Beyond Groupthink: A Mixed Economy Model for Higher Education Funding

• This blog has been kindly written for HEPI by Peter Ainsworth, the author of Setting Universities Free: How to deliver a sustainable student funding system (2022)

Picture the 1930s economic slump, absent Keynes’s challenge to prevailing thought. Classical economists were stuck with the mindset that laissez-faire would ultimately produce a recovery. Keynes confronted this consensus, demonstrating that – in the circumstances of the era – government intervention was indispensable, and so rescued a beleaguered economy. As he explained in the preface to his General Theory:

The difficulty lies, not in the new ideas, but in escaping from the old ones.^[1]

While UK higher education is currently buoyed up by international demand, there’s a disquieting undercurrent of pessimistic sentiment, similar to the mood of the 1920s and the fin de siècle apprehension of the late 19th century, which fears prosperity may be nearing its end. This mood is evidenced by the recent surge of articles and consultations on the topic of university funding and regulation. Notable examples include Justine Greening’s call for a graduate tax, Minouche Shafik’s appeal for a new review, Universities UK’s national conversation, The Economist’s headline ‘Useless Studies’, the joint call from four higher education groups for an inquiry into the Office for Students and the compelling witness evidence presented during the ensuing investigation.

A key concern is a parallel to Keynes’s observation of a lack of demand consequent on a limit as to how low interest rates could go; in this case, as teaching home undergraduates becomes increasingly loss-making, there is the risk of a surplus of demand from home undergraduate students unable, by government fiat, to pay a higher price. Instead of frustrated unemployed workers, there is the danger of creating a class of disillusioned British youth excluded from higher education because of a man-made tuition fee limit. Universities, for their part, are becoming increasingly vulnerable to shifts in political or global competitive climates, as their income and fortunes become ever more dependent on international students from China, India and Nigeria.

A striking aspect of the recent discussions on higher education is the prevalence of groupthink, with many stakeholders sharing near-identical perspectives. Much like the classical economists Keynes faced, who believed the free market was the panacea and could not conceive of a role for government intervention, the views expressed in the articles, consultations and hearings reveal a mirror-image conviction. There is a uniform belief that the government is the sole viable funder of home undergraduate education and that the free market has no place in this domain. In this sense, higher education faces an inverse challenge to the one Keynes confronted: whereas the economy was once trapped by an infatuation with free markets, higher education is now grappling with problems arising from an aversion to them.

As Keynes pinpointed the liquidity trap – the stickiness of interest rates as they approach zero – as the crucial flaw in classical economic thought, so too the current higher education funding system has a fundamental weakness. As Charles Clarke confirmed in his evidence to the Lords Committee, the problem stems from the politicisation of tuition fees and repayment terms: ‘it has become a political football’.^[2] Setting repayment terms at uneconomic levels may win votes, but it ultimately places an excessive burden on taxpayers, leading to constraints on tuition fees and chronic underfunding within the system.

In the current higher education landscape, the conviction that there is no alternative to having the government decide, for undergraduates, tuition fee levels and for it to fully fund them seems puzzling. The free market operates efficiently in relation to home postgraduate students and for international students, where universities are free to set their fees at any level. This has resulted in a wide range of prices but without there being any political backlash. These international students, who are often young and vulnerable like their British counterparts, do not benefit from risk-reducing income-contingent loans, yet their growing participation shows they recognise the immense value of a UK university education. 

A potential solution to the funding crisis lies in establishing a ‘Keynesian’ mixed economy approach to undergraduate funding. In this system, universities would be free to set tuition fees above the £9,250 level of the state loan, provided that they offered private income-contingent loans to their students to make up the difference. By allowing universities to set their own fees and requiring them to offer income-contingent loans to bridge the gap between the government loan and the new fee level, this proposal ensures that no student is required to pay any upfront costs and will only begin to repay the loan when their income reaches a certain threshold.

I helped the University of Buckingham launch an income-contingent loan scheme along these lines for its 2022 intake. As an Approved institution its undergraduate students could only secure state loans for a portion of its tuition fees. Having identified a third-party administrator able to operate income-contingent loans, I then designed the terms of two variants of income-contingent loan to meet the needs of different types of student, while protecting the interests of the University.

This approach not only provides an additional income stream for universities but also incentivises them to design courses and teaching methods that better prepare their graduates for successful careers, ultimately benefiting both the students and the institutions themselves. While there may be concerns about the impact of this system on disadvantaged students, the income-contingent nature of the loans ensures that these students do not face any upfront financial barriers and all repayments are affordable. Moreover, if it was found that certain groups of disadvantaged students are deterred from applying or have higher dropout rates, targeted grants or bursaries could be provided by universities or the government to address these specific issues.

As the higher education sector transitions to this new funding model, universities would have the opportunity to learn and adapt their strategies for designing income-contingent loans that best suit their mix of courses and students. This gradual learning process, combined with the continued government support through the £9,250 loans, would help institutions navigate the changing landscape and find innovative solutions to the challenges they face. Embracing a mixed economy approach to higher education funding could pave the way for a more efficient, effective and sustainable future for UK universities.

