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Circus 2

To: Dr. G. Lawson

From: Carol Cheung


Is it desirable to vary tuition fees charged to higher education students according to the costs of provision?



The structure and management of the UK higher education (HE) have undergone profound changes over the last decade: students numbers have increased; funding to HE have been squeezed; research & teaching quality are subject to regular assessment, etc. Hard evidence on the impact of these changes is scarce, but a widely held view within the sector is that the existing structure and funding systems are unsustainble (Greenaury, 1997). Thus, debates revolves around the ways of funding HE.


Whether a certain way of provision of HE is ‘desirable’ can be judged upon using different value arguments. For this question we can approach in a few ways, mainly divided into two categories. We can discuss the issue of equity-efficiency based on Pareto concept, compensation principle (Kaldor, Hicks) and human capital theory (Becker, 1965). The limitations in these concepts imply market failures like externalities, consumer sovereignty and capital/labour market imperfectation. Alternatively, we can discuss the issue of equity-efficiency from the perspective of education funding which is what the question focuses on. We can also examine the viability of the existing grant system, and plausible alternatives like government loan, graduate tax, National Insurance Loan (NIL) scheme and voucher system. Though these may be useful, we should be aware of the fact that the effectiveness of public provision and regulation is limited by information costs, fiscal restriction (policy dichotomy of expanding HE and controlling budget) and political constraints.


We can distinguish between macro efficiency (resource utilisation across stages of education) and micro efficiency (between types of education). The issue of equity can be divided into vertical equity (redistribute between different groups) and horizontal equity (opportunity for education).


We can examine some stylised facts on efficiency and equity. While the UK’s higher education share of GDP remains at 1% since 1980s, the participation of students has risen from 14% in 1982 to 30% in 1990. This implies both macro efficiency (no rising relative cost) and equity (more access to public). However, more than 60% of these students are from high-skill rich families while a mere 10% from low-skill poor families; this implies current system is not horizontally equitable.


While the Pareto identifies the criterion of efficiency, the Second Fundamental Theorem of Welfare Economics (henceforth, SFTWE) suggests that equity can be achieved via lump-sum transfer among individuals. However, the social welfare function (henceforth, swf) faces the problem of aggregating preferences under the Arrow’s impossibility theorem (where no swf can satisfy the four conditions due to limited information contained in the individual preference ordering).

We can use Kaldor-Hicks compensation principle in which a better-off person A can compensate the worse-off person B to the extent of them are better off. However, it is not clear we can measure the impact of education for both A and B (measurement problem), and it violates Scitovsky’s paradox as well.


We should also examine whether the market mechanism works (ie. Should the provision of education be charged according to it’s cost?)

The human capital theory suggests that as long as the gain in wage gap between skilled workers and unskilled workers outweighs the loss of direct cost (cost of education) and indirect cost (opportunity cost foregone in the sense of unskilled wages), a rational individual would purchase the education (Becker, 1965).


Becker’s analysis ignores the problems of externalities, uncertainty over consumer sovereignty and imperfect capital/labour markets. HE is not really a public good because it is subject to excludability and rivalry. It is more of a merit good because it generates positive externalities such as more skilled workforce (Johnson, 1984), knowledge-diffused economic growth [new endogenous growth theory by Lucas (1988)] and moralised society. The externalities-based arguments favour subsidising education to raise efficiency but at the expense of higher inequality (why pay for those in HE who tend to earn more in the future).


While we tend to assume the causality chain of consumer sovereignty à free choice à competition among universities à allocative and productive efficiency, we neglect the problem of uncertainty for consumers (lumpiness of purchase and uncertain future income) and regional monopoly power for universities. This implies substantial degree of inefficiency and equity across imperfect education, capital and labour markets.


While market failures may justify the role of government in funding the HE, the way of funding is often subject to criticisms. The current grant system may be interpreted as ‘excessive subsidies, too low participation’ because of two things; social returns are too low (Dearing Report, 1997) and a mere 10% participation from low-skill poor families.


The government loan system may resolve underinvestment (from imperfect capital market) since it encourage more participation at greater credit access (Friedman, 1962). The problem is it may harm access (inequality) because the payback of such loans may be discouraging to uncertain students. Similarly, the graduate tax system suggests that students can pay back by tax (piggyback on the existing tax system). However, it is not much different from loans (again, harming access) and did not specify when do you stop paying such tax.


The National Insurance Loan scheme (henceforth, NIL) Contributions is similar to graduate tax, but the advantage is it allows the students to access into the funds if they wish to purchase future training, or provide access for their children. This may encourage expansion (macro efficiency) and improve access (equity) because of its simple/cheap administration (‘piggyback’ on the existing NICs) and minimum default (difficult to evade NICs).



            While the NIL may resolve the problem of tax finance for poor students, it may not tackle the sociological problems in which few children from a working-class background to go to university. We could provide complementary policies such as information network to increase awareness among working class, or establish a voucher system in favour of the working class.


We need to introduce competition among universities to encourage macro efficiency. In 1988, the government introduces a two-part pricing system in which universities tender competitively (i.e. two-part bid) in which they can bid for A students for the price £ X and a further B students at price £ Y (Cave and Weale, 1992). This process is facilitated by a list of ‘guide prices’.


The problem with such list is it acts as focal point for collusive behaviour in which very few bids are made beneath the guide prices because the universities seek to predict the marginal prices and tender it (Johnes, 1992). This led to 1992 introduction of ‘yardstick competition’ in which institutions have to beat the exogenous system average to receive additional funded members.


Such intense price competition under asymmetric information may lead to the problems of universities underbidding and finding themselves unable to deliver the required level of quality. To resolve this, the government needs to improve information among consumers or allow universities to develop 'brand names' such as Oxford and Cambridge (however, quality assurance through reputation building can take a very long time).


While continuous attempts to refine the provision of education, the actual government intervention may be constrained by information cost, fiscal restraints and political constraints. The more the government tries to regulate the education market, the less alignment between goals and control (a principal-agent problem). In the political perspective, when the Labour government proposes the introduction of university tuition fees, it was fiercely opposed by numerous organisations including CBI (Financial Times, Nov 1997).


The conclusion is that it is undesirable to vary tuition fees charged to higher education students according to the costs of provision due to various reasons such as externalities. Generally we believe that the existing grant system is regressive; excessive subsidy and lack of participation. This provides some support to reform it to raise efficiency and equity, but there might be some trade-off between these two. Regulation over the education market remains vital, though subject to considerable constraints in reality. While it is useful to identify several criteria for efficiency and equity in policy-making process, the impact of these policies on the criteria can somehow be less obvious.

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