HIGHER EDUCATION FINANCE: some political economy issues

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HIGHER EDUCATION FINANCE some political economy
issues
Geraint Johnes
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• Political economy of funding and economic welfare
  - conceptual issues
• Back of the envelope calculations
• New UK legislation - impact on institutions
• Impact of the funding council

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Motivations for public provision of education 1.
Market failure
2. Redistribution
3. Merit good arguments
If none applies, then beneficiary pays
principle applies hence economists support
for free market in higher education.
Aim is to begin to understand why governments to
intervene to evaluate what the costs of
non-intervention might be.
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The Model
Assume Individuals incomes depend on their
education Individuals undertake schooling iff the
private benefit exceeds the private
cost Government seeks to maximise social welfare,
which depends on the level and distribution of
individuals incomes If the government funds
education, it does so by raising a proportional
income tax
Quick conclusion There are circumstances under
which the government should fund education there
are also circumstances under which it should
leave education to be financed privately.
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Yi (Y0 si?i)(1-t) individuals income
(Y0 si?i)(1-t) - ci ? Y0(1-?) education
decision
Tax revenue ?nY0 ??max - ?(?max-?min)/2

• ??max-c0 ? ?(??max-c0)2 2?2Y0(?max-?min)/?
  (?max-?min)
• where ? is the proportion of cohort undertaking
  education

W n(1-?) (1-?)Y0 ?? Y0 ???max-?(?max-?min
)/2 social welfare
Choose t to maximise W (bearing in mind that t
influences ?)
Consider cases where s 1, s 0, 0ltslt1.
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Utilitarianism s 1 Welfare is unweighted sum
of net income, and so long as the tax rate is
chosen so that the optimal number of people get
educated, it doesnt matter who pays hence
welfare is identical under private finance and
tax finance
Rawlsianism s 0 Welfare is determined by the
utility of the uneducated. Under tax finance,
there will be no education since the tax cost
would reduce the utility of the uneducated. Under
private finance, only the educated benefit. So
utility of the uneducated (and hence social
welfare) is the same under both regimes.
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Intermediate cases 0ltslt1 With high values of s,
private finance yields higher welfare than tax
finance, since equity is not highly valued. With
lower values of s, tax finance yields higher
welfare though access to education is
restricted to those that are selected into the
public system.
With assumed parameter values
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The value of s (the relative weight attached to
the utility of higher income individuals in the
welfare function) is crucial. Yet economic
analyses have typically not taken distribution
issues into account preferring to concentrate
on efficiency.
Work in the literature on the economics of
happiness suggests that s may be about 0.3.
Since the critical value of s (using assumed
parameters) is 0.94, this provides a way of
understanding government involvement
albeit not a libertarian case!
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If public funding is used to finance education at
levels that the private market would choose,
there is a welfare loss due to enforced payment
by non-beneficiaries
in the UK this amounts to about 1 of economic
welfare.
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Caveats are many
Assumptions made about the parameters and
distribution Absence of externalities (other than
distributional effects) Absence of incentive
effects of taxation Extreme scenarios only what
happens when a public/private mix is adopted?
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UK Higher Education Act 2004 Introduces
differential tuition for HEU UGs up to 3000pa in
England. Tuition may vary across institutions and
subjects.
Bursaries to be provided to ensure widening of
participation.
Full loan available for tuition (as well as for
maintenance), repayable on income-contingent
basis. Small maintenance grants reintroduced for
students from low-income families.
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One view of this is that HEIs will play a
Bertrand-Nash game in which there is price
competition
q11 ?11 - ?11p11 ?p21 ?p12 ??p22 where
qij is the demand for places on course i in HEI j
and pij is the corresponding level of tuition
If ?1 p11q11 p21q21 c1 where pi is surplus
of ith institution, then the solution to the game
implies
p11 f(?11,?12,?21,?22,?11,?12,?21,?22,?,?) and
similar expressions exist for the other prices
too.
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What does this mean? The level at which tuition
should be set for each subject in each
institution depends, in a precise manner, on
demand conditions for every subject in every
institution
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Implication 1 For an institution to understand
the demand for its own provision requires that it
should also understand the determinants of demand
for its competitors
An institution should have at its disposal
information about how a change in its own price
setting behaviour would affect its competitors,
and about how a change in its competitors
pricing affects demand for its own provision
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Implication 2 Institutions should know how
pricing affects students choice of subject
Institutions should consider how they can
ring-fence subject areas that charge different
levels of tuition
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Implication 3 Institutions should know the
elasticity of demand for places on each course,
independent of what is happening at other
institutions or on other courses
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Implication 4 Collusion is possible (cf the UFC
auction?) - there is evidence that it happens in
the US Tim Boswell raised the possibility in the
House of Commons (5/3/04)
But cartels are not only illegal but inherently
unstable
With a low maximum tuition, it is likely that
many HEIs will set tuition at the maximum, and
that strategic behaviour will take place over the
award of bursaries
This requires an even more extensive information
set
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• Three challenges
• what do we know about the determinants of
  students choice of institution, and how can we
  use this knowledge to inform pricing?
• what do we know about the determinants of
  students choice of subject, and how can we use
  this knowledge to inform pricing?
• what do we know about the relevant patterns and
  sensitivities of demand, disaggregated by
  background of students?

