FUNDING REFORM

Rates of return and funding models

in Europe

Final report to the Directorate-

General for Education and Culture
of the European Commission

January, 2007

CONTRACT N 2006-1665 / 001-001 SO2-81AWB

This study was requested by the European Commission, Directorate-General Education
and Culture. This report does not reflect the views of the European Commission. The
interpretations and opinions contained in it are solely those of the authors.

Centre for the Study of Higher Education Management (CEGES)

Valencia University of Technology
Ed. NEXUS, 1 Pl.
46022 Valencia
ceges@upv.es
www.ceges.upv.es

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 Authors

Jos-Gins Mora, CEGES, Valencia University of Technology (coordinator, foreword)

Luis Vila, University of Valencia (Chapter 1: Summary)

George Psacharopoulos, EENE (Chapter 2: Rates of return)

Evanthia K. Schmidt, The Danish Institute for Studies in Research and Research
Policies (Chapter 3: The case of Denmark)

Hans Vossensteyn, CHEPS, University of Twente (Chapter 4: The case of the

Netherlands)

Enrique Villarreal, University of Valencia (Chapter 5: The case of the Region of

Valencia, Spain)

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CONTENTS

0. FOREWORD 6
0.1. Funding Higher Education in Europe 6
0.2. Reducing the funding gap and make funding more efficient in education and
research 7
0.2.1. Contributions from students and industry 7
0.2.2. Increasing effectiveness and efficiency of public funding 8
0.3. Equity in higher education access 9
0.4. The role of the EC 10
0.5. The present study 13

1.SUMMARY 15
1.1. Introduction 15
1.2. Returns to HE 15
1.3. Changes and Trends in the Financing of HE 19
1.3.1. An outline of the current funding systems in the three case studies 19
1.3.2. Impacts of changes and reforms in HE financing 20

2. THE RETURNS TO INVESTMENT IN HIGHER EDUCATION: METHODS,

DATA AND POLICY IMPLICATIONS. 24
2.1. Introduction 24
2.2. Returns species 24
2.3. Estimating methods 25
2.4. Data 29
2.5. Evidence 32
2.6. Equity 35
2.7. Policy 41
References 45
Annexes 49

3.THE DANISH FINANCING MODEL OF HIGHER EDUCATION 58

3.1. The Financing System 58
3.1.1. Financing of education - the taximeter principle 58
3.1.2. Financing of research at HEIs 60
3.2. Financing System and Higher Education Policies - The Formal Relationship 61
3.2.1. Financing of education 62
3.2.2. Financing of research 62
3.3. Effects of the Financing System on Higher Education 62
3.3.1. Financing of Education Effects of the taximeter system 62
3.3.2. Financing of research - intended and unintended effects 63
3.4. Strengths and Weaknesses of the Financing System - Stakeholders Views 65
3.4.1. Financing of education: 65
3.4.2. Financing of research 66

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3.5. The future of the Danish financing system 70
3.6. Conclusions 73

4. FUNDING REFORMS IN DUTCH HIGHER EDUCATION 75

4.1. Introduction 75
4.2. Funding in Dutch higher education 75
4.2.1. The Dutch higher education system 75
4.2.2. Funding flows in Dutch higher education 77
4.2.3. Funding teaching in Dutch higher education 78
4.2.4. Current funding of research in Dutch higher education 84
4.2.5. Tuition fees and student financial support in Dutch higher education 87
4.2.6. Other financial mechanisms 91
4.3. Impact of funding arrangements: opinions of various stakeholders 92
4.3.1. Some general trends 92
4.3.2. The impact of greater performance orientation in the funding HEIs 95
4.3.3. Impact of tuition and support policies on student enrolment behaviour 102
4.3.4. External opinions on funding issues 104
4.4. Critical summary 106
References 108

5. THE FUNDING OF THE UNIVERSITY SYSTEM IN THE REGION OF

VALENCIA, SPAIN 111
5.1. Features of the Valencian university system 111
5.2. Funding Valencian universities 113
5.3. The pluriannual funding system of Valencian universities 114
5.3.1. The first funding programme (1994-1998) 115
5.3.2. The Valencian public university systems second funding model (1999-2003).
118
5.4. The grant system 123
5.5. Investment plans 125
5.6. The external opinion on the Valencia funding system. 126
5.7. Conclusions 132

EXECUTIVE SUMMARY 136

Higher education funding: the current situation 136

Higher education funding: the role of the EC 136

Higher education funding: the rates of return 138

Higher education funding: some examples of funding models 138

Higher education funding: searching the right balance between equity and efficiency 140

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0. FOREWORD

0.1. Funding Higher Education in Europe

At present, most European universities are not competitive on a global scale with the
institutions of our major competitors; neither in access for European students
population, nor in attractiveness for third country students, nor in excellence of
education and research. The necessary reforms cannot be accomplished within the
current levels and patterns of investment. The funding gap between European
universities and the universities of our key competitors should be bridged to overcome
this.

The total (total public and private) spending on higher education in the EU 25 in 2002
was 1.3% of GDP (1.2% if we only take into account direct public spending and thus
avoid double counting), compared to 2.8% (2.6%) in the USA. The three highest
spending countries (total public and private spending) are Denmark (2.8%), Sweden
(2.3%) and Finland (2.2%). To close the spending gap with the US, the EU would have
to commit an additional 140 billion Euro per year, securing in particular substantial
increased investment from the private sector. For now, universities of our main
competitors have far more substantial means than those of European higher education
institutes.

As remarkable as the funding gap is the difference in the origin of the funding-sources
between European and Non European countries. Private resources are higher in most
all of our main competitors: Japan, Australia, Canada, US and Korea. Under-funding
and dependence on state funding do not only lead to the relative poverty of the higher
education sector. Consequences vary from low enrolment rates and failure to prepare
students for the European labour market to difficulties in attracting and retaining top
talent. The biggest funding deficit in European education and training is the
comparatively low contribution from private sources (companies and individuals) in
addition to (not as substitute for) the public funding.

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 0.2. Reducing the funding gap and make funding more efficient in
education and research

How to reduce the funding gap in order to offer more and better higher education to
European citizens and students from other countries? How to increase the funds for
research in order to make more competitive European science and technology, and
eventually increasing the well-being of European citizens?

Still there is room for more public investment in higher education. Nevertheless, most
of the new resources should be provided by private sources. There at least three
reasons for that. First, it is highly unlikely that additional public funding can alone make
up the growing shortfall of European higher education. Second, it would be fairer from
a social point of view a higher private participation in higher education funding. Third, a
higher private share will probably increase the effectiveness and efficiency of the whole
higher education system.

0.2.1. Contributions from students and industry

There is general agreement that graduates not only have more employability and
receive higher earnings, but also acquire higher social status, greater efficiency in
consumption, better health, greater access to technological change and a broad set of
cultural benefits including better opportunities for leisure. Benefits from education are
also gained by enterprises. General education reduces the need for training and
retraining when new technologies are incorporated. The higher productivity of more
educated people, especially those having the abilities and skills that transmit higher
education, is spilled out to other workers having an important effect on the whole
productivity of the enterprise. A considerable part of the externalities that higher
education graduates produce is captured not only by society in general (which justifies
the public funding of higher education), but specifically by enterprises and graduates.

