How new securities are an alternative to student debt
As students in India increasingly take loans for studies, fears of them becoming future NPAS have risen. Enter human capital contracts, proposed by the likes of Milton Friedman as an alternative to debt for students, young individuals and entrepreneurs.
WHAT ARE THE BENEFITS OF HCCS?
HCCS are securities that give you access to a specified fraction of an individual’s or a group’s future incomes for a fixed period in return for a lump sum payment today. For students, such securities are an alternative to debt, with the risk of bankruptcy being reduced. For investors, it is a new asset class—akin to buying “shares in humans”. For governments, it represents a scalable idea for higher education financing. If a student does not get a good job, she might not have to pay anything depending on the exact contract. If she is very successful, she may have to pay more than what she would have with a loan.
HOW DOES SUCH A CONTRACT WORK?
Say you want a ₹20-lakh MBA student loan. You can either get a five-year loan at 10% interest rate, or, with an HCC, promise to pay 15% of your total income for the next five years.
Also, assume the average starting salary for a student at your institute is ₹25 lakh and annual increments are in the mid teens. On average, both HCC and loan options will have a similar total outgo although, in this case, the loan repayment will be relatively frontloaded. Also, there would be more variability for an HCC investor overall—some MBA students could be unemployed while others may earn a lot more than average.
CAN IT MAKE QUALITY HIGHER EDUCATION ACCESSIBLE?
Courses that last for a short duration and are more vocational in nature are very well suited to HCCS, with the legal infrastructure around such contracts strengthening and regulatory uncertainty reducing. For conventional degrees, however, these agreements will probably still be used in combination with debt and aid.
WHAT ARE THE PITFALLS FOR HCC STARTUPS?
First, there is adverse selection. Students who know they are good are unlikely to sell themselves cheap, while others would love to “cash in”.
This is just good old information asymmetry. Moreover, once a student signs an HCC, the incentive to work hard falls. She may focus on a less lucrative but more satisfying career. This moral hazard is the second issue with HCCS.
One way to tackle these is to buy a stake in entire cohorts of a university batch or class. That would need legislative intervention to force holdouts, which isn’t likely.
DOES THAT MEAN THE HCC HAS NO FUTURE?
Not at all. One way the idea can thrive is for the government to c harge c i t i z ens who have received subsidized higher education with a small extra tax for a finite period—or, to use the jargon, “income contingent student loans”. Such specific taxes are effectively national HCCS that may crowd out various HCC startups. But that won’t be so bad. In fact, nations can securitize a small fraction of their future tax collections—that would be the ultimate HCC.