A Review Of Instruments For Student Loans In Tertiary Education

© Blackwell Publishing Ltd 2004. Published by Blackwell Publishing Ltd, 9600 Garsington Road, Oxford OX4 2DQ,
UK and 350 Main Street, Malden, MA 02148, USA.
A Review of Instruments for Student Loans in
Tertiary Education
OLIVIER DEBANDE
Introduction
It is now recognised that investing in knowledge and skills to enhance competi-
tiveness and preserve countries’ standards of living is important.This came out at
a time when educational systems have been facing great changes: the raising of
the school leaving age, the widening of access to and participation in tertiary edu-
cation, the shift from an élite to a mass system of tertiary education, and the devel-
opment of lifelong learning. The move to a ‘mass’ tertiary education system —
even at a reduced per student cost — is increasing the cost of what has often been
a system which was free at the point of use. Over the relevant time scales, this will
combine with greater pressure on pension systems, indicating a significant and
growing fiscal problem. The shift to a ‘mass’ tertiary education system induced
changes on the supply-side by increasing the number of institutions and the variety
and quality of subjects and modifying the mix of education and research activi-
ties. Hence, there is also a need to revisit the current funding mechanisms to take
into account the greater differentiation and competition within the tertiary edu-
cation system.
Looking at the share of the national income allocated to education in the EU
between 1995 and 1999 (Eurostat, 2002), a reduction in public expenditure on
education as a proportion of GDP is observed in most countries, with the excep-
tion of Denmark, Greece, Portugal and Sweden. In addition, the greater poten-
tial mobility of students and graduates is affecting the long-term sustainability
of the current funding system of tertiary education, creating unbalance between
countries in function of the net inf
flow of students.The decrease in public funding
is only partially compensated by an increase in the direct private expenditure for
tertiary education institutions (OECD, 2002) in absolute terms and as a share
of total expenditure.
Cost-sharing between the taxpayers and individuals in the form of tuition fees
and/or full-cost recovery for the provision of non-instructional services gives addi-
tional freedom to public authorities to support the development of tertiary edu-
cation and lifelong learning.The revision of tuition fee policies could be justif
fied
by different considerations: (i) equity based on the notion that those who benef
fit
should share in the costs; (ii) eff
ficiency, since the payment of some tuition will
make students and families more discerning customers and universities more
European Journal of Education, Vol. 39, No. 2, 2004
* DISCLAIMER
The findings, interpretations and conclusions presented in this article are entirely those of the author(s)
and should not be attributed in any manner to the European Investment Bank.

cost-conscious service providers; and (iii) responsiveness of tertiary education
institutions to individual and societal needs. But cost-sharing schemes cannot be
implemented equitably without adequate student support mechanisms for aca-
demically qualif
fied but needy students. Indeed, national systems and individual
institutions must maintain and improve the accessibility of tertiary education.
Two ways of offering students f
financial support are available based on the mobil-
isation of public and private resources: (i) targeted scholarship or grant schemes
and (ii) student loan programmes leveraging in additional resources and making
funds available to all students who wish to borrow to pay for their education and
will repay the loan from subsequent earnings after graduation.
The student loan mechanism is based on the lending of funds to students
in order to cover the direct cost of education and living expenses until they
complete their studies, recognising that while students cannot easily afford to
pay more, graduates in principle can. After a short grace period corresponding
to the time required to f
find a job, the graduate starts repaying the loan over
several years. By introducing a loan system, they become more aware and
more empowered in their learning decisions. It could be assumed that indi-
viduals will be more motivated to ensure that the potential benef
fits are actually
achieved to secure the repayment of the loan. In most European countries,
the institutional form implemented to manage national publicly-supported
student loan schemes corresponds to the creation of a public agency, although
new forms of public-private partnership are emerging, especially in Eastern
countries. In parallel, commercial banks developed student loan programmes
that essentially target post-graduate students engaged in business schools pro-
grammes with a relatively low-risk prof
file. In this case, the loan is provided at
market conditions.
The potential advantages of ‘reimbursable’ student funding schemes are:
1. Partial release of the funding constraint by an associated revision of tuition
fee and grant policy to ensure tertiary education participation and acces-
sibility (without compromising ‘equity’);
2. Better cost-sharing schemes securing additional public and private
funding of tertiary education and ensuring the sustainability of the
support schemes;
3. Leverage effect on public funds already allocated for education; additional
funding for education is generated in excess of the actual education public
spending;
4. Better internal efficiency of the tertiary education system (greater
accountability of institutions, reduction in the length of time needed to
complete a degree . . .).
The gradual shift to students’ loan mechanisms is based on the notion of replac-
ing the current ‘implicit’ system of public funding of a free tertiary education
system based on the assumption of having sufficient fiscal returns to tertiary edu-
cation, i.e. the graduate reimburses the cost of studies through a progressive
income tax system (assuming the existence of an effective progressive tax system).
In this ‘explicit’ system, public authorities will advance the students’ financing
during the first years of its creation, since students will start repaying loans once
they have completed their studies. The actual cost for the State will depend on
the organisational arrangements put in place for guarantees (in case of default)
162 European Journal of Education
© Blackwell Publishing Ltd 2004

and interest rate subsidies, as well as on the extent of the public-private partner-
ship with commercial banks or private investors. The issue will be the extent to
which supplementary resources are introduced and the radicalisation of any
rearrangement of tertiary education funding as a whole. Indeed, the pace of
change of the transition process must be designed so as to attract sufficient support
to avoid the adverse consequence of the ‘big-bang’ approach in Australia.
The discussion about student loan schemes is directly related to the existence
of liquidity constraint for students, especially for those from lower socio-
economic backgrounds who are unable to f
finance their education. Because they
are less wealthy and more risk-averse, higher returns on their investment in
human capital are expected. Although the presence of capital (credit rationing)
and insurance (income risks) market imperfections related to investment in
human capital could justify public subsidies for tertiary education, an equity par-
ticipation model where the government buys shares in future graduates’ revenues
that are associated with the degree obtained (i.e. their level of human capital) in
exchange for funds that cover tuition and living costs during the course of their
studies could be considered as suff
ficient to overcome these market failures (Bas
& vanWijnbergen, 2002). Students will obtain funds independently of their back-
ground, thus releasing the liquidity constraints. The importance of liquidity or
credit constraints has been recently questioned by various American studies
(Carneiro & Heckman, 2002) that identif
fied distance from college as one impor-
tant constraint on access to college education.
Finally, income insurance by pooling income risks could be a potential
mechanism to alleviate the under-investment problem due to risk aversion. In
parallel to a public loan scheme, the same approach could be developed in credit-
based student loans with adequate risk-pooling between the portfolio of bor-
rowers (i.e. students). However, this may have adverse student selection effects,
i.e. increasing the cost for those who are likely to be successful and reducing it
for those who are likely to fail, as illustrated by the failure of the ‘Tuition Post-
ponement Option (TPO)’ developed by Yale University (Salmi, 1999).
The review of international experiences with student loan schemes in indus-
trialised and developing countries has shown a low repayment rate of loans due
to heavily subsidised interest rates, high default rates and high administrative
costs. In order to reform the existing schemes, various countries implemented
income-contingent loan systems in which loan repayments were a f
fixed propor-
tion of a graduate’s annual income. This system is more equitable, since repay-
ment is function of income and could reduce the debt aversion of some students
and their family when adequate safeguard mechanisms are introduced in addi-
tion to adequate grants and scholarship systems.
In this article, a f
first macro-assessment classif
fies the European countries with
respect to the practicability of implementing respectively a public loan system
and a commercial credit-based system on the basis of four feasibility criteria (indi-
vidual, funding, institutional and educational criteria). The UK, France and the
Netherlands rank high regardless of the nature of the loan system to be imple-
mented. In terms of public loan systems, Southern countries seem potential can-
didates, whilst Nordic countries could be considered as interesting candidates for
a commercial credit-based system. In the case of Southern countries, the justif
fi-
cation for developing tertiary education student support schemes is related to the
need to improve the internal eff
ficiency of the system and to promote mobility of
Olivier Debande 163