Addressing concerns about competition, increased domestic competition in higher education can be seen as a positive development in a landscape of growing demand, changing work environments and international competition. Encouraging competition at home can help UK universities better position themselves to attract international students and compete with institutions in the US and elsewhere. Varying fees, as seen with postgraduate fees, should not become a political issue when set by the institutions themselves, thereby avoiding undue public concern. Moreover, the implementation of income-contingent loans need not be overly complex or burdensome. There are third-party administrators in business to manage the financial promotion aspects and organise collections. 

This proposal is reminiscent of the Teaching Excellence Framework (TEF), which was designed to enable universities achieving Gold or Silver to increase their tuition fees. However, the proposed mixed economy approach offers a more refined implementation of the same principle. Instead of relying on a bureaucratic evaluation system that may not accurately reflect the true value of education provided, this proposal directly links universities’ incomes to the actual post-graduation earnings of their students. This ensures a more transparent and tangible measure of success, incentivising universities to deliver the highest quality education and fostering a competitive environment that ultimately benefits students and institutions alike. 

It may be shocking to some that this proposal values education based on future earnings. It is accepted that future earnings are the worst possible measure of the value added by a higher education – apart from all the others. Despite its limitations, using income as a measure of the value of higher education is the most tangible and objective method available. All other methods have their own shortcomings, and income-based measurements can reveal valuable insights that qualitative evaluations may overlook. For instance, as Alex Proudfoot highlighted in his evidence to the Lords Committee, Norland Nannies College risks being considered underperforming by the Office for Students because nannying is classified as unskilled work so few of its graduates make it into ‘professional’ employment. However, this so-called unskilled work can yield an income of £42,000 to £70,000 in the UK and up to £120,000 for those working overseas.^[3] By using income as an indicator of value, we can better recognise the true worth of such education, which might otherwise go unnoticed.

The prevailing consensus that government must fund undergraduate education has also led to the widespread belief that statutory regulation is a necessity. With significant public expenditure and taxpayer-funded losses on student loans, the state feels duty-bound to ensure that the sector provides value for money to both students and taxpayers. However, by adopting a mixed economy solution to funding, we can alleviate the need for such stringent regulation, which many of the witnesses to the Lords Committee described as expensive, burdensome and a barrier to new entrants.

Studies on the graduate premium typically find varying levels of average returns but consistently report that the distribution of earnings outcomes, whether measured by course or institution, is extremely wide. Consequently, some individuals will experience exceptionally high returns on their educational investment, while others may even see negative returns – meaning they would have been better off financially had they not attended university. The advent of AI technologies, such as ChatGPT-4, introduces even more uncertainty regarding which careers will yield high incomes in the future.

A 2017 paper that considered the impact on innovation under conditions of high or low outcome uncertainty found that where uncertainty was high, as for higher education, statutory regulation had a material inhibiting effect on innovation as it tends to enforce conformity based on past success rather than allowing for the flexibility needed to adapt to evolving conditions.^[4] In contrast, voluntary self-regulation was shown to be more effective in facilitating innovation, as it allowed for knowledge sharing without preventing institutions from experimenting. A mixed economy approach to funding then goes hand in hand with a switch to self-regulation which will help the sector respond to the current challenges. That might also be a solution to the difficulties flowing from the QAA standing down as the Designated Quality Body.

By adopting a mixed economy solution, universities would gain the freedom to innovate in their educational approach. They might develop more courses resembling the 1980s Youth Training Scheme (YTS), which combined real work experience with institution-based learning to help young people find productive employment. This is just one example of the potential outcomes of increased experimentation and pricing freedom, illustrating how a less regulated environment could enable universities to cater better for employers’ needs and enhance the scope and value of the education they offer.

In conclusion, the issues of inadequate funding for universities, burdensome regulation and the risk of home students being displaced by international students are pressing concerns for the higher education sector, especially as the population of 18-year-olds is projected to grow in the coming years. By adopting a mixed economy approach to funding, combining both private and state resources, it is possible to address these challenges and ensure a sustainable future for higher education. Just as Keynes successfully tackled the problems of economic slump with a mixed economy model, there is an opportunity to now use a similar strategy to create a more flexible, innovative, and resilient higher education sector that benefits all stakeholders.

^[1] Keynes, J. M. (1936). The General Theory of Employment, Interest, and Money, Preface. London: Macmillan.

^[2] Charles Clarke witness evidence to the House of Lords Industry and Regulators Committee, 14 March 2023 P9

^[3] https://www.norland.ac.uk/keeping-up-with-the-windsors-norland-nannies-earn-120000/ Accessed 27/04/2023

^[4] Blind, K., Petersen, S.S. & Riillo, C.A.F., 2017. The impact of standards and regulation on innovation in uncertain markets. Research Policy, 46(1), pp. 249-264.