Abstract
Chile’s higher education system stands out as being one of the most privatized and open to the market in the world. Recently, the Chilean Congress passed Law # 20.027 of 2005, which provides the legal framework for the creation of a student loan system guaranteed both by the State and by higher education institutions (HEIs), financed by the private capital market through the securitization of the loans. The system operated for the first time in 2006, where approximately 21,000 students were able to access financing of their higher education for the remainder of their careers. It is expected that as the system matures, more and better information will be available, which will benefit the students and the HEIs; and it is highly likely that the current number of financed students could grow significantly in the next few years. The purpose of this article is to describe the outstanding characteristics of this system, explain its conceptual basis and analyze the public policy choices available in its design.
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Notes
The education system in the United States developed early on with a market orientation, but in most other countries this tendency is recent.
The argument is as follows: the economic growth models postulate that production is a function of capital, labor and raw materials. Historically access to raw materials was critical (XIX century); having a large stock of capital allowed for greater investment, and technology tended to be a possession of the countries that developed it. Nowadays raw materials can be purchased in international markets, and are not the main source of creation of value. Furthermore, a country’s investment is not restricted by domestic savings, since there are international capital markets in which capital flows to the most profitable opportunities, and almost instant information flows make technological progress spread to countries much quicker. Therefore, the combination of technological progress and international competition give education greater importance in respect to economic growth than ever before.
This indicator is the gross rate of higher education, defined as total registration for higher education over the population of the age group which in each country is assumed to be typical for higher education. It is gross (and not net) in the sense that it considers total registration of students, regardless of their age.
The fundamental conceptual framework for this analysis was developed by Economy Nobel Prize winner, Gary Becker, see for example his book “Human Capital”, 2nd edn. New York: Columbia University Press, 1975.
There is a technical point regarding the conditions for competitive equilibrium of signals. For the resulting market equilibrium to be dynamically stable that the most productive employees have a lower marginal signaling costis only a necessary but not a sufficient condition; a sufficient condition is that the marginal cost of signaling decrease fast enough as quality or ability increases.
It is possible that some of these external issues could be greater in primary school and high school than in higher education, for example, greater social cohesion. However, others are potentially strong in higher education, for example higher taxes and increasing the productivity of others. See Barr (2000) for a broader discussion of possible external effects of education.
There are certain exceptions to this difference. For example, soccer teams can sell player passes, thus recovering the investment made. And in the case of higher education financing, companies and universities finance or contribute to financing postgraduate studies with costly exit clauses. But these two mechanisms for safeguarding the human capital investment made by an institution or company are rather exceptional, and frequently not as strong as in the mortgage case.
This probability is greater than 50% in several careers in the Chilean higher education system.
In effect, the fact itself that there is no active market to finance higher education, also makes availability of information referring to education returns very poor or non-existent.
The problem of adverse selection is mitigated when loans are assigned to those with the most “need”, in such a manner that taking these loans or not is a completely free decision (unlike buying health insurance, for example); and the potential problem of moral risk is limited by the requisite of academic performance to maintain the loan in the future.
In the past university was provided by the State at no cost, as currently in Argentina and in certain European countries.
The last figure available is for year 2000; see Alan Heston, Robert Summers and Bettina Aten, Penn World Table Version 6.1, Center for International Comparisons at the University of Pennsylvania (CICUP), October 2002.
Registration rates in public institutions as a proportion of the Chilean per capita GDP appear as the third highest in a sample of 16 countries analyzed by Brunner et al. (2005), only after China and Korea, higher than the per capita GDP of public education in the USA, Japan, Great Britain, Holland, Austria and France, among others.
This is a joint publication by Universidad Adolfo Ibáñez edited by Meller and Brunner (2004) and Universidad de Chile (2004).
“Public” universities also include private universities, such as the Catholic ones and other subsidized private universities such as the Universidad de Concepción, among others.
Regretfully, the Ministry of Education does not have a control process for non-payment. The only statistics it keeps relates to global recovery or loss including income contingency (non-payment because the installment exceeds 5% of income) and remission of principal and interest because the term extends for over 15 years. Each university manages the loan fund for their students, and recovery varies greatly from one university to another, due both to differences in the quality of their graduates and to differences in collections management across institution. Larrañaga (2002) estimates the recovery rate at between 12 and 55% depending on the university.
See Fuentes et al. (2006).
The gap in college participation between rich and poor students is not only due to financial barriers (credit constraints), but also due to differences in academic preparation and social factors. But this program will help reduce the gap in the cases of talented poor students; and it will be more effective generally in conjunction with public policies directed to improve the quality of elementary and high school education of students in need.
This student loan system can be complemented with scholarships based on merit.
Rationalization of public expenses is a worldwide tendency. In Chile it began in the 1980s, due to the fiscal crisis and multiple social needs; but since the mid 1990s, UNESCO projected that in the future not even governments in developed countries would be able to finance quality massive higher education by themselves.
In the case of first year students, the Commission determines who receives the student loan benefit, and the HEI decides if it accepts or not (committing its guarantee).
The role of the Commission as a lender of bad loans is a useful device, as it focuses the public funds in those students which would otherwise be discriminated against by the private sector because of gender (females), prestige of the HEI, etc.
The Small Companies Guarantee Fund (FOGAPE) (“Fondo de Garantía de Pequeñas Empresas”) operates in a similar way in Chile. That is, the guarantees are tendered and each awarded entity decides which company to lend to, within the size restrictions defined by the fund administrator.