students allowing them to choose the most appropriate tertiary education insti-
tutions for their f
field of studies.
After reviewing the funding of tertiary education systems in Europe, the eco-
nomic and f
financial issues related to student loans are addressed. The main fea-
tures of the student loans schemes in Europe are then summarised and compared
with several non-European countries. The article ends with a market assessment
of the demand for student f
financing schemes in Europe.
The Funding of Tertiary Education in Europe
The funding of education comes from a mix of different sources: private individuals
(students and/or parents), taxpayers (or public authorities), the tertiary education
institution, the private sector and philanthropic institutions. The funds can be
either provided to the tertiary education institution and/or to the students. In
terms of students’ funding, financial supports can be designed to cover all or part
of the direct education (i.e. tuition fees) and living costs. This raises the question
of the separation between supporting the cost of educational services and that
of living costs. By including in a loan scheme the possibility to cover all fees and
all living costs, tertiary education is ‘free’ at the point of use, deferring the cost.
Table I describes the financing of tertiary education along these two dimensions.
To respond to the need for additional resources to support a ‘mass’ high-
quality tertiary education system in a context of government budget constraints,
European governments will have to diversify the source of external funds. Based
on Table I, additional funding for tertiary education, ceteris paribus, could come
from: (i) charging/increasing tuition fees; (ii) reducing students’ living allowance;
(iii) increasing private sector funding; (iv) developing student credits and other
TABLE I. Sources and mechanisms of tertiary education funding
Mechanisms of funding
Tertiary education institution Student
Student self-financing Tuition fees Daily expenses (food,
Family members Accommodation (student halls) transport, clothing . . .)
Study material
Taxpayers Recurrent general or specific Subsidised tuition fees
grants or subsidies (salaries, Grants
buildings, and equipment, Cash benefits
research . . .) Tax relief
In-kind transfers (subsidised
accommodation, food,
transport . . .)
Tertiary education Own resources (consultancy, Scholarship or grants
institution applied research, sales of In-kind transfers (subsidised
goods and services, accommodation, food,
endowment . . .) transport . . .)
Private sector Loans Loans
(firms, banks . . .) Research grants and contracts Grants
Sponsorship and chair Sponsorship
Philanthropic Chair Donations
institutions Donations
Sources
of
funding

student funding mechanisms; (v) involvement in work-study or national services
programmes commissioned by public authorities; (vi) developing business spon-
sorship of students; (vii) developing and charging for university consultancy and
applied research services and (viii) encouraging donations.
Table II provides an overview of different funding indicators. Public f
financ-
ing has been considered the traditional approach to support tertiary education
in most countries (Jacobs & vanWijnbergen, 2002). Even if tuition fees have been
introduced, they only contribute for a small amount to the funding needs of
tertiary education institutions. The average subsidy rate for tertiary education
(def
fined as the share of direct public expenditure in educational institutions and
total public subsidies to households and other private entities in total sources of
funds for tertiary education) in European countries ranges from 76% to 99%. In
most, it is over 90%. In other words, tertiary education is provided free at the
point of delivery. Looking at the cost per student, important variations are
observed between European countries and within the sample of countries, the
highest level of spending per student being in the US.
In order to evaluate the funding needs of the different countries, the required
amount spent as a proportion of GDP to equal the EU average has been esti-
mated. Under-spending seems to be highest in the f
five major European coun-
tries, although private funding is increasing in most. Of these countries, Italy is
facing the most important f
fiscal distress situation.
In the case of tertiary education, it could be argued that individuals should
contribute large amounts to the costs of their education because of:
䊉 The greater private rate of return to tertiary education compared to other
levels of education. Various studies have estimated the ‘graduate premium’
on earnings and shown the financial returns associated with a tertiary edu-
cation degree. However, recent studies in the UK (Colon & Chevalier, 2002)
show that returns from post-compulsory education are not evenly distrib-
uted across social classes (students from poorer backgrounds experience
much greater variation), fields of study and tertiary education institutions.
䊉 Lower exposure to the ‘unemployment risk’. Those with a tertiary educa-
tion qualification have about half the average unemployment rate.
䊉 Better job quality for graduates. They benefit from greater job stability, a
better ‘suitability’ of their job with their qualifications . . .
䊉 Additional private benefits are derived from better health and personal sat-
isfaction for those who obtain a tertiary education qualification.
Hence, tertiary education could not be considered as a pure public good. Since
it generates social benefits (e.g. the positive impact on the rate of technological
innovation), taxpayers still have to contribute to its financing, but an appropriate
mix between private contribution and public funding must be found. Indeed, the
regressive nature (Barr, 2000; 2002) of public subsidies (i.e. taxpayers’ contribu-
tion) to finance tertiary education implies a reverse distribution effect, since the
incidence of the costs is borne by the average taxpayers whereas the benefits accrue
to the most talented (noting that in Belgium and in Germany, recent studies
(Barbaro, 2001;Vanbenberghe, 2001) do not find evidence of a regressive impact
based on the analysis of the fiscal incidence and on the identification of a fiscal
rate of returns to tertiary education (defined as the interest rate equalising the
public expenditure for tertiary education and the additional fiscal revenues derived
Olivier Debande 165

166
European
Journal
of
Education
©
Blackwell
Publishing
Ltd
2004
TABLE II. Funding of tertiary education system and funding needs
1999 Number Cost per Subsidy Public Additional Increase in Government
of students students rate to expenditure amount of private debt as % of
(PPP, €) tertiary for tertiary public funding expenditure GDP
education education to reach EU (1995 = 100)
(% GDP) average
(million €)
Austria 252,893 12,754 98.7 1.6% -525.5 54 63.2
Belgium 351,788 11,048 100 1.1% 496.7 n.a. 107.6
Denmark (1999, $ PPP) 189,970 10,657 97.7 2.2% -1,353.6 406 44.7
Finland 262,890 8,761 97.4 2.0% -782.1 109 43.4
France 2,012,193 6,722 88 1.0% 4,170.8 99 57.3
Germany 2,087,044 9,889 91.8 1.1% 4,243.4 119 59.5
Greece 387,859 4,171 99.9 1.1% 241.3 175 105.1
Ireland 151,137 7,653 77.4 1.1% 171.0 134 36.4
Italy 1,797,241 5,734 86.5 0.8% 5,573.8 133 109.8
Netherlands 469,885 11,625 79.7 1.4% -276.3 229 52.8
Portugal 356,790 m 92.9 1.0% 322.5 265 55.5
Spain 1,786,778 4,248 77.4 0.9% 2,214.3 125 57.1
Sweden 335,124 16,199 88.4 2.1% -1,663.8 206 56.6
UK 2,080,960 7,645 73.9 1.1% 2,813.2 103 39.1
Australia* 11,725 53.4 1.2% 143
Canada* 15,211 100 1.9% 113
New Zealand* m m 1.2% n.a.
US* 19,220 46.9 1.4% n.a.
* based on OECD data.
Source: OECD (2002), EUROSTAT (2002).

from graduates) that is higher than the private ones, which means that graduates
are more than repaying the implicit loan granted to them in a free of use tertiary
education system). Considering the potential contribution of graduates, the instru-
ments that could be used are the following: student loans associated with an
increase in the tuition fees or a graduate tax.There are two dimensions of equity:
redistribution in favour of those with wealthy parents and redistribution in favour
of those who, because they are bright, will earn high salaries as a consequence of
going to university. The first seems less socially acceptable than the second. A
system of means tested grants would avoid the first and encourage the participa-
tion of those from poorer backgrounds.
The review of the funding mechanism of tertiary education must take into
account student mobility. The push towards free circulation of people associated
with a modif
fication in the openness of labour markets and the recent conver-
gence of European tertiary education systems initiated by the Bologna process
could favour mobility of students and graduates and hence affect the sustain-
ability of the public f
financing of tertiary education. Indeed, the contribution of
graduates through the tax system to the funding of tertiary education depends
on their decision to live in the f
fiscal territory where the public funding of tertiary
education institutions is coming from (the principle of ‘origin’). The potential
mobility of students and graduates not only induces a form of ‘brain drain’ and
loss of human capital for the educational host country but will put additional
pressure on the nature of the funding f
flows within the tertiary education sector.
This could partially be compensated if the exit of graduates is mitigated by the
entry of graduates from foreign countries. But it would only indirectly contribute
to generating revenues.
At OECD level, student mobility increased over the last years. Figure 1 pro-
vides an evaluation of the asymmetric mobility of students in the EU by ranking
Olivier Debande 167
-8.0%
-6.0%
-4.0%
-2.0%
0.0%
2.0%
4.0%
6.0%
8.0%
Australia
United
Kingdom
Austria
Belgium
Germany
United
States
Spain
Sweden
France
Netherlands
Canada
Denmark
New
Zealand
Country
mean
Portugal
Italy
Finland
Ireland
Net intake of
foreing students
relative to total
FIGURE 1. Mobility of students in tertiary education (2000)
Source: OECD (2002)

