Bring up the subject of college financing and most people think about government loans and grants. But the market has a good alternative that is beginning to show up around the world.
Students face a growing challenge: where will they find money to cover college costs and, once they do, how can they be sure that they can pay back their loans?
Here is an idea: let someone else pay for a student’s higher education now, while requiring the student to pay back a percentage of future income for a set period of time after college. The amount you pay reflects the amount you earn.
Human capital contracts (HCCs) do just that. Like all contracts, HCCs are based on the mutual expectation of gain. They are attractive to those who provide the funding because they’ll receive a return on their investment. They are attractive to students because they will get the education they want, with payments adjusted to changes in their income.
HCCs would also provide a signal of the value of higher education. Investors would want to make sure that the students they invest in are serious about their education and attend institutions that offer good value for money. The investors’ choices would also make the market’s needs for particular sets of skills more transparent.
And let’s not forget another, much larger group that should like HCCs—taxpayers. HCCs don’t involve government in the business of paying for college. Today, taxpayers are subsidizing students who are likely to be in the highest income brackets a few years after graduation.
HCCs were first proposed more than 50 years ago. Part of the logic behind them—that payments should be income-contingent—has been slowly becoming public policy throughout the world. For example, Australia’s Higher Education Contribution Scheme (HECS) has followed that logic since 1989. A new Cost Reduction and Access Act (H.R. 2669), which caps payments at 15% of the graduate’s income, follows this logic as well.
Since the early 1990s, private entrepreneurs have been tinkering with the idea, too. The initial attempts in the United States didn’t take off, however. One company, Human Capital Resources, abandoned the idea due to what it considered an unworkable legal environment. The other, MyRichUncle, reverted to traditional student loans.
Even so, two companies have been accumulating experience with HCCs outside the United States. Their results, though still on a small scale, are encouraging.
CareerConcept has been raising capital in Germany since 2002 and has financed thousands of students—in a country where tuition at public institutions is free. Demand comes from students who attend private schools or who need to cover their living expenses. Under a typical CareerConcept contract, students receive funding in exchange for 5 per cent of their income for the next 10 years. Payments are capped so that the actual cost never exceeds a maximum, which varies depending on the contract.
Lumni, an American company, designs HCCs and has financed students since 2002 in four different countries. It first funded students in Chile and now also operates in Mexico, Colombia, and the United States. Because the markets in these countries are less developed, Lumni’s repayment periods have been shorter than those offered by CareerConcept, with a typical contract having a 5-year repayment period. Lumni has funded more than 100 students and recently raised capital to fund many more.
Yet these companies face significant challenges. As companies innovating with financial contracts, they operate in highly regulated environments—environments that will likely get even more regulated after the 2008 financial crisis.
The United States poses a particularly difficult regulatory environment. The different laws and regulations that apply in every state make working in the U.S. more like operating in 50 different countries. Additional problems arise from the complicated interactions between state laws and the general federal framework.
For example, some states prohibit individuals from assigning their wages to someone else. While it’s possible to define a human capital contract as a claim whose value depends on future income without actually assigning wages, a judge might interpret the contract as an assignment of wages. That generates uncertainty as to the enforceability of the contract. Prospective lenders naturally shy away from uncertainty.
Companies offering HCCs confront another issue: students seem to perceive them as fair when their income is low, but unfair when their income is high. This is easy to understand, analogous to loathing the idea of paying insurance premiums when one never has a claim to file. If HCCs are perceived as unfair, they risk triggering an opinion backlash or further regulatory intervention. Thus, companies offering HCCs may need to change students’ perceptions or modify their product. One approach might be to cap the total value of payments as CareerConcept does.
Innovation is the source of all prosperity. HCCs are an innovation that could add large value by unloading risk from those who build their human capital. However, dealing with regulatory frameworks remains a challenge. Will policymakers facilitate the HCC innovation? For the sake of students and taxpayers, they should.