Who really bears the cost of education?

by Marie-Hélène Doumet
Senior Analyst, Directorate for Education and Skills

It can be difficult to get your head around education finance. Who actually pays for it, where does the money come from, and how is it spent are all crucial questions to ask if you want to understand how the money flows in education. In many countries, basic education is considered a right, and governments are expected to ensure universal access to it. However, educational attainment has reached unprecedented levels, and more people are participating in education than ever before, leaving governments struggling to meet the demand through public funds alone. The role of private funding has become more significant in the past decade, particularly at the pre-primary and tertiary levels of education. 

But the reality is more complex than a binary public-private model would suggest. Other financing mechanisms, involving the transfer of funds between governments, households and other private entities, are blurring the lines of what is commonly understood as public or private.

Take government-subsidised loans to students. A loan, by definition, needs to be repaid, and so is commonly considered as a private cost to households.  But before that, loans actually come out of the public purse, and so are actually a public cost to governments at the time the loan is issued. The cost, however, shifts to individuals once they enter the labour market and start earning enough to make repayments.  

The latest Education in Focus brief  tries to answer the question “Who really bears the cost of education?” by looking at these transfers as two sides of the same coin.  Separating out transfers from the traditional public-private split of costs also provides more granularity on the sourcing of private expenditure, differentiating what comes in the form of government support from what is truly out-of-pocket costs. 

Consider, for example, two countries well known for their reliance on private expenditure to fund tertiary education: the United Kingdom and Japan. In 2014, both countries relied on private funding to provide around 70% of the cost of tertiary education (when considering the final allocation of funds after transfers). However, two-thirds of that private funding in the United Kingdom comes from government transfers to private non-educational entities, mostly in the form of loans, with advantageous repayment schedules and conditions, to students. This means that while the private sector is ultimately responsible for this expenditure, it is the public sector that bears a significant share of the initial cost, not only of the value of the loan, but also the risk of future default on payments. By contrast, in Japan, only 20% of final private expenditure originated from government transfers, leaving the private sector, a large share of which are households, to fund the rest from their own pockets.  

The chart above shows the extent to which countries balance out public and private funding in tertiary education, and how they compensate for private funding through government transfers to households, students and other non-educational private entities. Interestingly, some countries with the largest share of private funding in education provide the least financial support as a share of total private expenditure. This is the case in Chile, Japan, Korea and the United States. By contrast, countries such as Belgium, the Netherlands and Slovenia cover a large share of private expenditure through public-to-private transfers, and households bear much less of a financial burden. In between the two models, countries such as Australia, New Zealand and the United Kingdom rely on public funds to unlock private ones.  A strong financial support system, mostly structured on publicly subsidised loans, lightens the initial high cost of education for individuals, but allows graduates to repay the loans when they are most able to do so.    

Central to the idea of who should bear the cost of education is the philosophy behind who actually benefits the most from it: the public or the individual. Primary and secondary education are generally considered as a fundamental human right to basic skills that should mostly be provided by governments, which, indeed, is often the case. However, the earnings premium provided to higher education opens the debate as to who benefits the most from higher education and therefore, who should be paying for it. But thinking mainly in terms of public or private spending misses an essential element: what happens behind the scenes in the form of public-to-private transfers. Understanding these financial transfers provides insights as to how the cost of education shifts between the public and private sectors over time, and sheds some light on a sometimes overlooked measure of education finance.  

Links

Education Indicators in Focus No. 56 - Who really bears the cost of education? How the burden of education expenditure shifts from the public to the private sector

Education at a Glance 2017 - OECD Indicators

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Is free higher education fair?

by Andreas Schleicher 

Director, Directorate for Education and Skills 

Skills have become the currency of 21st century economies and, despite the significant increase the UK has seen in university graduation over the last decade, the earnings of workers with a Master’s degree remain over 80% higher than those of workers with just five good GCSEs or an equivalent vocational qualification. Sure, not every university graduate will end up with a great salary, but the claim that for many studying does not pay is a myth: just one in 10 university graduates earn less than half the median salary, a figure which is double for adults with only five good GCSEs, and another 22% of graduates earn between half the median and the median salary. Conversely, 21% earn more than twice the median, three times more than those with five good GCESs. Beyond the monetary benefits, higher education brings important social benefits for individuals and nations, ranging from better health through to greater social participation, and up to more trust in people and institutions.

Some say these trends are all futures of the past, and that the job prospects of future graduates may look much worse, particularly if bringing in more and more people eventually means including less qualified applicants. But people have been saying these things ever since I began tracking those numbers over a decade ago, and the bottom line is that, so far, the rise in knowledge workers has generally not led to a decline in their pay, as we have seen for people at the lower end of the skills spectrum.

That brings up the question of who should pay for this, because there simply is no free university education.