the different countries in function of their net balance of international student
exchange. A great disparity exists, with the UK having the highest net intake and
Ireland the highest net outf
flow of students. Student mobility is driven by various
factors, including the academic reputation of an institution, access conditions,
f
financial support mechanism for international mobility, etc.
There is a lack of evidence to assess the magnitude of the migration of
high-skilled workers. A recent study (Teichler & Jahr, 2001) based on surveys of
graduates in Europe identif
fied a correlation between student mobility and the
likelihood to work abroad after graduation. However, it reported that ‘the ma-
jority of formerly mobile students are employed at home’ (p. 456), not corroborating
evidence about a brain drain of graduates (Psacharopoulos (2002) reported that
Greek students obtaining their degree from well-known Anglo-Saxon universities
are not returning to Greece to work).
The future trend in terms of professional mobility would be affected by the
development of ICT technologies, reducing the need to be ‘physically’ present
in a foreign country, by the situation on the labour market, etc. Hence, the po-
tential student and graduate mobility will require modif
fications in the current
organisation of tertiary education funding f
flows, e.g. through the implementation
of an adequate European student loans scheme that supports student mobility
across the EU.
Tuition fees are charges levied upon students but effectively borne by students
and their parents and are designed to cover a share of the instructional costs of
tertiary education. The adequate level of tuition fees is directly related to the
sharing of the costs of tertiary education between the different stakeholders (i.e.
public authorities, families, students) and includes elements related to the ex ante
ability-to-pay of students. The design of the tuition fees raises issues about the
differentiation between institutions and f
fields of study and in terms of the deter-
mination by the regulatory authorities or by the tertiary education institutions.
In addition, the f
final impact of an increase in tuition fees will depend on the
price elasticity of enrolment. Studies for the US (Jacobs, 2002) identif
fied a non-
linear positive enrolment (price) elasticity: increases in tuition fees resulted in a
decrease in enrolment but the higher the tuition, the more enrolment was affected
by an increase in the fee’s level. However, evaluations of the Australian experience
do not allow to infer a negative impact of an increase in tuition fees on enrolment.
Student Financing Schemes: Economic and Financial Issues
The presence of a liquidity constraint for students due to the lack of sufficient
income or capital market failures when deciding to participate in tertiary educa-
tion has three major effects: (i) a loss of talent, since high ability low income stu-
dents will be deterred from applying for tertiary education, generating an
efficiency and a social loss; (ii) a loss of opportunity and (iii) a stronger link
between family background and a person’s lifetime income. To overcome this sit-
uation and improve efficiency and widen participation, students could benefit
from financial support mechanisms during their studies through loans and grants,
whilst contributing to its financing through the repayment of their loan and/or a
graduate tax. Depending on the degree of subsidisation of tuition fees, student
support mechanisms can cover education (tuition fees) and living costs.The grad-
uate tax is designed as an additional income tax, but paid only by the beneficia-

ries of tertiary education who have received a grant to complete their studies.
Grants are awards given to students to help them pay their living expenses whilst
engaged in full-time study. Students are not formally required to pay back grants
to the awarding authority upon completion of their studies. Hence, in the absence
of a graduate tax, the cost of grants is borne by the taxpayers.
Although the graduate tax (Oosterbeek, 1998; Johnes, 1993; Barr, 2001) is
perceived as favouring equity by equalising the starting positions of students from
low and high income families, it does not seem to be the appropriate solution to
the current funding problem of tertiary education systems in Europe.The advan-
tages of a graduate tax are: (i) contingent upon the earnings of graduate; (ii) low
demanding in terms of administration costs; (ii) generating large amounts of addi-
tional funding in the long term. However, in a structure with an open-ended grad-
uate tax, this system seems unfair, since people with high lifetime earnings repay
considerably more than they borrowed to complete their degree. In addition, this
system mixes educational and income policy. It does not differentiate total earn-
ings from the incremental amount coming from tertiary education. In addition,
it creates a substitution effect in terms of labour supply and could be conditioned
by the enforcement of labour tax harmonisation in a framework of international
asymmetric mobility between students and graduates (as in the case of the UK).
A loans system allows eligible students to claim support during their years of
study. Unlike grants, loans must be repaid. The repayment regulations vary con-
siderably according to Member State and the loan component of student main-
tenance generally implies a f
financial commitment by the government (subsidies
of interest payments, guarantees against default . . .).
The main advantages of the loan system are:
䊉 To increase and diversify the source of funding for tertiary education,
minimising additional burden on public finance. In parallel to the imple-
mentation of student loan schemes, tertiary education institutions must
benefit from greater flexibility in their tuition fee policy.
䊉 To improve the use of fixed educational stock as a result of a higher student
throughput since it will allow students not to have to delay or break off
their studies because of a shortage of finance (i.e. releasing the liquidity
constraint).
䊉 To induce a better match between the final beneficiaries (graduates) and
the source of funding of tertiary education.
䊉 To favour wider access to tertiary education and improve the equity of the
current system based on low tuition fees by introducing a universal loan
scheme completed by targeted aid mechanisms for the low-income group.
In equity terms, a distinction must be made between the situation of the
students at the time of enrolment and the lifetime situation (i.e. static versus
dynamic equity). At the time of enrolment, it refers to the opportunities
given to students from low-income families to participate in tertiary edu-
cation. From a lifetime perspective, it refers to the objective of subsidising
those who do not belong to the better-off group of their age-cohort.
䊉 To induce students to choose their fields of study wisely and try to go
through the curriculum as rapidly as possible in order to minimise the
amount they have to borrow, since students will be confronted with the real
costs of education.
Olivier Debande 169

䊉 To increase the accountability of tertiary education institutions since
students who pay for educational services will be acting like customers,
demanding better services from their professors (attendance, quality of lec-
tures) and from educational institutions. Assuming that teaching standards
will improve as a consequence, it will justify higher salaries for teachers (that
could be financed by additional funds from an increase in the tuition fees),
creating a virtuous spiral.
Private Capital Market Rationing and Insurance Market Imperfections
Barriers to student loan financing result from the uncertainty faced when invest-
ing in additional education (failure to complete studies, skills becoming obsolete,
career paths with a low earning potential . . .) and from the intangible nature of
human capital (illiquid nature of the educational investment and lack of collateral).
Uncertainty about future earnings of graduates makes lenders unwilling to finance
education at going market rates, asking for a risk premium. This makes the costs
of studies much higher for those who borrow from the capital market than for
those who obtain resources from their family. On the lending side, two major prob-
lems could be identified (Oosterbeek, 1998):
1. The repayment of the loan depends on students’ future effort to earn a
high income and on their behaviour (‘moral hazard’). If students who
borrow under this scheme drop out or choose to live on a small income,
this scheme will incur losses. Although the lender cannot observe the
graduates’ efforts to maximise their income, the ‘moral hazard’ should be
limited by having parents co-sign the loan agreement and provide a form
of collateral. But this voids the attempt to help the poor.
2. The effect of the risk premium added by commercial banks to the market
interest rate. Students who have high-income expectations or a low-risk
profile may find the sum of the interest rate and the risk premium too
high.They could have recourse to other financing sources (‘adverse selec-
tion’). As a result, the remaining group will have on average a higher risk
of default. However, this effect could be mitigated through the provision
of loans with subsidised interest rates and the extent of this ‘adverse selec-
tion’ would be affected by the (limited) size of the group of students who
could be both ex ante confident of high income and have access to other
financing sources.
On the borrowing side, students could be excluded from resorting to loans to
finance their studies for the following reasons:
1. The risk aversion. Students are uncertain about their ability to secure a
good job and complete their studies. If they over-weigh the likelihood of
bad outcomes, it will prevent them from having recourse to a loan scheme.
This risk aversion effect is expected to be exacerbated for those from low
social backgrounds with parents who do not have a high level of qualifi-
cations — precisely the targeted group.
2. The lack of experience of students in financial management, especially
young students. Limited experience, inadequate knowledge and self-
discipline in handling personal finance could be an additional problem,

either in the incentive to borrow or in their ability to ensure repayment
of the debt.
3. The inadequate information of prospective students and their families
about existing schemes, including loans support. The lack of appropriate
information on available state and commercial support implies that
ignorance is a deterrent to access and aggravates debt aversion, especially
amongst those from low-income families.
To solve the liquidity constraint faced by students on the borrowing side, student
loans seem to be a better option than reducing through a subsidy the cost of edu-
cation since it avoids over-spending on education by students who are not, as a
result of their initial endowment, subject to capital market imperfections.
The resulting capital market imperfection leads to a shortage of student loans
capital in European countries. However, although not through student loans,
commercial banks show an interest in the student market, spending substantial
resources (marketing, free overdrafts and other inducements), since they regard
it as very important for future business. Hence, it could be inferred that part of
the information gap with their student customers has been addressed.
Insurance market imperfections (Jacobs, 2002) are related to the diff
ficulties
of achieving a suff
ficient risk diversif
fication when investing in human capital.
The extent of this market imperfection is expected to have a greater impact on
students from disadvantaged socio-economic backgrounds, who will require a
‘human capital equity premium’. This is because less advantaged families face
different borrowing costs than rich ones (i.e. cannot borrow at the same rate) or
they discount future benef
fits of human capital investment at a greater market rate
since they are more ‘impatient’, do not see the utility of continuing studies (linked
to various factors such as lack of conf
fidence . . .) or fail because of a cultural
def
ficit to appreciate the benef
fits of education. As in the case of the capital market
failure, income insurance contract could be more diff
ficult to implement because
of legal restrictions.This potential insurance market failure could be partially alle-
viated by having an income-contingent scheme with adequate threshold levels
and f
flexible repayment mechanisms, mimicking the future f
flow of revenues
generated by the investment in tertiary education. In addition, the investment in
tertiary education generates a substantial wage premium and a return that is as
large as returns on equity. Since the level of unemployment is negatively cor-
related with the level of education, the investment in education acts as an in-
surance device, meaning that the risk premium on investment in tertiary
education is negative. This situation leads to a puzzling ‘human capital equity
premium’ issue.
Student Loans Mechanisms
There are usually two schemes (Barr, 1993): (i) mortgage-type loans and (ii)
income-contingent loans. The first, which can be supplemented by social back-
ground dependent grants, is based on a repayment scheme in fixed instalments
over a fixed period of time. The second type is based on a repayment scheme
taking the form of x percent of the borrower’s subsequent annual income, making
the repayment period endogenous. It is important to have a mechanism that offers
the borrower insurance against potential future poverty in order to reduce the
Olivier Debande 171