On the other hand, enterprises are the primary and more direct beneficiaries of the
scientific and technical advancement produced largely in universities. Consequently,
the participation of enterprises in the funding of higher education institutions, through
research contracts, provision of services and philanthropic funds, could be considered
as a consistent restitution for the benefits that corporations receive from higher
education.

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At this moment, if both quality and equity are to be enhanced in European countries,
and public expenditure can not be largely increased, only a better balance between
public and private funding of higher education could be helpful. This better balance
should be the consequence of: a) the recognition that the benefits of higher education
accrue to private individuals and their employers; b) the expectation that competition
for funds will increase institutional efficiency and responsiveness to economic and
social needs; c) the recognition that social equity would improve if, at the same time, a
rational system of student aids is developed. It is within this situation that European
universities should look to raise private funds through three main sources:

Tuition Fees. Establishing or increasing tuition fees is a topic currently being

debated in many countries. Charging or increasing tuition fees, however, has
proved to be a very difficult policy from a political standpoint since it challenges
many of the fundamental precepts of egalitarianism and could raise conflicts
with students. On the other hand, the different levels of taxation in European
countries produce different approaches to this question.

Research and Service Contracts. Another source of private funds for European
higher education institutions has been sought through privately contracted
research and related services from industry. These activities seem to be on the
rise in all countries. The incorporation of private research and contracts is
nevertheless slowed by many of the traditional legal and structural factors of
highly state centralised university systems.

Fund raising. A third opportunity for universities to raise private funds comes
from voluntary support. However, with some exceptions, most European
universities have not seriously sought voluntary support until the present.

0.2.2. Increasing effectiveness and efficiency of public funding

An important question is how public resources should be poured in HEIs. Public funds
must be granted to higher education institution in such a way that effectiveness,
efficiency and quality are promoted. In this sense, funding tools that have been
experimented in some countries are the following:

Formula base funding. In many countries public funds are delivered to

institutions as a lump sum based on a set of variables related to costs but also

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 to basic outcomes. These experiences have shown a positive effect on
institutions and on their results.

Performance funding. Performance funding is the generalized way for funding

research but it is less usual for funding teaching activities. In some countries a
portion of the funds granted to higher education institutions are linked to the
achievement of certain standards which were previously agreed between public
authorities and institutions. The results of these experiences are also very
positive.

Competitive and targeted funds. As we have mentioned before, in spite of

research in Europe in under-financed comparatively with the US, indicators of
research outputs show that the gap is lower in results than in funds. This
indicates that efficiency of European basic research is relatively good. One of
the explanations may be the way of financing research. Generally speaking,
research is financed under criteria of competition among institution,
departments, research groups or individuals. In addition, most research
programmes previously set targets and objectives. There is another reason
explaining the relative success of European research: the European funds for
research. European research programmes have remarkably increased the
competence among research teams and they have opened the research
systems from a national, and sometime parochial, market to a more global one.
The question is, why do not translate these mechanisms to the core activity of
higher education institutions, the teaching and learning activities? Financing
targeted teaching activities or setting up programmes for financing educational
activities in a competitive way among institutions must be explored. In this case,
the possibility of establishing a broad European programme, similar to the
research framework programmes, for developing quality and competition among
European institutions for developing excellence should be considered.

0.3. Equity in higher education access

In European countries, data show a high participation in higher education. It seems

reasonable to assume that with this high level of participation, though no selection
criteria have changed and/or no affirmative actions have been implemented, the
opportunities of access to higher education for people of lower socioeconomic levels
should have improved.

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In many countries we find that the level of democratization and participation in higher
education of different socioeconomic groups has improved significantly, though
children from families in the bottom of the income distribution are underrepresented in
higher education. As suspected, low family incomes and parents low education levels
decrease the opportunity for children to enter higher education. Nevertheless, when we
consider both types of factors, we find out that educational levels are dominant, while
family income shows less influence in the decision to enter higher education. This
result emphasizes the importance, at least in more developed societies, of the
background factors which impel young people to enter higher education. These results
reveal that to equalize the probability of accessing to higher education for all individuals
requires compensating all the family and social shortages, among which parents
education and environment are the most significant factors.

These results from several European countries confirm a fact pointed out fro
researcher some time ago: the base for equity in higher education is not in entrance,
but in previous environmental conditions of the students. Complete equality could only
be reached if out-of-school influences vanish. Although this problem is not easy to
solve, it seems evident that it should be undertaken in earlier stages of the educational
process. Increasingly, it appears that academic ability, as reflected by academic
performance in high school and by performance on standardized tests, constitutes the
most important barrier to expanding access to higher education. Concurrently, efforts
are needed to enhance the academic performance of students in their pre-higher
education years. In consequence, public economic efforts should concentrate on pre-
higher education in order to guarantee equity in higher education.

0.4. The role of the EC

In regard to this situation the EC undertook an active role. The new investment-
paradigm in education and training was first set out in the Communication Investing
efficiently in education and training: an imperative for Europe in January 2003. The
need for a substantial increase in investment in human resources was raised in view of
reaching the Lisbon Goals: The lack of a clear upward trend in public expenditure on
education and training, and a deficit in private funding in key areas for the knowledge
economy, calls for a smart combination of targeted public investments and higher
private contributions. The price of investing in education and training is outweighed by
high private, economic and social returns. The Communication suggested Member

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States to target investment on the long term efficiency of systems and to focus on
areas where it is most likely to produce more quality, relevance, efficiency and access
possibilities.

The Communication Mobilising the Brainpower of Europe: enabling universities to

make their full contribution to the Lisbon strategy gave a comprehensive overview of
the role of universities in achieving the Lisbon Goals and it provided suggestions for a
modernisation agenda. The Communication underlined that closing the funding gap
with our main competitors is a core condition for achieving the Lisbon Strategy. It called
upon Member states to have fiscal rules enabling and encouraging partnerships
between business and universities, also to provide continuing strength to universities.
And lastly it pointed to the need to build in guarantees for fair access to higher
education.

In "Time to move up a gear", the European Commission's 2006 Annual Progress

Report on Growth and Jobs, the aim for the EU to devote at least 2% of GDP to higher
education by 2010 is reconfirmed. By the end of 2007, universities should be allowed
and encouraged to seek complementary private sources of funding.

On 23/24 March 2006 the European Council called on the Member States to facilitate,
in line with national practices, universities' access to complementary sources of
funding, including private ones, and to remove barriers to public-private partnerships
with businesses.

In May 2006 the new Communication Delivering on the modernisation agenda for
universities: education, research and innovation established nine strategies for the
modernization of European Higher Education. One is the need of to reduce the
funding gap and make funding work more effectively in education and research. For
reaching this goal, the Commission proposes that the EU should also aim, within a
decade, to devote at least 2% of GDP (including both public and private funding) to a
modernised higher education sector. Member States should therefore critically examine
their current mix of student fees and support schemes in the light of their actual
efficiency and equity.

The need of increasing private funds is based in the assumption remarked by the
Communication, that money spent on obtaining university qualifications pays returns

11
higher than real interest rates. Rates of return to higher education become an
important issue for supporting this funding increase.

