(This essay was published in Hong Kong Economic Journal on 18 May 2016.)

 

What price has not changed for 18 years in Hong Kong?

 

Since 1997 the annual tuition fees that undergraduate students pay at universities funded through the University Grants Committee have been frozen at HK$42,100. Government tuition policy seeks to recover 18 percent of the recurrent provision for undergraduate education. By implication, the government has also not increased the funding it provides per student to the universities.

 

University tuition fees are soaring in most countries and have become one of the recurrent complaints of middle-income families everywhere. In the US, average annual tuition fees at private non-profit universities increased from US$19,000 in 1995 to US$32,000 in 2015 in constant 2015 dollars, and from US$4,400 to US$9,400 at public universities.

 

The ratio of public university tuition to median household income provides a meaningful comparison of the relative cost burden of families in Hong Kong and the US. In the US, a household with median income had to spend 8.4% of its income to send one child to a public university in 1995, which rose to 17.4% by 2015. That’s more than double in two decades. Of course the burden of a private university education will be much higher.

 

In Hong Kong, a household with median income had to spend 20.0% of its income to send one child to a public university in 1997, which fell to 14.9% by 2015. If we factor in government grants for families without means, then the percentages were 12.3% in 1997 and 11.3% in 2015.

 

In 2015, students received an average grant of HK$10,364, which is about 25% of the tuition fee. This amount has declined over time, presumably because there are fewer qualified families. In 1997-98, the average student grant given was $16,168.

 

Having low university tuition fees lowers the burden on parents in sending a child to university, but what are its consequences? And is this good policy?

 

Parents and students in Hong Kong are under a lot of pressure to score well in public examinations in order to get into the university. This pressure is not unique to Hong Kong, but is particularly intense here because of two related factors.

 

First, students receive unusually high private rates of return if they are successfully admitted into university. Second, the number of subsidized places is limited (approximately 60,000 students compete for 15,000 places). This limitation is responsible for the unusually high private rates of return, i.e., there is an element of economic rent contained in them.

 

In 2001 the private rates of return were 20.8%, which increased to 23.6% by 2011 (see Figure 1). These are estimates of the internal rate of return that take into account the cost of education a student has to bear (including the forgone earnings for not working while at university) and her future expected increase in earnings over her lifetime compared to a secondary school student. A rate of return of 23.6% over a working life spanning 40 years is very impressive, even beating the performance of Warren Buffet’s Berkshire Hathaway over the past 40 years.

 

 

Such unusually high rates of return are seldom found in rich economies and are only occasionally found in some undeveloped economies. The US is well known to have underinvested in high school and universities in the past four decades and is also witnessing high private rates of return, but still not as high as in Hong Kong.

 

The estimated rates of return in the rich economies are 15.1% in the US, 14.1% in Australia, 12.8% in Germany, 12.7% in South Korea, 11.9% in the UK, 11.8% in France, 11.1% in Switzerland, 10.3% in Singapore, 8.2% in Canada, and 7.4% in Japan.

 

Educators and humanists have insisted that the purpose of a university education is more than getting a better-paying job. If this is the case and non-pecuniary goals are factored in, then the returns to university education  must be even higher.

 

But since university education is subsidized, these private rates of return do not take into account the cost to society in providing the subsidies. To find out what is the return to society’s investment in university education we have to calculate social rates of return by including the subsidies that are provided as part of the cost of providing university education. The social rates of return to university education are found to be 11.9% in 2001 and increase to 13.1% in 2011 (see Figure 1). Even these social rates of return are unusually high. Where could the government have found a long-term investment that pays a 13.1% social rate of return for 40 years?

 

Consequences of high rates of return

 

The very high rates of return generate multiple consequences.

 

First, unusually high private rates of return mislead parents to overestimate their children’s suitability for university education and strive too hard to get into a subsidized university place. A parent and a child may not know their true suitability perfectly, but still they make decisions by looking for market signals about rates of return.

 

Second, public examinations become the only acceptable means for allocating scarce public university places. Any other means will be seen to be unfair and subject to abuse. Parents and students cram for public examinations in order to secure these university places. Whether cramming is the best form of learning has been widely debated, but most would agree that excessive cramming is not desirable for developing a wide variety of hard and soft skills that society values.

 

Third, the appearance of highly in-demand for-profit institutions that tutor students to prepare for examinations is also a by-product of the high private rates of return. Their business model aims to capture part of the gains from the unusually high private rates of return to a university education. Their activity is mostly rent dissipation to the extent that their primary role is not learning, but preparing students for success in examinations where rewards are distributed in a zero-sum game. It is therefore primarily an unproductive activity.

