Ryan Shorthouse: Our unversities must learn a valuable lesson in student economics

Above all, a market is fair to students. We know that, even after allowing for parental background and prior academic attainment, students from some universities can earn substantially more than their peers from other universities. Presently, all students are being charged just over 3,000 for courses that differ dramatically in quality and eventual returns. That is not fair.

To generate additional revenue for universities, especially in a period of fiscal retrenchment, increasing contributions from graduates who benefit significantly from their degree is the right approach.

However,there is a better option than Lord Browne's proposal of making students take out loans for the upfront costs of tuition.

Ministers could instead transfer debt for tuition costs from young people to institutions. This would be unequivocally progressive, generate additional savings for the taxpayer and finances universities by the results they achieve for their graduates. The Social Market Foundation has devised a funding model where universities borrow from government and repay through the earnings of their graduates.The Student Loans Company would collect the contributions from graduates at an income threshold, repayment rate and repayment period set by government.

Universities would be free to set a maximum graduate contribution, competing on the limit they set, thereby creating a market. The contribution limit will be based on what universities expect each cohort of graduates to earn and will have to take account of interest on their loans and a level of insurance for low-earning graduates.

Under the Lord Browne system, yes, the very poorest will be protected by a higher repayment threshold and debt write off. But as most graduates will face a growing debt with a real interest rate, it is ambiguous whether middle-income graduates get a better deal than wealthy students who pay their tuition upfront or high-earning graduates who pay off their loan early.

The SMF model offers the possibility of relieving middle-earners of more of the financial burden so that top earners unambiguously pay more.

The other potential disadvantage of the Browne model is that if most students are expected to take on a growing debt, debt-aversion could damage access. In the SMF system, the idea of a debt burden on students is removed. The model proposed by the SMF offers the possibility of cutting government expenditure further. Browne suggests, quite rightly, debt forgiveness for low earners after 30 years, which many graduates are likely to qualify for if paying higher fees. But the taxpayer has to pay for this. In this alternative model, low earners would instead be subsidised by high earners. Maintenance loans, provided at a zero real interest rate, could be more tightly means-tested, again relieving pressure on Treasury finances. Lord Browne's model does address the credit constraint students face in paying tuition by providing loans for total costs. But it is not clear whether his model will rectify the information constraints they face. Students are unsure of whether what they are paying for is a sound investment that represents real value for money for them.

This risk the students face is reduced in the SMF model. To generate higher revenue through higher loans, the graduate earnings profiles of universities have to be strong. Universities, therefore, have an incentive to improve the career prospects of their graduates, making them co-partners in their graduates' long-term careers. In the Browne model, universities take little risk for the fees they charge: any low earners who can't pay their tuition fee are subsidised by government. In the SMF model, universities will only be able to loan what they expect to acquire from their graduate earnings.

Thus, the graduate contribution limit charged by universities will be a more accurate reflection of the value of the institution a graduate attended and course they studied. If universities deliver substantial returns for their students, and thus for the economy generally, they will be rewarded with the opportunity to derive substantially more income.

For those institutions providing socially useful courses with little economic returns, the state should still subsidise these. For those not socially or economically useful, they should fail. This will create a fairer marker in higher education. Ministers should seriously consider it.

Ryan Shorthouse is a researcher from the Social Market Foundation

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