The New York Times
By: David Bornstein
June 2, 2011
Fixes looks at solutions to social problems and why they work.
If you were a student looking for financing to pursue a degree in social science, would you accept an offer of $16,000, in exchange for paying 4.5 percent of your income for 10 years after you graduate?
In Tuesday's column, I wrote about a social enterprise called Lumni, which helps predominately low-income students in Colombia, Mexico, Chile and the United States finance their college educations through "human capital contracts." In exchange for the financing they receive, the students commit to repayment schemes along the lines of the one outlined above (the terms vary). After the time period elapses -- it's always 10 years or less -- the obligation expires, no matter how much has been repaid. Some readers thought this could be an attractive alternative to student loans, but many others had strong negative reactions. I'd like to address their concerns.
Students who take on traditional loans can get locked into high payments that limit their career options.
As I mentioned, human capital contracts are not a new idea. The Nobel-prize winning economist Milton Friedman proposed them in the 1950s. Decades ago, Yale University experimented with a program through which students could postpone tuition and repay it later as a fraction of their income. The idea was abandoned after the introduction of federally subsidized loans. Australia allows students to pay for college through a special tax after they graduate, which operates in a similar fashion. And in 2009, the U.S. government introduced income-based repayment for federal loans, which are available to students whose debt is high relative to their income. What's common to these programs is that they all try to lessen the financial burden of a college education by shifting from fixed loan obligations to payments that fluctuate based on income.
Ironically, it is this very feature -- income-contingent repayment -- that elicited the greatest outcry from readers. "This whole concept gives me the creeps," wrote Bignybugs from New York (24). "[It] sounds like indentured servitude. This is just gross: letting capitalists invest in human beings!" RandFan from Memphis (40) added: "Is owning 14 percent of a man's labor less morally reprehensible than owning 100 percent, or the 85 to 90 percent that was probably more indicative of U.S. slavery outside the deep South."
It's not clear to me why someone who agrees to sell a portion of his future earnings for a given period of time is being enslaved. The essence of servitude is a loss of freedom. What happens today for many college students who take on student debt is that they get locked into high payments that limit their career options. I've met many students who say they would love to spend a number of years after they graduate working for a social-purpose organization, or serving in a program like Teach For America, or trying to start a business -- but many of them end up going the corporate route because of their loans. That sounds more like servitude to me.
With human capital contracts, students would have wider options. They would know that, regardless of their career choices, their payments would not be unmanageable. For example, doctors who financed their education this way could feel more comfortable going into lower-paying, urgently needed specialties like geriatrics or serving in low-income communities, where they might earn less; young professionals in many fields could trade off some income for the chance to do work that is more meaningful and potentially more fulfilling.
The other big objection from readers was that higher education shouldn't be financed through market-based mechanisms; it should be financed by governments. "Why does everything have to be market based?" wrote Phil Perspective of Redwood City, Calif.. (3) "Why should some rich person further enrich himself at my expense so I can go to college? Why not have free college (I know it's not really free, but it would be part of the taxes you pay)?" Swaroop from San Jose, Calif. (10), agreed that a better way to address the problem of college financing was through "progressive taxation and government subsidized college education."
For what it's worth, I agree, too. In my view, education (and health care) should be treated as public goods and financed accordingly. (I grew up in Montreal and my college tuition at McGill University was $1,500 a year. Cheers for Canada!) But this column is about solutions. And that means operating within the boundaries of possibility, or at least foreseeable possibility. It's hard to imagine that citizens around the world will muster the political might to get governments to raise taxes so that college becomes freely accessible to all. This approach is losing ground even in Europe. In many developing countries, governments can't even collect taxes and are woefully corrupt. In the U.S., with the current budget deficit, we're struggling just to keep our children's libraries from closing.
Human capital contracts can be used to fund socially valuable careers, but not impoverished ones.
Different countries will continue to advance different models to finance higher education. The point is that human capital contracts can increase options for a large number of students -- though not all -- by tapping into new private funding sources. They are not a solution to the whole problem of education financing; they are a piece of the puzzle.
Would such contracts, if they became more common, push students into more marketable careers at the expense of other pursuits? NMorgan from Knoxville, Tenn.(30), noted: "While poets, philosophers [or] teachers are a poor financial investment, it is hard to argue that such careers do not provide society with anything of value." Ed from Philly (33), added: "The problem with this concept is that it tends to attract money for the most profitable outcomes."
This gets to the advantages and disadvantages of human capital contracts. They work best to finance education where there is some predictability about students' future salaries. The salaries don't have to be high, just reasonably predictable. Lumni finances lots of teachers, nurses and social workers. Each contract is valued based on expectations of earnings. What Lumni won't do is issue a contract if they believe a student is pursuing a career path that is unlikely to lead to employment -- or if they believe students need too much financial assistance relative to the value Lumni assigns to a particular academic program. They make these judgments based on numerous factors: the school's graduation rates, the success of graduates in finding work in their fields, and the economic potential in those fields.
Human capital contracts can be used to fund many socially valuable pursuits, but they are not suitable to fund careers that are difficult to justify on economic terms. For example, a student who wants to study international development and then spend five years working in an African village, would need to find other sources of financing. There will always remain certain kinds of work that society has to fund as public goods, which is to say through taxation, financial aid, subsidized loans, free college education, all the various models that already exist. But human capital contracts can help: if they open up a more robust private financing channel for courses of education that are likely to provide economic returns for students, it would free up public resources for things that truly depend on public support -- things that society systematically undervalues, like the arts and social entrepreneurship.
In many cases, Lumni already works with nonprofit funders to do things like this. In Chile, for example, it finances students who want to become school teachers in rural areas. "A rural teacher is going to earn a salary that the return for us will be very low or negative," explains Felipe Vergara, Lumni's co-founder. "However, the return for society is huge. So we need to find a way to finance this."
Economists have argued that human capital contracts would fall prey to the problem of "information asymmetry." The contracts are priced based on projections of a student's future earnings -- drawing in part on information that students provide themselves. For obvious reasons, students who say they want to go into banking will be asked to pay a lower percentage of future income than students who say they want to go into teaching. But what is to stop a student who secretly wants to become a teacher from pretending that he wants to become a banker?
Well, it turns out that 18-year-old students don't have very clear ideas about their future paths, so things average out. "We probably have better information about the expected earnings of the students than they do," says Miguel Palacios, Lumni's other founder. "Because we have the law of large numbers." They also have databases that carefully track college programs and salary rates. They have become skilled at interviewing students, identifying factors like resilience, commitment and the ability to set and follow through on long term goals. They also provide coaching -- how to give a good job interview, how to wear a tie and so forth. All of this helps them make better predictions.
What happens when students are very successful? "Some say, 'Wow, this is awesome, I owe it to you guys, I'll pay happily, in fact I'm going to become an investor,'" says Palacios. "In other cases, they say, 'This is much more than I planned to pay. This is unfair. Let's renegotiate.' " So, Lumni is experimenting with solutions, such as offering buyout options for the contracts.
The bottom line is this: Human capital contracts are not just loans by another name. One of their key advantages is that they provide students with a form of career insurance. Student who opt for them will discover that their cost of financing is lowest when they need money most, and it will be highest when they need it least. They give up a portion of their success at the upper end for peace of mind when times get tough.
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