6 - The case for human capital contracts

Summary

If traditional solutions adequately addressed the market failures in financing education, there would be no case for human capital contracts (HCCs). However, because traditional solutions have not produced the desired results, a better alternative is needed. The discussion that follows addresses characteristics of HCCs that make them an attractive alternative for meeting the growing need for higher-education funding from private sources. The discussion is divided in two sections. The first addresses the advantages that income-contingent repayment schemes (ICRS) have over traditional mortgage-type contracts. HCCs, income-contingent loans (ICLs), and graduate taxes are ICRS, since the payments that students make are related to their income. The second section addresses the advantages HCCs offer that other ICRS do not.

The case for income-contingent repayment schemes

There are two main advantages of ICRS that make them superior to traditional mortgage-type loans. First, students reduce the risk they take when they invest in additional education; second, ICRS target educational subsidies, or payments below actual cost, to only those individuals who need them over a long period of time after graduation. These two advantages are described in more detail below.

Reduced income risk for students

As discussed in chapter 2, even though the average returns on education are high, the individual variance in the returns is also high. Ability and labor opportunities differ for each student. Moreover, there is the general threat of unemployment and incapacity.