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Game-playing already occurs in setting tuition
for PGs and OS UGs.
The new legislation raises the stakes, with more
competitors and higher student numbers
In the absence of full information, mistakes will
be made. Rewards will be available to
institutions that learn from mistakes made by
themselves and others
The vision to identify new markets will become
increasingly important, and HEIs will need to
reward such vision
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Role of the Funding Council
HEFCE emphasises sustainability as a goal also
unwilling to see public funds supporting private
activities.
(i) model without tuition fees
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Ci c c0qi c1qi2 ?
p c0(q1q2)c1(q12q22)2(c?)/(q1q2)
The problem faced by each institution is
therefore a Nash (1951) game with maximand max
c0(q1q2)c1(q12q22)2(c?)qi/(q1q2) - c0qi -
c1qi2 (c?) qi The FOCs are given by
qi22qiqj-qj2 2(c?)/c1 ?i, j?i and hence qi
?(c?)/c1 ?i
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(ii) Model with tuition If HEFCE assures
zero-surplus, then the problem of how
institutions set tuition cannot be solved. So
assume that HEFCE assures zero-surplus for
institutions that set both output and tuition at
optimal levels.
Suppose that each institution faces an inverse
demand function given by ti Q ?tj - ?qi ?i,
j?i where ti is the tuition fee paid per student
at institution i. Substituting for tj yields ti
Q - ?qi - ?qj ?i, j?i where Q, ? and ? are
appropriately defined.
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Assuming that the funding council remunerates
institutions such that they make zero surplus, p
c0(q1q2)c1(q12q22)2(c?)/(q1q2) Q
?qi ?qj The Nash game is then represented by
the maximand facing both institutions max
c0(q1q2)c1(q12q22)2(c?)/(q1q2)Q-?qi-?qj
qi -c0qi -c1qi2(c?) qi The FOCs are given by
2?qi?qjQc1q2(q122q1q2-q22)-2qj(c?)/(q1q2
)2 0 Analytical solution of this model is
simplified by assuming c10. Hence, solving the
pair of simultaneous equations yields qi
Q??Q2-2(c?)(2??)/2(2??)
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There is tension between government goals and
HEFCE goals. In a model with tuition, it is not
clear what effects changes in funding will have
on quantity (or quality) of provision.
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Conclusions Favourable conditions for the
expansion of private education include
abandonment/reduction of subsidy paid to students
in public education.
Private provision is desirable under many
conditions.
A case can be made for public provision in terms
of equity.
More research is needed to establish the optimal
mix of public and private finance of higher
education.
New funding arrangements in the UK will challenge
institutions - interesting times ahead.
Policy-makers have heretofore failed to recognise
and mitigate tension between the goals of key
funders.