applicant’s risk aversion, but at the same time provides the discipline to ensure
the repayment of the loan. Repayment is spread over the professional career of
the student, improving the matching between repayment of the loan and the
materialisation of the benefits of the investment. However, the choice between
mortgage or income-contingent loan scheme is a second order issue, especially
when the management of the students’ loan scheme is done with sufficient flexi-
bility (e.g. allowing for deferment and forbearance in case of hardship) to take
into account the current income situation of the graduates and to tailor the repay-
ment to individual specificities.
Based on existing studies (Oosterbeek, 1998; Barr, 2001; Chapman, 1997;
Johnstone, 2001), a well-designed loan scheme should be:
1. Based on adequate repayment mechanisms that allow for fluctuations in
income (i.e. linking repayment and financial return of the investment in
tertiary education) and flexible income threshold reflecting the earnings
evolution of the graduates (especially to deal with the risk-aversion of the
eligible students and to take into account hardship periods);
2. Defined to cover all tuition fees and a proportion of living costs in order
to converge towards a tertiary education system which is ‘free’ at the point
of use and to reduce the need for parental support;
3. Based on wide access, reducing the complexity of the management of the
system;
4. Complemented with aid mechanisms that target the low-income groups
and a revision of the tuition fee policy of tertiary education institutions.
The financial support system should include a structure offering grants
— subsidised/guaranteed loans — credit-based loans (based on income
and credit information requiring in some case the parents’ co-signature),
responding to the different needs of students;
5. Extended to other groups of students, e.g. students engaged in adult edu-
cation or vocational training;
6. Managed under the form of a ‘one-stop shop’ favouring the offer of finan-
cial support tailored to the needs of each student and ensuring the ade-
quate follow-up and monitoring of the grant/loan.
Interest Rate and Risk of Default
Another important issue is the interest rate level. Lenders must include in the
interest rate a premium that reflects the estimated risk of default. With the exist-
ing ‘adverse selection’ problem, commercial banks could be confronted with a
market where bad risks will drive out good risks.This could be partially mitigated
by increasing the student population, favouring more heterogeneity within the
student population and by the information collected by the banks on the student
market. However, the lenders could use the academic records during the com-
pulsory studies as an indicator of the student’s future default probability. Even if
it is based on student performances regardless of their financial background, there
is a risk of not promoting access to tertiary education given the cumulative nature
of the education process (recognising that this objective of promoting access is not
the responsibility of commercial banks).The level of interest rate could be adapted
in function of the target group (e.g. on the basis of means-testing mechanism) at

the cost of additional complexity in the management of the scheme, lower uni-
versality and greater risk of inefficient discrimination between families . . .
To deal with the risk of default, two general approaches could be considered:
risk pooling amongst students or risk shifting to society. It is important, espe-
cially for students from disadvantaged backgrounds, to have some insurance in
case of non-repayment. Risk pooling is an insurance system where risks of default
are shared amongst graduates. The interest rate on the loans will contain a risk
premium to cover the average cost of default of a given population of students.
Implicitly, it implies redistribution from the students who succeed in repaying
their loan and those who fail to do so. This principle was used for the Tuition
Postponement Option atYale University in the early 1970s and was not very suc-
cessful. The main disadvantage is to put the borrowers at some risk, depending
on their future earnings capacity, and more particularly on how many potential
high earners choose to exit the income contingent repayment scheme for fear of
getting into a cohort with too many potential low earners (adverse selection
problem). This mutualisation approach must be designed in such a way as to
avoid that the shortfalls from low earners should be made up by a particular class
of higher earners who also had to borrow to f
finance their tertiary education.
Under risk shifting, the default risk is borne by the taxpayer. A potential option
is to f
find mechanisms to transfer the cost of the default premium on taxpayers
rather than on borrowers.The provision of subsidies and guarantees by the State
is justif
fied by the economic benef
fits of the student loans system (higher student
throughput, greater accountability and eff
ficiency of the system, reduction in grant
support . . .). But the introduction of interest rate subsidies by increasing the
f
fiscal burden of the system would reduce the amount of funds available for tar-
geted interventions in favour of students.To avoid this, Barr (2002) suggests that
graduates would have to pay an interest rate equal to the government’s cost of
borrowing. However, it could be argued that ex post subsidies are higher than ex
ante subsidies: subsidies are only given after graduation when they are not able
to repay their debt. This approach could be justif
fied to promote acceptance of
borrowing for funding investment in education amongst individuals from low-
income families.
The default risk to the f
financial intermediary or ultimately to the State as
guarantor could be mitigated by recourse to the tax and/or social security system
(as in the UK) to ‘catch’ defaulters. In a certain sense, the proposal would amount
to a closed-end graduate tax limited to the capital and interest on loans.
The absence of collateral, the enforcement problem of the loan contracts
(especially when loans are guaranteed by the State), and the imperfect informa-
tion on the ability of students could justify some form of guarantee by public
authorities. In addition, the introduction of a student loan scheme is expected to
relieve state budgets from student grant f
finance and from reduced budgetary
support for universities.The latter effect, combined with the eff
ficiency and equity
gains in the functioning of the tertiary education system identif
fied above would
seem to justify some measure of state guarantee, as already stated. But this ques-
tions the nature of the loan system itself. With unsubsidised loans (Barr, 2001;
2002) the source of student support is the student. On the other hand, public
subsidised loans are a mixture of loan and implicit grant, i.e. the source of support
is in part the student and in part the taxpayer. In addition, this public backing
of the loan can also reduce the incentive of the commercial bank to engage in
Olivier Debande 173

effective monitoring of student loans. The associated cost of providing interest
rate subsidies should ref
flect the extent of support that public authorities want to
provide to favour participation in tertiary education.
The lack of effective student f
finance mechanism in most Continental Euro-
pean countries could be a factor that leads to less well-off students living at home,
thus restricting academic choice if their local university cannot offer the course
in which they are interested. In addition to distorting students’ choice of f
field of
studies, it could induce an over-crowding effect in the big metropolitan univer-
sities because they are located in the largest conurbations and lead to the homo-
geneity of university provision.This is observed in Italy and Spain. In the Spanish
case, Mora and Vidal (2000) show that the lack of mobility of students due to
cultural factors and the unavailability of adequate student support programmes
reduce the competition faced by universities and hence their incentive to differ-
entiate themselves in order to offer a curriculum that matches the demand of stu-
dents and the skilled manpower requirements of the economy. By having a captive
market because students seek to attend the closest university irrespective of the
quality of academic programmes, it generates additional ineff
ficiencies, which are
exacerbated in Spain by the regionalisation process leading to a potential dupli-
cation or at least lack of coordination between tertiary education facilities.
Student Loans and Debt
Finally, the student loan mechanism must be designed (repayment pattern, upper
threshold on the debt, etc) to avoid excessive indebtedness of students.The poten-
tial repayment problem might be affected by different factors such as the fields of
study, the gender of the borrower, the overall level of consumer debt load.
Various studies have investigated the effects of the rising cost of tertiary edu-
cation and increasing levels of student debt. Most studies focus on the US. Dif-
ferent reports from the United States Department of Education (Choy & Maw,
1994; Choy & Carroll, 1996; Choy & Geis, 1997) focused on the use and con-
sequences of loans to f
finance participation in tertiary education. It appears from
these studies that the exposure to borrowing is greater for students from low-
income family: as family/students income increased the likelihood of borrowing
to f
finance tertiary education decreased. In a complementary study (King &
Bannon, 2002), the trend amongst American graduates is an increase in the
amount of debt incurred for students from low-income backgrounds (amount-
ing to over 8% of their monthly incomes contrary to what was observed until
mid-90s) and the increase in the level of debt was parallel to the reduction in the
grant aids programme. The existence of grant and loan schemes appeared to be
an important factor to release the liquidity constraint faced by students from dis-
advantaged social backgrounds. The existence of f
financial aid is crucial in the
decision of enrolment and in the choice of the tertiary education institutions for
low-income students. High levels of borrowing are also observed amongst stu-
dents from high-level family income, ref
flecting their greater likelihood to enrol
in private institutions that charge higher fees. Looking at the situation of gradu-
ates, the following emerged: (i) more than half the graduates had no under-
graduate debt one year after graduating; (ii) the level of outstanding debt is
directly related to the wage level obtained (meaning that debt burden could
become a real problem for low-income graduates) and on average repayment

