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How should developing countries finance higher education

3770 words (15 pages) Essay in Economics

5/12/16 Economics Reference this

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In recent years there has been mounting interest on higher education, especially with regards to how it should be financed. Developing countries have also been affected by such debates. Many developing countries have been facing surging demand for higher education. These increases have put high financial constraints on the resources of developing countries. As a result, a range of alternatives have been sought to deal with all these challenges.

This essay will explain how developing countries can finance developing countries focusing on policy options and sources of financing which would be more applicable in developing countries. The first section of this essay will look at some definitions which would be used throughout the essay; the second section will consider a literature review on theories on the returns to investment on education, the policy options available on financing higher education, the different sources available and the different instruments which can be used. The third section will critically examine some challenges facing higher education financing in developing countries and how they can be tackled. Fourthly, a case study based on India will be reviewed. Finally, the essay will conclude by summarising the main findings and highlighting the need for further research in certain areas of the essay.

2. Definition of terms

2.1 Higher education

The definition of higher education may vary from country to country. For the purpose of this discussion, higher education can be defined as post-secondary school undertaken at public and private institutions of higher learning such as universities, colleges, vocational schools and institutes of technology (Bray, 2010)

2.2 Financing higher education

Higher education financing refers to financial assistance provided to institutions of higher learning from both governmental and non-governmental sources (Tilak & Varghese, 1991). Such financial assistance is aimed at subsidising both private and public higher institutions to meet the diverse needs of students, economy and society.

2.3 Developing countries

The definition of the developing country used is from the World Bank which denotes such countries as having ‘low or middle income levels per GNP per capita’ (World Bank). The majority of people residing in such countries possess economically low standards of living.

3. Literature review

3.1 Theories on returns to investment on education

Theories on the returns of investing in education have been going on since the 1950’s, and are based on the human capital theory (Psacharopoulos & Patrinos, 2002). The human capital theory shows that staying in higher education has both costs and benefits. However, the theory argues that the benefits of higher education are greater because the individual ends up with a higher wage than would ordinarily receive. Essentially these are private returns to education. Furthermore, the theory argues that benefits can extend to society and result in societal returns on education. Barr (2001) mentions 3 external benefits linked to the theory which are increased future payments due to increased earnings, potential of making individuals more productive, for example by coping with technological change and cultural benefits such as increased involvement in community activities.

According to Bloom et al (2005), additional broader benefits of investing in higher education are job creation, entrepreneurship and economic growth. For example a study by Barro and Sala-i-Martin (1995) found that increasing tertiary education by 0.09 years leads to 0.5 percent yearly growth rate. Another study done in Taiwan indicates that if higher education rises by 1 percent, this could result in a 0.35 percent upturn in industrial production (Lin, 2004). This shows a significant role of higher education on economic growth and development in developing countries.

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However, this theory has been disputed by the Screening hypothesis (Barr, 2001) which concurs with private benefits, but refutes the notion of external benefits. The Screening hypothesis negates that education causes productivity to escalate. This theory only believes in an association between the two. The validity of this could perhaps be answered with empirical studies, which are unfortunately not conclusive on the matter. An acknowledgement can however be made of the presence of outside stimuli of features such as quality of teachers which are problematic to measure. To highlight this point a study showed that if quality of schooling is included in verifying, the returns fall by more than 13% (Behrman and Birdsall, 1987) and this shows that the quality of schooling can play some role.

Additional contrasts on the two theories are also highlighted in Behrman and Birdsall (1987) with the conventional viewpoint assuming returns on education to be high enough to permit an expansion of the education sector. Alternative studies however exist disputing that the returns are sufficient to qualify for a continual increase in the education sector. Although there are conflicting views on the market returns of education, it can be concluded that there are other broader returns which may be substantial such as educated women’s ability to understand the benefits of nutrition in meals and are thus able to raise healthier children and families (Behrman and Birdsall, 1987; Psacharopoulos, 1985)

3.2 Policy options on financing higher education

Given the potential returns of higher education, it is imperative to consider an appropriate financing strategy to be followed. Two models are identified as the ‘Anglo-American’ model and the ‘Scandinavian’ model OECD (1997 in Barr 2001). The former model is based on the assumption that institutions of higher education are different; it thus boosts diversity on those institutions. The latter model assumes institutions to be heterogeneous and hence the need for them to be treated in the same manner. There is support for a diversification approach through developing ‘alternative institutions differentiated in terms of missions, function and modes of delivery’ (Salmi 1992 in Johnson 1998). This is mainly seen in the increasing variety of institutions in developing countries such as community colleges, long distance learning programs and technikons amongst others. The presence of these dissimilar models brings into light the debate on the best strategy to be adopted especially with consideration of an individual person’s ability to pay.

