And as demand for human capital grows in middle-income Asian countries, enrolments and graduations can be expected to increase in the short and medium term.

Higher education is an investment in human capital that generates a return for students in the form of higher lifetime earnings. And yet the process is associated with considerable uncertainty for prospective students. For example, students do not fully know whether they will be capable of — or even interested in — the discipline of their choice in the long term, and this is accompanied by a risk of not graduating. Even if graduation is taken for granted, students still face a competitive job market where others may have more attractive skills. There is also uncertainty about the future value of the investment because demand for particular skills changes over time; as well, students from disadvantaged backgrounds may not have much information about graduate incomes.

These uncertainties are particularly important in a context of students having to finance their education through loans. Unlike with physical capital, if a student’s future income is lower than expected, it is not possible to sell part of the investment to help repay the loan or finance a different educational path. In other words, there is no collateral to protect a prospective lender against the costs of default. This makes lending to students very unattractive to banks, even if the cost of studying is partly subsidised by the government.

Fixing this market failure requires the government to become involved in financing higher education. The most common form of intervention internationally is for governments to provide a guarantee to banks to repay student loans in the event of default. However, even with this sort of government intervention the student still faces the costs of a potential default, including the loss of credit reputation. Student loans of the conventional variety also typically involve fixed repayments, much like a mortgage, which could impose a significant burden on graduates. This takes the form of hardship or a ‘repayment burden’: the proportion of a graduate’s income required to pay back the student loan.

To illustrate the importance of the role of repayment burdens a hypothetical student loan scheme for Vietnam and Indonesia has been constructed. This hypothetical scheme is based on current average costs of education in either country and a 10-year repayment schedule. The discussion of Thailand is based on the arrangements of the current student loans system.

So how large are the repayment burdens likely to be with respect to these kinds of loan schemes? The findings are as follows.

In Indonesia, graduates who earn relatively high incomes have repayment burdens in the order of 20–30 per cent, but low-income graduates face burdens of 40–85 per cent per year. The results are similar in Vietnam, where the repayment burden varies between 12 and 25 per cent per year for the advantaged, and 40–80 per cent per year for the disadvantaged.

In Thailand, repayment burdens are lower, with relatively poor graduates experiencing a burden of 8–22 per cent of income per year. This reflects two things: the relatively high incomes of Thai graduates, and the considerable subsidies associated with the scheme.

While there is no objective rule on what constitutes an appropriate repayment burden, there appears to be a consensus that it should not exceed 18 per cent of income in countries with high median incomes. In this context it would seem to follow that the repayment burdens faced by Indonesian and Vietnamese students in the hypothetical scenarios are extremely high. These burdens arguably constitute significant hardship for many graduates and increase the risk of default; schemes of this type will likely act as a deterrent to investment in human capital.

An alternative mechanism for funding higher education is income contingent loans (ICL), such as those used in Australia, New Zealand, England, Hungary and Chile. Under such a system, loan repayments depend on the income of graduates and are capped at around 8–10 per cent of yearly income. ICL remove repayment hardships and minimise the danger of graduates defaulting. Moreover, by collecting repayment through the income tax system, it is extremely difficult for graduates to avoid repayment.

However, ICL systems are only possible in countries in which there is an accurate record of student debt, a collection mechanism with a sound (almost certainly computerised) record-keeping system, and an efficient way of accurately determining the actual income of former students. In many developing countries, including Indonesia, Vietnam and Thailand, this may not be currently possible.

The governments of Indonesia and Vietnam, and perhaps Thailand, will likely be seeking significant expansions of their higher education sectors to sustain economic growth. But if this is to happen in an equitable and efficient way, excessively heavy loan repayment burdens must be avoided. Governments may need to consider institutional reform — perhaps specifically with respect to the income taxation system — to help resolve difficulties in funding higher education.

Bruce Chapman is Professor of Economics and Director of Policy Impact at the Crawford School of Public Policy, the Australian National University.

This is an abridged version of a paper presented by Professor Chapman at the 35th Pacific Trade and Development Conference (PAFTAD), held in Vancouver, Canada, 6–8 June 2012.