The Nordic countries in Europe pay for universities through the public purse and some even generously subsidise the living costs of university students. It makes sense for them because participation is almost universal and they have a steeply progressive tax system so that they can recuperate the funds from graduates who typically end up as the better earners.

European countries like France or Germany, too, say higher education is important, but their governments are neither willing to put in the required funds nor allowing most of their universities to charge tuition. They end up compromising quality and limiting provision, with the effect that all workers end up paying for the university education of the rich parents’ children. That is, because wherever access is limited, it tends to be the wealthiest and not the smartest students who get the best places, whatever the source of funds.

The third alternative is to allow universities to charge tuition, and interestingly, OECD data show absolutely no cross-country relationship between the level of tuition fees countries charge and the participation of disadvantaged youth in tertiary education. In fact, social mobility is worse in Germany, which pays for all almost university education through the public purse, than it is in the UK. That is because to mobilise those public funds for higher education, Germany ends up charging tuition for children in kindergarten, which leads to a much less level playing field from the start.

But getting tuition right is not simple either. If countries put the burden for tuition entirely on the shoulders of families, they risk not attracting the brightest but instead the wealthiest children to attend, which means not making the most out of the country’s talent.

If countries rely mainly on commercial loans which students have to repay once they finish their studies, they still leave students and families with the risk, because the promise of greater lifetime earnings of graduates is a statistical one, and there is actually very wide dispersion in earnings. The UK, and some other countries too, have tried to square that circle with a combination of income-contingent loans and means-tested grants. That basically means risk-free access to financing for prospective students with governments leveraging, but not paying, for the costs.

The loans reduce the liquidity constraints faced by individuals at the time of study, while the income-contingent nature of the loans system addresses the risk and uncertainty faced by individuals (insurance against inability to repay) and improves the progressiveness of the overall system (lower public subsidy for graduates with higher private returns). In the UK, the repayments of graduates correspond to a proportion of their earnings and low earners make low or no repayments, and graduates with low lifetime earnings end up not repaying their loans in full.

But even the best loan system is often not sufficient. There is ample evidence that young people from low income families or from families with poorly educated parents (but also youth who just don't have good information on the benefits of tertiary education) underestimate the net benefits of tertiary education. That’s why it has paid off for the UK to complement the loan scheme with means-tested grants or tuition waivers for vulnerable groups. It will be worth it to continue to do so, simply because people with better education will pay much more in taxes than what their education costs.

Sure, those loan and grant systems cost money, and have shifted risks to government which will end up paying for any bad debt. Indeed, it is very likely that repayment rates will end up a lot lower compared to what the Government anticipated in 2012. But these costs are just a tiny fraction of the added fiscal income due to better educated individuals paying higher taxes, let alone the social benefits. Keep in mind that the added tax income of those graduates who end up in employment, on average over £80 000 in the UK, is many times larger than any conceivable bad debt. And where students don’t pay their loans back, tuition will still have had important effects in terms of having students choose their studies carefully and complete them on time, something where the UK does so much better than most other European countries.

Every year I am reading media stories that the financial burden on students, perceived or real, is choking off entry into higher education. But every year our statistics show a rise in entry to higher education. It’s also noteworthy that the UK ranks second after New Zealand when it comes to the share of international students, which is another indicator of the attractiveness of UK higher education.

Still, there is a lot the UK can do to further improve its approach to financing universities. For a start, it can do better with aligning course offerings with societal demand. That may also mean thinking more carefully about fee structures, ensuring that these better reflect the cost of provision and the value to students. Indeed, it is crucial to ensure that fees reflect the educational value of the programmes for students, rather than the amounts that universities can extract from students simply because graduates can expect higher lifetime earnings that also reflect their prior attainment.

Consider that England currently has an above-average share of low-skilled 20-34 year-old graduates, but an above-average share of tertiary graduates. Any increases in tuition fees must therefore demonstrably go into better teaching and learning. The Framework of Excellence makes a start to address this, but it does not yet adequately capture the most important element in this regard: the value that universities add to student learning outcomes.

I also worry that the loan repayment parameters mean that many middle income workers – such as teachers, health professionals, public sector workers – will end up paying more for their education than better earners such as lawyers and bankers. Not least, it needs to be kept in mind that many UK students are likely to have some level of debt for up to 30 years and some research on the broader implications of student debt would be important. Contrast this with Australian students who pay off the loan for their undergraduate degree within nine years of graduation.

That being said, among all available approaches, a system of income-contingent loans and means-tested grants is still the most scalable and sustainable approach to university finance. From a public policy point of view, governments should invest public resources in education over the lifetime of a young person in those stages where its impact is greatest, both in terms of efficiency and equity. Higher education is not high on that list.

Links 
Education at a Glance 2017: How much do tertiary students pay and what public support do they receive?
Enhancing higher education system performance: Benchmarking higher education system performance

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