Can market prices help bureaucrats create better funding policies?

One for the economists: I’m working on a submission to the review of the Nelson reforms that I blogged on late last year. In particular, I am looking at the funding amounts for each funding cluster (a group of fields of study funded at the same rate), which are based on the so-called ‘relative funding model’:

The amounts for each cluster have their origins in the

19 thoughts on “Can market prices help bureaucrats create better funding policies?

  1. I generally agree that fees would provide a reasonable indication of costs, although I would highlight that price discrimination can arise even in competitive markets (eg womens haircuts are more expensive than mens whererver you go). But it must be an improvement over historical expenditure. As you say, cost is partly endogenous in that better academics brings better research brings greater demand.


  2. Andrew, I wonder if it would be worth benchmarking the relative prices for different courses with those from, say, the US and the UK. While there will be some differences because of different production technologies, (different types of universities, liberal arts colleges, community colleges and the like, degree structures and other factors) this might provide some evidence. It would be a much more lenghy exercise. Also, the US figures may have more extreme disparities due to larger wage differences between disciplines than is the case in Australia (at least, I suspect this is the case). If nothing else, it would give you a larger sample size.


  3. Unless you believe the market for higher eeducation is perfectly competitive., I suspexct that you will need to take account of demand in some fashion, however. If you considered the extreme cae, in which there wasa monopoly supplier who was constrained to charge a uniform price for all units in a particular discipline, Ramsey-Boiteux pricing would suggest that the prices will depend on the own and cross price elasticities of demand for units in each discipline. Of course, Australian universities are competing with US universities and UK universities for full-fee paying students. As such, maybe the market is sufficiently competitive to ignore these effects in a rough and ready study?


  4. Damien – Conceptually, the UK funding system has similarities to our own, and I certainly should compare it, but I’d be worried that in another highly politicised and centrally controlled system they have the same problems that we need to minimise here – disciplines that can no longer guarantee to complete their students (physio) and perverse incentives to under or over supply places in other courses to play the funding system. Some of this is unavoidable in a model like this, but possibly the extent of it can be minimised by having the funding ratios more accurately reflect the underlying cost differentials.

    In the US as you suggest the problem will be the diversity of the system, but I will see what I can find.

    The advantage of the Australian data remains that the costs for international students should be roughly the same as for the local students.

    Rajat – There certainly is price discrimination in the Australian market – for example, Australian full-fee students are often charged less than international full-fee students. In some cases, this is arguably just the lower costs involved with local students, but in ohter cases the gap is too big for that to explain it. Partly this is just politics, but also recognises that Australian students generally have a much cheaper HECS alternative, albeit in a course or university that is not their first preference.


  5. Andrew, I don’t think that finding OS students are charged less than government funded places means that the government funded places could be run for the same amount.

    This is because a) The amount it costs to teach students decreases the more students you have (especially for cattle type courses), and thus the thinking is that OS students represents the cream on the cake so to speak — little extra work for more direct money — particularily for courses with smallish numbers.

    and b) Many places I know have weird Stalinesque type departmental/university rules, where most money bounces through a governing source that allocates it often in an ad-hoc/corrupt way (often in more than once bounce, i.e., university->faculty->department). However, when dealing with OS money, it is extremely easy to quantify, and thus for reasons unknown (probably highly correlated with poor managment), often the departments taking these students may benefit more than taking government students even given the same amount of money, since the government student money gets siphoned off more. Thus at least at some levels, the feeling is these guys are worth more.


  6. Conrad – But I think it does mean that the *marginal* cost of a place is less than what the government provides for Commonwealth-supported places. I think this stands to reason – the physical and human infrastucture of a university is very expensive, but once you have it then up to a point adding extra students might be quite cheap – a few extra casual tutors and some admin expenses – until you reach the point where you need new facilities and new full-time staff to deal with them all. This is possibly particularly so in engineering and science, where there are high physical capital costs.


  7. I agree about the marginal cost of adding students, but I’m not sure what you can conclude from this. This is because:

    a) Most courses never get enough students before the marginal cost per student is essentially stable.
    b) Since overseas students are essentially additive on course numbers, it means the overall average cost per student is reduced thanks to them (since the cost of each additional student is less).

    This suggests that

    c) Whether it is worthwhile having OS students should be based on their marginal cost like you say. However, this cost doesn’t always give any great indication that courses could be run for less.

