The issue of contractible quality, quality assurance, and information asymmetries in higher education

The issue of contractible quality, quality assurance, and information asymmetries in higher education

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M. Xiaoying1, M. Abbott2 1North China Electric Power University, Shanghai, China; 2Swinburne University of Technology, Melbourne, VIC, Australia

1.1   Introduction In recent years, there has been some concern expressed that access to higher education should be expanded and student academic outcomes be enhanced. As part of this process, one international trend in the provision of higher education has been the growing tendency for governments to promote greater levels of institutional autonomy, while also requiring greater formal accountability measures of educational providers to regulators. This has usually involved the creation of formal regulations that aim to implement quality assurance measures, set levels of internal efficiency, implement quality, and provide for better financial accountability. This has applied not only to government owned higher education providers, but also privately owned ones. The structure and intensity of government regulation, including quality assurance regimes, depends on a country’s mix of public and private higher education providers. In practice, it is possible for governments to promote higher education by funding expansion of either the public or private sectors. This mixture varies greatly across countries (see Table 1.1 and Fig. 1.1). In economics, government owned education providers are generally preferred over private ones in delivering goods and services where it can be shown that there is some form of noncontractible quality that private sector providers cannot replicate, and governments cannot compel them to create that quality through contracts or regulation (Shleifer, 1998). In the case of higher education provision, the manner in which this quality is contracted/regulated through the enforcement of a quality assurance framework in an issue that is growing in importance. This has meant that in recent years, there has been a proliferation of regulatory regimes around the world designed to affect the behavior of higher education providers. The purpose of this chapter, therefore, is to reflect on the nature of higher education market regulation by identifying the economic rationale for the regulation of markets, more generally in the terms noncontractible quality and information imperfections, and to attempt to match this intervention with the various types of

A Global Perspective on Private Higher Education. http://dx.doi.org/10.1016/B978-0-08-100872-0.00001-X Copyright © 2016 Mahsood Shah and Chenicheri Sid Nair. Published by Elsevier Ltd. All rights reserved.

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A Global Perspective on Private Higher Education

Table 1.1 

Proportion of higher education in the private sector (%)

Argentina Brazil Chile China Germany India Indonesia Japan Malaysia Mexico Philippines Russia South Korea Thailand United States

%

Year

23.9 74.6 77.6 19.9 4.9 30.7 71.0 77.4 50.9 33.4 65.2 14.9 80.1 9.9 26.1

2005 2007 2007 2008 2009 2005 2007 2007 2009 2006 2006 2004 2006 2007 2006

Source: PROPHE.

90 80 70 60 50 40 30 20 10 0

s ia el da ia nd ly co ds in ia lic na ce ny m en rk ay a n le s i a d b u a ta i hi re a te al a C Ko Jap Sta str Isr ana us ala I ex rlan Sp In pu ent ran rma elgi wed nm orw R Ze M he e rg F e B S u e N h C d t R A D G u te A et ew ch ni N So e N U z C

Figure 1.1  Private funding of tertiary education as a percentage of total funding, 2012. Source: OECD.

regulation imposed. Given the lack of work that has been conducted in the area, it seems unlikely that the regulation of higher education markets is exactly what would be expected of analysts and critics of government regulation and market failure. The regulatory dilemmas provide a good example of some of the problems faced by governments when they attempt to create a quality assurance framework for the higher education sector.

