The Trouble with University Compacts
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Universities need competition, not central planning, argues Steven Schwartz

In the run-up to the 2007 election, Labor called for an education revolution. It was strong talk, but apart from promising to subsidise student computers (champagne all around at Dell and Compaq), Labor leaders never actually got around to saying what needs to change. Higher education barely rated a mention. The 2020 Summit produced the idea of reducing the HECS debt of graduates who undertake community work, but other initiatives have to await the results of a ‘comprehensive’ review of higher education. Although the review will not be completed until the end of 2008, statements made by the education and science ministers suggest that one matter has been decided even before the review has begun: in future, university–government relations will be guided by ‘compacts.’(1)

Compacts: A euphemism for central planning
‘Compact’ is an old-fashioned word for what most ordinary people would call an agreement or contract. But education experts rarely settle for a simple word when a fancy one is available. For example, expert advisors to the Scottish Executive are considering a ‘concordat’ with Scotland’s universities, though some educators believe that ‘covenant’ is a more appropriate term.(2)

No one knows precisely what concordats, covenants, or compacts will look like, or even how such agreements might be negotiated. But their purpose is clear. Compacts are a way of moving to a university funding system explicitly based on central planning. According to ministerial statements made so far,(3) compacts are general funding agreements that would foster institutional diversity by giving some universities more money to do research while others would be funded for teaching or widening the educational participation of currently underrepresented groups, or ‘engaging with the community.’

How will the commonwealth decide which universities will do what? According to ministers, universities will be expected to play to their strengths. This means that they will be funded for what they do well; those that are weak in one area will presumably find strengths in another. For political reasons, you can bet that every university, especially those in marginal seats, will be found to be good at something.

Even if a way can be found to keep politics out of the decision-making process, imagine how complex compacts will have to be. Even the smallest universities teach dozens of courses; some teach hundreds. There is similar diversity in research—universities pursue a bewildering array of projects in a huge number of areas. Will the government attempt to judge the ‘strength’ of each teaching area and each project in each university? This would take an army of bureaucrats, and would represent social engineering on a scale well beyond the dreams of even the most ambitious Soviet planner. It is just not practical. In practice, judgments will have to be made on global criteria. For example, universities that currently receive a lot of research funding will be designated as research universities and continue to be funded accordingly.

In other words, compacts will have to be backward-looking. By funnelling research funds to the current research universities, compacts will freeze the status quo in place by making it impossible for researchers at other universities to challenge the currently favoured ones. They will assure that what we have now is the best we could hope for.

Restricting competition through central planning will also limit the diversity and entre-preneurship that the government says it values. In a fast-changing world, we need institutions catering to many different niches, some of which we cannot anticipate. Guaranteed funding for research, teaching, or anything else could lead to complacency among the ‘winners,’ making them conservative and slow to react to changing conditions. It might be feasible to set the course of one large bus from a central command post in Canberra, but it is futile to try to direct every car, truck, and motorcycle on the road. Australia does not need a fossilised university system; it needs a dynamic one—and it will not get it from central planning.

In response to these arguments, Julia Gillard, the education minister and deputy prime minister, has said that aspiring universities would be given periodic opportunities to renegotiate their compacts, because each compact would be time-limited.(4) She did not nominate a length, but five-year agreements have always been popular among central planners. It would be ironic if compacts became five-year plans, because they have the same shortcomings. Both are examples of what the Nobel laureate economist Friedrich von Hayek called the ‘fatal conceit’: the apparently indestructible notion that fair, just, and efficient social institutions cannot arise from impersonal market forces, but only from deliberate design.(5) The assumption underlying the idea of compacts is that government experts have the foresight, creativity, and expertise to design better universities than those that evolve from the normal interplay of supply and demand.

