Callum Price is Director of Communications at the Institute of Economic Affairs, and a former Government special adviser.
I have a Plan 2 student loan.
I graduated in 2018 with just over £40,000 in debt. I got a job immediately after university and started paying it off as soon as I could.
Today, I have just over £50,000 in debt.
This is because of the interest that debt has accrued since, which is the Retail Price Index plus up to 3 per cent (based on income). Given that the measure is linked to inflation, the Government has this week announced that for the next academic year the interest rate will be capped at 6 per cent in total – amid fears of an energy price crisis leading to a major inflation spike.
It reflects the government’s heightened awareness of the issues around student loans and the increased debate about whether students and graduates are getting a fair deal. The problem is they aren’t – and a 6 per cent interest cap doesn’t change that, even if it was permanent.
The fundamental issue is one of incentives. Universities are not paid to train or educate; they are paid to recruit. They get their fee when they accept a student, regardless of how they do or whether they go on to get a job. The fee is fronted by the taxpayer, and the student is left to pay them back until it’s all forgotten about after 30 years.
Imagine this set up in any other sphere of economic life. If I took my friend out for dinner, and the moment we walked in I had to pay the restaurant the cost of our meal – which was set at the same cost as everyone else’s meal regardless of what was ordered. I paid for my friend, and he promised to pay me back. A few things would happen.
Firstly, it would be doubtful that we would get a very good meal. We’ve already paid, and there’s certainly no chance of any money off if it isn’t up to our satisfaction. Sure, the restaurant would have to ensure that there was enough of a buzz about the place that made people want to go there, but it helps that in this scenario the state has made it an explicit target that half of the entire population eats at a restaurant.
But because they are prevented from charging more for the more expensive meals, the owners would seek to get as many people through the door as possible to eat the cheap food with a glass of tap water, to subsidise those ordering steak and wine.
Secondly, I’m left out of pocket. I’ve covered the cost of my friends meal and given him an extended period of time to pay it back. Of course I’ll charge a pretty steep interest on this – he’s my mate, but I’m no schmuck – but given he is a good friend, I’ll probably let it drop after a while.
So my mate gets a sub-par meal and is left indebted to me for the foreseeable future. It is not the sort of debt that will harm a credit score, and he knows that I’ll let it drop if he drags it out long enough, but it’ll be over his head until then regardless – and steadily increasing thanks to that interest.
Finally, given the cap on the cost of the meals, the restaurant is left scrambling around to make ends meet, consistently on the brink of financial ruin. They’ve resorted to the tourist market, where the costs aren’t capped, to keep their doors open.
It is clearly not a perfect analogy. We don’t tend to eat out at restaurants to somehow boost our future earnings, it is consumption not investment. But it goes some way to illustrating the problem. There are three parties in the current student financing arrangement: the universities (the restaurant), the student (my friend), and the taxpayer (me). And it doesn’t work for any of them.
You don’t need to buy my somewhat tortured analogy to see it either – just look at the data. The graduate premium, the amount of extra income one should expect from having attended university, is falling. The government is spending billions a year writing-off student loans. And many universities are frequently on the brink of financial collapse. Capping the interest on the loan is welcome, particularly to protect against a likely incoming shock, but it is barely even papering over the cracks.
There is an alternative model, as Peter Ainsworth as pointed out for the Institute of Economic Affairs: take the taxpayer out of it entirely and make universities loan directly to their students. There are already third-party financing arrangements that do this – and if you remove other distortions like the student fee cap, a functioning market can and will appear.
This would mean the universities have a much stronger interest in ensuring that their graduates are able to pay them back – and thus are much more incentivised to provide them with an education that will help them actually secure a better job, and to keep supporting them after university to do so. Lifting the cap will mean they can charge what they need to keep themselves alive and would see a refocusing on courses that add value, to the student and the economy, away from those that don’t. The result would be a better education for students, a more secure financial settlement for universities, and working taxpayers no longer on the hook for unproductive degrees.
There are other questions that come off the back of a model like this, such as whether there is a role for the state in supporting some courses or students at all – but far better to have a more rational starting point for these discussions than our current system.
At the very least, we can stop ripping off everyone involved.