The Communications also made recommendation about the way of implementing these
funding reforms: Universities should be funded more for what they do than for what
they are, by focusing funding on relevant outputs rather than on inputs, and by
adapting funding to the diversity of institutional profiles. Universities should take greater
responsibility for their own long-term financial sustainability, particularly for research:
this implies pro-active diversification of their research funding portfolios through
collaboration with enterprises (including in the form of cross-border consortia),
foundations and other private sources. Each country should therefore strike the right
balance between core, competitive and outcome-based funding (underpinned by robust
quality assurance) for higher education and university-based research. Competitive
funding should be based on institutional evaluation systems and on diversified
performance indicators with clearly defined targets and indicators supported by
international benchmarking for both inputs and economic and societal outputs.
Consequently, not only more resources are needed, the way of allocating public funds
and the ability for obtaining private funds are also key aspects for the modernisation of
European higher education.

Finally, regarding efficiency and equity aspects on European higher education, the EC
has issued in September 2006 the new communication Efficiency and equity in
European education and training systems. This communication is accompanied by two
other documents: the Analytical Report for the European Commission prepared by the
European Expert Network on Economics of Education (April 2006), and the Staff
Working Paper (September 2006) both under the same title of the communication. The
three documents give a clear overview about efficiency and equity problems in
European education and the communication propose policies that should be
implemented by Member States in order to solve some of these problems.

This new communication remarks that there has been a steady growth in student
numbers and a widening of the expectations placed upon European universities, but
funding levels have not risen accordingly. At the same time, the expansion of student
numbers has not increased equity as it has mostly favoured individuals from higher
socio-economic groups or those whose parents attended higher education. [..] As a
result of inequities earlier in the education cycle, pupils from disadvantaged

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backgrounds often do not achieve the level of qualifications needed to access higher
education. Even those that do are often reluctant to consider going on to university.

The problem of equity in access to higher education is becoming a relevant issue for
the future of European higher education. The most generalised assumption is that a
free or low cost system of higher education will allow people from lower
socioeconomic background a high access to higher education. Nevertheless, facts do
not support this assumption and the main determining factor in higher education
participation is still parents socioeconomic background. On the other hand, there is
evidence of significant private returns on higher education and tax systems do not
compensate this advantage for those accessing higher education. Consequently, a
low cost higher education is actually regressive from a social point of view. The
Communication states: Evidence also suggests that the market effects of tuition fees
may improve the quality of teaching and management in universities, and reinforce
student motivation. Clearly, the development of tuition fees without accompanying
financial support for poorer students risks aggravating inequity in access to higher
education. In conclusion this documents states: Free access to higher education does
not necessarily guarantee equity. To strengthen both efficiency and equity Member
States should create appropriate conditions and incentives to generate higher
investment from public and private sources, including, where appropriate, through
tuition fees combined with accompanying financial measures for the disadvantaged.
Specific actions at school level are also needed. Higher education institutions should
offer a more differentiated range of provision and incentives to meet increasingly
diverse social and economic needs.

0.5. The present study

The objective of this study is to present evidence of some relevant facts to support the
process of improving the funding of European universities. In this sense, two set of
studies are presented:

1. Summary. Chapter 1 is a summary of the three case studies and the rate of return
chapter. This Summary provides an overlook on the whole study. It has been
prepared by Prof. Luis E. Vila, Professor of Economic of Education at the University of
Valencia.

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2. Rate of return analysis. In the 2nd chapter a throughout review of rates of returns to
higher education is presented. This chapter has been written by George
Psacharopoulos, the greatest authority in the world regarding this matter.

3. Funding models. In order to present the cases of some European countries where
innovative funding higher education models have been implemented, we have
selected:
3.1. Denmark. It has an innovative system of institutional financing and a broad system
of students aid. Both could be an example for other European countries. Dr.
Evanthia Kalpazidou Schmidt, from the Danish Centre for Studies in Research and
Research Policy is the author of chapter 3rd on Danish funding model.

3.2. The Netherlands. It represents a well developed system of higher education

financing both at institutional level and at student level. Dr. Hans Vossensteyn,
researcher in CHEPS is the author of chapter 4th, has been in charge of this
chapter.

3.3. Spain-Region of Valencia. Institutional financing is a regional responsibility in

Spain. The Region of Valencia implemented a model in 1993 that have been
adapted along the time. This model was a reference for other similar models in
Spain and it has produced interesting impacts. Prof. Enrique Villarreal, University
of Valencia, and Director General for Higher Education when the first model was
implemented is the author of chapter 5th.

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1. SUMMARY

1.1. Introduction

The purpose of this summary is twofold. First, to provide an overview of the evidence
about rates of return to investment in HE based on existing data, and of its main
implications regarding equity through the public subsidization for HE. Second, to
evaluate the impact of reforms in HE funding undertook in diverse countries regarding
their current education policy context. The three case studies include Denmark, the
Netherlands, and Comunitat Valenciana (CV), one of Spanish autonomous regions. As
knowledge about more effective ways to increase social wellbeing through education
progresses, funding policies and instruments should be continuously adjusted to the
most effective models of public funding for education.

1.2. Returns to HE

Investment in HE generates benefits that have been identified and measured in diverse
ways. The rates-of-return analysis covers only those benefits emerging from HE that
are realized in monetary terms through labour market participation, thus ignoring all
non-monetary effects of HE on peoples wellbeing.

Private rates of return are based on the costs and benefits of education for individual
students. Estimation compares how much people actually pay to attend HEIs, relative
to what they will earn, after taxes, relative to a control group who did not pursue HE.
This is a private spending efficiency question, likely to explain the behaviour of
students regarding HE demand. Private rates of return are used to analyze the equity
effects of public subsidies to HE.

Social rates of return are based on the costs and benefits of education for society as a
whole. The costs refer to what HE really costs to be provided, rather than just what
people pay. The benefits should be based on productivity differentials, rather than
earnings, although most often earnings before tax are used to proxy for productivity.
Ideally, estimation of social returns should also include the external effects, that is, the
benefits HE graduates spill over other members of society. This distinction between
"narrow" (without externalities) and "wider" (with externalities) social benefits is relevant

15
because, depending on the sign and size of external effects, different policy
conclusions could be reached. The social returns to HE are used to assess the
efficiency of public spending on HE.

There are two main approaches to the estimation of rates of return: the full discounting
method and the Mincerian equation method.

The full-discounting consists in calculating the internal rate of return based on

individual age-earnings profiles that vary over time. This is considered the most
appropriate method of estimating the returns to education because it takes into account
the most important part of the early earnings history of the individual. However, this
method requires a sufficient number of observations in each age-educational level cell
for constructing the age-earnings profiles.

The Mincerian equation method estimates the returns by fitting a regression with log-
earnings as dependent variable and education and work experience as explanatory
variables. The advantage of the Mincerian way of estimating the returns to education is
that it can handle incomplete cells in an age-earnings profile matrix by level of
education. The disadvantage is that it requires a sample of individual observations,
rather than pre-tabulated mean earnings by level of education.