Issue of contractible quality in higher education

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1.2  Noncontractible quality and information imperfections Education, through the creation of human capital, is considered to be an important part of economic development (Maglen, 1990, 1995; OECD, 2002, 2014). In the past, most governments have not only invested in physical capital by spending on the construction of such things as roads, rail, bridges, ports, and airports, but they have also invested in the education of human resources (Chapman & Pope, 1992). This notion that education can enhance the productivity of labor is not a new one, with Adam Smith as far back as 1776 explaining “that a man educated at much expense and time to tasks that require dexterity and skill and may be compared to an expensive machine that adds more to earnings than the cost of operating it” (Smith, 1776). This notion that investment in education can raise the productivity of the workforce and generate returns to investors has been embodied in the form of human capital theory, which states that investment in human resources is similar to that in physical capital, in that a person incurs costs in investing in education in the expectation that future returns will be made (Becker, 1964; Mincer, 1958; Schultz, 1961). A wide variety of studies have been undertaken on the link between investment in human capital and growth rates. The Organisation for Economic Cooperation and Development (OECD), in research on the relationship between growth in per capita output and inputs (including expenditure on education), found a significant relationship between growth and investment in human capital (OECD, 2002, 2014). Even if it can be shown that investment in education leads to an increase in economic growth, however, this does not necessarily validate government intervention on economic grounds. To justify government assistance, there needs to be a demonstrable market failure that leads to suboptimal levels of investment in human capital. This then brings us to the question of whether there are market failures in education markets (Quiggin, 1999). Generally, economists evaluate whether governments should intervene in markets by using the notion of market failure. A market failure generally embodies some force that prevents efficient allocation of resources from occurring. Market failures are generally derived from a variety of forms, including pure public good, externalities, and information asymmetry. Education is a fundamentally privately consumed good, but may be considered a quasi-public good if a significant amount of its benefit or cost flows from its production or consumption, affecting third parties (externalities) (Winston, 1999). In the past, the possible existence of positive externalities that flow from education has been used to justify the subsidization of both government and private providers of higher education (Gemmell, 1997; Maglen, 1990; Quiggin, 1999). Studies have been conducted and have generally found that positive externalities exist, although not to the extent of covering as high costs as is presently the case (Maani, 1997). Even if strong externalities can be shown that flow from higher education, this does not necessarily mean that the providers should be government owned. In economics, more generally the case for government ownership of service delivery is restricted, as these services can generally be provided by private companies that are the subjects of government regulation through contracting out provisions to private providers or subsidizing consumers (Shleifer, 1998).

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A Global Perspective on Private Higher Education

In the case of subsidizing or contracting out, if a government knows exactly what it wants a producer to provide, then it can put its wishes into a regulation or contract and then enforce it. This occurs in many countries where primary, secondary, and vocational education providers are concerned. In many cases, private (for-profit or not-forprofit) or church-owned providers are subsidized by the government and in return, must allow themselves to be the subjects of government regulation and inspection. In some cases, governments contract out school or training programs to private providers where the conditions of service provided are stipulated. More generally, if the government cannot reliably enforce regulations or contract conditions because of a lack of information, or if it cannot anticipate, describe, stipulate, regulate, or enforce what it wants in contracts, then government ownership of the provider becomes more plausible. This could arise because the provider might have to respond to changing circumstances and provide something expected, or because this aspect may be difficult to define or prove and exists because of information asymmetries in general (Hart, Shleifer, & Vishney, 1997). If contracts are incomplete, then those who own and control the education providers would get “residual control rights” over areas that are not covered in specific contracts or regulations. There would be therefore some form of “noncontractible quality.” Regulating or contracting the quality of higher education providers becomes an important part of government funding of higher education. Even if it is accepted that higher education creates important economic externalities that help to drive economic development, quality assurance regimes help to provide reassurance to governments that their funds are being effectively spent. This is especially true, given that tertiary-level student enrollment levels (higher education plus vocational education and training) are rising in most countries (see Table 1.2). Determining the level of quality of education providers raises other issues. For students to make rational choices about what areas they would like to study, it is necessary that they have sufficient information about the quality of the alternatives available to them. It might be that they have information about the general reputation of providers if those providers are old and well-established, but students might not have much knowledge about the standards of newer and less well-known higher education providers. It is possible that students might like to undertake shorter and even low-quality courses if the costs are less than high-quality ones. It might be that the distinction between the quality of the courses offered by different higher education providers could be hard to distinguish (Abbott, 2006). Another area where information may be deficient is the risk factor. Often students undertake studies that can extend over a number of years. In most countries, for instance, degrees take either 3 or 4 years of study to complete. Students who commit their financial resources and time to courses of considerable length might be concerned if there is some degree of financial uncertainty facing the education provider that they choose. This problem is particularly important in higher education markets where private providers operate without the backing of the government. A further problem is the risk of third-party losses in higher education markets due to systematic instability. This problem might arise when the promises by one provider are breached, and this leads to distress to other higher education providers that are well