amounted to less than 8% of monthly income until the mid-90s; (iii) the level of
debt did not affect saving decisions but increased the likelihood of still living with
their parents (especially during the f
first year of repayment of the debt). Another
recent study by King and Frishberg (2001) looked at the ‘sticker shock’ i.e. the
discovery that individual loan debt is much larger than planned or expected.
Based on data collected through a survey of students across the US, the study
conf
firmed the observation that low-income students were more likely to borrow
a much larger amount than the average undergraduate students. In addition, stu-
dents appeared to be poorly prepared to manage their level of indebtedness: they
were not aware of the total cost of their loan and underestimated the magnitude
of their borrowing exposure and the time needed to repay their loan.This stresses
the need to ensure a close monitoring of students, especially those from disad-
vantaged socio-economic backgrounds who show greater diff
ficulties in managing
their level of debt. In addition, it seems that low-income students are not more
‘debt averse’ than students from more privileged social groups. Combined with
the f
findings of McPherson and Schapiro (2000) for the US, students from low-
income families are more ‘price-averse’ than ‘debt-averse’, i.e. the up-front costs
of attending tertiary education — tuition and living costs — have a more deter-
rent effect on access for low-income families than the prospect of incurring debt.
Few studies have analysed the UK situation. Recent evidence showed that the
level of student debt has risen sharply with the shift from the maintenance means-
tested allowances to student loans: £5,636 was the average graduate debt in 2002
according to the NatWest Student Money Matters survey.As identif
fied in the New
Zealand experience, level of debt varied substantially according to the f
field of
studies and in specialised courses, the average debt level being around £11,600.
This could give adverse incentives to graduates when starting to work in order to
meet their repayment obligations. In addition, during their studies, to avoid incur-
ring too high a debt level, students could be induced to work longer hours with
potential adverse effects on their academic performance. According to this survey,
70% of undergraduates are worried about their debt on graduation, and just under
half will have a part-time job while studying. Callender and Kemp (2000) showed
that the levels of borrowing (rather than the decision to borrow per se) were asso-
ciated with students’ social class: students eligible for the highest level means-
tested government maintenance grants were those with high levels of borrowing.
Clearly, liquidity constraints (or f
financial family resources) are an important
explanation. Debt aversion appeared to differ amongst students (‘48% of students
from the lowest social classes expressed concerns about borrowing, debt and repayments
compared to 34% of students from the higher social classes and 37% of all students’ (Cal-
lender & Kemp (2000, p. 90)) and was also related to the type of courses. Hence
implicitly, it could be related to the social aspirations of students assuming that
the choice to attend a specif
fic course was partially related to social background.
Systems of Student Support in the EU in a Nutshell
The EU is characterised by a mix of different systems (Guille, 2002). With the
exception of the UK (and partially the Netherlands), European countries have not
favoured the emergence of effective funding mechanisms based on student loans,
in contrast to Canada (Schwartz & Finnie, 2002), the US, New Zealand and
Australia. National support schemes across Europe are difficult to compare and
Olivier Debande 175

to interpret for various reasons: (i) the total expenditure for student aid systems
depends on the size of the population, the number of eligible students and the
proportion of beneficiaries; (ii) the net effect of increase in tuition fees and finan-
cial aid per student; (iii) the impact of cultural factors; and (iv) the lack of
comparable harmonised data, especially to compare indirect subsidies (e.g.
student social security, parents’ tax deductions, canteens’ deduction . . .).
In order to provide a pan-European perspective, Table III summarises the
main characteristics of the existing grants and loans schemes. In addition to the
grants and loan systems, additional assistance is provided to students in the form
of state-subsidised social benef
fits for transport, accommodation, restaurant . . .
Tax relief schemes are also available in various European countries, allowing
parents to deduct specif
fied amounts from their taxes (Eurydice, 1999; OECD,
2000).
The existing loan schemes could be analysed by considering the following
parameters (Johnstone, 2001):
䊉 Means-tested criteria;
䊉 Educational awarding criteria;
䊉 Type of coverage: tuition fees living costs;
䊉 Terms of repayment;
䊉 Interest rate.
The design of these conditions aims, amongst other things, to protect students
from unmanageable levels of debt.
To complement Guille’s analysis (2002), it is worth reviewing the develop-
ment of f
financial student support mechanisms outside Europe, especially in
Australia, New Zealand and the US.
The Australian Experience
The Australian system (Chapman, 2001; Chapman & Ryan, 2002) is regulated by
the HECS system introduced in 1989 and revised in 1996. It introduced a uniform
fee charged to undergraduate students of $1,8000 (in 1989 terms and represent-
ing between 15% and 20% of average unit cost in 1989) with the option for the
students either to pay this up-front with a discount (originally 15%; later increased
to 25%) or to defer payment until their future income reached a particular thresh-
old with no real interest rate being charged on the debt. This system is designed
on the principle of deferred repayment of tuition fees and not as an income
support mechanism per se. This feature of the Australian system could be nega-
tively considered since the indirect costs of studying are often considered as impor-
tant financial constraints for students from low-income family. However, the limit
in terms of loan amount to the coverage of tuition fees could reduce the risk of
excessive debt for students. The current HECS system would benefit from the
introduction of maintenance grants targeting low-income students. Students
opting for deferred repayment benefit from an interest rate subsidies equal to the
real rate of interest for each year the debt remains unpaid. The Australian system
is offered to all prospective students, with no means-testing criteria. It is based on
the ‘risk-shifting’ approach where the default risk is transferred by society as a
whole. In this case, low risk/high ability students are not confronted with the costs
of default of high risk/low ability students: if the cost of default is borne by society,

Olivier
Debande
177
©
Blackwell
Publishing
Ltd
2004
TABLE III. Students’ financial support: an overview
Fees set by Grants Loans
Government TE Means Educational Means Educational Coverage Repayments Interest rate
institutions tested awarding tested awarding
Tuition Living Mortgage Income Start of
Criteria Criteria
fees costs contingent repayment
AUS ✓ ✓ ✓ No loan system
BEL ✓ ✓ ✓ ✓ No Partly After 3–6% subsidised
graduation
DK ✓ ✓ ✓ ✓ ✓* Partly ✓ One year 4.5% subsidised
after
graduation
FR ✓ ✓ ✓ ✓** Partly ✓ After Interest-free
graduation
FIN ✓ ✓* ✓ Partly/ ✓ To be agreed Approx. market
fully with the with State’s
Banks guarantee
GER ✓ ✓ ✓ ✓ ✓ Partly ✓ with 5 years after Interest-free
income- expiration
contingent of assistance
safeguard period
GRE ✓ ✓ ✓ No loan system still in place
IRL ✓ ✓ ✓ No loan system in place
ITL ✓ ✓ ✓ ✓ ✓ Partly ✓ partially After Interest free
with a limit graduation
of 20% of
income
LUX ✓ ✓ ✓ No loan system yet in place

178
European
Journal
of
Education
©
Blackwell
Publishing
Ltd
2004
TABLE III. Continued
Fees set by Grants Loans
Government TE Means Educational Means Educational Coverage Repayments Interest rate
institutions tested awarding tested awarding
Tuition Living Mortgage Income Start of
Criteria Criteria
fees costs contingent repayment
NL ✓ ✓ ✓ ✓ Yes Yes ✓ with Approx. market
income-
contingent
safeguard
PT ✓ ✓ No loan system in place
SP ✓ ✓ ✓
SWE ✓ ✓ ✓ ✓* ✓ Partly ✓ (4% of Two years Approx. market
income) after
graduation
UK ✓ ✓ ✓ ✓ Partly Partly/ ✓ (9% of After Zero real
Fully income) graduation subsidised
AUT ✓ ✓ Yes ✓ Zero real
subsidised
CAN ✓
NZ ✓1
✓ Yes Yes ✓ Approx. market
US ✓1
Partly Partly ✓ Subsidized
or or
fully fully
1. Under revision.
2. Private universities set their own fees as well as public state universities for out-of-state students.
* From the age of 20 at most, only student income is means tested; ** Very limited system of ‘honour loans’ of a low amount and provide to less than 1% of students.

