Milton Friedman and the Finance of Higher Education

Abstract

Friedman and Kuznets (1945) posed the puzzle that the return to investment in human capital was higher than to physical capital. They hypothesised a distortion causing under-investment in human capital and made brief mention of the idea that individuals might sell 'shares' in their future income to finance their investment in human capital. Friedman (1955) explored the idea in more detail, setting out the first worked out proposal for income-contingent repayments. After discussion of today's context, successive sections of this chapter discuss the nature of Friedman's idea, assess its impact on policy, and set out a view to the future, including future design options and potential theoretical work.Keywords: equity finance, loan finance, higher education finance, student loans, incomecontingent repayments, interest subsidies, debt aversion, credit constraints, prior-attainment constraint, imperfect information Milton Friedman's writing about education is best known for his writing about vouchers for school education. Less well-known but, I will argue, more important is his work setting out the logic of student loans with income-contingent repayments, i.e. repayments in the form of x% of the borrower's subsequent earnings rather than a fixed amount of $X per month. This chapter explains how that mechanism, though peripheral when first proposed in 1945 and more fully in 1955, has a central role in the finance of tertiary education, an astonishing impact from what (as far as I can tell) are Friedman's only pieces of writing about education. Today's contextIt is sometimes useful to think of human capital as of two sorts. 'Basic' human capital includes the ability to walk, talk, co-operate and do manual work. Most people have this type of human capital though some, for example with physical disabilities, may lack some of them. A second type of human capital derives from more explicit investment in skills, from literacy and numeracy through to advanced skills.HUMAN CAPITAL: MORE IMPORTANT THAN EVER. The starting point is the argument that the second type of human capital has become increasingly important over the years. There are at least two strategic sets of reasons -technological advance and demographic change -why this is so.Technological advance is a key driver. Though it can reduce the need for skills (more user-friendly computers), technological advance has increased the demand for skilled workers. The evidence (e.g. Autor et al., 2003) points to skill-biased technical change (i.e. new technologies that favour more skilled workers) being an important part of the explanation.Second, change is increasingly rapid, so that knowledge goes out of date more quickly. Thus skills need to be updated and to be flexible enough to adapt to changing technology. Put another way, investment in broad, flexible skills offers a hedge against technological dynamism. Specific skills may become redundant, but education and training should give people general skills, saving the resources that would otherwise be necessary for...