Such debates are of importance for developing countries since they might affect equity considerations. A choice needs to be made on either putting much emphasis on the individual’s background therefore supporting those coming from disadvantaged backgrounds or providing financing based on future prospects, hence giving more considerations for an individual’s ability to pay in the future. The latter consideration seems less limiting as concentrating on the past might hinder progress. This view is supported by Barr (2001) who assumes that the benefits of such a strategy could be improved social justice and efficiency.

The ability to pay for higher education or lack therefore needs serious consideration in developing countries, given the presence of financial constraints in such countries. For this to be adequately addressed, it is imperative to first identify who should pay and where such resources should come from.

3.3 Different sources for financing higher education

The government is the major financier of higher education in developing countries, mainly through taxation (Barr 2001; Bray 2010; Johnson 1998; Mingat & Tan 1986; Savaavedra 2002). The upsurge on the demands of financing higher education has put an increased burden on the government sources (Barr 2004; Tilak 1991). As a result there is a need for other financing alternatives to supplement government sources. Such options could include charging payment of fees on students; introducing grants and loans; encouraging private higher education; inspiring entrepreneurial activities and philanthropic activities which promotes scholarship awards for students (Johnstone, 1998).

Firstly, the presence of personal benefits derived from higher education supports the notion of students bearing some of the costs. However, this limits accessibility for the disadvantaged. The second option of loans and grants therefore needs to be pursued. In respect to grants and loans, Barr (2004) identifies 3 types of instruments as Mortgage-type loans; Income-contingent loans and a graduate tax. Mortgage loans are organized like mortgage with no flexibility; they thus carry an element of uncertainty. Income contingent loans are more flexible as they depend on the income of the individual after completion. They require a certain percentage on the income until the whole amount of the loan is paid off. A graduate tax resembles latter but have longer term periods.

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Table: 1




Mortgage Loans

Perfect knowledge of debt by borrower

Allows lenders to plan ahead

More beneficial in the longer term

The use of a means test can discriminate on poor students


Results in huge debt

Income contingent loans

Maximise access to higher education

Low interest rates thus more beneficial for students

Allows flexibility (allows timely repayment of loan)


Administrative costs can be high

Can deter less able students

Graduate tax

Free at entry point

More progressive (highly paid contribute more)

Less costly to administer

Can encourage students to leave the country

Can lead to brain-drain

Lack success history

Source: Barr, 2001; Johnston, 1998; Shen, 2010.

Table 1 above indicates some of the costs and benefits associated with the 3 instruments. Since the focus is mainly in developing countries, it is imperative to reflect on equity and efficiency considerations of the various policy instruments. Firstly, mortgage loans are assumed to be highly unequal and thus negatively affecting the disadvantaged. This is due to the presence of ‘cherry picking’ (Barr, 200:182).

Secondly, income contingent loans appears as a better alternative than mortgage loans for developing countries as they improve equity and accessibility for students coming from disadvantaged backgrounds (Barr, 2001; Bray, 2010;Johnstone, 1998). Lastly, the graduate seems to possess many benefits for the developing countries, but the lack of records on its successful implementation even in developed countries indicates that it is not an easy thing to set up.

Thirdly is the significant role that private higher institutions play in developing countries. The important role of private institutions can be observed in countries like Kenya, India and Chile. The benefiting from the system, Chile has seen an increase in student enrolments in higher institutions and accommodation of diversity (Johnstone, 1998). On the other hand, it is important to guard against costs such declining quality and exorbitant tuition fees. There is thus a need for governments to take a leading role in assessing and giving accreditation to private institutions to ensure that the required quality is maintained.

The investment by the International Finance Corporation (IFC) in different countries signifies the rise in private institution of higher learning in developing countries. Examples of such investments are an approval of US$ 230 000 to establish NITT Education and Training Centre in Ghana in 2000 and an approved 22 million rand investment in Edu loan (proprietary) Ltd In South Africa in 2000 to assist in student finance (Van Lutsenburg Maas, 2008)

Fourthly is the option of entrepreneurial activities. Such actions allow students an opportunity to transfer their skills to state firms, whilst assisting institutions to generate income instead of depending on public revenue. The possibility of such activities can be learnt from Argentina’s case which improved its University fund from 7% to 14% between the periods 1991 to 1996. And lastly, is the strengthening of philanthropic practice that could potentially provide alternative sources of finance to higher education in developing countries (Johnstone, 1998). Other countries like India and China has practised such systems.

