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Why the Government should never bail out a university

  • 1 September 2021
  • By Philip Booth

Today’s blog is by Philip Booth, Director of the Vinson Centre for the Public Understanding of Economics and Professor of Economics at the University of Buckingham.

Governments want many contradictory things. They desire high levels of government spending but not high levels of taxation. They want to reduce carbon emissions whilst not charging the full rate of VAT on domestic fuel. And many in government want the university sector to contract without any universities actually disappearing. Now is the time for the government to show that it has backbone in this area and to allow universities to fail.

It is not widely realised that universities are private institutions even though they are regulated and subsidised by the state. They are responsible for their own management and they must be held to account if that management fails.

During the COVID crisis, a special regime was set up to manage failing universities – the ‘Higher Education Restructuring Regime’. It was intended to deal with universities that got into financial difficulty as a result of COVID. The establishment of this quango was heavily criticised at the time but, whatever its merits, it should be wound up in November, as soon as the financial consequences of this round of admissions are known. And what should replace it? Nothing.

Just as in the banking sector, the possibility of being saved by implicit or explicit support by the government creates moral hazard in higher education. It incentivises universities to develop business models built on the assumption of unsustainable expansion. It incentivises over-gearing of university balance sheets. It encourages universities not to get to grips with their pension costs. University management and governors know that, in the event of failure, there is likely to be a financier of last resort. Most universities have significant amounts of property. So any university that has managed its balance sheet prudently should be able to obtain private sector loans to deal with year-to-year fluctuations in income.

Government support distorts competition. Not only does it benefit the imprudent over the prudent, but, when universities receive emergency support from the regulator, they remain in business and have a strong incentive to fish for students, taking them from better-managed universities whose courses might be more appropriate for the students and which have more sustainable business models.

Unlike in the banking sector, no university poses a systemic threat to the whole system if it goes bust. All universities have a student protection plan so that there can be an orderly resolution that is not significantly to the detriment of students.

But there is another reason why universities must be allowed to fail. If you add up the proposed expansion plans of all universities, they are not consistent with the likely trends in demand. In 2019, the OfS reported that universities were, collectively, expecting 10 per cent growth over four years while the number of 18-year olds was expected to fall by 5 per cent. Universities either need to be able to develop sustainable business plans based on the assumption of lower or stationary income (which will require a reduction in regulatory as well as other costs) or the number of institutions needs to shrink.

A failed university may be resurrected in another form; it might merge with another university; it might take radical decisions such as the sharing of back-office facilities with another university. The regulator can help with these kinds of discussions – especially if confidentiality is needed. However, there should be no financial bailouts, implicit or explicit.

Indeed, life will be a misery for university staff and management over the next generation if the sector has more institutions than can be justified by student demand. There will be 25 years of radical, or at least stealthy, cost cutting across the sector.

The message needs to go out loudly and clearly from government: no university has a right to exist forever. Universities should be more independent and not less. There should be less regulation and not more. And the quid pro quo is that no university will be bailed out financially, either implicitly or explicitly – ever. Prudent management and realistic growth plans must be rewarded and not penalised.

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  1. Sarah says:

    Could you dig a little deeper into the assumption that all growth depends upon the supply of eighteen year olds? What about those of us who are offering second chances, including at Russell Group and other high status institutions, to people who for whatever reason did not have the chance to attend university when they were eighteen?

  2. John says:

    ‘sharing of back-office facilities’.

    You are Eric Pickles and I claim my five pound.

  3. David says:

    The point about demand not meeting expansion plans is now out of date and so doesn’t quite hold. 18 year old numbers are now rising again significantly and will for much of the 2020s. That’s not to say that institutions are right to bank on forever expansion, just that it’s a better bet now than it was from c.2016-2020.

  4. Philip Booth says:

    Sarah – that is a fair point. Not all growth comes from 18 year olds. However, one wonders when universities will start developing business models that are not predicated upon growth – and they might be better models too. I happen to think that it is easier to serve students better (especially from a wp background) in smaller institutions. But that may be because I work for one.

  5. albert wright says:

    Congratulations to Professor Booth.

    The “University market” is a very artificial market. It does not make the best use of the resources it gets and I totally agree there should be no bail outs of individual institutions.

    The ability to cross subsidise different activities (academic research v undergraduate teaching v post graduate teaching / research) that produce totally different outcomes should result in a greater sense of personal responsibility when things go wrong.

    At the heart of this mess is the totally un-market position of each institution receiving a fixed amount of money for each undergraduate regardless of the subject studied, the quality of the undergraduate, the quality of the teaching and experience, or the true cost of supply.

  6. Paul Woodgates says:

    Thanks for initiating the debate. I agree that a university no one wants to attend should not be bailed out. But I would make three points on the article.

    1. I am unconvinced by the argument that the mere existence of a funding stream of last resort causes universities to take risks or manage the institution in ways which they otherwise would not. The Higher Education Restructuring Regime loans come with strings attached in terms of loss of autonomy which would be repugnant to most universities. And even if we assume that a university as a corporate entity might be swayed by the knowledge that a bailout would be forthcoming if all else fails, it’s hard to imagine that the individuals involved would take the same view; for the vice-chancellor and leadership, admitting that things had gone so badly wrong on their watch that a bailout was needed would surely be just as career-ending as outright closure.

    2. While all universities do indeed have student protection plans, the impact on students of a university closure would be huge. At the very least, students would not get the experience they signed up for, some would not be able to travel to new locations, some would find changes to programmes and pedagogy unacceptable. Dissatisfaction and dropout would surely be the result.

    3. There is no mention here of the central place that universities have in local communities. In some places, the university is the largest employer, the largest landowner and a significant player in local economic development. While that is no reason to throw money into a systemically loss-making institution, it is surely a good reason to promote and enable the necessary changes – to leadership, business model, portfolio and asset base – to ensure a turnaround.

  7. Julian Gravatt says:

    I’m not it’s right that “no university poses a systemic threat to the whole system if it goes bust” A university insolvency might:

    1. cause problems for partner universities on
    a range of research and quality assurance collaborations
    2. trigger clauses in loan agreements held by other universities resulting in higher charges or requests for more security
    3. prompt funded pension schemes (USS, LGPS) with the same impact
    4. hit domestic and international student confidence in promises made via the UCAS system

    Some government officials believed an FE college insolvency would be easy until they actually embarked on one in Kent in 2019.

  8. Anthony says:

    Re the future of our universities, the impact of students from abroad Is probably being factored in to some expansion plans rather than just UK demographics. Some of our most esteemed institutions have courses almost wholly populated by non-UK residents – partly due to educational reputation but also because English is the global lingua franca (sic).

  9. david player says:

    You have completely ignored the enormous contribution the higher education sector contributes to the economy. Unlike banks (which you use as a comparrison) they bring societal and technical benefits, as well as financial.

    your article just isnt well rounded enough to grasp the scope of topic.

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