Ample evidence, obtained using state-of-the-art econometric instruments over the best
data sets available, suggests that private returns to HE in developed countries are
positive and substantial. Estimation results also point out that the "narrow" social rates
are also positive but lower than the private rates; to the contrary, the evidence on the
"wider" social returns is much more limited because of the difficulties to conceptualize
and calculate the social externalities of HE. The analysis of existing evidence about
rates of return reveals some basic patterns:

The returns to education are higher in developing relative to advanced industrial

countries a reflection of the relative scarcity of human capital in poor countries

The private returns exceed the social returns a reflection of the public
subsidization of HE

The returns to HE have been rising in most dynamic economies in recent years a
reflection of the increased demand for educated manpower to complement
advances in technology

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 There exists wide differentiation of the returns by university faculty a reflection of
the relative demand and supply for graduates

Table 1 presents private rates of return to a number of OECD countries using a uniform
methodology (Mincerian equation) and data set (mainly the European Union Household
Panel Survey). These private rates certainly exceed the private returns to alternative
investment opportunities in OECD countries.

Table 1. Private returns to investment in HE, 2001

Country Rate of return (%)

Austria 5.9
Belgium 7.0
Denmark 5.8
Finland 6.8
France 5.8
Germany 4.3
Greece 4.8
Ireland 10.7
Italy 5.1
Luxembourg 10.5
Netherlands 5.7
Portugal 14.8
Spain 5.7
Sweden 4.8
UK 5.1
USA 7.0
Source: OECD (2006), Table 4.
Note: Studies duration for Belgium, Luxembourg, Portugal and
USA not available in original assumed to be 4.5 years.

Table 2 shows estimates of narrow social rates of return for some OECD countries1.
Again, these rates compare well to any measure of the social opportunity cost of capital
in the countries concerned.

1
Rates of return in Tables 1 and 2 are not directly comparable as they are based on different years,
dataset and methodology.

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 Table 2. Narrow social rates of return to HE, 2002

Country Rate of return (%)

Belgium 5.6
Denmark 4.8
Finland 11.0
Italy 8.4
Netherlands 8.4
Norway 6.8
Sweden 5.2
Switzerland 6.1
United States 12.4
Source: OECD, Education at a Glance 2005, p. 143,
Tables A9.9 and A9.10, males.

So, HE appears to be a profitable investment opportunity for individuals compared to

other private investment opportunities, as well as for societies at large compared to
social opportunity costs. However, two elements should be taken into account to
determine the optimal public funding for HE based on its rates of return. First, public
finance priority should be given to lower levels of education if their social returns
exceed those of HE; second, increased public subsidization of HE should be called for
if the social externalities of HE exceed by far the corresponding "narrow" social returns.

The returns to education have implications regarding equity questions too. It is well
known that high socioeconomic background students have a much better chance of
entering HE; additionally, there is limited evidence showing that they also obtain higher
returns than low students from lower backgrounds. Regressive income redistribution
effects of public financing of HE have been documented in many countries. Hence,
improving equity through HE will require targeted investment at earlier educational
stages as well as mentoring and counselling throughout the whole school cycle in order
to facilitate low socioeconomic background students, first, to enrol and complete HE,
and, second, to succeed later in the labour market.

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 1.3. Changes and Trends in the Financing of HE

1.3.1. An outline of the current funding systems in the three case

studies

In the Netherlands, there are four major funding flows that constitute the revenues of
HEIs. First, the basic funding provides the regular core funding for teaching and
research for universities and the hogescholen. HEIs are free to spend the grant as they
wish, provided it is for teaching and research. The size of this grant depends on a
formula. The research part of this grant represents about two-thirds of the total. The
second stream refers to competitive research grants provided by the Dutch Research
Council (NWO). The third stream funding concerns the revenues from contract
activities, consultancy and commercialisation of research activities. A large part of the
third stream activities refer to knowledge transfer in the sense of research carried out to
fulfil demands of the industry, the government and other public sector organizations. A
slightly smaller part refers to contract teaching for companies and individuals, short
courses, and lifelong learning. However, the largest part is contract research carried
out for government and not-for profit organizations. The fourth stream comes from the
tuition fees.

Danish Higher Education receives funds from the Ministry of Education to provide free
education through the so-called taximeter system, which links funding directly to the
number of students who pass exams. The teaching component is based on a unit-cost
principle, where an amount of money is paid to the university for each student who
passes exams. Denmark has a two-tier system for resource allocation to research. The
first tier is the basic grants from the Financial Act allocated by the different ministries
directly to the institutions. The second tier comprises resource allocation from the
National Research Councils, strategic research programmes, foundations, R&D funds
from the individual ministries, and private funds. Tuition fees have been introduced for
foreign, non-European students and for some courses tailor-made for adult education
and the needs of the entrepreneurial sector. Currently, the Danish financing system is
under rapid change. All aspects of the existing system, including the three main
sources with respectively the taximeter model, the basic grants and the external grants,
have recently been reformed or are expected to be reformed in the near future.

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In Spain, autonomous regions are responsible for the financing of HEIs. The CV was
the first region in establishing a financing model based on a formula calculation for
effective per-student cost. Currently, the financing for HEIs is the sum of four
components. First, a basic grant determined through an objective formula under
effective per-student cost principles. The public subsidy is calculated as the part not
covered by the private sources, and represents over 69% of total funding. It should be
noticed that the system operates on an open-ended budget basis, since the overall
amount of the public subsidy is not pre-determined, but calculated within the model.
Second, a financing stream linked to objectives regarding teaching, R&D,
employability, innovation, management, and cultural promotion, which are measured
through 31 objective indicators, and is intended to represent 10% of total financing for
HEIs, although the mark has not been yet reached. Third, a sum financing for costs
induced by national regulation modifying the elements used to determine per-student
cost or reducing other income sources of HEIs, which represents about 2% of total
financing. Finally, a fixed minimum grant, equal for all HEIs, intended to represent a
mere 1.25% of their total funding.

1.3.2. Impacts of changes and reforms in HE financing

The reforms related to the funding of HE in the three case-studies depict two common
major trends as funding-related means to increase efficiency and equity without quality
loses.

First, there is a general tendency towards increasing spending autonomy

leading to full freedom in the internal allocation of resources of HEIs

Second, there is a development towards greater transparency and simplicity in

the funding mechanisms, with an emphasis on the accountability of HEIs
performance

These two trends are the result of a multiplicity of changes in the financing
mechanisms and instruments for HE. The most noteworthy changes, their advantages,
disadvantages, and already observed impacts in terms of efficiency and equity gains
are the following:

20
 a) Changes from funding based on claiming public funds towards funding based
on objective formulae

Basic funds allocated through objective formulae are perceived as capital to HEIs for
long-term planning, for their adaptation to changes in the demand, and for the outcome
and quality of teaching and basic research. This type of mechanism states direct
demands on the amount of funds required and indirect demands on the quality in HE.
Because of principles of "lump sum" granting and the self-governing nature of HEIs, the
basic funds allocated through transparent formulae represent to HEIs increased
freedom to re-allocate their funds between teaching, research and other expenses.
However, the elements included on the formulae and the formulae themselves vary
substantially between countries, between fields of study within a country, and over
time. Moreover, the impacts of this mechanism depend on whether it operates on and
open-end or on a closed budget basis, and on whether input or output indicators
dominate in the distribution formulae.