4. Critical Analysis

Following, from the literature reviewed from the previous section, it is plausible to analyse if the issues raised hold, and can therefore assist developing countries in financing higher education. The theories on the returns to investment have serious implications for the need to finance higher education in developing countries. This is due to the assumption that before considering how financing should be done, the first question is whether the benefits for higher education are sufficient to warrant further persuasion on the matter. Whilst the Human capital theory advocates for higher education due to positive returns like improving skills and productivity of labour force; being key to economic growth; increasing community involvement and benefiting women amongst others (Psacharopoulos & Patrinos, 2002), it is important to view if there is sufficient evidence to support this.

Alternatively, if more evidence is for the Screening hypothesis which negates such benefits especially the presence of external benefits in education, it would be more advantageous for developing countries not to finance higher education. This could perhaps require funds to be shifted from financing higher education to the primary or secondary level which could have greater returns (Barr, 2001; Psacharopoulos, 1986; Mingat & Tan, 1986). On the other hand returns on primary level has been reported to be falling (Birdsall, 1996), especially as more people complete the levels. This shows that the evidence is mixed, for example the benefits if higher education are shown in Latin America; wherein compared to a 50% increase in earnings for a worker who has secondary schooling, there is a 120% and 200% in earnings for the worker with higher education (Albrecht and Ziderman, 2000).

However this is not sufficient to prove conclusively that higher education needs to be abandoned, especially given the inconclusiveness nature of the empirical evidence. A more substantial concern should rather be with the high costs of underinvesting on higher education due to lack of adequate information on the benefits and credit constraints (Barr, 2001). This is likely to have additional disastrous effects for developing countries. The possibility of positive benefits such as decreasing illiteracy, poverty reduction, worker productivity (Savaavedra, 2002) is extremely substantial for such countries.

The benefits for high education have been argued to be higher for low income countries (Psacharopoulos & Patrinos, 2002), and this is reason enough for developing countries to finance it since they derive the most returns for higher education compared to developed countries. Developing countries also appear to be more in need for higher education because the higher costs associated with its funding, might actually be due to the fact that there is a less number of individuals possessing it. An increase in the number would likely reduce the costs and show a higher percentage on the returns. Moreover the globalisation effects on less developed countries demands improved technical, entrepreneurial and research skills. Such can be attained through higher education (Birdsall, 1996). The discussed factors point to the need for higher education in developing countries.

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Out of the two discussed models, the ‘Anglo-American’ model appears more applicable in developing countries. It supports heterogeneity and encourages diversity of higher education. Based on the complex nature of our world, institutions need to be different to cater for the different needs of the community. This can be achieved through offering various types of degrees. Naturally, costs of such degrees or diplomas tend to differ. The varied skills and knowledge could be beneficial as developing countries sometimes possess raised costs as a result of sufficiently trained personnel (Birdsall, 1996).

Since government is a major financier, the question on the amount of subsidy is a cause for concern in developing countries. Given the argument that higher education is largely consumed by the advantaged individuals (Psacharopoulos, 1985; Bray, 2010; Jandhyala & Varghese, 1991), decreasing public subsidies on higher education could potentially improve equitability. Such efforts are prevalent, with reports of proliferation of decreased subsidies in different parts of the world such as Africa and Asia amongst others (Torres & Schugerensky, 2002). The importance of taxation as the major contributor to public revenue is a major challenge, mainly because developing countries faces many challenges such as inefficiency and under-development, hence the need for alternative sources of financing.

One alternative to reducing the burden on government sources is charging the fees on the students. However, this limits access and equitability as students from poor backgrounds might not afford to pay. To improve affordability of higher education by such students, loans and grants are suggested (Albrencht & Ziderman, 1991). However there are many challenges encountered on these options. For instance students from deprived backgrounds might have difficulties in accessing the loans. The notion of ‘risk aversion’ as highlighted by Reuterberg & Svennson (1991 cited in Albrencht & Ziderman 1991) can be a hindrance.

Also the costs of tracking loans can be a dreary process in developing countries, thus resulting in increased costs. The estimated costs of managing a loan are between 12 and 23% (Woodhall, 1983 in Albrencht and Ziderman, 1991) as confirmed by annual reports from loan organizations in world-wide. The defaults of loans can also be high and negatively affected by possibility of failure or repetition. Given such challenges, income contingent loans are a better option.

