Baker's time bomb defused

Iain Crawford and Nicholas Barr suggest privatising loans, starting with postgraduates. Kenneth Baker, the former education minister, started the clock on what, in his memoirs, he genially referred to as his time bomb for the Treasury in his Lancaster speech in January 1989. In that speech he set the goal of doubling the partication rate of school-leavers entering universities on undergraduate degree courses.

His reference to time bombs refers to his recognition that he was proposing to double the undergraduate system with no mention of additional resources. We are all familiar with the resulting overcrowding and related ills.

It is true that an undergraduate student loan system was introduced, but any savings that this scheme may eventually produce will arrive long after the bomb has exploded. Mr Baker's time bomb was obvious back in 1989. There is some evidence that the Education Department recognised it, and a number of us from the London School of Economics had lengthy discussions with ministers and officials; but the Treasury was not ready to recognise the danger, nor was it as committed as Mr Baker to expansion.

What was less obvious was that Mr Baker left behind not one bomb, but two. The doubling of undergraduate numbers, as people are starting to realise, triggered off an increase in demand also for postgraduate - in particular masters-degree - places, not least because the best students need a way to signal their ability to prospective employers.

The point is not just academic. About as many young people are getting degrees today as got A levels at the time of the Robbins expansion of the mid-1960s. Those who used to mark themselves out by getting a degree now increasingly seek to do so through a higher degree to meet employers' demands for a better and better educated workforce.

Both of these time bombs can be defused through more resources. There is now a consensus that these additional resources will not be provided by the taxpayer. Not even the National Union of Students is arguing for that any more. We have been arguing since 1989 that there is a simple and effective solution, which is to bring private-sector capital into higher education. Probably the only way to do so on any scale, and in a way which is both efficient and equitable, is for students to repay their loans as an additional penny in the pound collected alongside their National Insurance Contributions (NICs).

This is automatically fully related to the graduate's subsequent income and is administratively cheap. It is also very secure, because NICs have a very low default rate. Thus it is possible for students to spread repayments over a much longer time period, making repayment easier and fairer. This, together with the security of the loan, is what makes it possible to attract private sources of finance. The result is a loan, for which repayment ceases once the individual's debt has been repaid.

This is a genuine loan scheme. It is not, repeat "not", a new tax. The body administering the loan (there is no reason why it should not be the existing Student Loan Company (SLC) under its new management) would bring in private finance by selling the debt to the private sector. This technique, known as securitisation, is widely used, for example by credit card companies.

Suppose the SLC wishes to sell Pounds 1 billion of student debt. If it is thought that 10 per cent of total student borrowing will not be repaid (because of low earnings, emigration, premature death, etc.), the private market would be prepared to pay about Pounds 900 million for the debt. The Treasury would pay only the remaining Pounds 100 million, rather than the whole of student borrowing, as at present. The new owners of the debt would be entitled to the loan repayments of the students.

Thus no Treasury guarantee is needed; the financial market bears the risk of loan repayments falling short of Pounds 900 million. That is what financial markets are for.

But who might buy such debt? Since degrees are a long-term asset, it is efficient if students are allowed to spread repayment over an extended period. Thus the resulting long-term, secure, low-interest asset will be attractive to longer-term fund managers, for instance pension funds.

The asset opens up the (far from fanciful) prospect of the National Union of Mineworkers pension fund owning a stake in the long-term prospects of graduates; retired miners would be living off the sweat of young graduate financial analysts. This is the scheme which, we argue, would have solved the problem of resourcing the expansion at undergraduate level. By shifting the responsibility for student maintenance away from the taxpayer, public resources can be concentrated on teaching and research.

Postgraduate students, however, have never enjoyed the generous taxpayer support that has been available to undergraduates. Our loan arrangements solve this problem. There are good reasons for dealing with postgraduates first. The problem is urgent since most United Kingdom graduate students have no systematic source of support.

Many top universities are increasingly concerned at the declining proportion of UK students in graduate schools. Given that masters students are both fewer in number and study for fewer years than undergraduates, they are an ideal group for a pilot scheme. If there are any remaining doubts about the attractiveness of such student debt to financial markets, this group, given the quality of their earnings profiles, is the ideal place to start.

It will be attractive for a minister to announce in Parliament a pilot scheme that addresses the next problem and channels resources to a group which currently has none. The fact that we are suggesting a pilot scheme for masters students does not, however, disguise the urgency with which Mr Baker's original time bomb - that of funding undergraduates - must be addressed. This need not be the political nightmare which has hitherto inhibited politicians. The political advantages are enormous.

* Government will be able to offer undergraduates the opportunity to take out a larger loan, thus making it possible to abolish the parental contribution; * There would be no need for further county court summonses for defaulters (the SLC currently projects up to 490,000 defaulters by the end of the decade); * Students would benefit, because they would no longer be forced into dependence on their parents - a dependence made all the more cruel because of the number of parents who do not pay their contribution; * Parents would benefit, because they would no longer be compelled to offer support (though they could of course continue to do so if they and their children so wished). Parental guilt trips would be greatly reduced. There are nearly two million parents of current students, to say nothing of the parents of the increasing numbers of future students. Parents, in general, are voters; * The providers of higher education would benefit. The expansion in student numbers of recent years, with no parallel increase in funding, has eroded quality. Restoration of quality requires more resources for teachers, for researchers, for libraries and for computer networks.

The proposal fulfils the Conservative public-private finance initiative by suggesting a "public" sector collection mechanism as an enabler of "private" finance. It puts flesh on the bones of Labour's learning bank idea. There are no losers and, unusually in politics, it is hard to see where opposition arguments could come from.

Iain Crawford, head of public relations, and Nicholas Barr, senior lecturer in economics, are members of the Education Funding Group, Centre for Education Research, LSE.