How Friedman could rescue Scottish universities

03 Dec 2007

A version of this article by Professor Sir Alan Peacock was published in The Sunday Times on 2nd December.

Debate on university finance in Scotland has burst into flames once more. The embers have been glowing for a while now, but the latest Scottish budget - which appeared to denude our colleges of funds – fanned them into life.

The particular fuel for this latest crisis has been the introduction of fees in England. This innovation – rejected by our Scottish government - provides institutions south of the border with a financial advantage. It prompted Scottish principals to bid for a Ł168m rise in state support. Rejection, in the form of a more modest Ł30 million package, is the source of current anguish, and has prompted calls for us to follow the English model.

Too often public policy in Scotland develops in reaction to what is happening in England. If we want to provide the higher education worthy of our aspirations we should not simply react to events South of the Border. We have to return to basic principles of policy and - more difficult - define the path to make them operational.

To do that, we must rid ourselves of false notions about the role of government in achieving our aims. First and foremost is the idea that making university education free at the point of sale is an appropriate method for achieving efficiency and equity.

Consider the consequences of this concept of ‘free’ education. It must entail a complete centralisation of decision making in the hands of the supplier of funding - the state. Such control is the enemy of innovation and efficiency. Government must decide how much finance to provide and how it should be allocated. It must second guess the choices of students and their aptitudes. Yet we know from bitter experience how bad the state is at distributing resources in the absence of price signals.

In place of market information, governments attempt to devise criteria of efficiency upon which funding allocations for teaching and research are set. The associated controls have lead to a stream of complaints from university principals, notably in respect of the costs of providing the necessary information and the time involved in negotiating with government departments and research councils.

Some have raised the flag of freedom. They know not what they do. Would they carry their Courts, Senates and staff in a unilateral declaration of independence? They would be unable to raise sufficient funding from private sources unless governments who have provided them with most of their initial capital stock handed it over to them as a free gift. A new settlement must involve agreement among all parties, and that means persuading government that taxpayer finance is not just economically flawed but unnecessary on equity grounds too.

We often hear that, whatever the economic arguments, higher education should be provided free for ethical or social reasons. The First Minister has even taken to announcing that Scotland invented free education, and so should stick with it. Even at the school level this is dubious to say the least. But for universities it’s nonsense. During the 18th Century heyday of Scottish higher education, students paid at the lecture door for their courses. That certainly inspired their tutors to deliver value for money!

Our forebears had this right. Higher education is an investment that yields benefits primarily to its recipient. Moreover, unlike school, only some people attend university. The general taxpayer should not be expected to pay for something from which he receives no benefit.

A more serious claim is that the poor cannot afford university education, so the state must provide it for them. The experience of American universities shows that privately funded universities would provide bursaries for the poor. They have a powerful incentive to attract the best students, whatever their means, because their academic reputations rely on getting good results.

Besides, the best way to help the poor is not to provide them with ‘free’ goods, but with cash to make their own choices. This is now a well understood concept in welfare. If the state still felt the need to intervene on social grounds, it should do so by funding bursaries of its own.

If our universities are to overtake the Ivy League and Oxbridge, they will need to raise much more private funding in a way that wins public approval.

Part of the answer lies in attracting philanthropic funding. Philanthropy is particularly well suited for providing bursaries for the poor. It is also an important factor in allowing universities to provide courses that are lacking in obvious economic utility, but culturally or educationally important nonetheless.

The most successful universities in the USA have hundreds of thousands of pounds of endowment per student. Scotland’s two best endowed universities, Edinburgh and Glasgow, are minnows by comparison.

But endowments are unlikely to be the whole answer, especially in the short term and for less glamorous colleges. Nor is commercial sponsorship. The gap has to be filled by students themselves.

The usual remedy is for students to be charged fees for attending university, with various loans and bursaries attached to alleviate the financial burden. This is the English route, and the method used in the USA, at business schools, and private colleges across the globe.

However, the peculiar nature of education means that fees are not ideally suited as a way of paying for it. Education is a service that is delivered over time. You don’t know what you’re going to get out of it until graduation or later, and you can’t take it back and ask for a refund. So paying up front is risky. Fees reward colleges for their past reputation rather than their actual performance. This creates a very imperfect market - though still an improvement on state funding.

My preferred alternative is based on Milton Friedman’s idea for funding schools. It was reprised in the context of Scottish higher education in a paper published by the Policy Institute, University Bonds.

Under this scheme students would agree to pay their alma mater a small proportion of their future income once it reached a certain level. In order to generate money up front universities could issue bonds backed by this future income stream. The financial markets, adept at securitising borrowing against cash flows of all kinds, would assess their value according to the expected earnings of graduates.

Since their payment would be based on a proportion of future income, students need have no worries about incurring debts to pay for their higher education. If they were to earn little or nothing, for however long, they would pay little or nothing.

Government and taxpayers would be mercifully free of much of the financial burden and political headaches of funding higher education. Taxes could therefore come down or public spending be transferred elsewhere.

Something like 2% of graduates’ earnings over a 10 year period would be needed for universities on average to match their current income while 3% would mean a huge increase in funding for Scotland’s universities, enabling them to compete with the world’s best.

The beauty of the idea is that universities would be rewarded for their actual prowess in educating their students as reflected in their higher earning potential. They would thus have a powerful incentive to improve their performance. Students would only pay for what they got in return – a much more attractive prospect than the burden of fees or debt.

Such an approach offers a radical, peculiarly Scottish approach that could resolve concerns over equity, making change more palatable hastening reform. At the same time it would be economically more efficient, giving us a competitive advantage over our rivals in England and the US.

Radical change is needed if we are to create the conditions for superlative Scottish higher education. It is not enough to be the reluctant follower. Global leadership involves both ambition and original thinking.

The economist Professor Sir Alan Peacock has advised governments on education matters and served as Vice-Chancellor of Buckingham University (Britain’s only independent university). He is now a trustee of the Policy Institute, a Scottish think tank.