repayment conditions are independent of the risk characteristics, preferences and
abilities of students.The repayment will be collected through the tax system.With
a threshold of around A$ 33,000 in 2001, graduates had to pay 2% of their taxable
income each year with payment rising to 3% or 4% at higher levels of income
(progressive marginal rate of repayment). In 2000, the threshold represented about
65% of Australian average weekly earnings. In 1996/97, changes in the funding
system were announced: (i) increase by around 40% on average of all charges; (ii)
reduction in the income threshold triggering repayment, (iii) three-tier differenti-
ated charge structure aiming to reflect income advantages related to different
degrees but not allowing differentiation between tertiary education institutions
(i.e. only between categories of subjects); and (iv) free levels of fee that could
be charged by tertiary education institutions for undergraduates who were not
accepted under existing HECS quotas.This last evolution could be considered as
not promoting efficiency and equity within the system, since it allowed less able
students from wealthy families to access top universities on the basis of wealth
rather than ability. Even after these modifications, most students in Australia chose
to defer payments of the HECS charge. In terms of revenues generated by the
HECS for the government, Chapman and Ryan (2002) showed that, in 2001,
students (through up-front payments and deferred repayment through the tax
system) generated over A$ 800 million, representing 20% of the total recurrent
costs of the Australian tertiary education system. Estimations for 2005 correspond
to a proportion of 30%. However, the system remains relatively costly since it
incorporates an expensive and untargeted subsidy for students (especially given
the universal nature of the HECS). In terms of access of students from disad-
vantaged social backgrounds, evidence seems to show that the introduction of the
HECS and the subsequent ‘1996/97 reform’ have not affected their level of par-
ticipation and were associated with an aggregate increase in the participation of
students in tertiary education.
The New Zealand Experience
In New Zealand (Barr, 2000; Ministry of Education, Inland Revenue and Work
and Income, 2001; House of Representatives, 2001), the system of financial
support for students is also based on an income-contingent approach. Until
December 1999, it included: (i) flexibility for universities to set their own fee
levels; (ii) student loans covering fees and living costs; (iii) income-contingent
repayment schemes collected by the tax authorities; (iv) flexibility in repayment
allowing for voluntary payments; and (v) interest rate slightly above the govern-
ment’s borrowing rate. The interest rate includes a premium of 1% over govern-
ment’s cost of borrowing to cover half of non-repayments. This self-insurance
element introduced a form of risk pooling of default. There were additional safe-
guards for unemployed graduates or people who left work to bring up young chil-
dren by putting them in a category where they paid a zero real interest rate. Finally,
interest on loan became chargeable from the day the student took out a loan.The
government provided financial support to students through tuition subsidies and
student allowances, the latter being available to those who met the income-based
eligibility criteria.The New Zealand system rests on an ‘institutional architecture’
involving the Ministry of Education which designs the strategic policy for the
student loan scheme,Treasury,Work and Income NZ which is responsible for the
Olivier Debande 179

delivery (assessment of applications) and administration of the payment of student
loan managed on a yearly cycle, and the Inland Revenue which is responsible for
the assessment and collection of student loan repayment and management of
interest rate subsidies (if any). The compulsory fees are paid to the tertiary edu-
cation institutions, while support for the living costs and course-related costs is
provided directly to students. This reform which was implemented in 1992 was
based on the need to attract additional funding for the tertiary education system
and on the perceived large private benefits related to the award of a degree. On
average, student loan borrowers owe around NZ$ 20,000. The New Zealand
student funding system that could be considered as having fully integrated the
concept of tuition fees’ flexibility and of income-contingent student support was
not adequately implemented and generated various problems: (i) important
increase in student debt affecting their choice of courses and possible career path;
(ii) uncontrolled increase in tuition fees generating inefficient competition
between tertiary education institutions and ‘disincentivising’ students from lower
socio-economic backgrounds to access when they cannot afford to pay the fee up-
front and are reluctant to draw out a student loan; (iii) complexity of the com-
plementary allowances scheme forcing students to spend more time on part-time
work; (iv) inadequate magnitude and speed in the introduction of the reform,
especially regarding the ability of students to borrow substantial amount of funds
to successfully manage their finances. A reform of the system was introduced at
the beginning of 2000. It was based on three elements: (1) full-time students
charged a zero nominal interest rate during their studies, switching to market rate
after graduation; (2) low-income students not paying interest while studying (full
interest write-off) and (3) freezing of the interest rate level. This reform does not
address the main issues raised before. In addition, Barr (2002) estimated that
under the new arrangement, non-repayment would increase from 10% to 35%,
due to the interest state subsidies and, when fully phased in, it would generate a
loss of resources estimated at NZ$ 1.5 billion.
The US Experience
The US tertiary education system has some 1,701 public institutions (four-year
school and two-year community college) and some 1,694 private institutions (four-
year college and universities and two-year school). In addition, these institutions
compete with a large number of private for-profit four-year and two-year schools.
Enrolment increased substantially over the last two decades. In terms of funding,
the share of tuition fee represents respectively some 25% and 50% of the revenues
for public and private institutions. Over the last decades, tuition has been replac-
ing government spending (essentially state and local) at both public and private
institutions. Looking at the composition of tuition fees, the overall share paid by
families declined, resulting from an increase in the enrolment in public institu-
tions, the expansion of federal grants and contracts, and the rise in financial aid.
Financial support to students is provided either as grants (e.g. the Pell grant, chan-
nelling about $6 billion per year) or (un)subsidised/guaranteed student loans (e.g.
the two variations of the Stafford loans scheme: Federal Direct Student Loan
Program (FDSLP) and Federal Family Education Loan Program (FFELP); the
Perkins loans). Since 1990, the growth in guaranteed and direct loans has been
very important in real terms. The student loan default reached 22% in the early

1990s to drop to 6.9% in 1998, resulting from changes in the regulation and default
definition; in the characteristics of the programmes (flexible loan repayment plan,
adequate deferment and forbearance measures . . .) and in the monitoring proce-
dures used by the tertiary education institutions. Expenditure on the Pell pro-
gramme fell by 3% in real dollars between 1990 and 1997.This evolution has been
partially compensated by the increase in institutional grants while state grants con-
tributed for a decreasing share of gross tuition in a significant way, especially for
low-income students. Hence, a shift has been observed from grant funds (Pell pro-
gramme) targeting low-income students to federal loan subsidies that mainly target
middle-income students. In other words, the evolution of funding towards loans is
expected to move support provided at the federal level away from low-income stu-
dents towards the middle class. In parallel, recent evolutions showed an increase
in the costs to students of attending tertiary education institutions even after con-
sidering the effect of financial aid. Since studies (McPherson & Shapiro, 1991;
2000) identified the presence of a significant price or aid effect for low-income stu-
dents while increases in net cost of attending tertiary education did not negatively
affect enrolment of students from more privileged background, the modification
in the composition of the financial support scheme associated with an increase in
the cost of tertiary education could act as a deterrent, even if the private returns
to investment in additional training have increased over the last few years in the
US. Hence, the impact of redistributing funds by increasing the funding for loans
and reducing real funding for targeted grants for low-income students will be more
detrimental for access, especially if subsidised loan support is not a crucial factor
in the decision to access colleges for middle- and upper-middle-income students.
It means that family background rather than academic ability still determines in
most cases who enrols in tertiary education.The perverse effect of family income
level on access is even greater when considering the impact amongst students with
similar talent (knowing that measured ability is partly determined by family income
and parental education). In a situation of price and quality differentiation amongst
tertiary education institutions, the range of potential alternatives in terms of access
will be constrained by the family background (income, parental education),
generating efficiency losses in addition to inequitable effects.
Market Assessment of the Demand for Student Financing Schemes
in Europe
The concomitant analysis of the existing trend in the tertiary education markets
across Europe and of the current financial support mechanisms for students
shows:
䊉 More pressure on public funding for tertiary education at a time of greater
demand for a high-skilled workforce and the redefinition of priorities in
favour of compulsory education, given the recognised importance of achiev-
ing a basic skills requirement level;
䊉 Lack of improvement in the opportunities of access to tertiary education for
those from low-income families despite the large amount of public subsi-
dies still injected in European tertiary education systems;
䊉 Importance of the private financial and social benefits from obtaining a ter-
tiary education qualification, stressing the justification for redirecting the
Olivier Debande 181

subsidies in the direction of those achieving modest rate of returns to edu-
cation and showing greatest need;
䊉 Important variations across Europe in terms of share of student aid to
support instructional and living costs and breakdown between grants and
loans schemes;
䊉 Superiority of the design of an income-contingent student loan scheme that
incorporates sufficient flexibility and adaptability of the interest rate
and repayment conditions to the students’ condition and is part of a
comprehensive set of measures, including the revision of existing tuition fee
policies.
This section aims to rank the different countries in terms of practicability of
implementing student loans schemes. Two different forms of student loans must
be distinguished:
1. Public subsidised loan systems where the State provides interest rate sub-
sidies or other forms of guarantees;
2. Commercial credit-based loan systems developed by private banks and
based on the quality of the guarantees offered by the students.
Four dimensions are included in the evaluation of the demand and practicability
of student loans schemes:
1. Individual feasibility related to the magnitude of the private benefits of
investing in tertiary education. Those who derive high private benefits
from their education should contribute more to its costs through tuition
fees and loans. In other words, students who are likely to earn high wages
on account of their degree should pay back the capital they received.The
expected private benefits will affect the nature of the income taxation
system. Countries with a very progressive income taxation system would
not seem adequate candidates for a student loans system, except if a con-
dition for the full fiscal deductibility of the cost of the student loans were
introduced;
2. Funding feasibility. The expansion of participation in the tertiary educa-
tion system in most European countries increased the pressure on public
authorities to ensure a sustainable funding capacity in future. Moreover,
additional constraints are imposed on the ability of governments to allo-
cate funds to tertiary education, requiring strict prioritisation within the
education and the public sector;
3. Institutional feasibility. The reform of the funding of tertiary education is
also constrained by the internal capacity of the system to implement new
mechanisms. The existence of support mechanisms for students will
favour the shift to student loans (either by extending existing student loans
schemes or transforming the existing grant schemes into loan ones). In
addition, a market structure characterised by some form of competition
between public and private tertiary education institutions or between the
public institutions could encourage the development of alternative
funding mechanisms based on greater individual contributions;
4. Educational feasibility. The characteristics of the existing educational
system in terms of coverage of direct instructional costs through tuition
fees, of selectivity to access tertiary education institutions and of equal