b) Change from open-end funding to closed budget for HE

The move from open-end to closed budgets not only establishes bounds to the claims
for the allocation of extra resources to HE, but also enhances productive efficiency of
HEIs, especially when funds are distributed on the basis of performance. This type of
mechanism forces HEIs to use internal instruments to guaranty budgetary discipline,
and urges them to closely monitor for the performance of their academics in order to
keep current funding or to gain extra resources. The main risk of open-end funding is
the permanent increase of the public subsidy to, and even of the total cost of HE, as
has happened in the CV system. The move towards closed budgets may, on the other
hand, result in a risk of substantial decreases in the real value of funds available for HE
if public funds keep not pace with the growth of the demand for HE, as in the
Netherlands. This may force HEIs institutions to make continuous efficiency cuts, which
will presumably result in severe quality reductions in the long run.

c) Change from financing input towards output-based funding for HE

In the distribution of basic funding through objective formulae, output-based funding

according to effective-cost principles establishes an amount of money that is allocated
to HEIs for each student who passes exams or graduates, rather than for each full-time
enrolled student. Output-based funding systems enhance efficiency since there is no
direct link between the subsidies received and the actual expenditure of HEIs, thus

21
providing incentives for adapting the provision of HE to social demands and for efficient
educational production. As a consequence, HEIs are willing to improve their productive
efficiency to gain extra resources that increase funding autonomy. Reducing student
dropout and duration of study is a key efficiency objective in the three cases analyzed.
In the Netherlands and Denmark, with output-based basic financing, dropout rates and
average duration of study have systematically decreased over time. To the contrary, in
the CV as well as in the rest of Spain, where basic funding is still input-based, dropout
and excessive study duration are still lasting problems that need to be addressed.
Nevertheless, efficiency in the education process could also be influenced by changes
in course structures, and may be increased in the long run by using combinations of
many other policy instruments. These may include shorter nominal study programmes,
more flexible learning paths and structures, greater student inputs in teaching matters,
and financial incentives for students and institutions to stimulate efficient degree
completion.

d) Change towards linking basic funding to objectives through performance

indicators

Funding based on objectives improves the efficiency in the education process, since
the lack of use of performance indicators in the allocation of funds weakens the
mechanisms specifically intended to enhance educational productivity. Accuracy in the
formulation of key objectives becomes capital for the effectiveness of this funding
instrument. The CV experience shows how even a relatively small share of funding
related to a modest list of objectives does improve efficiency, while linking funding to a
too complex set of objectives results in difficulties to decide the appropriate
performance indicators and, ultimately, in reduced funding and efficiency cuts.
Certainly, increasing the pressure on HEIs from performance objectives and
accountability of teaching and research outcomes may push academics to latently
decrease standards and threaten quality assurance in HE. However, the Dutch
experience in the use of incentives linked to performance indicators shows that the
quality levels do not necessarily suffer because of the pressure for efficiency; rather to
the contrary, quality assurance has been progressively integrated as a natural fact in all
aspects of academic life. Indeed, a greater emphasis on linking funding to objectives
has led in this case to improved performance of academics regarding both teaching
and research.

22
 e) Increased share of funding allocated through competition

Competition for external research funds stimulates more dynamic research agendas by
promoting applicability and quality of the results obtained from academic research. If
competitive research funding is focused in the right areas, competition among
researchers and HEIs would increase reflection, originality, creativity, and innovation,
thus raising the social value of research outcomes. Additionally, HEIs would further
increase their factual possibilities of autonomy and self-governance by gaining
competitive research funds. However, increasing the share competitive research funds
would result in three main risks if competition is ill-targeted. First, it would limit the
possibilities for long-time research planning for the HEIs. Second, it would cut current
research on areas where funding is more difficult to obtain, irrespective of its social
value. Third, it would generate a move regarding strategic management of HEIs to the
funding agencies.

f) Increasing the share of private sources in HE financing

The need for extra resources, as well as the realization about the private returns to HE
being higher than the social returns, highlights the need for a shift from public budgets
to private sources in HE financing. A greater share of costs is to be asked of students
and their families by means of tuition fees and student loans since HE graduates are
the main beneficiaries of HE. At the same time, a greater emphasis is placed on HEIs
market oriented activities such as research contracts and consultancy as founding
sources. The Dutch case illustrates how increasing the share of funding from private
sources by raising tuition fees and student loans does not have necessarily a strong
negative impact on equity: The influence of higher tuition fees on student enrolment
behaviour is neutral when potential students from lower income groups or other socially
deprived groups are adequately compensated by grants and scholarships.
Nonetheless, when the systems of scholarships and financial support to students are
weak and unreliable, as in the CV case, debt aversion and fear of tuition may become
insurmountable barriers for the application of cost-sharing instruments such as tuition
fee differentiation and income contingent repayment.

23
2. THE RETURNS TO INVESTMENT IN HIGHER EDUCATION: Methods,
Data and Policy Implications.

2.1. Introduction

The purpose of this chapter is to provide an overview of the rates of return to

investment in higher education based on existing data, incorporating where possible a
differentiation for socio-economic background. The chapter discusses the shortcomings
of the methods and data available. The size and pattern of the returns to higher
education are put in the current education policy context.

Before presenting the rate of return evidence, it is essential to understand what these
rates are (section 2.2), how they are being estimated (section 2.3) and on what kinds of
data (section 2.4). Section 2.5 presents the available evidence on the returns to higher
education, while section 2.6 adds the equity dimension. The final section 2.7 discusses
the policy implications of the evidence.

2.2. Returns species

There are several types of returns to education, depending on the question one is
interested in answering, e.g. how efficient is public spending on education, what is the
return to an individual investing in higher education, or how much the state gets back
relative to what it spends on education.

Private returns are based on the costs and benefits of education, as those are
realized by the individual student, i.e. how much he/she actually pays out of pocket to
attend a higher education institution, relative to what he/she gets back, after taxes, in
terms of increased earnings, relative to a control group of secondary school graduates
who did not pursue tertiary education studies. This is a private spending efficiency
question. Private rates of return are used to explain the behaviour of students
regarding the demand for higher education, or the equity effects of state subsidies to
education.

Social returns are based on the costs and benefits of education, as those are realized
by the state or society as a whole. The costs are all inclusive, i.e. they refer to what
education really costs, rather than just what the students pay out of pocket. Earnings

24
are before tax, as taxes are a zero-sum-game regarding the social calculus. Social
rates of return should be based on productivity differentials, rather than earnings. They
should also include external effects of education, e.g. a higher education graduate
spilling benefits to others by means of being more educated. The social returns to
education are used to assess the efficiency of public spending on education, and can
be used as a guide on whether to expand or contract a particular university faculty.

Fiscal returns to education are based on a narrow measure of costs and benefits
those relating to the public coffer. They can be used to assess how well the Treasury is
doing when spending on education. They relate to the countrys public finances and are
not estimated as widely as the private and social rates.

Narrow vs. wide social returns. Ideally, the benefits part of a social rate of return
estimation should include external effects, i.e. benefits that are realized by others than
the individual investor. An externalities-inclusive social rate of return is called wide,
vs. the narrow social rate of return that includes only benefits internalized by the
individual. This distinction is important because, depending on the size of externalities
and the differential externalities between levels of education, diametrically opposite
policy conclusions could be reached.

Pseudo-returns. The literature contains a plethora of papers purporting to have

estimated the returns to education, although the authors have really estimated the
wage effect, i.e., the earnings advantage of a particular graduate. A proper rate of
return estimation should also take into account the cost incurred for achieving that
advantage.

