A novel solution to the student loan ‘problem’
In the 2005 election the Labour Government found itself in a very tight battle to retain power. In order to mobilise the student vote, Labour promised interest free student loans. The bribe assisted Labour in returning to Government for their third consecutive term.
At the time National called the interest free loan scheme “irresponsible”. Since coming to power in 2008, however, they have maintained the policy, presumably for similarly cynical political reasons as led to the policy being introduced in the first instance.
As a result of the policy, students have been encouraged to borrow more and pay back less. Debt has ballooned. There are obviously other factors to take into account, such as increasing student numbers during the economic downturn. Nonetheless, it is clear that when given the option of borrowing interest free money, those with student loans have limited incentive to pay anymore than the minimum from their loan, for which they might as well borrow the maximum.
What is National’s response to the perceived student loan problem? The introduction of a $50 administrative fee that student loan borrowers must pay annually. Note that National have also provided an incentive for students to voluntarily pay back their loans through a 10% discount on their loans.
I propose a rather simpler solution. Abolish the half measures currently in place and start charging interest on student loans again. Only then will the correct incentives be instilled.
Do you have a view on how much interest that should be?
Currently interest is charged on some loans, such as for the loans of those living overseas. The current interest rate is 6.6% and is adjusted annually by the CPI.
That rate seems to be in the ballpark for mine. The rate needs to be set so that it is higher than market rates (i.e. to reduce the incentive for students to borrow the lot and invest), but not so high as to be unduly punitive.
Quite right, we are spending far too much money on student loans that has no discernable effect other than to increase government costs – most students would study regardless of whether there is interest on student loans.
The $50 fee reminds me of the 36 months (or whatever) interest free offers you see advertised for retailers like Harvey Norman.
If you listen to the verbal small print, or read the documents in-store, you’ll notice there’s an annual fee, probably $50, that needs to be paid before a customer gets the interest free credit. On an item costing $1000 – that represents 5% annual interest – although technically it’s a fee not an interest payment. If you add up all the $50 fees paid across New Zealand each year, I’d say that’s a hefty income stream and because the money is paid up front each year, goes a long way to subsidise the interest free loan.
I’d never buy anything this way, but thousands do.
BTW. What’s the betting the annual $50 fee will rise at a rate much higher than CPI?
The average student loan is well in excess of $20,000 though, which suggests the administrative fee goes nowhere near far enough to cover the cost of the loan.
As such, I hope the annual fee does rise by much faster than CPI, in the absence of actually charging interest. 😉
@Dave Guerin
And even if they wouldn’t, investing in human capital when the rate of return is below the market rate of return sounds like a waste of resources to me.
@goonix
How about banks provide the loans – and the government pays the part of the student fees that they determine is in the “social good” (including some component to provide equal opportunities if the society is that way inclined). That way a student can decide to study on the basis of private costs and benefits.
Note: Putting this in place would sting me heavily – but that doesn’t stop it being the right policy …
@Matt Nolan
I agree that competition in the market for student loans would be a positive move. However, I’m not sure I see the benefit of changing the structure of how government contributes. Couldn’t it just remain that government fund unis, unis charge students the ‘difference’ and students get the necessary loans to cover this difference from competing institutions?
@goonix
Yar. In essence, the government funding is equivalent to the government paying the “social good” portion of the loan. It seems a bit large on that basis – and poorly targeted (as it doesn’t target the courses with higher social value more highly) but this is the underlying way it rolls.
My only point was that the portion a student should pay due to private benefits should face a market rate of interest that is determined by the market, rather than set arbitrarily by government.
If my mum could hear me say this she would clip me around the ears – but it is just the most transparent and IMO the fairest way to distribute the costs from education.
@Matt Nolan
I agree that the rate should be set by the market, I’m glad you’ve raised that point. My initial comment (6.6% adjusted by CPI) was if the government were a monopoly provider of student loans – subsequent discussion of introducing competition into the student loan market has rendered that comment obsolete.
@goonix
Agreed for sure – just wanted to get the pro-market point out there, so students would want to yell aimlessly and angrily at us.
It is in my personal interest for them to avoid doing this for a while – but us economists don’t work on personal interest, we work for the greater good. *Include further arrogant speel here*. Indeed.
I think the student loan scheme is a great example of something government can run well, no innovation in the service and the alternative is oligopoly
@EbolaCola
Why would no innovation in the service be a good thing?
im not saying its a good thing im saying there is little-no innovation in the service, eg. whats the difference between your mortgage today and a mortgage 50 years ago?
Ill accept that the interest rate on the student loans should at least rise to the level of inflation
@EbolaCola
At the fundamental level, sure, the same service is being provided. However, I would contend there is certainly room for innovation in terms of competition. Consider mortgage packages that offer free legal fees for buying a property, for example. In the absence of a monopoly on mortgages I doubt we would see such offers. I’m not sure what student loan companies could offer in terms of innovative products but all I am saying is that there is certainly potential for some and I would not wish to preclude such offerings (and I think it would be interesting to see what the financial institutions could come up with!).
ok lets have the student loan scheme raise its interest rate to the rate at which the government borrows + a margin for default + user pays for administrative costs.
I don’t think there would be any competition from the private sector
@EbolaCola
Is the banking sector really an Oligopoly – I thought that the introduction of Kiwibank had cut back the level of supernormal profits.
Even if there is, the trade-off is between a cost from market power and the benefit of having some actual market pricing regards the return on investment for different types of capital (human capital vs physical capital namely). If we are concerned about the impact on the accumulation of human capital we could make the same argument for the entire banking system – and I just don’t find that convincing tbh.
@EbolaCola
But why should the rate of interest be determined solely by the cost of provision, and not due to the opportunity cost associated with investment?
on the suggestion of banks providing the loans, a few years ago, before the interest free thing Westpac were offering loans to pay off your student loan, at really low rates of interest. about 3% when student loans were at 7%. essentially they were willing to take a loss in order to capture a customer with potential for continued high income.
I think they should bring back the interest (though with my loan it would hurt me substantially). if they really want to help students, put the money thats being spent on zero interest at the moment back into education. with the cost of the policy, (aprox 48% of the value of a loan to when it is paid off), it would reduce fees substantially. (though to be fair on people with existing loans, pay off a portion of the fees part of their loan… or maybe i’m just biased since i have a massive loan myself)
Matt why shouldn’t citizens through collective action via their government have access to funds at a lower rate? I would support the student loans scheme being run to recover its costs but not market interest rates.
I’m gonna make the wild assumption that goonix opposed the introduction of kiwibank and either denied or endorsed the “supernormal profits” you refer to…