Lets talk about uni-ver-si-ties. Lets talk about all the good things there can be (with apologies to Salt-n-Pepa). Risk is not as exciting as sex, but it is at the core of dramatically improving higher education around the world.
Let me start with some fascinating news out of Oregon this week. The state government has approved a little known education financing mechanism that is often viscerally rejected as modern indentured servitude: the human capital contract. In this model, students repay the financing of their education not through the current standard of principal plus interest (i.e., debt), but rather through a fixed proportion of their earnings (i.e., effectively equity). The approach has been around for decades (centuries, in fact; they were originally mooted by Adam Smith in the Wealth of Nations), but has never caught on due to the operational challenges (tracking income for the often long repayment periods) and ethical concerns (try raising the idea with ten people and see how many respond immediately with revulsion). New outfits like Lumni and Pave are trying to build markets for the instrument, as highlighted in this recent Economist article, but they have a long way to go to prove their viability and reach meaningful scale.
The Oregon adoption is a surprising – even shocking – and welcome legitimization and path to scale for the model. At a time when young people across the country, and increasingly the world, are being ground down by massive student debt, this approach offers some hope. It reduces the downside risk for students (if you aren’t earning, you don’t owe anything), while remaining a viable business model for those with capital. As a result, it could reduce the number of young people whose potential is suffocated by Sisyphean or through the necessity to spend years in soul-crushing corporate jobs to shed the burden. To be sure, Oregon is an experiment and there are many pitfalls in its path in the years ahead. But an experiment in an entire state system is nothing to shrug at and this is yet another clear sign that people are finally starting to wake up to the unsustainable trajectory of higher education and pursuing radical new solutions.
Yet even this appealing financing method is just a band-aid that will do little to staunch the flow of blood from the gaping wound that is the current higher education system. Young people are currently being crushed by student debt because they are not being adequately supported to learn relevant 21st century skills, complete their degrees, and secure attractive jobs. High drop out and unemployment rates will similarly undermine wide use of human capital contracts: investors rather than students will feel the pain and be unwilling to extend financing beyond the most talented students, who need the support least. To truly change the outcomes of higher education and the prospects of young people, we need bold solutions to the core affliction of the system: the lack of performance incentives for universities and colleges.
Financing is fundamentally about risk. In current education loan schemes (particularly the til-death-do-us-part system in the US), the student bears the bulk of the risk. In human capital contracts, some of that risk shifts to investors (student risk is now overpayment if they strike it rich). In both approaches, the institution that is actually responsible for delivering the product that is being financed, the university, holds no risk. The university gets paid regardless of whether the student completes their degree and secures a job. They may face indirect consequences (e.g., lower enrollment) if many of their graduates end up unemployed. But this is generally a faint risk since the quality of universities is currently judged by measures such as the sport facilities or research produced rather than student outcomes. As such, institutions’ current incentives are to focus on superficial trappings (many US universities spend millions of dollars every year on lawn care) and high-profile research rather than students’ employability (as we have written before, most consider career services to not be their core business).
The natural solution would be for universities to start bearing some of the risk. In this model, they would put up some of the money alongside the student or investor. If the student does well, they, like the investor, would stand to make more than they put in, which they could use to further improve their quality and therefore student outcomes. If the student drops out or ends up unemployed, they also lose. Those incentives could be linked to the individuals running the institutions – if many students are unemployed and the institution is losing money, managers are docked pay or sacked. Ensuring that incentives are not skewed in the other direction (e.g., pushing students into safe but unappealing jobs) will require some finesse. But many institutions and sectors around the world have been effectively using performance-based payments for years (this is simply a cash on delivery approach to higher education) and higher education does not transcend the quantification of results.
It may seem strange for someone who is in the process of launching a new university to argue that higher education institutions should assume more risk. But this is a challenge that we at Kepler would welcome. Carrying more risk will enable us to reach more and poorer students (by effectively lowering prices). And it will increase the pressure on us to achieve our goals of significantly increasing learning outcomes and employment rates. Institutions that have the confidence in their approach to take some more risk can offer the best value proposition to both students and loan providers and could therefore thrive in the rapidly evolving higher education landscape. We still have many details to work out about our student financing approach, but we will surely look closely at this potential to literally put our money where are mouths are. As always, watch this space.