2.3. Estimating methods

In the empirical literature, two main methods have been used in arriving at rate of
return estimates: the full-discounting or elaborate method, and the Mincerian
earnings function method. Historically, the elaborate method was used in the beginning
of the economics of education in the early sixties, followed by the Mincerian method in
the seventies. Both methods try to map observed data, as those illustrated in Figure 1,
to a rate of return formula. 2

2
See Psacharopoulos and Mattson (1998).

25
26
Figure 1: Stylized age-earnings profiles

Earnings

University

Graduates

Benefits

Secondary School

Leavers

Costs

0 Age
18 23 65

Time (years)
5 42

27
The full-discounting or elaborate method, consists in calculating the internal
rate of return based on individual age-earnings profiles that vary over time (t), i.e.,

n (W Ws )t m
= (W C u )(1 + r ) ,
u t
+
t = m +1 (1 + r )
t s
t =1

where (r ) is the discount rate that equates the benefits from the extra education

(proxied by earnings differentials in the economy), to the sum of opportunity costs

(foregone earnings of the student while studying), and the direct resource costs of
schooling at a given point in time. Thus, (Wu Ws ) t is the difference in earnings

between two levels of education.3 Wu is the annual earnings of a more educated

person.

The Mincerian earnings function method starts by fitting a regression to the data
in the form

ln Wi = + p D p + s Ds + u Du + 1 EX i + 2 EX i 2 + i

where EX stands for years of labor market experience, defined as

Age S School starting age , and D is a 0-1 dummy variable corresponding to the
subscripted level of schooling (Mincer 1974). The private rate of return to higher
education can then be calculated from the earnings function by the following formula,

u s
ru = .
Su S s

The discounting of actual net age-earnings profiles is the most appropriate method of
estimating the returns to education because it takes into account the most important
part of the early earnings history of the individual. However, this method requires
comprehensive data one must have a sufficient number of observations in a given

3
In this example, subscripts u and s stand for university and secondary education, respectively.

28
age-educational level cell for constructing "well-behaved" age-earnings profiles (that is,
not intersecting with each other).

The advantage of the Mincerian way of estimating the returns to education is that it can
smooth out and handle incomplete cells in an age-earnings profile matrix by level of
education. The disadvantage, of course, is that it requires a sample of individual
observations, rather than pre-tabulated mean earnings by level of education.

2.4. Data

The data used for estimating a rate of return to investment in education depend on the
type of the returns one is interested in. Private and fiscal rates can be estimated on the
basis of observed after-tax earnings in all sectors of the economy and the cost of
education to the individual.

In a social rate of return calculation, the costs include the state's or society's at large
spending on education. This includes the rental of public school buildings and teachers
salaries. Gross earnings (that is, before taxes and other deductions) should be used in
a social rate of return calculation, and such earnings should also include income in kind
where this information is available.

A key assumption in a social rate of return calculation is that observed wages are a
good proxy for the marginal product of labour. This could be the case in a competitive
economy using data from the private sector. Civil service pay scales are irrelevant for a
social rate of return calculation as they are unlikely to represent marginal productivity.
The pay of civil servants, however, should be used in calculating the private returns to
education, as it reflects what people actually get, regardless of productivity.

The "social" attribute of the estimated rate of return refers to the inclusion of the full
resource cost of the investment (direct cost and foregone earnings). Ideally, the social
benefits should include non-monetary or external effects of education -- for example,
lower fertility or lives saved because of improved sanitation conditions followed by a
more educated woman who may never participate in the formal labour market. Given
the scant empirical evidence on the external effects of education, social rate of return
estimates are usually based on directly observable monetary costs and benefits of
education.

29
Since the costs are higher in a social rate of return calculation relative to the one from
the private point of view, social returns are typically lower than a private rate of return.
The difference between the private and the social rate of return reflects the degree of
public subsidization of education.

The benefits of education are typically classified into a four-cell matrix, as shown in
Table 1 (McMahon 1997, Wolfe and Zuvekas 1997, Villa 2000). The easiest to
document benefits are those in the northwest quadrant, namely private benefits that
manifest themselves in the labour market and can be measured in monetary terms.
The hardest to document benefits are those in the southeast quadrant, namely the
social benefits that are not directly observed or measured in monetary terms.

Table 1 A classification of the benefits of education

Benefits type Private Social

Market Employability Higher productivity

Higher earnings Higher net tax revenue

Less unemployment Less reliance on government

financial support
Labour market flexibility

Greater mobility

Non-market Better consumer efficiency Reduced crime

Better own and family health Less spread of infectious

diseases
Better children quality
Lower fertility

Better social cohesion

Voter participation

Sample selection should be random, i.e. being representative of the population as a

whole. Data should refer to the individual person, rather than tabulated mean earnings
by level of education, as was practiced in the early days of the economics of education.
Individual earnings allow for the control of covariates, i.e. factors correlated with
education that affect earnings, e.g. differential ability or socioeconomic background.

30
Randomly generated data, along with covariates, is the exception rather than the rule.
It is problematic when the estimated rates of return are based on a survey of firms
rather than households because firm-based samples are highly selective. In order
to control survey costs, such samples focus on large firms with many employees.
Second, the questionnaire is typically filled by the payroll department rather than by the
individual employee. Typically, this approach leads to the use of samples concentrated
only in urban areas.

Data generated by virtue of natural experiment are much better relative to econometric
control for covariates, e.g. identical twins separated early in life and receiving different
amounts of education. Or, because of a military draft legislation, or month-of-the-year
birth date, some people received different levels of schooling than others.

Another problem occurs when rate of return estimates are based on samples that
include civil servants. On average, the inclusion of civil service pay flattens the
earnings differentials giving lower returns among those working in the public sector
(Psacharopoulos, 1983). Of course, in many countries although fewer now than in the
past the majority of university graduates end up in public sector employment.
However, civil-service-pay based rate of return estimates are useful in private
calculations regarding the incentives set by the state to invest in education.

Covariates. Beyond education, there is large list of factors that may affect earnings,
such as differential ability. The undisputable and universal positive correlation between
education and earnings can be interpreted in many different ways. The causational
issue on whether education really affects earnings can only be answered with
experimental data generated by assigning at random different people to various levels
of education. Given the fact that moral and pragmatic considerations prevent the
generation of such pure data set, researchers have used indirect inferences or natural
experiments. Examples of a natural experiment in this context is identical twins who
were separated early in life and received different amounts of education (as to control
for differences in genetic ability) or differential date of birth and eventual educational
attainment. Estimates of the returns to education based on twins samples have
corroborated the statistically significant link between education and earnings
(Ashenfelter and Krueger 1004, Ashenfelter and Rouse 1998).

31
 2.5. Evidence

Before presenting the formal rate of return estimates to higher education, let us list two
major benefits enjoyed by higher education graduates. As shown in Table 2 there is a
negative relationship between holding a university degree and being unemployed. On
average, those who have not completed upper secondary education are two and a half
times more likely to be unemployed relative to tertiary education graduates.

Table 2. Unemployment rate by level of education (%)

Country Below Upper Upper Secondary Tertiary

Secondary

Australia 7.0 4.3 3.0

Canada 10.9 6.5 5.2
France 12.1 7.5 6.1
Germany 18.0 10.2 5.2
Japan 6.7 5.4 3.7
UK 6.9 3.9 2.4
USA 9.9 6.1 3.4
OECD mean 10.2 6.2 4.0
Source: OECD (2005), Table A8.4a, p. 113-114
Note: Number of 25-64 year old who are unemployed as a percentage of the labor force aged 25-
64.

