Economic (basket) case (1 of 2)

December 16, 2010

Since the 1997 Dearing report, successive UK governments have framed their policy for the academy on a set of economic assumptions that do not make sense, even on the principle that those who benefit from higher education should pay for it.

The debate over private/public returns to higher education typically misses out an element central to investment considerations: risk. There is clearly a risk to the state (and "society") in investing in higher education, but like a good index-tracking fund, it can be spread over a large number of individuals and sectors.

An 18-year-old considering higher education does not have that luxury. For them, it is a risky investment with many frontloaded costs and highly uncertain and mostly distant returns. What school leaver knows what their employment returns will be in three years' time, let alone 40?

For the 18-year-old, university can be akin to investing their life savings in a speculative mining venture. A rational person would demand a high risk premium for doing so and heavily discount any future projected benefits.

Lord Dearing used the Treasury test rate of discount used for low-risk public investments to measure the private rate of return to students and graduates. This grossly overestimated the returns and the share of the cost that should reasonably be borne by them. Most individuals and developed nations know this instinctively. If you use an appropriate discount rate that fairly reflects the true private risk factor, it changes the analysis and conclusions, but such treatment has never been applied by the UK government since Dearing.

Economics is about incentives, expectations and the efficient allocation of resources. On these grounds, the government is now set on a course of action that will have adverse effects for decades.

Neil Kay, Emeritus professor of business economics, University of Strathclyde.

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