    Take an example:

    Course with 5 government students at $5 each. After 5 students, costs decrease to $2.50. However, no more students want to do that course — engineering is too hard . However, OS Student comes along, but will only pay $3. Even though this is less than the government cost of local students, we now make a 50c profit, so taking them is worthwhile, and doesn’t change much else.

    I think this sort of situation is pretty common, but it doesn’t neccesarily tell us much about how much courses should be funded — without the OS student cross subsidy, the governement would in fact have to pay more per student.


  8. The problem with using US ‘prices’ as a comparison is that the diversity is of a really problematic sort … well, problematic for comparative analysis. At first sight the data looks neat but, once you get into the guts of it, it becomes clear that interpretation is very difficult. (Though, I’m most familiar with the private elite institutions.) There is a surprisingly high degree degree of similarity between sticker prices within institutions … i.e. the sticker price varies little between different undergrad majors / graduate schools even when faculty salaries vary significantly. Actual prices (i.e. less merit and need-based aid provided by the institution) vary wildly from student to student making the use of average measures completely useless. As you would be aware, researchers try to deal with these issues by just using California as a comparison point. However, by concentrating on California, researchers neglect the significant role that private elite east coast institutions play in establishing sticker and actual prices.


  9. In setting prices, the first step is to work out how much it costs to deliver a particular service.

    Armed with that information you can then look at market prices, and from there you can set prices with a view to determining longterm viability.

    Untangling the process by which costs are determined would be interesting. You might even get some clarification of the role of the CSIRO in an age of diminishing pure research. Then there’s the notion of comparing like with like: middle-to-bottom ranked (or teaching-only) unis should not feel obliged to match it with G8 unis but with their equivalents.


  10. If good cost information was available, then surely there would be no need for the price information in order to move the relative funding model in the direction of actual cost differences? Presumably prices are is imperfectly correlated with costs. If price information is being considered as a potential basis to reform the current relative funding model, then good cost information is probably difficult to find.


  11. Damien – University financial systems tend to be unsophisticated, plus there are incentives to mislead or inflate on costs. At least market prices have an external discipline on them.


  12. Getting solid information on costs will be a challenge, but the payoffs could be worth it. Maximising the gap between income received and income spent is a market discipline in itself. The market price of a good/service bears no relation to the cost of providing it.


  13. “The market price of a good/service bears no relation to the cost of providing it. ”

    This isn’t true, since in a market few goods are provided at below cost in the long run. That is why the finding that the average full-fee price for science and engineering is below the revenue for a Commonwealth-supported student is potentially significant.


  14. I think the person who works for a university was putting it the other way around – that in a market, price often exceeds cost by a great deal. That is also contentious, because in a reasonably competitive market, one would expect prices to tend towards costs. The role of competition policy is to preserve and strengthen competition to help achieve these outcomes.


  15. There is another factor at work in the university market, which is that most of the players are non-profits and work within an ideology of access that makes them reluctant to exploit whatever market power they have. The angst suffered over increases of about $1,000 a year when they had to set their own fees for Commonwealth-supported students was quite amazing. This, plus the global competition, plus modest surpluses relative to turnover, all suggest that there is not huge profiteering going on. Averaging fees over many universities should help lessen the effects of those universities that might be charging excessively.


  16. Andrew, I wasn’t criticising your proposed approach. Rather, I was suggesting one possible reason why you might like at prices rather costs. In terms of the issue of either overstaing costs or cost padding (gold plated whiteboards?), the fact that the funding for disciplines would be an average over all universities will tend to reduce the incentive for doing this. If you increase the sample size by including overseas institutions, then the incentive would be further reduced. Indeed, if you benchmarked the costs by using only overseas institutions, the incentive for Australian universities to either overstate costs or pad their costs would be completely removed. In any event, unless Australian institutions have anticipated that cost data might at some point be used as a basis for future funding, then historical data would not be distorted through either overstatement of costs or cost padding.


  17. The second sentence in my previous comment should read:

    Rather, I was suggesting one possible reason why you might look at prices rather costs.


  18. Actually, while the incentive for cost padding is reduced by averaging over all Australian institutions, the incentive for an institution to overstate costs is not reduced by such averaging (unless there is a cost to such overstating, such as increased probability of being found out and losing some larger amount of future funding). However, as noted in my first comment, using only overseas institutions to obtain a benchmark estimate of costs would avoid both problems.


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