For example, the desertion rate of careers such as Civil Engineering at Universidad de Chile (43%) are extremely high, as opposed to careers such as Elementary School Teacher in the same university (Dominichetti 2005).
Academic desertion rates of first year students tend to be higher.
Females may marry and stay at home; and those that work earn lower salaries on average.
Another alternative is to complement the loans with a system of scholarships to cover a reasonable level of housing, food and clothing needs. But if the number of students in need is sufficiently large, it is possible that it may not be able to be free, therefore the amounts of the loans could be increased. In addition, considerations of social justice (students are poor, not graduates), suggest loans and not scholarships; if the loans are contingent on income, they become scholarships for those that expost cannot pay them.
This average figure does not prevent the fact that in certain careers and/or at certain stages of the professional cycle, the financial load could be higher than that amount.
This figure coincides with the proposal for new education policies of Brunner et al. (2005, Op. Cit.).
Specifically, the Chilean model includes a 0.5% annual reduction in the interest rate for students that pay more than 70% of the interest in the study period and annually pay at least 10% of the corresponding interest. That is, at the moment of beginning to pay the principal, the installment is calculated using a rate of 0.5% (50 base points) less than the stated rate. Banks that administrate CORFO loans require obligatory payment of interest.
This characteristic was part of the original design, but did not have the support of the Treasury Department (“Ministerio de Hacienda”) for implementation at this phase.
On the other hand, a tendency to opportunistic conduct of unwillingness to repay could encourage too much indebtedness; but this incentive should be eliminated with efficient collections, such as the proposal in the model that entrusts this responsibility to the banking system.
As Barr argues in several articles, in a student loan system with adequate coverage (includes cost of living), (1) education is free when studying, and (2) those that pay the loans are not students, but graduates. There is no reason to subsidize those that being among the most gifted of society, will probably obtain the highest income.
To the extent that certain minimum academic standards are met and their socioeconomic situation does not undergo significant variations.
In the Chilean case, the base rate is Benchmark UF 10 (set daily by the Santiago Stock Exchange), plus a spread of 250 base points. This represented in the order of 6% real annual the first year the model was applied.
There are similar loans in the mortgage market, although the base rate is not a long-term rate as the one proposed, but generally the TAB rate at a 1-year term. But there is experience and know-how to valuate these interest rate options (cap).
Consumption synergies or scope economies occur when from the point of view of the consumer, the well being obtained from separately consuming financial services is less than that generated by the acquisition of a financial services package.
For example, experience shows that the regulation that imposes a limit on the interest rate (maximum conventional rate) is often obviated through granting additional products to the client, such as a sight account where fees are charged in which the loan is deposited, therefore the client ends up paying a much higher effective rate.
This describes the current tender mechanism (2007), in the first year (2006) there was a slight difference, in that the quantity was fixed, and financial institutions only competed thru price.
If a financial institution sells back the loans to the Commission at par, the adjusted price is cero; if it sells them above par the adjusted price is positive; and if it sells them below par (at a discount) the adjusted price is negative.
For example, the Small Entrepreneur Guarantee Fund has been assigned with guarantee levels below 70%.
This guarantee is lower than that granted by the US Federal Government for student loans (which began with a 100% guarantee and today has a 98% guarantee).
Corporación de Fomento de la Producción, a state entity.
The interest rate is similar for loans with mortgage guarantees, which have been operating for a long time in the Chilean market, where the guarantee at inception is 1.25 times the amount of the loan and grows with time.
This definition was made in the regulation of the system.
Technically, the value of the main bond will depend on the quality of the portfolio that supports it. The greater the risk of that portfolio, the further away the value of the main bond will be from the total value of the loans and the higher will be the value of the residual or “junior” bond.
Remember that first-year students are guaranteed entirely by the HEIs.
This system has one important difference with respect to the Australian model (for a description see Chapman, 1997), and that is that in the Australian model the state provides the financing whereas in the Chilean model the government provides guarantees. For cultural reasons, in Chile it seems more difficult to enforce the repayment of the loans if they are financed by the government, as the experience with the previous system shows; also if the government provides guarantees can multiply the effects of the public resources; the same amount of public money allows to finance more loans in the Chilean system. Another difference is that in Australia the real interest rate is zero (implying an exante subsidy), while in Chile is a positive, market rate (so that the eventual subsidy is better focalized to the expost needy). On the other hand, a desirable characteristic of the Australian model that we suggest implementing in the Chilean model is to have monthly repayments proportional to income.
In general terms, it also repurchases part of the portfolios from financial institutions, but if it securitizes them it recovers the initial cash outlay.
This leads us to a discussion of which is the long-term interest rate of the Chilean economy, which is outside the scope of this project. From an operative point of view, however, the law establishes that it is the Board of the Managing Commission that must set the rate; for this it could engage three independent studies from different consultants.
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C. Larraín is a partner of CL Group, and Salvador Zurita is a Professor of Finance at Universidad Adolfo Ibáñez. Larraín, in his role as consultant, led the design and implementation of the new model for student loans for higher education in Chile as of 2006. Zurita served as advisor to the Ministry of Education at different times during the designing of the same model. The authors thank José Joaquín Brunner and Harald Beyer for their valuable comments.
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Larraín, C., Zurita, S. The new student loan system in Chile’s higher education. High Educ 55, 683–702 (2008). https://doi.org/10.1007/s10734-007-9083-3
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DOI: https://doi.org/10.1007/s10734-007-9083-3