Bitter pill should be swallowed

16:00, Jan 18 2013

When the Labour Party campaigned to remove interest from student loans in 2005, its critics condemned the move as a blatant election bribe.

Whatever it was, it worked. Since April 2006, student borrowers living in New Zealand have not had to pay any interest.

The policy has since cost taxpayers at least $3.8 billion in foregone interest, perhaps as much as $4.5b. Meanwhile, total student debt has spiralled to $13b, and is growing by roughly $1b a year.

During the past six years the country's finances have slid from prosperous to precarious, but the scheme still stands. The National Government has cut student allowances for post-graduate study, limited borrowing in some areas and bumped up the repayment rate. But it still refuses to confront the elephant in the room - which it had savaged while in opposition.

The interest-free policy makes up by far the biggest cost of the loan scheme, responsible for writing off 33c out of every $1 the Government lends.

In a speech last year, Prime Minister John Key bluntly admitted the decision to leave it alone was about political expediency, not policy-making.


Rather than marring the debate with populism and politicking, we asked a panel of economists for their independent opinions.


Few people would deny that improving access to higher education is a good thing. University of Auckland economics professor Tim Hazledine says the student loan scheme is certainly well-meaning.

But it is also "one of the most expensive examples of unintended policy consequences in New Zealand's modern history".

Unfettered access to borrowing has saddled students, many from lower-income families, with heavy debt.

"Thrusting large sums of money on to young people to buy beer and groceries just isn't very smart," Hazledine says.

Eric Crampton, senior economics lecturer at the University of Canterbury, has noticed several unwelcome distortions caused by the lack of a market interest rate.

There is a case to be made for backing student loans, he says, but "it's awfully hard to provide a sound economic justification for zero per cent interest rates".

"Because successful students typically wind up earning more than those who do not go to college, we might wonder whether it's particularly fair to run a system that transfers money to the current and future well-off."

And when the Government is handing out what amounts to free money, there is ample opportunity for rorting the system.

"Even students who do not really need assistance will have strong incentive to borrow the maximum amount and simply put the money into term deposits," Crampton says.

Infometrics economist Benje Patterson knows the loopholes of the system better than anyone.

As a student, he borrowed as much as he possibly could, put it in the bank and used the interest income to support his lifestyle. He intended to pay it back upon graduation, but then his loan became interest-free indefinitely.

When National introduced a 10 per cent early repayment bonus, Patterson created a spreadsheet model to calculate how long he should rack up compound interest before paying off his loan in full.

He described his decision as the product of "distorted incentives and sound economic reasoning".

The cost to society is tiny in isolation, he says, but it mounts up when others follow similar strategies.

Students are not stupid, and you certainly don't need to be an economist to figure this stuff out.

Treasury documents reveal about 2600 students looking to make a quick buck drew down loans and then repaid them in full during 2011.

They benefited to the tune of $1.8 million in early repayment bonuses - on loans they did not even need.

This little taxpayer-funded caper is one of the reasons why the voluntary repayment bonus will be axed in April. But it won't be the end of the middle-class welfare.

Inland Revenue extracts student loan repayments at the glacial rate of 12c for every dollar earned over $19,000. Once the repayment bonus ends in April there will be no financial incentive to repay a loan any faster.

The obvious strategy is to simply borrow as much as possible, whack it in a term deposit and let inflation steadily chip away at the balance.

Presumably the majority of students don't actively set out to game the system. The bigger issue is there is nothing to dissuade them from borrowing heavily.

Tertiary education should be viewed as an investment, Patterson says.

"If there's a market interest rate, you're going to set your level of investment more appropriately, you're going to think of the level of the cost."

That means not only fewer graduates in underwater basket-weaving courses, but less borrowed to support frivolous lifestyles - Hazledine's "beer and groceries".


Student unions vehemently defend the hallowed interest-free policy.

But perversely, it may actually be detracting from the overall quality of tertiary education.

The policy is costly, Crampton says - a fact the Government is all too aware of.

University enrolment numbers and tuition fee hikes have been capped in recent years. Crampton suspects the move was aimed at stopping the amount of zero per cent debt from ratcheting up.

The changes have had wider ripple effects, making it harder to attract quality teaching staff in disciplines with international salary competition.

"If we have zero per cent student loans, governments that do not want to have extraordinary cost blowouts in the education budget clamp down with those other kinds of tools," he says.

Jean-Pierre de Raad, chief executive of the New Zealand Institute of Economic Research, says the interest-free policy is "poor economics".

He notes tuition fees are already heavily subsidised but he is unconcerned by the overall amount of cash spent on tertiary education.

"Investment in knowledge and skills is important for economic growth and it boosts individual incomes."

The cost of removing interest is not huge compared to behemoths like healthcare, New Zealand Super, and Working for Families.

"But it does mean the money is not available for other things that might give society a better return, whether that is sorting out the tail of underperformance in schools, reducing taxes, or . . . getting back to surplus."


The Treasury issued an optimistic note to Finance Minister Bill English last year, suggesting even introducing a 2 per cent rate would save between $900m and $1.1b over five years. He ignored it.

Patterson suggests the rate should cover the cost of inflation at the "bare minimum".

Crampton reckons market interest rates combined with student allowances for lower-income students would represent an improved use of the limited funds.

Hazledine says it would be more fair and efficient to reintroduce interest on loans, and then channel the resources into further subsidising tuition fees.

If the policy has to stay, he suggests loans could be restricted to a proportion of course fees, with families and students sorting out the cost of living arrangements.

Hazledine's colleague Sholeh Manni, a leading expert in the economics of education, says the student loan system is vital to creating a level playing field for access to higher education.

She suggests directly subsidising loans for students who would otherwise have difficulty - which could be done through upfront discounts or means-tested differential interest rates.


None of this is news to the Government. But saving a few hundred million dollars each year simply isn't worth aggravating tens of thousands of voters.

And yet the sacred cow may eventually be hauled off to the slaughterhouse.

Crampton reckons it might prove more tenable to phase in interest rates on new loans, while announcing existing ones will be eligible for interest soon.

Students have now been sucking on the election lolly for more than six years. One thing's for sure - it will be a bitter pill to swallow.


Reuben Tilley is living proof that it's possible to make it through uni without taking out a student loan.

The University of Auckland graduate managed to pay his way through a bachelor's degree in arts, majoring in politics and geography, by working hard during semester breaks.

He received a means-tested student allowance during part of his study, but did not rely on his family for handouts.

"My mum was out of work at the time, and she's a solo mother so she didn't have anything to support me above just a roof, really."

Tilley is currently working fulltime but plans to head back to university to do honours - and remain debt-free if possible.