Issue of contractible quality in higher education

Table 1.2 

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Tertiary education enrollment ratio: 1999, 2006, 2013

Argentina Australia Brazil Canada Chile China France India Indonesia Japan Malaysia Mexico New Zealand Philippines Russia South Korea Thailand United Kingdom United States

1999

2006

2013

47 64 14 59 34 6 51 11 15 44 23 18 62 29 Not available 65 31 59 73

64 73 26 62 47 21 56 17 17 57 29 26 80 29 76 98 44 60 82

80a 86 Na Na 79 30 60 25 32a 61a 37a 29 79 34 76a 98 51 60 89

a2012.

Source: UNESCO.

managed and commercially sound. In financial markets, this systematic instability has been used as a rationale for the creation of prudential supervision (Neal, 1997). The regulation, therefore, of higher education providers can have some justification according to economic theory.

1.3  Educational providers Although there have been problems associated with the regulation/contracting of quality standards, in private education, there appear to be difficulties in the case of public provision as well. In recent years, there has been a falling degree of confidence shown by many countries’ governments in the ability of public universities to maintain quality standards in higher education. This has manifested itself in the growth of a number of quality assessment regimes in countries such as Australia, the United Kingdom, New Zealand, Japan, the United States, and the Netherlands (Dill, 2000; Dill & Soo, 2005; Huisman & Currie, 2004). In recent years, even in developing countries such as China, quality assurance frameworks have been developed (Ma, 2012). In Australia, for instance, although the vocational education and training sectors (both government and private providers) have been subjected to quality assurance regulation, the universities are increasingly being subjected to similar regulation, a process that intensified

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A Global Perspective on Private Higher Education

with the establishment of the Tertiary Education Quality and Standards Agency in 2011 (TEQSA, 2012). In the past, governments in these countries provided funding to government universities with a high degree of trust in education providers to deliver educational programs; in recent years, governments required greater degrees of accountability. To a large degree, this occurred because of the changes in the governance and management of higher education providers and the attitudes of governments to the role that higher education plays. Traditionally, higher education providers have been governed by either of two main models: what Jose-Gines Mora called the “Anglo-Saxon” model and the “Continental” model (Mora, 2001). In countries like Australia, New Zealand, the United Kingdom, Ireland, Canada, and the United States, universities have been governed by the former model, where universities were separate legal entities that owned property, directly employed staff, and to a degree, governed their own destinies. The role of the government was limited to providing funds and setting the general criteria as part of its higher education policy. This approach can occur for both government owned and privately owned universities, as is the case in the United States. In continental Europe, universities were governed under a firmer degree of control by the state. In Europe, governments in the past have controlled the finances, programs, and appointments to senior academic positions in universities and employed staff as public servants. Over the years, there has been a degree of convergence between the two models. In particular, there has been a process of giving Continental-style higher education providers more autonomy and then enforcing formal regulations that provide quality assurance measures (Dill, 1997, 2000; Mora, 2001). In countries such as New ­Zealand, Australia, the United Kingdom, and the United States, where universities in the past were fairly autonomous institutions, there has been an increase in the degree to which they are formally audited or assessed by government statutory agencies (Mora, 2001). In both cases, there has been a tendency for universities to have a degree of autonomy from the government and be affected by market forces, while also subjected to quality assessment and assurance systems. As an example, in New Zealand, both of these trends have occurred. On one hand, the largely Anglo-Saxon-style autonomous universities are now more often the subjects of external regulation, while on the other hand, the formerly departmentally controlled polytechnics have been given institutional autonomy, subject to external regulation (Ma & Abbott, 2008). In the United Kingdom and Australia, similar processes occurred. In the former, the Further Education Colleges, and in the latter, the Technical and Further Education Institutes were disestablished from departmental control and established as separate legal entities (Teather, 1999). Formal regulation tends to take on one of three forms: namely, accreditation, assessment, and academic audit (Dill, Massy, Willams, & Cook, 1996). These forms of quality assurance programs have been used for a variety of purposes and are distinct from each other, but often are used in some combination. Accreditation is a process of external quality review and is used by higher education providers to provide guarantees that certain standards are met. The United States has the oldest accreditation system, which evolved over 100 years of accreditation by