opportunities of access for those from different social backgrounds will
affect the potential feasibility of having recourse to student loans mecha-
nisms. Maintenance costs are a very important deterrent. A loan would
help even in the absence of an increase in tuition fees. Countries that do
not charge any or charge limited tuition fees could face important social
or political resistance to an increase in tuition fees. In addition, countries
with free entry to tertiary education institutions without or with limited
entrance examinations are adding an academic risk to the financial risks
borne by students. Finally, countries with an important regressive distri-
bution system characterised by a low participation of students from
disadvantaged social backgrounds will be in a better position to argue
in favour of transferring a greater share of the cost of education to
individuals.
Table IV summarises the most important dimensions and assigns some qualita-
tive evaluation for each dimension for the different European countries. In a
second step, the different countries are classified in terms of likelihood or suit-
ability of implementing the public and/or credit-based student loans scheme on
the basis of a multi-criteria analysis where it is assumed that each dimension
receives equal weighting.
In Table V, a f
first attempt is made to rank by quality the countries in various
clusters representing the likelihood of implementing a student loan system. The
last two columns aim to discriminate between the likelihood of having either
public loan systems or commercial credit-based student loans schemes. The f
first
ranking of European countries is based on the un-weighted sum of the perfor-
mance of each country along the various feasibility dimensions. A f
first cluster of
three countries can be identif
fied: the UK, France and the Netherlands.The place
of each country is affected differently by the identif
fied feasibility factors. For
instance, the high position of France is linked to the private benef
fits associated
with the investment in tertiary education and the funding needs to sustain its
development. In addition, the existence of a large private tertiary education
market associated with relatively high selectivity explains the position of France.
A second cluster includes Ireland and the Nordic countries, with the exception
of Denmark, and the Southern countries. Finally, the last cluster groups the coun-
tries of Mid-Western Europe: Belgium, Germany, Austria, and Luxembourg; and
Denmark. As already stated for the case of France, the main drivers behind the
position of each country differs substantially. For Italy, the great funding needs
to guarantee the long-term sustainability of the tertiary education system are a
dominant factor, followed by the level of the individual benef
fits of completing a
degree. At the same time, the low internal rate of returns to tertiary education
has a negative effect on the ranking of Italy.
To ref
fine the ranking of countries, an attempt has been made to classify the
countries with respect to the feasibility of implementing a public loan system and
a commercial credit-based system. In the f
first case, greater weight is given to the
funding and educational feasibility, while in the latter, individual and institutional
feasibility are considered as the most important dimensions. This mapping
exercise only provides an indication of the potential feasibility of student loans
mechanisms and is conditioned by the quality of the data. It cannot accurately
ref
flect the business opportunities of each country.
Olivier Debande 183

184
European
Journal
of
Education
©
Blackwell
Publishing
Ltd
2004
TABLE IV. Assessment of the practicability of student loans schemes in Europe
Individual feasibility Funding feasibility Institutional feasibility Educational feasibility
Wage Private Funding Fiscal Size of Level of Scope of Level of Selectivity Access for
differential rate of needs distress the private students loans tuition low-income
returns sector support system fees students
Austria M L L M L M L L M L
Belgium M L M H H L/M L L/M L L
Denmark L M L L L H M L M M
Finland H M L L L/M M M L M H
France H H H M M L L L/M M M
Germany L L H M L M M L M L/M
Greece M M M H L L L L H n.a.
Ireland M H M L L L L H M M
Italy M L H H L/M L/M L M M L/M
Luxembourg n.a. n.a. L L H n.a. L L L L
Netherlands M H L L H H M M M M
Portugal H M/H M M M L L L H L
Spain H M H M L/M L L L/M H L
Sweden M L/M L M L/M H H L H M
UK H H H L H H H M H L
H: High; M: Medium and L: Low.

The policy implications of the ranking of countries are affected by additional
factors:
䊉 The performance-based orientation of the tertiary education system. The
development of incentives in the funding of tertiary education institutions
related to the time needed to complete a degree is expected to reduce the
academic risk faced by students and hence offers a more appropriate envi-
ronment for the implementation of student loan schemes. This approach is
in operation in Denmark (taximeter model); partially in Sweden and in the
Netherlands; and implicitly in the UK (since a university can only claim from
students what is deemed to be the standard length of a course, the institu-
tion has the incentive to make sure students complete their course on time);
䊉 The extent of debt aversion. Students and their family could be averse to
borrowing for learning. In addition, social groups perceive borrowing very
differently. Debt aversion could be a great deterrent, especially for those
from low-income families. Mitigating factors could be required to minimise
the perceived financial risks of borrowing during the first year at university
(namely to reduce the academic risk) or through a modification in the
threshold triggering off the repayment of the loan;
䊉 The nature of the income tax system. Students who live in countries with
a progressive tax system would be reluctant to accept the switch from an
implicit to an explicit loan system. Indeed, a high marginal tax rate implies
that those who benefited from subsidies for their tertiary education studies
will repay part of them because they will earn higher incomes than if they
had not gone to university. Tax deduction of the student loans could par-
tially alleviate this problem;
䊉 The mobility of students and graduates. At the European level, student
mobility is asymmetric (OECD, 2000): the UK, Austria and Germany
Olivier Debande 185
TABLE V. Ranking of countries in terms of likelihood of developing a student
loan scheme
Ranking Without discriminating Public loan system Commercial credit-based
between public and credit- system
based criteria
1. UK UK UK
2. Netherlands France Netherlands
3. France Italy Sweden
4. Sweden Spain France
5. Italy Netherlands Finland
6. Spain Sweden Portugal
7. Finland Ireland Italy
8. Portugal Portugal Spain
9. Ireland Finland Belgium
10. Belgium Belgium Ireland
11. Germany Germany Denmark
12. Denmark Greece Germany
13. Greece Denmark Greece
14. Austria Austria Austria
15. Luxembourg Luxembourg Luxembourg

record a positive balance of foreign OECD new entrants in tertiary educa-
tion in the percentage of total enrolments, whilst Ireland, Denmark, Finland,
Sweden, Spain and Italy record a negative balance. Independently of the
issue of ensuring the repayment of a student loan when graduates return to
their host country to work, it also questions the potential redistributive con-
sequences of such trends in public-funded tertiary education. In addition,
student loan debt could be an additional emerging ‘push factor’ in the
growth of departure from a country, as seen in the case of New Zealand
(Report of the Education and Science Committee, 2001).
Moreover, the size of the market could also be a relevant factor related to the
administrative and institutional costs of implementing a loan system. For instance,
in Greece (although it does not seem a potential candidate according to its
ranking), public financial support is very low (estimated at around € 1.5 per month
on average per student) and only covers a small share of students’ expenditure
(not more than 2%).
Conclusion
In most European countries, the tertiary education system is funded through the
tax system with minimal or no tuition fees. Public funds are proving increasingly
insufficient to finance tertiary education, given the high social demand for addi-
tional education, the increase in the cost per student and the need to supply a
highly-skilled workforce to meet the challenge of the knowledge-based economy.
A direct consequence of the lack of funding is a lower quality and efficiency of
European tertiary education.To support the achievement of the objectives defined
at the time of the Lisbon Council, the European Commission stresses the need
for a substantial increase in the per capita investment in human resources. This
means a diversification of funding sources and the inflow of additional private
funding, reflecting the high private returns on university education observed in all
European countries. The pursuit of this objective includes the need to improve
the internal efficiency of tertiary education systems and to promote social equity
in access to university.
The student loan mechanism is based on the lending of either state/
public agency or commercial bank funds to students to cover the direct cost of
education and living expenses until completion of studies. This recognises the
fact that, while students cannot easily afford to pay more, graduates in principle
can. Normally, after a short grace period corresponding to the time required to
f
find a job, the graduate starts repaying the loan on a periodical basis over several
years.
Lessons learned from existing experiences suggest that an effective student
loan scheme must address the following dimensions:
1. Assessment of the demand and absorption capacity of the market: stu-
dents must be aware of and understand the nature of the existing finan-
cial product proposed (eligibility criteria, grace period, repayment
obligations, interest rate, etc) as well as endorse the responsibilities and
obligations linked to the loan.The student loans support scheme must be
promoted and managed by a reputable and credible institution. In addi-

