U.S. Trade Policy Primer: Frequently Asked Questions
U.S. Trade Policy Primer: Frequently Asked Questions
Investors could finance students’ education with equity, not debt. In exchange, investors would receive a fraction of students’ future income.
ACADEMIC economists like to make fun of businesspeople: they want competition when they enter a new market but are quick to lobby for subsidies and barriers to competitors once they get in. Yet scholars like me are no better. We work in the least competitive and most subsidized industry of all: higher education.
We criticize predatory loans by mortgage brokers, when student loans can be just as abusive. To avoid the next credit bubble and debt crisis, we need to eliminate government subsidies and link tuition financing to the incomes of college graduates.
Nearly eight million students received Pell grants in 2010, costing $28 billion. In addition, the federal direct loan program, which allows nonaffluent students to get government-guaranteed loans at low interest rates, cost taxpayers $13 billion in 2010-11. Total subsidies to university education amount to $43 billion a year, including around $2 billion in Congressional earmarks — and that does not even include tax subsidies (for college funds); tax breaks (for university endowments, for example); and subsidies dedicated to research.
Just as subsidies for homeownership have increased the price of houses, so have education subsidies contributed to the soaring price of college. Between 1977 and 2009 the real average cost of university tuition more than doubled.
These subsidies also distort the credit market. Since the government guarantees student loans, lenders have no incentive to lend wisely. All the burden of making the right decision falls on the borrowers. Unfortunately, 18-year-olds aren’t particularly good at judging the profitability of an investment without expert advice, and when they do get such advice, it generally counsels taking the largest possible loan. The stock of student loans has reached $1 trillion, while the percentage of borrowers in default jumped to 8.8 percent in 2009 from 6.7 percent in 2007.
Last but not least, these subsidized loans keep afloat colleges that do not add much value for their students, preventing people from accumulating useful skills.
I do not want to suggest that helping underprivileged students attend college is bad. A true free-market system equalizes opportunities, if not for fairness, at least for efficiency: talent should not be wasted.
The best way to fix this inefficiency is to address the root of the problem: most bright students do not have any collateral and cannot easily pledge their future income. Yet the venture-capital industry has shown that the private sector can do a good job at financing new ventures with no collateral. So why can’t they finance bright students?
Investors could finance students’ education with equity rather than debt. In exchange for their capital, the investors would receive a fraction of a student’s future income — or, even better, a fraction of the increase in her income that derives from college attendance. (This increase can be easily calculated as the difference between the actual income and the average income of high school graduates in the same area.)
This is not a modern form of indentured servitude, but a voluntary form of taxation, one that would make only the beneficiaries of a college education — not all taxpayers — pay for the costs of it.
The cost of enforcing contracts contingent on future income is very large, but there is an effective solution: piggybacking on the tax collection system. The Internal Revenue Service could perform collection services on behalf of private lenders, and at no cost to taxpayers. (In Australia, such a system has been in place since the 1980s. The national tax agency enforces repayment of loans contingent on income, though the payments of the wealthiest graduates are capped, and therefore less affluent graduates need to be charged more to make the program viable than in the system I am proposing.)
Yale tried a form of loan repayment contingent on income in 1972. It failed, but the problem was that the Yale plan made all students mutually responsible with respect to the repayment of the total debt, generating a snowball effect in defaults: the burden on nondefaulting students was increased by the default of their classmates. (Similar problems afflicted a company, My Rich Uncle, that went bankrupt in 2009.) Furthermore, Yale had a comparative disadvantage in enforcing these contracts, because the act of enforcement was alienating its own alumni, creating bad will.
In fact, top colleges like Yale are already — implicitly — using a form of equity contract. They charge the average student less than the average cost of educating each student, while financing the shortfall with donations from the wealthiest alumni. It is tantamount to an implicit stake on the wealthiest alumni’s income. This system works very well for the top schools, which produce at least a few multibillionaires. It is much less effective for normal, middle-of-the-road colleges. It is precisely for these colleges that a formal equity contract would work best.
Equity contracts would diversify the risk of failure, with highly compensated superstars helping to finance the educations of less successful college graduates. They will also avoid pushing graduates into lucrative jobs just to pay off debt. Most important, these contracts would provide financiers with an incentive to counsel students wisely, as financiers would profit from good educational investments and lose from bad ones. This would create more informed demand for the schools, exerting pressure on them to contain costs and improve quality.
The most important effect of these equity contracts would be to show that it is possible to intervene to help the disadvantaged without turning that help into an undue subsidy for the producers (universities) and the creation of a privileged class (professors like me) at the expense of everybody else (students and taxpayers). After all, how can we scholars criticize crony capitalism when we benefit from it?
Our patent system grants drug companies the exclusive right to sell their innovations without “generic” competition for years. Big Pharma points out that such patents are necessary because without them it can’t recoup the massive costs of creating new products. There’s another solution to this problem: a way to directly fund the drugs we’re not getting and avoid the high cost of artificial monopolies.
