England’s universities need to be free to set domestic fees and offer loans

The finances of England’s higher education sector are being squeezed between the rock of government fiscal constraints and the hard place of politically awkward levels of immigration.

Having frozen tuition fees at £9,250 from 2017 until at least 2025, the government is now suggesting that the sector’s financial escape route – more foreign students – might be cut off. Despite Jeremy Hunt’s recognition, in his first speech as chancellor, that higher education is one of the UK’s world-class industries, the government does not appear to have the ability or inclination to provide it with the financial support it justifies.

In a recent paper for the Institute of Economic Affairs that I co-wrote with Tom McKenzie, “Setting universities free”, we set out a policy that squares the circle: significantly increasing the level of resources flowing to universities while reducing the burden on the taxpayer and maintaining access. Universities would be free to set the level of home undergraduate tuition fees independent, and in excess, of the value of state loans. But to ensure access and affordability, institutions would be obliged to offer income-contingent loans to fund any difference between the tuition fee and the state loan.

Although students would see tuition fees increase in nominal terms, there is little evidence that much higher real levels of fees in recent years have discouraged anybody from studying. A 20 per cent increase in fees in 2023/24 would only take the real level back to its 2012 equivalent, while generating about as much income as replacing 20 per cent of home students with international students would do.

This sharing of risk between student and university aligns interests and eliminates the moral hazard that occurs in the present set-up, where all the incentives for universities relate to recruitment. It would be expected to lead to universities putting much more emphasis on helping their students to secure gainful and rewarding employment. Hence, earnings outcomes – the real test of the appropriate level of tuition fees – would be likely to improve.

Evidence from the US, where such risk-sharing arrangements have been growing in popularity, suggests that there will be no impact on the range of courses on offer if universities have an incentive based on employment outcomes. Course provision would be driven by student demand, and CBI surveys consistently report that degree subject is of much less concern to companies than soft skills – tacit knowledge that cannot be perfected by telling and understanding so much as by practising.

Increasing the focus on tacit knowledge may bump up against course content regulation, whose reliance on written codification orients programmes towards teaching explicit knowledge. However, in an environment where universities are sharing in the earnings outcomes risk, there is a case for abolishing all course content regulation. It is unnecessary – as the provider has an economic incentive to deliver value – and it is unfortunate as it adds cost, constrains innovation and inhibits the teaching of essential soft skills. Liberating universities from course content regulation would be transformative, permitting academics to use their own judgements about what and how to teach.

Instituting this policy would enable English universities to add a new revenue stream while still being able to rely on the state subsidy built into the £9,250 student loan – so long as a proportion of their graduates earn enough to make some repayments. Although graduate repayments would not flow for a few years, it would be possible to borrow against the expected revenue.

Longer term, it may be desirable for the state loan level to remain at £9,250, so that inflation erodes it gradually to irrelevance. Institutions would learn over time how to increase the revenue from graduates while still being supported by a slowly declining state subsidy. Ultimately, it may be easier to achieve desired outcomes by abolishing the state loan altogether and providing direct grant support only where there is evidence of market failure – a course that government considers valuable, which is popular with students but where provision is minimal.

As the proportion of taxpayer subsidy of tuition fees declines, the government should also cease its objection to supposedly “low return” courses. Such low returns are typically measured by reference to the cost incurred by government – the level of the student loan. But a course might generate adequate earnings returns relative to the marginal cost of running it, even if it does not contribute to institutional overheads. More direct funding from students, with a reduced role for the state, will allow an institution to make more holistic judgements about its range of course provision without politicians looking over its shoulder.

It has been suggested that an alternative way to boost university funding would be to charge employers a levy for every graduate they employ. Yet that would price home graduates out of many jobs. It would also be grossly unfair on companies if the employee did not stay with them for long, and it would encourage a brain drain as any such levy could not be enforced against foreign companies.

Absent an improvement in the government’s fiscal position or more international recruitment, the only possible source of the extra income the universities need to thrive is the home student. Instituting loans directly between student and university aligns their interests for the long term. And the lower burden on the taxpayer should encourage the government to give universities back their freedom to set their own course.

Peter Ainsworth is managing director of Consulting AM.