“The frog is slightly dead” – Nick Barr in conversation on fees and loans

“This is an important step for higher education”.

Nicholas Barr describes the way student loans currently appear in the public accounts as “exactly wrong”.

“It pretends for nearly 35 years that loans don’t make a loss and then, all of a sudden, after 35 years there are massive write-offs. And that creates horrible incentives for politicians to do naughty things.”

Barr is professor of public economics at the London School of Economics, best known for his wide-ranging involvement in policy and particular influence over the HE debate since the mid-1980s. He spent ten years campaigning for income-contingent loans and is described as one of the architects of the 2006 reforms – the introduction of £3,000 variable fees in England. He is also the author of books including Economics of the Welfare State.

Earlier this week, the Office for National Statistics published a landmark decision on the treatment of student loans in the public accounts, calling on the government to account properly for the fraction of student loans that do not get repaid. According to Barr, the ONS proposal is a welcome change: “This is a case in which it’s better to be approximately right than exactly wrong.”

The aim of this move is to better align the accounting treatment of student loans with the economic reality. The ONS proposes that when students borrow, their loan will be divided into two parts: the part that is estimated to be repaid in full, based on graduate employment projections, and the part that estimates suggest will not be repaid because of insufficient earnings over the course of the next 30 years, at which point the loan is written off. Under the ONS proposal, the projected loss on loans issued this year will count as public spending this year, as opposed to at the time of the write-off, in thirty or more years.

The change does not affect the long-run cost of financing higher education, but adds a chunk (estimated by ONS at around £12bn this year) to the headline deficit figure.

Political short termism

Barr hails the ONS’s solution on the basis that governments that want to make loan repayment terms more generous will “face the costs of their decisions immediately”. To him, the issue is one of political short-termism:

It’s kicking the fiscal can down the road in a massive way and its an incentive that politicians from George Osborne onwards haven’t been able to resist.”

In Barr’s view, because of this fiscal illusion, HE since 2012 has been partly financed on a fiscal bubble, so the ONS judgement has come at the right time:

The bubble is being deliberately burst before it gets too large. There may well have to be some belt-tightening on the part of HE, but the system as a whole will remain in robust shape rather than the whole system being threatened, which is what could happen if the bubble is allowed to get really large.

Calls for the ONS to review the place of student loans within public accounts have been persistent over the years, but gathered pace following the publication of two select committee reports: both the House of Commons Treasury Committee in February, and the House of Lords Economic Affairs Committee in June produced damning judgements of the government’s treatment of student loans.

The frog is slightly dead

But what led us to this state of affairs?

Barr recalls the initial setup of income-contingent loans around the turn of the century. “This has grown out of what started life as a perfectly sensible system,” he says.

The frog is in the saucepan, the heat gently raises the water temperature and by the time the frog realises how hot the water is, the frog ends up slightly dead.

The issues faced by the current system were present in previous iterations, but were not a pressing concern until the cap on tuition fees trebled in 2012, the interest rate on student loans increased, and the repayment threshold increased considerably, all of which had the effect of greatly increasing both the size of loans and the total loss.

Barr makes the point that we have always known the scale of the projected loss on student loans and the accounting loophole was not a major problem when as loans were small. But losses become a major problem when loans are large, inviting exploitation by successive governments for short-term political gain.

However, to be slightly fair to government this political short termism has “been made possible because the international accounting rules that govern the ONS’s methods have not dealt with income-contingent loans before”. The rules to govern the current system simply weren’t there.

The ONS’s proposal faces a number of complexities in its execution, not least the task of projecting the loss on student loans issued each year. Barr admits that this will never be 100% accurate, but “it will be more accurate than assuming there will be no losses until 2050”.

Tertiary as a whole

The concern is whether a greater contribution by the HE sector to the budget deficit could, in light of the ongoing review into post-18 education and funding, lead to a reduction of resources in future. Barr is a strong advocate of looking at tertiary education holistically, rather than separating higher and further education.

“Funding needs to be balanced across the whole of tertiary education, and that probably means that resources for higher education will rise less rapidly than might otherwise have been the case,” he says.

The Augar review had a very difficult, if not impossible, task before the ONS announcement and this makes it even more difficult. The saving grace is that the ONS’s verdict puts things on a sounder footing which forces politicians to be honest.

So, is it time to return to the Browne model? Barr says it is, in the sense that the Browne model offered a strategic view of HE, but that it needed to be more wide ranging. “You need a Browne model for the whole of tertiary education.”

Right system, wrong parameters

Barr’s views on the current system of funding can neatly be summarised as “right system, wrong parameters”. The parameters in question are taxpayers’ contribution to teaching (too low), the interest rate on student loans (too high), and the repayment threshold (too high). A lower repayment threshold and lower headline tuition fees would make student loans more self-supporting because graduates would be able to pay back a higher proportion of their loans, hence write-offs would be less. This, in turn, would free resources to widen participation and balance resources between FE and HE.

As Barr says, if he were a dictator, he would “worry much more about fixing the parameters of the system and less about the fact that the deficit might rise in the short run. After all, this is investment in skills, which is incredibly important.”

At this stage, the pressing question is whether it is as clear-cut as it seems: do the solutions our funding system needs all rely purely on good economics? “The economics of HE finance is easy. The politics of HE finance is easy. The difficult bit is that they go flat in opposite directions,” he says.

Economics says that one should finance HE through a mixture of tuition fees and taxpayer finance; should help students to pay their costs through a well-designed system of income-contingent loans; and should introduce a series of policies, a lot of them earlier on in the system, to widen participation from students of disadvantaged backgrounds. The political argument is easy: higher education should be free.

Politics vs economics

At a time where the government’s bandwidth is almost entirely dominated by attempts to manage Britain’s exit from the EU, the political solutions needed for the problems we face as a sector are not apparent. Communication is one such issue.

Barr puts the failure to communicate the loans system to students, graduates and the wider public down to the word “debt”.  “When you use the word debt people think of credit card debt. Student loans are payroll deductions – something that is very different.”

Changing the name could be helpful but given the current level of distrust of politicians, such a strategy would be easily rumbled.

One needs a trusted entity – whether that is Martin Lewis or Which? Magazine – to explain things. Any entity that is seen as being trustworthy and not involved in party politics.

One question remains: where do we go from here? Barr says the answer to a lot of the sector’s problems lie in putting forward a united front.

Any good system needs to work for the entire sector – and that, for me, is not just universities – it’s all of tertiary education. If I were a wise vice chancellor, I would be trying to get universities to think about universities as a whole. Competition has gone too far – there’s been an overshoot and now, it’s a question of clawing it partly back.