Principles of higher education funding

William Gort and Matt Wright


January 4th, 2015

In light of the higher education reform debate in parliament, Deloitte Access Economics’ William Gort and Matt Wright discuss the efficiency of subsidies in the university system.

The Government’s proposed Higher Education reforms are intended to expand opportunities for more students to complete higher education, increase contestability and choice in the system and ultimately to drive greater allocative efficiency to increase the sustainability of the overall system (The Commonwealth of Australia, 2014).

As professional economists, part of our role is to assess the efficacy of these reforms, and so it is necessary to understand the preconditions for optimal higher education systems, and the extent to which they are reflected in the current funding and regulatory arrangements. This brief article considers the economic principles around the expansion of higher education funding to non-university higher education providers (NUHEPs).

Following the Dawkins reforms to higher education in the late 1980s and early 1990s, the rate of participation in higher education rapidly increased, while the number of Commonwealth supported higher education institutions was consolidated, largely through mergers of existing Centres of Adult Education and universities. This rationalisation allowed universities to exploit increased economies of scale, to the benefit of their efficiency and international competitiveness.

However, there is an argument that the protection of large university institutions through exclusive access to the Commonwealth Grant Scheme (CGS) and Australian Research Council (ARC) funding, has allowed significant barriers to entry in the higher education sector to develop over time. Indeed this may have allowed anachronistic cost structures and slow productivity growth in the sector, and may be restricting options for some consumers who demand higher education offered in a way that differs to the programs of teaching and learning currently undertaken by most universities.

Government reform that aims to introduce competition to drive greater allocative efficiency, and thereby consumer welfare, should principally focus on achieving competitive neutrality in funding arrangements for universities and NUHEPs. The appropriate calibration of government subsidy forms one part of achieving competitive neutrality.

In addition, there is a suite of market design features required to address market failures that may arise in the market for higher education; these include: improving price (and fee) disclosure, establishing appropriate and independent oversight of competition, ensuring transparency of quality and maintaining an effective balance between consistency and flexibility (ESC, 2011).

While Universities are, on the whole, public institutions, in general it is wrong to think about universities as providing a public good. The core business of a university is knowledge dissemination through education, which, to some extent, is both rivalrous and excludable.

However, undoubtedly, elements of output from the productive unit of a university generate public good. This good is appropriately considered to be an economic public externality and can be addressed through an appropriately calibrated Pigouvian subsidy. Quantifying and attributing the magnitude and nature of these externalities is essential in attributing the correct level of government funding reflected in this subsidy to achieve a socially efficient outcome (Chapman and Lounkaew, 2011).

So, the key consideration in determining a government subsidy rate for higher education is the level of public benefit attributable to the unit of output to which the subsidy is paid.

Further, for a multi-product firm like a university, calibrating the appropriate rate of a Pigouvian subsidy is not straightforward, due to cross-subsidisation of production outputs that, themselves, have a public externality. If teaching undergraduate courses enables the efficient production of research, the public externality associated with that research should be, in part, attributed as a social marginal benefit of undergraduate education.

In principle, it is possible that a university is able to deliver teaching and learning in such a way that it is uninhibited by or unrelated to any of the research or other obligations it produces, and that does not materially sacrifice the production of such obligations insofar as to compromise the institution’s ability to function as a ‘university’ (Cohn and Cooper, 2006; Tertiary Education Quality and Standards Agency Act 2011.).

However, this may not necessarily be the case. Universities, through their institutional structure, may produce value to society that would not be replicated in a NUHEP and would be placed at risk through increased contestability in a market for higher education that gives too much support to NUHEPs.

If a university subsidises research and other activities through teaching and learning revenue, this is likely be because it is financially optimal for them to do so. However, to the extent CGS funding is actually intended (by the Government) to support the efficient production of research, and that universities have calibrated their cost structures to reflect such an arrangement, it would be appropriate to remove that component of funding from the rate of CGS support extended to NUHEPs who are not required to undertake research activities as Universities.

With Minister Pyne raising the matter of the Government’s higher education reform package in the lower house in late August, the economic rationale behind these reforms will be under increasing scrutiny and the Governments’ view on the funding issues outlined in this article will likely become clear.  Deloitte Access Economics has had an influential role in this process which has made the opportunity of joining as a recent graduate both exciting and rewarding.


The Commonwealth of Australia, “Budget 2014-15: Higher Education”, 2014,

Chapman, B. and Lounkaew, K., The Value of Externalities for Australian Higher Education, (Australian National University: 2011).

Cohn and Cooper, “Multi-product cost functions for universities: economies of scale and scope”, in International Handbook on the Economics of Education, ed. Geraint Johnes and Jill Johnes, (Edward Elgar: 2006), 579-612.

The Essential Services Commission, “VET Fee and Funding Review”, 2011,

Johnes and Johnes, International Handbook of the Economics of Education, (Edward Elgar: 2006)

McMahon, W., “The Social and External Benefits of Education”, in International Handbook on the Economics of Education, ed. Geraint Johnes and Jill Johnes (Edward Elgar: 2006),  211-259.

The views expressed within this article are those of the author and do not represent the views of the ESSA Committee or the Society's sponsors. Use of any content from this article should clearly attribute the work to the author and not to ESSA or its sponsors.

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