labour market info, but an under-theorised one.

    Charles – While some people may make overblown claims about markets, that is not what I do and these claims are not necessary to support for the market system. As Rajat suggests, the debate is about which system is likely to be better, not whether or not various textbook criteria for perfect competition exist.

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