Human Capital Contracts: Attracting Private Financing to Higher Education Miguel Palacios Batten Fellow, Batten Institute Darden Graduate School of Business Administration International Finance Corporation, Washington, D.C. January 23, 2004

2 An Introduction Human Capital Contracts: What are they? How do they work? How are they different? How are they better? What is required for implementation?

3 Human Capital Contracts: What Are They? Human Capital Contracts: Are a means of financing education through which investors finance students’ expenses in exchange for a percentage of students’ future earnings. –Percentage of income and duration of payments are based on students’ expected earnings. “ Upon graduation, each student will pay X% of income for Y years for each $100 of support received.”

4 Human Capital Contracts: How Do They Work? 1.Funds delivered upfront to finance students’ education –Pre-arranged percentage income based on expected future earnings –Set period of time for repayment 2.Payments begin upon securing post-graduation employment –Payment amount based on actual income –Total payments made may be more or less than amount financed 3.Collection administered by private entities or government

5 Human Capital Contracts: How Are They Different? Financing Mechanism Value of Payments Remarks Conventional LoansPayments are fixed. Payments are fixed and not sensitive to the student’s ability to pay them. Assuming the student can pay, the return to investor is fixed. Human Capital Contracts Payments depend on income until the repayment period ends. Payments are sensitive to student’s ability to pay by adjusting the total amount paid by the student. Investors participate in the good fortune of highly successful students that offset the low payments from low-income earners. Income Contingent Loans (e.g. Australia) Payments depend on income until the loan is repaid. Payments are sensitive to the student’s ability to pay through an adjustable repayment period. Return for investor is fixed but it can fall below the initial value of the loan if income is not enough to repay loan during a long period of time.

6 Human Capital Contracts: How They Differ from Conventional Loans Graduate payments Graduate income $ $ HCCs Loans

7 Human Capital Contracts: How They Differ from Income-Contingent Loans Graduate payments Graduate income $ $ Income-Contingent Loans

8 Human Capital Contracts: How are They Better? Human Capital Contracts: Attract private funds and extend public ones Reduce financial risk of seeking education Allow choice of educational institution and field of study based on their long-term financial value rather than direct cost Add liquidity to investments in human capital Reveal information on relative financial value of educational fields and institutions

9 Human Capital Contracts: What is Required for Implementation? Successful implementation requires: Reliable means of verifying individuals’ income Cost-effective system of payment collections Supportive legal environment for both students and investors: Students should not be coerced by investors Investors need legal recourse if students default

10 Human Capital Contracts: Points to Remember Human Capital Contracts: 1.Are an income-contingent instruments for privately financing education. 2.Can attract private capital to finance higher education if the appropriate framework exists. 3.Benefit students by reducing the risk of their investment in education through adjusting payments to their capacity to pay, and allowing them more freedom to choose the field of their choice.

11 Contact nformation Contact Information Miguel Palacios Batten Fellow, Batten Institute Darden Graduate School of Business Administration University of Virginia 1 - (510)