It’s time for a brutal lesson on HECS, price signals and HECS

The future of tertiary educational in Australia continues to be discussed. Should the fees be deregulated? Should places be capped? Should interest rates on student loans be charged at the rate of bond yields. The list goes on and on.

In spite of all the debate, the HECS, which was designed by Bruce Chapman, and implemented by Hawke-Keating, has received widespread praise. It’s a good thing: the HECS system allows students to pay for their education costs over time and based on their income. It accomplishes two things. It provides students with credit, eliminating the need for them to pay upfront tuition fees. It also provides protection against the risk of losing a job. Only when you earn a steady income are loan payments due.

You must be thinking that it is all good. I thought so too. Peter Noonan, a scholar on education policy and , recently said that:

Anyone who believes that a system which blunts price signals will simply be used to underpin the price deregulation does not understand economics.

The Australian quoted Glyn Davis, Vice-Chancellor of the University of Melbourne.

We don’t yet know if HECS will work if it blunts price signals so much.

Really? Really?

I understand economics, but I disagree. In this market, HECS increases the price transparency, not decreases it.

Prices explained

Let’s define a price signal first. People like me love markets because of the price mechanism’s remarkable ability to aggregate information and communicate it. It can achieve what no central planner ever could.

When I lived in Boston, my favorite story about the remarkable price mechanism in this respect comes from that time. Every day I would go to the supermarket near me and buy orange juice that was squeezed in store. On a winter day that was similar to the previous ones, I noticed that the orange juice price had doubled, from $3.25 up to $7.00. I noticed that an employee was using a pricing gun to change the prices of other juices.

What happened? The frost that occurred in Florida 18 hours prior had caused damage to orange trees and disrupted the supply. Traders were aware of this, the price of frozen concentrate orange juice had risen, and orange suppliers in Boston immediately raised their prices. Realizing that the supermarket manager could raise prices on both bottled and in-store squeezed juice, he also raised those prices. In 18 hours, all markets were covered.

What would the price be and what kind of information would that convey in an Australian market deregulated for tertiary educational? Of course, the price would be tuition. A high price could indicate a valuable degree, perhaps due to the field of study. The reputation of the university, the quality of education or the educators are all factors that can influence the price. Prices are essentially the exact same right now, so there is no price signal.

Diverse potential students may have different perspectives and information about the value of certain disciplines, faculties, and universities. In a deregulated marketplace, the price of different degrees aggregates and assembles that information. The Austrian economist Friedrich Hayek made this point forcefully in 1945. It was formalised later by the great American economic Sandy Grossman.

There are other sources of information than just prices. These include rankings, word-of-mouth, ATAR cutoffs and more. Prices would not be the only information source in a deregulated market for tertiary educational services, but they are still very important.

It is important to realize that the majority of students have credit constraints. They do not have the cash on hand to pay for tuition in full. They have to borrow. HECS offers them very generous terms to borrow. What if there was no HECS? What would you do?

If the private loan market did not step in, a large number of students would be unable to afford university. They would then not be able to participate in the market. It would be terrible not only for them but also for the market. The price of tertiary education would be higher because their valuable information would not be included.

Bottom line: for markets to function well, they must be liquid – they need a large number of participants. The more liquid the market, the better it is at gathering and communicating information. It’s not good for people and the market when a large number of people cannot participate in the markets because they are restricted by credit. Allowing them to enter, as HECS allows, sharpens price signals.

Would it still be sharper without the income-dependent repayments? I don’t think so. This would increase the risk of students on the labour market and force more students to leave tertiary study. Price signals are improved by both efficient risk-sharing as well as efficient credit provision. HECS is exactly what HECS does.

Noonan & Davis are in a trap by assuming that prices are less informative because HECS reduces the responsiveness of students to price changes. It’s not true.

Markets that work well do two things. The markets equate demand and supply, and also convey information. Both are important! It’s the second that really matters, especially in a market with dispersed data and uncertainty.

Hayek liked HECS. It is a tool that helps the market to work its magic, and not a hindrance. It helps the price mechanism to work better. It’s about time we stopped apologising!

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