4/30/2014 @ 8:05AM
Yesterday’s column looked at how we might shift from a “pay as you go” model of student aid to a Human Capital Savings Account. Today’s ideas look at how we can better leverage private capital and investors to promote the public good.
If you’re wondering why we need to reform our approach to higher education finance, you can either go back to part one or wait until tomorrow, when my colleague Awilda Rodriguez will release a new study of Parent PLUS loans. If you need proof that our financial aid system is fundamentally busted, look no further than PLUS loans.
Taking an Equity Stake in Students (Income Share Agreements)
Federal student loans have become a primary means of financing higher education. But what if they’re poorly suited to do the job at hand?
The thing is, payoff to college is high, but it is also highly variable; some students earn more than enough to pay off any debt they took on while others struggle to pay back even small loan amounts. Investing in college is not risk-free, but federal student loans encourage enrollment in any program at any price—regardless of the student’s ability to repay or the quality of the program. Students have access to the exact same loan package whether they attend Harvard or Hollywood Upstairs Medical College, so long as both are accredited. The lack of underwriting does not protect students or taxpayers; it sends no signal about the value of particular programs and leads students and their families to borrow more than they will be able to repay. When these bad loans come due, students bear the risk almost entirely.
Imagine a scenario where the incentives for both students and investors were better aligned. As Miguel Palacios and I recently argued in the Wall Street Journal, a more dynamic, market-based approach to higher education finance would condition financing on a student’s likely outcome after graduation. This is what Income Share Agreements (ISAs) do: investors (private firms, nonprofits, or governments) pay the cost of attendance in return for a percentage of the student’s income after graduation. It’s not a loan, and there is no balance due. Students who earn more than expected will pay more, but those whose choices don’t pan out will pay less—perhaps nothing.
The beauty of the ISA model is that the terms of the contract will be tailored to reflect the value of various programs, sending a powerful signal to the consumer about what they should choose. Want to study massage therapy at $40k a year? Expect to pay a much larger percentage of your income than you would if you studied for an associate’s degree in applied science, for instance.
This idea is not new, but it is gaining renewed momentum. Republicans Marco Rubio and Tom Petri introduced a bill that would set some basic standards for ISA contracts and clear up legal uncertainty that has kept investors away. This is a good start, addressing one of the barriers that Miguel, Tonio DeSorrento, and I flag in our recent report “Investing in Value, Sharing Risk.” For more on the other policy changes needed to promote a vibrant ISA market, check out the report.
Social Impact Bonds
Though college presidents and faculty resist being called “job trainers,” the truth is most students enroll in order to better their labor market prospects. And local employers are the top consumers of college graduates. Private firms also spend a ton of money on training, professional development, and tuition reimbursement for employees. But these investments have traditionally been ad hoc and uncoordinated.
That’s partly because employers face a tricky dilemma when it comes to investing in postsecondary education. On the one hand, offering training or tuition assistance provides opportunities for employees to learn new skills that will raise productivity and help employers retain top talent. But they also face a free rider problem, in that additional training can make their employees more valuable, which would entice competing firms to poach them.
As my colleague Mike McShane and I argued last year, social impact bonds represent one possible solution to this dilemma. Under a social impact bond, private investors front the money for a particular social program that is then carried out by a nonprofit or public organization. The idea is that a successful social program will save the government money in the long run: programs that reduce recidivism lower the amount of money spent on corrections, while those that provide training reduce the chances that somebody winds up on the welfare rolls.
The innovation in the social impact bond is that investors reap a portion of those savings as a return on their investment. If the program is successful, the government repays the investors; if it exceeds expectations, the investors reap a return on their investment. And if the program fails, the government is off the hook.
The social impact bond mitigates the free-rider problem. If employers can reap a return whether or not the workers who obtain more schooling join or remain with the firm, the firm will have more incentive to invest. It also provides local businesses with an additional avenue to shape postsecondary offerings to reflect labor force needs.
How could this model work in education? Consider workforce training programs geared for at-risk youth, unemployed adults, and dislocated workers—programs that are typically found to be ineffective. It’s easy to image a situation in which a group of local employers band together to offer job training programs, and sign an agreement with the local workforce investment board that if the training programs reduce unemployment (and, hence, the number of individuals collecting unemployment benefits) they would be entitled to their investment plus a slice of the savings.
Remedial education might also be a top target. Some projections reckon that at least 50% of undergraduates require a remedial course when they enter college—courses that are not for credit and require significant sums of money from states and the federal government. Social impact bonds could be used to create partnerships whereby private organizations that start, finance, and operate successful preventive programs for students to avoid remediation before they enter college receive a cut of the savings.
There are likely other areas where social impact bonds could work. The point is that we often leave private sector capital out of the discussion of college affordability. But we no longer have that luxury thanks to relentless growth in college costs. Building a sustainable, equitable system of higher education finance without breaking the bank will require leveraging private capital to promote the public good.