Thursday 04/08/2016

Will Latvia be able to hold onto educated specialists?

Author: Anders Paalzow, Rector of SSE Riga

From an economist’s point of view higher education is a very interesting good. It has substantial private benefits, but unlike most other goods, it has external public or societal benefits as well – increased social capital, innovations and stronger institutions. Studies on the United States indicate that the societal benefits of higher education amount to almost 90 per cent above and beyond the private earnings.

The standard approach for an economist as well as policy maker when there is a case with substantial societal benefits is to introduce a subsidy. In terms of higher education this is what is done in Latvia as well as in most other countries. It is seen as “an investment in the nation’s human capital”. And there it gets complicated. An investor who invests in a machine can decide where and how it should be used. The same goes for an individual who invests in his/her human capital: he/she can decide whether to work at the Ministry of Finance or for a private bank or whether to work in Latvia or in Germany.

So far this is fine. The problem arises when there is someone making what we might call a co-investment – this investor could be either the government with the overall aim of increasing the nation’s well-being or an employer investing in employees. In a world with labour mobility it is very difficult for the co-investor to control the investment. A government that subsidizes a medical school will find it very difficult to prevent its graduates from seeking employment abroad.

To address this issue, governments as well as employers have tried what one might consider a milder form of slavery. A student who has studied through a government subsidy might be forced to work in the public sector for a number of years to pay off his/her debt to society. Otherwise the subsidized tuition fee has to be paid back. Similar contracts have been tried in the private sector. Such programmes have in common that they have seen very limited success.

Among the two investors, the individual investing his/her time, money and effort into his/her education and the government investing through subsidies in human capital, there is accordingly a huge asymmetry in terms of risks. To understand this, consider Latvia, whose educational system is gaining in competitiveness – in particular in the fields of medicine and engineering. It produces graduates that are very attractive on the international labour market. From an investor’s perspective, for every medical doctor that leaves the country, the Latvian government has to write off the investment. The graduate will on the other hand continue to reap individual benefits from the publicly subsidized higher education. The public benefits, on the other hand, will essentially go to the hosting country, which experiences a windfall gain.

Put differently, the Latvian government (like most governments) is doing what no parent would do – giving a five-year-old a treat prior to entering Rimi with the intention of avoiding a tantrum in the check-out line. They would rather tell the kid: if you behave well, we’ll buy you an ice-cream.

Hence, policy makers can actually learn from the common wisdom of all parents and reward actual behaviour rather than assumed behaviour. What would such a system look like? The system should increase the students’ individual investments in their own human capital through substantially increased tuition fees. This has to be accompanied by a reformed system of financing studies, granting students, irrespective of socio-economic background and family credit history, the same access to student loans in order to provide equal access to higher education.

Like at Rimi, the reward should come when the desired behaviour has been observed, i.e. when the graduate starts contributing to society by producing societal benefits through being professionally active in the country that provided the education. There are many ways to do this, but the easiest is probably to write off a certain percentage of the student loan for every year the student works in the country where the education was provided.

This will further increase the opportunity cost for, e.g., a medical doctor going to Germany right after education. The considerably higher German salary offered has to be reduced by the amount of the student loan not written off, which in turn will lower the attractiveness of the German offer. However, if the graduate still goes to Germany, the cost will be borne by the individual and most likely the German tax payers, who have to pay a higher salary to lure the Latvian doctor to Germany – and rightly so since it is the Germans and not the Latvians receiving the societal benefits.

Will this work financially? Well, the ice-cream costs the same irrespective of whether it is bought when entering or exiting Rimi. The only difference is that the risk of having a tantrum at the check-out is zero if it is bought when leaving Rimi. So for Latvia, with a relatively low GDP by EU standards and hence less resources to pay competitive salaries, but with an educational system that is getting stronger, this might be a way of creating stronger incentives for local graduates to stay in Latvia. However, it will not solve the entire problem. To do so, one also has to address the extremely low Latvian salaries for highly educated professionals, whose contribution to societal benefits is several times larger than their salaries.

The article has been published in the magazine IR NAUDA (No 26, August/September, 2016)

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