Saturday, November 18, 2017

Unis should never be allowed to set their own fees

The Productivity Commission has changed its ideological tune, shifting away from the slavish adherence to an idealised version of the "neoclassical" model of the economy for which it and its predecessors became notorious.
It's moved to a more nuanced approach, recognising the many respects in which real-world markets differ from those described in elementary textbooks.
This shift has been underway since the present chairman of the commission, Peter Harris, succeeded Gary Banks in 2012.
You could see it in the commission's 2015 report on the Workplace Relations Framework, which acknowledged, readily and in detail, the factors that made the simple neoclassical, demand-and-supply model unsuitable for analysing the labour market.
But it's even more apparent in the commission's blueprint for a very different approach to economic reform, Shifting the Dial. Consider this.
Remember the plan in the Abbott government's first budget, of 2014, to deregulate the fees universities are allowed to charge students doing undergraduate degrees?
It was a logical next step following the Gillard government's decision some years earlier to deregulate the number of undergraduate places each university was permitted to offer.
The unis had responded by hugely increasing the number of government-funded places, at greatly increased cost to the federal budget, after successive governments had spent decades trying to quietly privatise the unis and get them off the budget.
The economic rationale was that "market forces" – competition between the unis – would prevent them for using their new fee-setting power to overcharge students.
It was a reform that all right-thinking people should support, and those terrible popularity-seekers in the Senate should never have blocked.
Get this: as part of its plan to improve the teaching of uni students, and in the course of explaining how some students are being charged higher fees than they should be, the commission also shows why deregulating fees would have been a crazy idea.
At the same time as it allowed unis to set their own fees, the government's intention had been to cut its funding of places by 20 per cent. It wasn't hard to see that, as unis continued to raise their fees each year, the government would keep cutting its own funding contribution until it was no more.
The commission argues (on page 109) that government "regulation" of the maximum fees unis may charge for particular undergrad courses "is necessary because price competition [between universities] is difficult to establish in the domestic university market.
"This is primarily because the vast majority of domestic students have access to income-contingent HELP loans and consequently have a low price sensitivity, which was a necessary by-product of enabling university access on merit, rather than family income."
Get it? The elementary model's promise that "market forces" – competition between sellers, plus the self-interest of buyers – will stop firms overcharging rests on an assumption that customers have to pay the price upfront.
In the case of uni fees, however, the upfront price is paid by the government, and students incur a debt to the government, which they don't have to start repaying until their income reaches a certain level at some uncertain time in the future.
How long they'll be given to repay the debt is also uncertain, though it's certain their repayments will be geared to their ability to pay, and the only interest they'll pay is the rate of inflation. Cushiest loan you'll ever get.
With the cost of university tuition to a student so far into the future and so uncertain, it's unrealistic to assume students will shop around to find the lowest-charging uni. (Actually, they all charge the maximum allowed.)
Remember, too, that the fee is less than the full cost of the tuition, meaning the unis are "selling" a product whose retail price has been heavily subsidised by the government.
The commission notes that price competition is further limited by the geographic immobility of students. Because more than 80 per cent of commencing students live at home, and moving out would add greatly to their costs, you might get competition between the unis in a particular capital city, but that's all.
But even that's unlikely. The elementary model assumes "perfect knowledge" – both buyers and sellers know all they need to know about the prices and qualities of the products on offer.
In reality, knowledge is far from complete, and is often "asymmetric" – sellers know far more than buyers, usually because the sellers are professionals, whereas the buyers are amateurs.
The commission explains why all unis – big-name or bad-name, city or country – charge the maximum fees allowed.
"In the absence of good information, lower prices may undermine the prestige of a university and its capacity to attract good students," the commission says.
This is an admission of a weakness in the elementary model that affects far more than uni fees. The assumption of perfect knowledge leads to the further assumption that the prices market forces allow a firm to charge fully reflect the quality of its products relative to the quality of rival products.
As behavioural economists have pointed out, however, quality is something that's often very hard for buyers to know in advance. Only after they've bought it and tried it will they know. Think bottles of wine.
So whereas economists assume buyers' foreknowledge of differences in quality is what determines differences in the prices of similar products, buyers who don't know the differences in quality assume they can use prices as a quality indicator. Higher price equals higher quality.
So why don't lesser unis seek to attract more students by charging lower fees than the big boys? Because it would be taken as an admission of their inferior quality, and could lose as many customers as it attracted, maybe more.
The assumption that market forces would prevent unis from abusing their freedom to set fees as they chose was extraordinarily naive, as the commission is now happy to explain.