Friday, July 29, 2005



Incentives, behaviour, and empiricism

National is trying to inflate the estimated cost of Labour's interest-free student loans by assuming that everyone will borrow as much as they can. But while they're entirely right about the incentives the system will create, they're wrong about the effect. How do I know? Because we've done the experiment. Student loans have been interest-free while studying since 2000. National made exactly the same argument back then: that it provided an incentive for everyone to borrow as much as possible, and so student debt would skyrocket. It didn't happen. Why not? Because people aren't as economically rational as economists think we are.

Only a fool would choose an assumption derived from economists' laughably simplistic model of human behaviour over one based on empirical fact. But that is exactly what National has done - not once, but twice. I guess the reality must be too inconvenient for them...

9 comments:

Then why do't you go and max out your credit card as you get 30 days interest free on that?

Whats stops (well apart from the idiots who can't control their spending habits) people doing that? The knowledge that they have to pay interest on the card after the 30 days is up.

Same deal with this particular fuck up - knowledge that Interest needs to be paid on the balance of the principle at the end of the interest free study period puts a brake on principal drawn down.

Posted by Hobbo : 7/29/2005 09:09:00 AM

There are people (not so much in NZ) who have dozens of credit cards and pay one off with the other to take advantage of interest free periods and cheap deals - not enough to be a problem to the card companies though.

Given that you need to be a student to get a student loan, the vast majority will need their loan for fees and subsistence - only a very few rich people will even contemplate banking the cash.

If it really becomes a problem, then an asset limit for student loan eligibility could be introduced. Just make anyone wanting a student loan sign to say they have net assets under e.g. $10k. For the accountant types who might try and game the system, the possibility of a fraud conviction and consequent disbarment would be an adequate deterrent, I feel.

Posted by Rich : 7/29/2005 10:50:00 AM

Yawn.

I remember the predictions by ACT and National that everyone would max out their student loans and use the money to get more interest on the open market ("they'll pay down their parents mortgages and pocket the difference" was the claim).

ACT and National made this prediction back in the early 90s when Labour first set student loan interest at less than market rates.

They made it again in 2000 when Labour cancelled paying of interest while you're still a student.

They're making it again now.

But actually, most students come close to maxing their loans out now - that's how they eat.

And as for cost, I think people are missing the importance of the "but you pay interest if you leave the country" feature.

This policy bribes the people we have just given expensive educations to stay in the country for a while. Training people and then sending them overseas is costs us a lot of money (paying $60k to train a pharmacist who promptly moves to Oz is equivalent to sending Oz $60k in foreign aid).

Posted by Icehawk : 7/29/2005 11:46:00 AM

I've done some calculations about profiting from the living allowance. I used the saving calculator at sorted.org.nz

I based this on an after inflation return of 3%pa (it has to be a bank account, because the most you can borrow is a weekly installment of $150 a week)

Assuming you borrow living costs from the 1st of February to the 15th of November each year, and earn only interest over the summer, this is what you would get.

First year:
$150/week = $6148.97
Study period interest = $70.43
Summer interest = $38.30
Total profit = $108.73

Don't want to go on too long (already done), but in the second year you would get $295.20, and in the third $488.28 .

If you never paid the money back, for all this trouble you could get about $500 per year. Not much after 3 years study.

I believe that only the pathologically anti-tax would go to the trouble.

Posted by James : 7/29/2005 11:53:00 AM

Should add that after 3 years you'd have about $19,500 in your account, but that spending this would leave you severely liable should the policy change.

Which it would, if anyone did this.

Posted by James : 7/29/2005 12:01:00 PM

Have you looked at the Westpac evaluation of this Idiot? They say pretty much the same thing as ACT and National here.

While certainly not everyone would borrow and borrow to the max (they would be stupid not to), there will undoubtably be a huge increase in student loan debt. Instead of students feeling the pinch because of their borrowing others in society, including truck drivers that struggle to put food on their family's table, will be left to pick up the tab.

2000 saw an increase by 10% in the number borrowing, and saw the average amount borrowed increase by (I think) 23%. And you say it had no effect. Just keep your head in the sand there buddy. As Hoobo said what stopped a complete blowout in 2000 was the realisation that this would need to be paid back with interest.

If this comes in then there is absolutely no disincentive not to borrow more than necessary.

Posted by Mike Collins : 7/29/2005 01:55:00 PM

> If you never paid the money back, for all this trouble you could get about $500 per year.

what is the net present value of $500 pr year plus a lump sum on death minus forced repayments of lets say 10% of the average income. Nothing to be sneezed at I think. also what do you mean by extra effort? if you are already borrowing money it is no extra effort. If you are not it is just a small setup cost in effort.

> I believe that only the pathologically anti-tax would go to the trouble.

I am positively pro tax and I would go to the trouble so that shoots that argument in the foot.

> Should add that after 3 years you'd have about $19,500 in your account, but that spending this would leave you severely liable should the policy change.

How would you know people were doing that? One could always plausibly argue there was no significant increase in that sort of thing like IS is arguing about last time.
Besides does anyone "not pick up money lying on the street" because they knew if everyone did it there would be no money on the street?

GNZ

Posted by Anonymous : 7/29/2005 10:03:00 PM

OK these are my rough calculations - most people will acquire a home loan or car loan or somthing similar a cash windfall would rationaly displace those loans and most labour supporters would acept that hte policy helps students get into their own homes faster.

Current floating loan rates are 9%. So if you borrow the maximum amount possible first year you have 6148.97 you and pop that in the bank.
You then get half a years worth of interest off whatever you were paying for a new car at whatever percent. then you get another 6148.97 next year - again you save the interest on the other half of your car (12,000 dollar car not terrible for a student who doesnt really need to borrow money). You finish off my assumed average student time with another half year adn get 3074.48
Now together with the money from your part time job (which otherwise would have gone into paying off your car) you now have deposit for a house (lucky you) and some job earning about 30K lets say (entry level) you repay 3,000 a year (increacing by 6% per-annum) and you buy a house for about 200 k with a 21 k deposit which displaces a rather expensive 1005 finance home loan rate but we will assume it just displaces the 9% floating rate. by my calculations this amounts to around $2,000 (there are some tax deductions and benefit deductions I guess but there abouts). as a fraction of the 18 k or whatever you get after tax it is not bad. better yet you get life insurance because if you die your partner and new baby get the 20k lump sum. (not that you would have bought it otherwise).

Not a bad deal in the life of that theoretical normal student. Well worth the effort I'd say.
As for in the bank asumptions - who has spare money to put in the bank at that age?

Posted by Anonymous : 7/29/2005 10:33:00 PM

Some interesting points above. Investing in a house begins to look tempting...

As to having spare money, investing the living costs would only be open to those who don't need the money to er.. live.

My assumption that it would have to go into a bank account was based on the fact that payments are in $150 weekly increments. So no term deposit until after the first academic year at least.

Under my current loan contract students can be prosecuted for "fraud or false pretence", which might be broad enough to catch investment or other uses of the living costs money.

We should also note that eligibility for allowances is being expanded, and that if you get an allowance that this cuts into the amount you can borrow for costs.

Posted by James : 7/29/2005 11:17:00 PM