Australian education officials point to California as an example of the successful use of compacts. This is misleading. The compact agreed to in 2004 makes no attempt to evaluate the strengths of the institutions within California’s two university systems.(6) It does not even apply to individual universities, only to the system as a whole. Moreover, the California compact does not seem to be binding on the government. It certainly has not prevented budget cuts, even though the compact called for a budget increase.(7)

Compacts are a form of central planning. They set out to engineer a university system by freezing the current arrangements in place while leaving room for politicians to interfere where they wish.

The twenty-five best universities
The alternative to central planning is competition. Allowing universities to compete will produce a more efficient, higher-quality outcome than any amount of central planning. This is not just my opinion—there is compelling evidence to support my argument. Consider table 1, for example. It lists the top twenty-five universities in the world, as judged by Shanghai Jiao Tong University’s higher education research unit. The Shanghai list ranks universities according to several indicators of research performance, including alumni and staff winning Nobel Prizes and Fields Medals, highly cited researchers, articles published in the prestigious journals Nature and Science, articles indexed in major citation indices, and the per capita production of books and journal articles.

Table 1: The world’s top twenty-five universities (2007)

Source: Shanghai Jiao Tong University Institute of Higher Education (8)

The most striking thing about table 1 is the number of US universities—eighteen of the top twenty-five. What is it about the American higher education system that has produced such outstanding universities? The answer is comp-etition. American universities compete for students, staff, grants, donations, and contracts—indeed, they compete for everything. Eleven of the eighteen American universities in the top twenty-five are private. Any government money they receive is won in competition with other universities (for research grants, for example). The public universities on the list (Wisconsin, for example) receive government subsidies for teaching, but they must compete with the private universities for research grants, donations, contracts, and students. This intense competition produces exactly the same outcome as it does in other sectors of the economy—excellence at the top.

Australia has no universities in the top twenty-five. If higher education is the engine of productiv-ity (a belief both sides of Australian politics share with the OECD), we need the best education we can get. Alas, we are letting our universities decay. Just visit any Australian university campus. You will find all of the vices associated with state-funded enterprises—decomposing buildings, antique equipment, and increasingly demoralised staff. This is not the fault of the Rudd government, but is the result of policies implemented by previous administrations. Now, having promised a tax cut and a large budget surplus, the current government does not have enough extra money to give to universities. Yet a revolution is still possible: a revolution that comes from introducing market forces into university funding. In the rest of this article, I will show how this can be done, first for research and then for teaching.

Fostering research
Research in Australian universities is funded by a dual support system. Research project costs are funded by grants from the Australian Research Council, the National Health and Medical Re-search Council, and other granting bodies. The government funds the cost of research infrastructure (including equipment, libraries, and internet charges) according to a formula. The two processes require at least two comp-liance regimes, and sometimes the result is a lack of alignment between research projects and infrastructure funding. Unless the government wants to micromanage every grant, a compact arrangement will have to focus on the infrastructure funding. That is, certain universities will be designated as eligible for higher levels of research infrastructure funding.

In contrast to the dual funding model, research at universities in the US is funded by a single mechanism that adds indirect (overhead) costs to research project grants. In other words, grants cover the full cost of research rather than only the direct costs. University academics must apply in an open competition for grants, and those institutions that earn many grants also receive considerable infrastructure funding.

Because every American academic can compete for a research grant, every university can conceivably be a research university. Of course, things do not work out that way. Because of their ability to attract the best researchers, research funding tends to accumulate in universities such as those appearing in table 1. However, unlike a centrally planned system based on compacts, competition is possible here. Occasionally, new entrants knock off those higher up the list. For example, the University of California, San Diego did not even exist when I was at school. It is now number fourteen on the Shanghai list. Continually having to fight off challengers ensures that the top American universities remain on their toes.

The way to encourage world-class research universities to develop in Australia is to adopt a competitive, unitary funding system where grants pay for the full costs of research and then permit any academic or institution to bid for grants. Money will flow to the best researchers doing the best projects. If these researchers are located at currently strong research universities, those institutions will win the vast majority of research funding. If they do not, then they do not deserve it. Either way, Australia gets the best research its money can buy.

