Why might higher tuition fees be a good thing?

2012 was the year that tuition fees increased from £3,000 to £9,000 per year. Although this was somewhat of a blow, it did not stop thousands of students, myself included, from attending courses of further education. What is perhaps more disheartening is the recent news that Labour plan to reduce University fees down from £9,000 to £6,000 per year:

http://www.theguardian.com/education/2014/mar/30/labour-cut-student-tuition-fees-6000-a-year

If such a figure was introduced, then there would only be a select few students of our generation bearing the burden of £9,000 fees. The questions surrounding fees have been plentiful over the past few years and this post looks at one theory behind the price of education and why higher tuition fees may not be such a bad thing after all.

Why go to University?

Although some people go to Uni simply for the social experience, the majority choose University after A-Level’s because they want to get a ‘good job’. This can be associated with a term in labour markets called signalling, which we will come to later.

The Lemons Problem

Firstly, imagine a simple labour market where there are just two types of workers:

Low ability workers (Ls) and High Ability workers (Hs)

With marginal products aL and aH respectively. (*i.e. how productive they each are)

Low ability workers have a wage equal to aL and high ability workers have a wage equal to aH:

WH = aH and WL = aL

Understandably, the wages of high ability workers exceeds the wages of low ability workers:

WH > WL

Now, before a firm hires someone, they cannot identify whether a person is a low ability worker or a high ability worker due to hidden information. They may be able to distinguish whether their employee is an Ls or an Hs after hiring, but due to employment law and redundancy payments, they cannot simply get rid of the Ls.

This means that firms will only supply an average wage because they can only expect an average marginal productivity. This is a classic example of the lemons problem. Some high ability workers may be unwilling to accept the average wage as it is lower than the wage they should be receiving. The labour market becomes dominated by low ability workers who are more than happy to receive a wage that is greater than what they should be getting.

Obviously this is a very simple example of a labour market, but it still outlines the importance of education. It shows how it is in the interest of high ability workers to find a credible signal they can send to employers about their abilities. More importantly it must be a signal that low ability workers are unwilling to take.

Higher Education as a Signal

Now, let us suppose that the cost of education is different for the two types of workers. For a low ability worker, the cost of University education may be greater as, not only are there monetary costs, but they may have to study longer and harder than higher ability students meaning greater disutility and less time for earning supplementary income or socialising.
So cH < cL

This is not to be confused with the monetary differences between courses. Understandably, going into an apprenticeship after A-Levels will be cheaper than University education, this algebraic equation simply means that the cost of going to Uni will be higher for lower skilled people than higher skilled people. This means that people of higher ability are more inclined to undertake further education as a signal to employers whilst lower ability people are unlikely to attempt further education to give a signal that they may be of a higher ability.

This satisfies the following equilibrium and creates an efficient labour market:
(where e* is higher education)

(aH-aL)/cL < e* < (aH-aL)/cH

put simply, worthwhile for high ability workers attaining e* to gain the extra wages, but no incentive for low ability workers if costs of education are more than the gain in wages.

This separating equilibrium developed by Michael Spence in 1973, although quite obvious, outlines why it is important for higher education to be expensive so it can act as a signal for employers. It must be noted that this is a very simple model:

  • It assumes productivity is not affected by education.
  • Education acts solely as a signal and not as training
  • Assumes attending University is a disutility because of the costs

However, it still explains why it is important for the labour market, that the cost of further education is still high. Although £9,000 is expensive, it does not come anywhere near to the fees in the US. Using further education as a signal for employers to help create an efficient labour market means that it does have to be costly if it is to be effective. The Government needs to get the right balance between encouraging high ability workers to attend University and encouraging low ability workers to avoid further education which could prove even more costly for them. This model assumes that higher tuition fees can benefit the labour market and economy as a whole; leaving higher ability and lower ability workers in the best position they can be in.

2014 UK Budget Outline

Will be blogging about some aspects of what the budget means for different people, but in the meantime here is a general outline for the 2014 UK budget released yesterday (19/03/2014):

  • Point at which people start paying income tax will be raised to £10,500
  • Threshold for 40p income tax to rise from £41,450 to £41,865 next month and by a further 1% to £42,285 next year
  • Inheritance tax waived for members of emergency services who give their lives in job
  • Tax on homes owned through a company to be extended from residential properties worth more than £2m to those worth more than £500,000
  • All long-haul flights to carry lower rate of air duty currently charged on flights to US
  • VAT waived on fuel for air ambulances and inshore rescue boats

Savings

  • Cash and shares Isas to be merged into single New ISA with annual tax-free savings limit of £15,000 from 1 July
  • The 10p tax rate for savers abolished
  • Cap on Premium Bonds to be lifted from £30,000 to £40,000 in June and £50,000 next year

Pensions

  • All tax restrictions on pensioners’ access to their pension pots to be removed, ending thee requirement to buy an annuity
  • Taxable part of pension pot taken as cash on retirement to be charged at normal income tax rate, down from 55%
  • Increase in total pension savings people can take as a lump sum to £30,000
  • New Pensioner Bond, paying “market-leading” rates, available from January to over-65s, with possible rates of 2.8% for one-year bond and 4% for three-year bond – up to £10,000 to be saved in each bond
Alcohol, tobacco and gambling
 
  • Beer duty cut by 1p a pint
  • Duty on spirits and ordinary cider frozen
  • Tobacco duty to rise by 2% above inflation and this escalator to be extended beyond the next general election
  • Bingo duty will be halved to 10%
  • Duty on fixed-odds betting terminals increased to 25%
Energy and fuel
 
  • Fuel duty rise planned for September will not happen
  • £7bn package to cut energy bills, including £18 per ton cap on carbon price support, predicted to save medium-sized manufacturers £50,000 and families £15 a year

State of the economy

  • GDP forecast to grow by 2.7% this year and 2.3% next year, then by 2.6% in 2016 and 2017 and by 2.5% in 2018

Coinage

  • Twelve-sided £1 coin to be introduced in 2017

Welfare

  • Budget to be capped at £119bn for 1915-16, rising in line with inflation to £127bn in 2018-19. The cap includes child benefit, incapacity benefit, winter fuel payment and income support – but does not include state pension and Jobseeker’s Allowance

Public borrowing/deficit

  • Deficit forecast to be 6.6% of GDP this year, 5.5% in 2014-15 then falling to 0.8% by 2017-18 with a surplus of 0.2% in 2018-19
  • Borrowing forecast to be £108bn this year and £95bn next year, leading to a surplus of almost £5bn in 2018-19
  • A new charter for budget responsibility to be brought in this autumn
  • Promises to make permanent £1bn reduction in government department overspends

Business

  • Direct lending from government to UK businesses to promote exports doubled to £3bn and interest rates on that lending cut by a third
  • Business rate discounts and enhanced capital allowances in enterprise zones extended for three years

Housing/infrastructure

  • Help to Buy equity scheme for new-build homes extended to 2020
  • Support for building of more than 200,000 new homes
  • £270m guarantee for Mersey Gateway bridge
  • A “new garden city” at Ebbsfleet in Kent
  • Legislation to give Welsh government tax and borrowing powers to fund infrastructure needs, including improvements to M4
  • £140m extra for flood defence repairs and maintenance
  • £200m made available to fix potholes

For the full budget click this link:https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/293759/37630_Budget_2014_Web_Accessible.pdf 

For more info on the new twelve-sided £1 coin, this article seems to be quite informative: http://www.theguardian.com/money/2014/mar/19/cost-new-pound-coin-business

Britain's new £1 coin will be the same shape as the pre-decimal threepenny bit.