 

Fourth, some parents are also transformed into monster parents. Mothers, in particular, are devoting more time to supervising homework and preparing children for tests, rather than in other productive activities with their children. Again, the zero-sum nature of admissions into subsidized university places is not only leading students into excessive cramming that yields not only diminishing but even negative returns, but is dragging parents into it.

 

Fifth, low tuition fees are in effect an implicit subsidy that benefits mostly the better-off families, who unlike the less well-off families could afford to pay more. Moreover, the children of higher- and middle-income families have a better chance of entering university than lower-income families. This results in a perverse effect on intergenerational mobility.

 

Sixth, the very considerable subsidies the public provides for university education is also a heavy burden on public expenditure making it difficult for government to increase university places at these heavily subsidized rates. As a consequence, further expansion of university places has to take the form of self-funded degree programs in order to control public spending on university education.

 

Seventh, because of the shortage of subsidized university places, students who did not perform well enough in the public examinations will have to continue their education without subsidies. This means that students with better ability (as proxied by public examination scores) are subsidized, but those with lower ability are not.  This will worsen income distribution. Furthermore, if public examination scores are correlated with family background, as they are likely to be, then the negative effect on income distribution is further worsened.

 

Eighth, the high rates of return make successful candidates less demanding of the type and quality of education they receive at university. Low tuition fees transfer more discretionary powers to providers of education. Universities, departments, and teachers become less responsive to student demands. This is not an ideal arrangement for universities striving for excellence in education, especially if online education becomes a serious competitor in the future.

 

A better alternative

 

A university education system that provides heavy subsidies per student inevitably encourages too much effort in trying to get admitted. It also necessitates a highly rationed system to limit the supply of places that, in order to be perceived as fair, inevitably relies heavily on public examinations. Society’s effort is therefore unavoidably channeled into cramming for examinations.

 

Extreme competition breeds monster parents, drill sergeant teachers, for-profit examination tutoring institutions, and one-dimensional children who miss out on the fun of learning. Study and examination pressures have been persistent complaints of our education system since my childhood days.

 

At the heart of the problem is the shortage of university places and the high private rates of return. The rapid expansion of subsidized university places from 1981 to 1994 brought some belated relief, but not soon enough to meet the demands of a rapidly transforming service driven economy.

 

Public examinations alone do not produce a very reliable statistic for screening students for admission when applied to different segments of the student population. Students have heterogeneous talents and skills, and some of these attributes may be positively correlated with examination scores but others are not. Among elite students, say those at the top 5% of the population distribution, examination scores and the other attributes may be highly positively correlated, but is not necessarily the case at the 25% cutoff mark. Using public examination scores to admit the top 5% of the student population is less prone to error than when admitting at the 25% cutoff.

 

At the very least this must be the case because the distribution curve is thicker at the top 25% cutoff than it is at the top 5% cutoff. This means using a single public examination score to admit students today is more error prone in examining the suitability of students admitted into the university than it was three decades ago.

 

The education reforms that replaced two public examinations with one have brought some relief to study and examination pressures, but still to an insignificant degree because subsidized university places remain in short supply.

 

The new subject of liberal studies was introduced with the intention to develop critical thinking. But it too is becoming just another examination subject where students are drilled to provide more than one point of view to give the appearance they have thought critically about everything.

I am unconvinced that they learn how to think critically by cramming for liberal studies.

 

If anything, this only teaches students confusingly many points of view, all of them  valid to some extent, and that they are free to choose whichever one they like as they do on Facebook and abandon the relentless pursuit of truth that is the central purpose of why a person should develop critical thinking. I believe making liberal studies a pass or fail examination subject would restore the fun back into liberal studies.

 

Raising tuition fees would also be a good strategy to alleviate many of these ills that arise due to the misallocation of effort. When every child spends a dozen years cramming for examinations, one has to be seriously concerned if they are learning the right things they will need to be ready for the world of the future. Human resources are Hong Kong’s valuable resource to be wasted, particularly its youth.

 

Let me say at the outset that raising tuition fees need not and indeed should not disadvantage students from less well-off families. The existing grant and loans scheme should be enhanced and better funded to alleviate any negative effects that might arise. Higher tuition fees should only imply that those students who are from well-off families would have to pay more.

 

The additional fees could be used to finance transfers to the less well-off families and to expand the number of subsidized university places. Both effects will work in the direction of lowering the rate of return to university education. Government spending on university education would most likely increase, but in a way that will foster greater efficiency and equity.

 

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