Fostering teaching
In the run-up to last year’s election, the Group of Eight research-intensive Australian universities launched a far-reaching higher education policy paper called Seizing the Opportunities.(9) There, they resurrected the idea of education vouchers (which they called national scholarships). Ever since Nobel laureate Milton Friedman first suggested it in 1955, the idea of vouchers has periodically surfaced in Australia only to be met with strong opposition from education unions and yawns of apathy from everyone else.

Why are vouchers better than compacts for funding students? The answer is that vouchers encourage competition, while compacts reduce it. Under the current funding arrangements (which are already a kind of compact), the government assigns each university a quota of student places and provides a block grant that partially subsidises the cost of teaching. Students pay most of the remaining costs through HECS. Because the government not only controls the number of places but also caps HECS fees, market forces are weak in higher education. As a result of quotas, many qualified students are turned away from their first choice of university. They are forced to try their second, third, or even fourth choice until they finally find a university that will admit them. By limiting the number of places, the government makes it impossible for universities to expand their intake in response to student demand. It is a way to protect less popular institutions whose students might go elsewhere if given the chance.

The Group of Eight’s paper suggests scrapping the quota system. In its place, the Group wants the government to award ‘national scholarships’ that students can take to any university that will admit them. Because they would not receive a block grant, universities would have to compete for student scholarships to survive. Some would compete by developing niche courses, while others would teach at night or in the workplace. For the first time, universities would be able to expand or shrink their intakes in line with community needs.
In the past, vouchers were not taken seriously because they were considered impractical and politically unpopular. Critics could claim that no country used vouchers to fund education. Now that school voucher systems operate successfully in several countries, and a university voucher system has been introduced in Colorado, their practicality is no longer in question.

Vouchers’ political popularity is less clear. It has been assumed that vouchers would be unpopular because they would have to be rationed. Those who missed out would naturally be unhappy. Rationing was considered necessary because it was feared that promising everyone a voucher would lead too many students to enrol, causing a budget blowout.(10) But times have changed. There is no longer any need to worry about hoards of frustrated students queuing up for vouchers because, according to the government’s own figures, there is no longer any unmet demand. Everyone who meets the entrance requirements and wants to attend university is already studying. The only undergraduate Australian students not currently subsidised by the taxpayer are ‘full-fee’ Australian undergraduates studying in our universities, and students studying in private institutions. As the government has decided to abolish full-fee university places and compensate universities with subsidised places, the only extra costs of a universal voucher system would be subsidising students in private institutions. This will be a small amount, and could be offset by reducing the interest subsidy on HECS or by reducing bad debts.(11) The main point is that a universal voucher entitlement would cost the government little more than the current block grant system.

In the past, vouchers would probably have increased administrative expenditure because they would have required universities to develop expensive billing and accounting systems. This  no longer applies, because all universities now have such billing systems in place to deal with international student fees.

A more fundamental objection to vouchers comes from those who argue that market mechanisms are inappropriate to education.(12) Students making their own choices will have the power to shape the direction of universities, and they may choose to abandon certain courses and institutions. The result could be a small group of elite universities and a long tail of struggling ones. Regional universities may be especially affected: some may find themselves without students. To some extent, these fears are exaggerated. There is already an elite group and a long tail, and competition will give universities in the tail an opportunity to develop new specialties. Still, it is possible that the competition will adversely affect some courses and some regional universities. If there is some social value in maintaining courses and universities that no one wants to attend (an odd concept), then the way to do it is to provide a higher-value voucher for students who wish to study in regional areas.

Giving funding to students as vouchers, and eliminating quotas, will allow universities to adjust supply to meet demand. But vouchers will not be enough. To ensure the highest levels of excellence, they should be combined with deregulation of university fees.