Not only higher education boosts employment chances, but once employed graduates
have a clear earnings advantage (Table 3). In the United States, the earnings of tertiary
education graduates are two and a half times higher than those of high school
dropouts.

32
 Table 3. Relative earnings of the population 25-64 year old with income from
employment by level of education (Index)

Country Below Upper Upper Secondary Tertiary

Secondary
Australia 77 100 132
Canada 79 100 136
France 84 100 150
Germany 87 100 153
Korea 67 100 141
UK 69 100 162
USA 70 100 183
Source: OECD (2005), Table A9.1a, p. 130.
Note: Index base, upper secondary education = 100.

There have been several compilations of the returns to education, both at the World
scale4 and for several OECD countries.5 Annex tables A-1 to A-4 present as a master
reference the returns to higher education in a large number of countries classified
across several dimensions. The basic pattern that emerges is that:

The returns to education are higher in developing relative to advanced industrial

countries a reflection of the relative scarcity of human capital in poor
countries.

The private returns exceed the social returns a reflection of the public
subsidization of higher education.

The returns to higher education have been rising in most dynamic economies in
recent years a reflection of the demand for more educated manpower to
complement advances in technology.

There exists wide differentiation of the returns by university faculty a reflection

of the relative demand and supply for graduates.

Most of the estimates presented in the Annex master tables are dated, and many have
been based on very selective samples to be representative of the true recent trends.

4
Psacharopoulos (1972a,b,c, 1973, 1981, 1985, 1989, 1994), Psacharopoulos and Patrinos
(2004a).
5
Asplund and Pereira (1999), De la Fuente ( 2003), Blondal et al. (2002), OECD (2005, 2006).

33
Table 4 presents private rates of return to a number of OECD countries using a uniform
methodology (the Mincerian earnings function) and data set (mainly the European
Community Household Panel). Private returns in most countries are of the order of 4-7
percent, and are especially high in Ireland, Luxembourg and Portugal. These private
rates certainly exceed the private returns to alternative investment opportunities in
OECD countries, e.g. Bank deposits.

Table 4. Private returns to investment in higher education, 2001

Country Rate of return (%)

Austria 5.9
Belgium 7.0
Denmark 5.8
Finland 6.8
France 5.8
Germany 4.3
Greece 4.8
Ireland 10.7
Italy 5.1
Luxembourg 10.5
Netherlands 5.7
Portugal 14.8
Spain 5.7
Sweden 4.8
UK 5.1
USA 7.0
Source: OECD (2006), Table 4.
Note: Studies duration for Belgium, Luxembourg, Portugal and USA not available in
original assumed to be 4.5 years.

The OECD has recently produced comparable narrow social rates of return estimates
for some of its member countries (Table 5). These rates range from 4-8 percent in most
countries, and are especially high in Finland and the United States.6

Again, these rates compare well to any measure of the social opportunity cost of capital
in the countries concerned.

6
Rates of return in Tables 4 and 5 are not directly comparable as they are based on different years,
dataset and methodology.

34
 Table 5. Social rates of return to higher education, 2002

Country Rate of return (%)

Belgium 5.6
Denmark 4.8
Finland 11.0
Italy 8.4
Netherlands 8.4
Norway 6.8
Sweden 5.2
Switzerland 6.1
United States 12.4
Source: OECD, Education at a Glance 2005, p. 143, Tables A9.9 and A9.10, males.

The OECD also presents returns from another point of view, that of the state as
collector of taxes. The provision of education at all levels entails loss of taxes from
those who are in school or at the university. It also entails higher tax revenue from
those who graduate and have higher incomes. As shown in Table 6, the result in all
countries is a gain from the fiscal view point (Table 6).

Table 6. Fiscal rates of return in OECD countries by level of education, 2002 (%)

Country Rate of return (%)

Belgium 5.6
Denmark 4.8
France 6.7
Finland 4.8
Italy 9.5
Netherlands 10.7
Norway 4.1
Sweden 1.7
United States 12.3
Source: OECD (2005), p. 143, Tables A9.7 and A9.8, males.

2.6. Equity

Beyond the private and social efficiency questions, the returns to education can be
used to answer equity questions. For example, in the United States there has been
increased wage inequality between 1973 and 2005, and this has been attributed to the

35
increase in the returns to investment in higher education (Lemieux, 2006). This in turn
is due to the increased demand for skilled workers (Chilhui et al. 1993, Hauser et al.
1973).

Higher education access. To start with, higher socioeconomic (SES) students, as

measured by the education of their parents, have a much better chance of entering
higher education (Table 7).7

Table 7. Impact of parental education on access to tertiary education (%)

Parental education
Below upper Tertiary
secondary education
Country
education
Australia 20.0 39.2
Belgium 15.3 49.7
Canada 23.7 57.2
Germany 16.0 38.4
Ireland 12.0 57.4
Netherlands 12.8 42.6
New Zealand 21.4 45.3
Sweden 18.7 40.2
United Kingdom 16.5 47.0
United States 19.7 64.2
Source: OECD (2001).
Note: Percent of the population 16-65 years who have completed tertiary education, by
level of educational attainment of parents.

Higher education students come from a higher socioeconomic status relative to the rest
of the population. The representation index shown in Table 8 is the ratio of the
proportion of students whose father has a university degree and the proportion of
university degree holders in the population. A value of 1 means equal representation.
The higher the index, the more inequitable the system. Tables 9 and 10 document a
similar inequitable situation in Greece and the UK.

7
See also Haveman and Wolfe (1985, White (1982).

36
 Table 8. Representation of university students by fathers SES, 2005

Country Higher SES representation

index
Germany 2.1
Spain 1.5
France 2.0
Ireland 1.1
Italy 1.8
Netherlands 1.6
Austria 2.6
Portugal 5.4
Finland 1.8
Source: Eurostudent, 2005.

Table 9. The inequity of university access, Greece

Fathers occupation (1) Labour force Student entrants Representation

share (%) (3) index (4)
share (%) (2)
Executive and managerial 21.8 26.0 1.2
White collar worker 31.4 48.0 1.5
Manual worker 29.4 14.0 0.5
Farmer 16.5 5.0 0.3
Source: Psacharopoulos and Papakonstantinou (2005)
Note: Col. (4) = [Col. (3) / Col. (2)

Table 10. Probability of attaining a university degree by fathers occupation, UK

Fathers occupation Probability of child attaining a

university degree (%)
Professional 42
Non-manual worker 27
Unskilled manual 5
Source: Dutta et al. (1999).

One reason for such differentiation is that those coming from higher SES
families are better able to pay and prepare for university entry (Table 11).

37
 Table 11. Private expenditure per university student by family income, Greece

Family income Expenditure ( /year)

Top 20% 4,215
Bottom 20% 3,467
Source: Psacharopoulos and Papakonstantinou (2005).

Family background. Another equity issue is how people from different socioeconomic
status benefit from public spending on education. Do those who come from poorer
families benefit more relative to the offspring of richer families? There are two analytical
tools for answering this question one involving rate of return estimates, and the other
the incidence of public spending and benefits on higher education by income group.