tion, student loans must be attractive and account for cultural factors (atti-
tude towards borrowing and risk aversion).
2. Funding and long-term sustainability: sufficient financial resources must
be available to offer new loans and expand coverage.The amount of poten-
tial public subsidy must be in inverse proportion to the rate of returns to
individuals. The financial viability of any student loan scheme is affected
by the level of interest rate subsidy, the default rate and the administra-
tive costs. The default rate will be function of the income situation of
graduates, the effectiveness of the collection mechanism and the type of
repayment schedule applied.
3. Eligibility and targeting: Criteria for the selection of students who are
eligible for a student loan programme should integrate ‘financial need’
and ‘academic merit’. The social characteristics of the recipient, the
universal nature of the scheme . . . must be defined and monitored in
order to ensure an adequate representation of students. Commercial
banks could target a market segment of students who are able to pay and
ensure that the financial intermediary will obtain a sufficient return on
investment.
4. Terms and conditions of the loans:The critical terms and conditions of a
loan programme are the origin process (institutions providing and dis-
bursing the loan), the loan amounts and limits (definition of the minimum
expenses ensuring university participation), the nature of the guarantee
(e.g. parental co-signatory) and the interest rate (integrating or not public
interest rate subsidy).
5. Repayment schemes:The nature of the repayment scheme is linked to the
terms and conditions of the loans. The scheme needs to be designed in a
way which mimics the income profile or earnings capacity of the gradu-
ate (income-contingent approach) to partially alleviate debt aversion (if
there is no return, there is no repayment). The length of the repayment
period, the required percentage of income, the provision for deferment,
forbearance or forgiveness and the nature of the collection and servicing
mechanism must be considered.
6. Student debt: evidence shows that students from the most disadvantaged
backgrounds tend to accumulate the largest debts. The design of a finan-
cial support scheme for students must integrate the possible negative con-
sequence of a high level of debt both as an ex ante deterrent and distorting
factor (e.g. students intending to attend a shorter course or more local
institutions; or not participate in tertiary education due to a risk-aversion
for lower paid jobs) in the choice of tertiary education institutions by
students from less privileged socio-economic backgrounds and as affect-
ing the future consumption and saving behaviours once they have gradu-
ated.The level of debt aversion seems to be linked to the lack of awareness
of the benefits associated with investing in more education and with cul-
tural factors.
Student lending schemes alone cannot solve the funding problem faced by most
European tertiary education systems but they offer complementary approaches to
share the cost of education between the different stakeholders. The practicability
Olivier Debande 187

of such a system in Europe is affected by various feasibility dimensions, as seen
in the intense debate in the UK.
Acknowledgement
I would like to thank Constantin Christofidis (EIB),Tom Hackett (EIB), Eugenia
Kazamaki Ottersten (EIB) and Steve Wright (EIB) for helpful comments and
suggestions. I also benefited from the comments of Gianni De Fraja, José-Ginés
Mora and Vincent Vandenberghe. Errors of fact and opinion remain, of course,
my own.
REFERENCES
BARBARO, S. (2001) The Distributional Impact of Subsidies to Higher Education —
Empirical Evidence from Germany (Goettingen University, Department of
Economics).
BARR, N. (1993) Alternative funding resources for higher education, The Economic
Journal, 103, pp. 710–720.
BARR, N. (2000) A strategy for financing tertiary education, Submission to the
Education and Science Select Committee — Inquiry into Resourcing of
Tertiary Education.
BARR, N. (2000) A strategy for financing tertiary education, mimeo, Department
of Economics, LSE.
BARR, N. (2001) The Welfare State as Piggy Bank: Information, Risk, Uncertainty,
and the Role of the State (Oxford, Oxford University Press).
BARR, N. (2002) Funding higher education: policies for access and quality. House
of Commons Education and Skills Committee, London.
CALLENDER, C. & KEMP, M. (2000) Changing student finances: income, expenditure
and the take-up of student loans among full- and part-time higher education
students in 1998/9, Research Report n°RR213, Department for Education and
Employment.
CARNEIRO, P. & HECKMAN, J. (2002) The evidence on credit constraint in post-
secondary schooling, mimeo, University of Chicago.
CHAPMAN, B. (1997) Conceptual issues and the Australian experience with
income contingent charges for higher education, Economic Journal, 107/442
(May), pp. 738–751.
CHAPMAN, B. (2001) Australian higher education financing: issues for reform
(Centre for Economic Policy Research, DP n°434, Australian National
University).
CHAPMAN, B. & RYAN, C. (2002) Income-contingent Financing of Student Charges
for Higher education: assessing the Australian innovation (Centre for Economic
Policy Research, DP n°449, Australian National University).
CHOY, S. & MAW, C. (1994) Characteristics of Students who Borrow to Finance
their Education (United States Department of Education, NCES 95–
310).
CHOY, S. & CARROL, C. (1996) How Low Income Undergraduates Financed Post-
secondary Education 1992–93 (United States Department of Education).
CHOY, S. & GEIS, S. (1997) Early Labor Force Experiences and Debt Burden (United
States Department of Education, NCES 97-286).

CHOY, S. & CARROL, C. (2000) Debt Burden FourYears after College (United States
Department of Education, NCES 2000-188).
COLON, G. & CHEVALIER, A. (2002) Financial returns to undergraduates, Council
for Industry and Higher Education (CIHE), May 2002.
EUROSTAT (2002) NewCronos database, European Commission, Luxembourg.
EURYDICE (1999) Key topics in education — Financial support for students in higher
education in Europe — Trends and debates (vol 1) (Brussels, European Com-
mission). (http://www.eurydice.org/Documents/KeyTopics/en/FrameSet.htm)
GUILLE, M. (2002) Student loans: a solution for Europe?, European Journal for
Education, 37, pp. 417–431.
HOUSE OF REPRESENTATIVES (2001) Inquiry into student fees, loans, allowances and
the overall resourcing of tertiary education. Report of the Education and Science
Committee.
JACOBS, B. (2002) An investigation of education finance reform. CPB Discussion
paper, n°9, July 2002.
JACOBS, B. & VAN WIJNBERGEN, S. (2002) Optimal Financing of Education with
Imperfect Capital and Insurance Markets (University of Amsterdam) mimeo.
JOHNES, G. (1993) The Economics of Education (The MacMillan Press).
JOHNSTONE, B. (2001) Student Loans in International Perspective: Promises and
Failures, Myths and PartialTruths (Center for Comparative and Global Studies
in Education, State University of New York at Buffalo).
KING, T. & FRISHBERG, I. (2001) Big loans bigger problems: A report on the stocker
shock of student loans, State PIRG’s report.
KING, T. & BANNON, E. (2002) The burden of borrowing: a report on the rising rates
of student debt, State PIRG’s Higher Education Project.
MC PHERSON, M. & SCHAPIRO, M. O. (1991) Does student aid affect college
enrollment? New evidence on a persistent controversy, American Economic
Review, 81, pp. 309–318.
MC PHERSONC, M. & SCHAPIRO, M. O. (2000) op. cit. Financing lifelong learn-
ing, trends and patterns of participation and financing in US higher educa-
tion, Higher Education Management, 12, pp. 131–156.
MINISTRY OF EDUCATION, INLAND REVENUE, AND WORK AND INCOME NZ
(2001) Student Loan Scheme — Annual Report.
MORA, J.-G. & VIDAL, J. (2000) Adequate policies and unintended effects in
Spanish higher education, Tertiary Education and Management, 6, pp. 247–258.
OECD (2002) Education at a glance — OECD Indicators 2002 (Paris, OECD).
OOSTERBEEK, H. (1998) An economic analysis of student financial aid schemes,
European Journal of Education, 33, pp. 21–30.
PSACHAROPOULOS, G. (2002) The Social Cost of an Outdated Law:Article 16 of the
Greek Constitution. Paper presented at the 19th
Annual Conference of the
European Association of Law and Economics, 19-21/09/2002, Athens
(Greece))
REPORT OF THE EDUCATION AND SCIENCE COMMITTEE (2001) Inquiry into
student fees, loans and allowances and the overall resourcing of tertiary education,
House of Representatives, New Zealand.
SALMI, J. (1999) Student Loans in an International Perspective: the World Bank
experience. LCSHD Paper Series n°44 — World Bank.
SCHWARTZ, S. & FINNIE, R. (2002) Student loans in Canada: an analysis of bor-
rowing and repayment, Economics of Education Review, 21, pp. 497–512.
Olivier Debande 189

TEICHLER, U. & JAHR, V. (2001) Mobility during the course of study and after
graduation, European Journal of Education, 36, pp. 443–458.
VANDENBERGHE, V. (2001) Inégalité d’accès aux diplômes de l’enseignement.
Effet Matthieu, rendement ‘fiscal’ du diplôme, et migration asymétrique des
qualifiés (UCL, IRES-GIRSEF).

A Review Of Instruments For Student Loans In Tertiary Education

Recommended

Recommended

More Related Content

Similar to A Review Of Instruments For Student Loans In Tertiary Education

Similar to A Review Of Instruments For Student Loans In Tertiary Education (20)

More from Daniel Wachtel

More from Daniel Wachtel (20)

Recently uploaded

Recently uploaded (20)

A Review Of Instruments For Student Loans In Tertiary Education