Issue of contractible quality in higher education

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private, nonprofit associations. Accreditation basically requires the determination by an external body whether a provider or program meets threshold quality criteria and thereby certifies to the public the existence of minimal educational standards. It is criterion-based; that is, it compares the observed performances or providers against preset standards, usually determined by the accrediting body. Assessment involves the evaluation of the quality of specific activities, such as education or research quality, within academic units. Assessment goes beyond accreditation to make judgments about academic quality levels rather than binary judgments relative to threshold standards. Assessments, or systematic program reviews as they are often called, have been used in the United States for a very long time and, in recent years, have spread to other countries around the world. Academic audit is the third and most recent type of quality assurance process. Academic audit is where external peers review the internal quality assessments and improvement systems of an education provider. Audit differs from assessment in that it does not evaluate quality but instead focuses on the processes that are believed to produce quality and the methods by which academics ensure that quality has been achieved. Its purpose is not to assess academic performance, but instead to verify the rigor and reliability of each provider’s system for assessing the quality of teaching and learning as well as its quality assurance procedures. This form of assurance has been implemented in Australia, New Zealand, Hong Kong, Sweden, the Netherlands, and the United Kingdom. It was developed in the late 1980s and early 1990s in the United Kingdom following concerns that the rapidly expanding university system was leading to a decline in the quality of teaching (Dill, 2000). In the United Kingdom, there had been a system of inspection of polytechnics and universities. In 1992, the Higher Education Quality Council was created to monitor the quality of teaching in universities (Brown, 2000, 2001). The spread to the other countries mentioned earlier was a result of similar pressure from governments for greater accountability in academic quality in the university sector. Although quality assurance measures are new to universities outside of the United States, they are by no means unheard of at a professional level in many countries and in higher education. In many countries, professional degree qualifications have been the subjects of accreditation processes by professional associations in fields such as medicine, accountancy, and dentistry. More generally, in the tertiary education sector, it has been very common in a range of countries for vocational training qualifications (and even non-university degrees) of various colleges (government and private) to be accredited by industry boards. The trend toward quality assurance in countries such as the Australia, the United Kingdom, and New Zealand is more generally a part of the process of convergence of the higher education and vocational sectors. The main justification for quality assurance regulation is that it helps to reassure governments that the funds forwarded to higher education providers (both government and private) are used in an accountable fashion. If governments are to forward funds, then presumably they have an interest in being assured that this money is being spent in an effective manner. In the United States, where quality assurance is privately undertaken this regulation is often a condition for government funding of both government-owned and privately-owned providers.

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A Global Perspective on Private Higher Education

The other main justification for imposing quality assurance programs, besides providing reassurance to governments, is that the programs provide information to students that the students would not easily otherwise get. Licensing and an insistence on a minimum degree of competence is a common response on the part of governments in situations where it is difficult for members of the public to gain reliable independent information about the quality of a product or service. In most countries, for instance, plumbers, dentists, electricians, and doctors need to be registered with legislated registration boards. The same is true with most countries that have a long and extensive history of private school education. The general purpose of this approach is to ensure that consumers are able to be certain that professional service providers meet certain standards. Of course, there is no particular reason why such a structure should be a government owned one. As mentioned earlier, the United States has had a long history with this process going back to the 19th century, mainly private associations. This is a product of the extensive size and scope of higher education providers in the United States. The positives and drawbacks from government control of the quality assurance process are straightforward. On the positive side, it is possible that a single regulator of standards provides students with a consistent approach to information provision. Further, it is possible that a government body would be able to reduce transaction costs of the establishment and bring about coordination of quality assurance measures. This is far more likely in the case of countries that do not have a history of external quality assurance regulation. In the United States, it is unlikely that a government body would be able to reduce transaction costs below that of the existing private organizations. Indeed, the present structure provides some scope for competition between accreditation agencies, which would encourage them to act in an innovative and efficient manner. Monopoly administration of the accreditation process by a single government regulator runs the risk of an overly bureaucratic and potentially inefficient approach to regulation. This process of accreditation, assessment, and audit of qualifications and higher education providers helps to reduce the difficulties of information asymmetry. It can provide assurance that minimum requirements are achieved, but it provides no more information about the level of quality maintained. Typically, no information on the relative standing of providers is given, such as the rankings of a number of international higher education providers. Furthermore, this process often provides students with little information about the basis by which the regulator has judged quality standards. Students are, therefore, given a broad indication that the accredited providers meet a regulated minimum standard, but they are provided with no indication of what that minimum standard might be. In addition where the education providers are well established and well known institutions, little is gained from the process as students generally have a fair idea of the relative standing of institutions. One difficulty with this type of regulation is that it can often either impose a significant burden on providers, which is fed onto consumers in the form of higher prices, or can be used by education providers to exclude entry into the market. This can occur in cases where the costs of meeting the licensing requirements are too burdensome, which can restrict competition by making new entry difficult. Another form of market failure that might occur in higher education markets is that of systematic instability. This might take place with private providers; government providers generally make