The entire U.S. patent system needs serious repair, but the most broken thing about it is the way we patent prescription drugs. Federal and state governments spend billions of dollars on basic medical research, and the resulting science winds up informing (at least indirectly) the development of blockbuster pharmaceuticals. But our patent system then grants drug companies the exclusive right to sell their innovations without “generic” competition for years. Big Pharma points out that such patents are necessary because without them it can’t recoup the massive costs of creating new products. Meanwhile, there are some classes of drugs that the world desperately needs—new lines of antibiotics, for example, or treatments for tropical, emerging, and rare diseases—but that the current system, dependent on blockbusters, doesn’t readily produce. The incentives are out of whack.
There’s another solution to this problem—a way to directly fund the drugs we’re not getting and avoid the high cost of artificial monopolies. Let’s take a page from some of our deep-pocketed philanthropists, who have used competitions to rejuvenate space technology (the X Prizes), mathematics (the Millennium Prize), and more. Instead of granting patents, the government should offer lump-sum payouts.
History shows this is not such a heretical idea. Indeed, stimulating innovation through prizes is actually as old as patent law. In the 1750s, Britain’s Royal Society of Arts offered what it called premiums, rewards for solutions to pressing technical or commercial problems: Spinning wheels, mechanical telegraphs, naval construction, and brocade weaving were all “premium” inventions. Although the winners got a handsome prize in return—in total, the RSA paid out tens of millions in today’s dollars—the solutions could not be patented. This meant that other people could adapt and improve on them.
Prizes create a kind of artificial economic system that maintains most of the key advantages of the free market. They create incentives and competition, and they diversify the number of minds working on the problem. But the prizes eliminate wasteful spending, since they are rewarded only when genuine solutions have been achieved. And when combined with limits on patent monopolies, prizes can ensure that those innovations will flow more readily through the society at large.
>Prizes can ensure that those innovations will flow more readily through the society at large.
Right now, most of the marquee prize-backed challenges are still funded by philanthropists or the nonprofit sector. But governments have begun to get involved. The Obama administration’s Open Government Initiative has created more than 150 challenges, everything from developing new fuel scrubbers for the Air Force to a Healthy App contest sponsored by the surgeon general.
Because they are targeted explicitly at individuals or groups who are not on the government’s payroll, state-funded challenges offer a way around the traditional complaints about government bureaucracy. The problems may be defined by government insiders or politicians, but the solutions arise from the edges of the network, not the center. A prize system widens and diversifies the web of collaboration, encouraging scientists and entrepreneurs to make a contribution, even if they have no direct connection to the authorities in Washington.
So how can this mechanism solve the prescription drug crisis? Either by redirecting research money or appropriating new health care funding, we could offer billions of dollars of prize money for new pharmaceutical innovations. And we could mandate that the prizewinners share their innovations open-source-style, forgoing any attempt to patent their discoveries. Last year, U.S. senator Bernie Sanders of Vermont introduced two bills along these lines: the Medical Innovation Prize Fund Act and the Prize Fund for HIV/AIDS Act. By creating an outlandish award for a successful product—a treatment for HIV/AIDS could win billions of dollars—Sanders seeks to increase the number of organizations attacking the problem. And by mandating that the innovators not block generic versions of their drugs, these laws would allow still more organizations to enhance and refine those discoveries.
Sanders is the most left-wing member of the Senate, but it’s essential to note that his approach breaks from the mirrored alternatives of Big Capitalism and Big Government. The state isn’t trying to come up with breakthrough drugs or even to make direct decisions on which firms to back. Instead, the bills try to use government dollars—and publicity—to widen the network involved in solving these crucial problems and to make it easier to share the solutions that emerge. In our current system, government patents allow marketplace victors to profit for years at others’ expense. A prize-based system would allow everyone to win.
Steven Johnson (@stevenbjohnson) is the author of the new book Future Perfect (Riverhead Books), from which this essay is adapted.
What America can learn from taxpayers who foot the bill for free university.
The next time you pull out your checkbook to pay that hefty tuition bill or pay down your student loan, consider this: there are countries where students pay nothing to attend university. Denmark, Sweden and Germany for example all have tuition-free college.
WGBH Radio’s “On Campus” team wondered how these countries do it, and if there are things the U.S. can learn from their model. Their search to understand how German universities keep costs down and quality up began in the Rhineland.
It was a frigid evening on the banks of the Rhine in the medieval city of Cologne. Under the vaulted ceiling of an old Gothic church, the 80-piece university orchestra was tuning up.
In the land of Beethoven and Handel, it makes sense that a university would invest a lot in its orchestra. But that commitment extends far beyond the music program. In Germany, one of the world’s wealthiest countries, taxpayers fully subsidize the cost of public higher education. While American students now graduate with an average of nearly $30,000 of debt, college in Germany has always been free.