Another more advantageous option could be the introduction of a graduate tax. It has additional benefits of the State contributing to human capital investment and reaping benefits in the form of a tax. However administration challenges might reduce the efficiency of the tax, especially since it desires the existence of a consistent tax base (Johnstone, 1998). Desirable as it might be, a graduate tax might be too complex for most developing countries to introduce.

Other options like private higher education, entrepreneurial activities and philanthropic practices need to come on board to assist in the financing of higher education. This comes from the admission that even though loans have had success in some developing countries like Mexico, China and Columbia; challenges have been prevalent. A joint effort from all these options could maximise the efficient financing of higher education in developing countries taking into consideration the diverse characteristics of such countries.

Case study based on India

5.1 Background

The government of India bears a large responsibility for funding higher education in the country. It spends around Rs.10 thousands million annually, that is approximately 0.9% of its GNP. Towards the late 1980s its high education had almost 10 million learners enrolled in 188 universities and close to 14 thousand colleges (Tilak & Varghese, 1991). The various forms of higher institutions include universities, institutions of national status, research institutions and colleges amongst others. These assorted institutions are therefore based on the ‘Anglo-American’ model.

5.1.1 Rates of return

Table 2: Rates of return to higher education




Social rate of return

Private rate of return


Tilak (1987)

1 Degree



11 Degree



Higher (Professional)




Debi (1988)

Graduate (General)



Post graduate (General)



Medical graduate



Source: Tilak (1987)

The table above shows the increased rates of return in India between the periods 1977-78 and 1988. Given the moderately high rates of return, it can therefore be concluded that investing in higher education in India is economically resourceful. Interestingly, the different layers of higher education were observed to have made enormous contributions to economic development. Such contributions however varied. This implies that to attain efficiency, different investments might need to be made according to amount of contribution. This could however sacrifice equity considerations on the less disadvantaged.

Financing higher education in India

As in most developing countries, the expenditure for higher education in India has increased. The increase from the 1950s to the 1980s has been at the growth rate of 14, 7% annually. The sources of finance are classified into government and non-government. Public funds are the main contributor of financing. Since the dependence is estimated to be around 70% to 90% (Tilak & Varghese) of total expenses, this highlights the burden on the public expenditure. The non-government sources therefore need to play an assisting role.

Consequently, the role of the private sector in India is vital. A majority of private colleges charge moderate fees because they are essentially financed from the public funds. However, recently there has been an increase in the number of private engineering and medical colleges (Tilak & Varghese, 1991) which are not subsidized from the state coffers. Nevertheless, these have been criticized as being mostly concerned with making quick profits and political power (Kothari 1986 in Tilak & Varghese, 1991). Such elements can be detrimental on equity considerations in India given the existing poverty and reduced living standards.

5.3 Additional techniques of higher education funding

The first suggested alternative is student loans. Potentially, this could reduce the heavy dependency on the state. Unfortunately, major challenges are imminent with such an intervention. Examples include the negative view of debt in the Indian community; the underdeveloped credit market which might not handle reduced interest rates for student loans; high default rates as well as the administration costs of such loans (Tilak & Varghese, 1991).

Secondly is the option of graduate taxes which has an advantage of ensuring that both the private and public sector contribute in financing human capital investment. The downside is however the likelihood of discouraging establishments to hire graduates. Lastly is the option of school fees. Since these are known to have the ability of discouraging the disadvantaged, a ‘discriminatory fee structure’ which is sensitive to equity considerations is encouraged (Tilak & Varghese, 1991). All the suggested alternatives for funding higher education have benefits, as well as flaws. This might imply the need for a combination of the different approaches instead of depending on one single approach.


This essay has explained how financing in developing countries can be done. From the reviewed literature it was argued that even though there are challenges in conclusively estimating the rate of returns in higher education, the costs of underestimating would be more disastrous for developing countries. Therefore, higher education investment is considered as a requisite in less developed countries. A shift in focus from constricted government sources to other non-governmental sources was highlighted. This necessitated an examination on the different tools to be used to assist with the financing of higher education in developing countries. The importance of equity considerations and accessibility were emphasised as they are vital in developing countries. Hence the conclusion that income contingent loans would be more prudent as it takes into cognisance such concerns.

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Finally, limitations such as the uniqueness of some developing countries which make it challenging to implement some financing instruments need to be considered. Also, there is a need to balance equity and efficiency considerations. This might require a combination of approaches instead of overly depending on a single approach. Further work needs to be done by developing countries to efficiently combine different sources of financing such as entrepreneurial and philanthropic activities and seek mechanisms in the effective implementation of a graduate tax to assist in higher education financing.

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