Issue of contractible quality in higher education

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the taxpayers bear all of the risk of financial failure on the part of educational providers. It may have a particularly important effect at the national level, as increasingly, students are traveling to overseas countries, often to private or private-government partnership institutions. The collapse of a single, very large provider in a particular country could lead to a general aversion on the part of overseas students to study at all educational providers in that country. Quality assurance does not appear to give students much additional knowledge about the degree of risk associated with different providers. In the case of government owned universities, it would be expected that the government would bail out any that face financial difficulties. In the case of the private education providers, quality assurance regulations generally give no assurance to students that prudent commercial behavior on the part of a higher education provider is followed in the way that prudential supervision of the financial sector is carried out. Quality assurance regulation instead concentrates more on establishing and maintaining the quality of programs, rather than giving students any knowledge about the degree of risk involved in enrolling with any particular institution. The failure of a provider is not necessarily a bad thing. One of the accepted benefits of a market is that there is a tendency for productively inefficient operators to be either forced out of the market or taken over by more efficient operators. Resources can then be reallocated to education providers, which achieve a higher level of efficiency. The problem of systematic instability means that the regulator must prevent this institutional failure from spreading to other providers. At the same time, it should try avoid committing itself to the open ended financial support of education providers in that this can lead to the added difficulty of “moral hazard,” that is, the possibility that promising to financially support providers in difficulty might encourage commercially risky activity. In the American case, one of the main purposes of the quality assurance programs is to encourage cross-credit arrangements between education providers. This acts to facilitate the transfer of students from failed providers to other providers so that they could complete their studies. What this does is effectively eliminate the risk to students of attending any single private provider. Theoretically, then systematic instability should not be created if students see that the areas they are studying are not tied to the financial situation of the provider they are enrolled in. A problem might arise, however, with the development of qualifications by the education providers themselves in that it might be expected for other providers to have equivalent programs to which students could transfer in the case of failure. This might not be the case if a private provider develops innovative programs. Any statutory provision that education providers maintain transfer arrangements might help to safeguard the interests of the student, but it might also be at the expense of the dynamic innovation of new programs.

1.4  Conclusion The regulation of the higher education sector does seem to help to overcome the problems of information asymmetry and systematic instability to some degree, especially where there is a number of new, privately owned institutions. The protection

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A Global Perspective on Private Higher Education

of student’s fees and the ability to transfer credit for work completed seem to be the two main elements that protect the interests of students and reduce the possibility of systematic instability. In terms of information imperfections, quality assurance measures tend to give students some information about the level of quality of a provider’s programs. This is a less important issue where the market is dominated by wellestablished and well-known institutions. These benefits to students, however, do not mean that the regulations are specifically designed to overcome potential market failures arising from information asymmetry and systematic instability. It is unlikely, therefore, that they were expected to be entirely successful in overcoming the associated problems. Future studies of formal quality assurance measures should consider the role that regulators can play in reducing the problems associated with these two possible causes of market failure, as well as attempt to design a regulatory framework that imposes as few costs as possible on education providers and students. A further area of study that should be undertaken is the cost of regulation. Regulation imposes costs of education providers and in education markets, just as in any markets, can create distortions and excessive cost structures. Balancing the costs and benefits of regulation is important in ensuring that an optimum level of accountability and information can be provided for both students and governments.

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