Since tuition is free here, German students don’t really worry about student loan debt. Instead, they worry about their exams or learning a trade. Seventy percent of the students at the University of Cologne work part-time jobs. Students, parents, administrators and business leaders of all political stripes say the same thing: higher education in Germany is seen as a public good.
The University of Cologne is Germany’s largest university with 48,000 students, a medical school and a law school.
“I have to be honest, I really like this university even though it’s not the most beautiful one, as you can see,” says tour guide Valerija Schwarz, a Ph.D. student in German Literature.
The university’s central square swarms with bicycles. Many students bike to school or take public transportation, Schwartz explains — that’s why there’s no big parking garage.
Students park their bikes outside one of the University of Cologne’s newest buildings.
Students park their bikes outside one of the University of Cologne’s newest buildings. – Photo by Mallory Noe-Payne/WGBH
Students in Germany also tend to stay local, so there aren’t any dorms. There are no active student clubs, or big football stadium. And every lecture hall looks huge.
“Most of the time you don’t even know who is sitting next to you or who your professor is,” Schwarz says. “You just listen and then reproduce your knowledge during the exams.”
All of this translates to savings: the average cost of an undergraduate degree in Germany is $32,000, paid for by the state. In the U.S., some schools charge that much for one year, and student loan debt has surpassed $1.2 trillion.
South 160 miles from the University of Cologne, tucked in the heart of Heidelberg’s quaint but vibrant city center, the University of Heidelberg offers a full program of courses from ancient history to biochemistry. It is one of Germany’s oldest and most prestigious institutions.
“A majority of German voters agree that a decent start in life includes the possibility of a free higher education,” says Frieder Wolf, a political science professor at the school.
To limit spending, Wolf says, professors teach more and earn less than their American colleagues.
“This is not to complain. I love my job and I have a lot of freedom but this is how we keep costs down — larger classrooms,” Wolf says. “We’ve got courses with 40 participants, 50 participants in the social sciences, where [American universities] might have tutorials of four or five students.”
And unlike their American counterparts, German universities have very little administrative bloat.
“Many administrative tasks for which you would have specialized personnel in the States is done by the teachers and professors here,” Wolf says.
But are German students getting the same quality learning experience?
Germany isn’t widely known for having top-tier colleges like Harvard, Yale and Princeton. But, says Wolf, what it does have is “reliable quality.”
“With all due respect, [America has] the best colleges but [it also has] some of the worst,” Wolf says. “There’s probably a new sort of class divide between people who get there and who don’t get there, where as in Germany basically most everybody who wants to go to an average college can go there and get a decent education.”
In the U.S., the closest comparison to Germany’s no-frills, low-cost higher education is probably state and community colleges. President Obama has proposed making two years of community college tuition-free for students who keep their grades up, but Republican leaders in Congress have plans to stall that plan.
“It’s a very big commitment,” says Sandy Baum, a higher education economist with the Urban Institute. “People want it to be free, but they don’t really mean they want to pay higher taxes to make it free.”
Baum says Americans also don’t want to give up the residential college experience, with all its bells and whistles. But, she says, the U.S. needs more affordable choices.
“In many European universities, you go and you listen to a lecture and that is what is involved in the university,” Baum says. “It’s a lot cheaper to do that than the many things that people are asking for on college campuses here. And people are voting with their feet, and we need to have multiple options.”
Baum says those options should include more online learning and apprenticeships.
Willing to pay, despite free tuition
Still, there are German families who, despite the promise of free college, are willing to pay for the elite American experience.
Jane Park and two of her three children in their home in Essen, Germany.
Jane Park and two of her three children in their home in Essen, Germany. – Photo by Mallory Noe-Payne/WGBH
Johannes Kim and Jane Park live in Essen, a neighboring city 50 miles north of Cologne. In the kitchen one recent evening, as Park prepares dinner, their three small children were listening to an opera lesson on tape.
Kim graduated from the University of Heidelberg and he thinks the opportunity to build relationships with professors is something you really can’t put a price tag on. He wants their kids to attend schools with strong brand recognition.
“The American college experience is something that instills some sort of emotional bond to your university. That is something that is completely missing from the German system,” Kim says. “Although I went to the oldest university in Germany, there is not the feeling that I’m a proud alumni or graduate of that school.”
Park, who is Korean-American, finds Germany’s tuition-free model appealing, though she’s conflicted about the American system.
“I like to think that I have a strong sense of social justice and great education is almost reserved for the elite despite scholarship opportunities and financial aid,” Park says. “That, I find disturbing and in some ways I am squaring, ‘OK, do I want to feed my children into that sort of system?’”
Their kids are young, so it will be a while before they go to college. And by that time, there’s no guarantee that Germany will still be committed to the idea of free college education.
German states are on a five-year deadline to balance their budgets, meaning states, and taxpayers, will be taking a close look at what they can afford.