At present, the government largely determines the amount that students pay through HECS; universities have only limited leeway to charge more. Yet, our universities are in competition with generously funded competitors from around the world. If we want to compete in the premier league, we have no choice but to direct resources to those institutions that achieve the highest standards of excellence. Lifting the cap on student contributions will allow our best universities to raise their fees, and this will bring them the additional resources they need to compete with the world’s best. To ensure that access to elite higher education institutions is not limited to the rich, universities that raise their fees should be required to use some of their new wealth on income support for needy students.

In reality, only a small number of institutions would be able to charge premium fees and provide exceptional services. Many would go for low price and high volume. Other models would also develop. Some universities will offer vocational and technical types of education. Others will focus on distance learning. Some will deliberately focus on a small number of programs that meet student needs, and conduct these programs better than anyone else.

Summary
Instead of compacts, Australia needs a competitive system based on fully funded research grants and national scholarships or vouchers. Competition will ensure that the best research is rewarded, and will force universities to be attractive to students, because that is the only way they will receive their vouchers. Students will benefit because they will control the purse strings and will be able to influence what gets taught, who teaches it, and when. Institutions will benefit by being able to adjust their offerings to meet student demand. Most of all, Australia will benefit from having strong universities to produce the research and graduates we need to ensure social and economic progress.

Steven Schwartz is the Vice Chancellor of Macquarie University, Sydney. Parts of this article have appeared in different forms in The Australian, the Canberra Times, and the Australian Financial Review.

Endnotes
(1) Announcing the review, Gillard said ‘It is my intention that the recommendations of the Review will build on the collaborative new approach to Government university relations embodied in our proposed mission-based compacts.’
(2) Fiona Macleod, ‘Universities Offered “Olive Branch”,’ The Scotsman (29 January 2008), news.scotsman.com/latestnews/Universities-offered-39olive-branch39.3719158.jp.
(3) Alan Robson, ‘Compact Funding for Diversity,’ (address to the Sixth Annual Higher Education Summit, Sydney, 3 April 2008).
(4) Julia Gillard, personal communication with author, March 2008.
(5) F. A. Hayek, The Fatal Conceit: The Errors of Socialism (Chicago: University of Chicago Press, 1988).
(6) Brad Hayward, ‘Gov. Schwarzenegger and UC, CSU Leaders Announce Multi-year Compact Addressing Funding and Accountability’ (11 May 2004), www.universityofcalifornia.edu/news/compact/ucpressrelease.html.
(7) University of California, ‘Governor’s Budget Proposes Cuts to Address Deficit,’ UC Newsroom, www.universityofcalifornia.edu/news/article/17131.
(8) Shanghai Jiao Tong University Institute of Higher Education, ‘Academic Ranking of World Universities 2007: Top 500 World Universities (1–99),’ ed.sjtu.edu.cn/rank/2007/ARWU2007_Top100.htm.
(9) The Group of Eight, Seizing the Opportunities: Designing New Policy Architecture for Higher Education and University Research (Canberra: The Group of Eight, 2007), www.go8.edu.au/policy/papers/2007/Go8%20paper%20on%20higher%20education%20and%20university%20research%2006.06.07.pdf.
(10) J. Hall and W.D. Eggers, Health and Social Services in the Post-welfare State: Are Vouchers the Answer?, Reason and Public Policy Institute Policy Study 192 (Los Angeles: Reason and Public Policy Institute, 1995).
(11) Student debt has an interest subsidy because, depending on the type of student loan, no interest or a low real rate of interest is charged. Bad debts arise because some graduates leave Australia and never repay, and because debts are extinguished on death. Britain and New Zealand already charge student debtors living overseas, and Australia could do this too. HECS debts could be recovered from the estates of past students.
(12) Griffith University, ‘Submission to the Review of Higher Education Finance and Policy’ (1998), www.dest.gov.au/archive/highered/hereview/submissions/submissions/G/griffith.htm.