Casual empiricism might suggest that what appears to be a return to investment in

education is in fact a rent derived from one's socio-economic origins. At the theoretical
level, this issue was addressed early on by Becker (1972) who noted that if parents'
education influences childrens earnings, this is due to the fact that wealthier parents
invest more in the education of their children. Thus, the effect of family background is
nothing other than an intergenerational effect of human capital.

Returns to education by SES can be estimated by using the full discounting method
within groups of people of different socioeconomic background. A second best is using
the Mincerian earnings function, adding an SES independent variable, or interacting it
with higher education.

The available literature is not very forthcoming on the returns to higher education by
socioeconomic background, although there exist several estimates for the returns to
education on average by SES. If the returns in general are increasing by the level of
SES, the same pattern should be observed if the researchers had broken down the
sample by SES and estimated the returns to higher education within SES groups.
Tables 12 and 13 show that in several countries those coming from a superior
socioeconomic background enjoy much higher returns.

38
 Table 12. Returns to education by socioeconomic status (%)

Country /Ed. level Lower SES Higher SES

Overall
Brazil 11.4 13.9
Israel 8.9 13.8
Kenya 6.5 16.7
Tanzania 6.7 9.6
Greece 4.8 5.7
UK 3.1 8.4
USA 8.1 9.2
Post-compulsory
Spain 4.3 6.6
Higher education
France 16.3 20.9
Source: Patrinos (1992, 1995). Spain from Vila and Mora (1999).

Table 13. The returns to education by fathers occupation (%)

Fathers occupation USA France

Laborer 6.2 11.9
Farmer 6.4 --
White collar -- 12.9
Manager 7.6 --
Professional 7.2 --
Source: USA from Cohn and Kiker (1986), Table 3. France from Vawda (2003), Table 1.

Several studies have included measures of family background in the Mincerian

earnings function, finding minimal effects on the returns to education. For example,
Altonji and Dunn (1996), using sibling pairs from the United States Panel Study of
Income Dynamics, find mixed evidence on whether parental education raises the return
to education. Using a sample of Australian twins, Miller, Mulvey and Martin (1995,
2005) find no evidence that the returns to education are overestimated by the non-
inclusion of family background factors.

39
Papanicolaou and Psacharopoulos (1979) in the UK, Patrinos (1995) in Greece. Mora
(1999) in Spain and Ichino and Winter-Ebmer (1999) in Germany included an SES and
education interaction term in the Mincerian earnings function have found a positive
coefficient. This means that a higher SES is associated with a higher rate of return to
investment in education.

It should be noted, however, that Card and Krueger (1992) find that holding school
quality constant, there is no evidence that parental income or education affects state-
level returns to education. But Newman (1991) using Israeli data found that the returns
to schooling are higher to those coming from more favourable socioeconomic
backgrounds.

Socioeconomic privilege confers many direct benefits, both through a home culture
which tends to reinforce the goals of formal education and through the capacity to fund
access to education in private schools and post-compulsory education (Dearden, 1998;
McPherson and Schapiro 1991, 2000).

Particularly in the post-compulsory phase, systems of educational finance also have an

impact on outcomes by virtue of how they distribute the costs of human capital
investment between different parties. Overall outcomes for any individual depend not
only on the benefits of educational attainment, but also on how much of the cost of that
education is born by the individuals who benefit.

Overall, the expansion of tertiary education in OECD appears to have had little impact
on the relative prospects of young people from less advantaged backgrounds. This is
hardly a surprising finding. Parental and school influences are extremely important
determinants of participation at post-compulsory level. In most countries tertiary
education requires prior qualifications -- generally at upper-secondary level so that
attainment in the compulsory phase of education, as much as anything which occurs
subsequently, is a key to tertiary participation. Therefore, the expansion of capacity at
the tertiary level will not, in itself, have much impact on these factors. The challenge to
public policy of delivering equality of opportunity in tertiary education is sizeable, and
falls not only on the system for tertiary education itself, but also on support for children
and their families, reaching back to pre-schooling and into compulsory and upper-
secondary schooling.

A number of research studies demonstrate that children who grow up in a low-income

40
family typically have lower educational achievements and, subsequently, lower returns
to education than children who grow up in a wealthy family (Haveman et al., 1991).
Their findings are consistent with the findings of Card (1999), who associates mothers
higher educational level with a childs higher returns to education.

Wilson (2001) finds that higher parental education is negatively related to income for
late teens and early 20s but positively related at older ages. Her conclusions are
supported by the evidence that children of higher-educated parents typically attend
college after graduating from high school, and while their initial earnings are lower
during years spent studying, their returns to education significantly increase after they
receive a college degree. Wilson also concludes that growing up in a low-income family
and having a working mother are associated with lower returns to education. In
addition, she determines that having a higher-educated mother or one that works,
increases the likelihood of graduating (Wilson, 2001).

Incidence of public spending. This entails comparing the taxes families of rich and
poor students pay, to the education benefits these groups appropriate by attending a
subsidized public higher education system. This is called the distributive incidence of
education subsidies, or who really pays and who really benefits from public education
expenditure.

Hansen and Weisbrod (1969) were the first to study the issue exploring the income
redistribution effects of the financing of public higher education in California. Since
eligibility for the higher-subsidy institutions was positively related to family income, and
since university attendance increases as family income rises, the result was that the
distribution of subsidies actually favored upper income families. These subsidies were
compared with state and local taxes paid. The results showed that families with
children enrolled in public higher education received a positive net transfer (subsidy
less taxes paid) and that these net transfers were an increasing share of family income.
The regressive nature of public financing of higher education has since been
documented in many other countries (Yang 2002, Vawda 2003).

2.7. Policy

What does the above review mean for designing efficient and equitable higher
education policies, bearing in mind the state of available data and methodological

41
shortcomings?

Based on the existing evidence, it is clear and definitive that higher education has a
value, both to the individual who invests in education and to society at large. The state
of our knowledge today is that the evidence on the private value of higher education is
more robust than the social value. This asymmetry has implications for public
education finance policies.

Based on Blondal et al. (2002) it is possible to construct a summary table on the private
and narrow social returns to higher education in a number of OECD countries (Table
14), along with the influence of various components in arriving from the private rate to
the social rate. Thus we could conclude that the private and social returns are around
the 10% mark, the narrow social rates being lower than the private rates by two
percentage points.

Table 14. Rates of return to higher education, 1999-2000 (%)

Country/ Private Taxes Unemplo Tuition Public Fully Narrow

pretax impact yment fees student adjusted
Adjustment return risk support social
private rate return
Canada 8.4 -0.5 1.3 -2.3 1.8 8.7 6.8
Denmark 7.9 -2.1 1.0 -0.1 4.8 11.5 6.3
France 13.3 -1.6 2.4 -1.1 1.3 14.3 13.2
Germany 7.1 -1.5 1.1 -0.3 2.7 9.1 6.5
Italy 8.0 .. 0.3 -0.8 0 7.5 9.7
Japan 8.0 -0.3 0.9 -2 1.3 7.9 6.7
Netherlands 11.7 -2.0 0 -0.6 2.9 12.1 10.0
Sweden 9.4 -1.5 1.2 -0.7 3 11.4 7.5
UK 18.1 -2.1 1.6 -2.7 3.6 18.5 15.2
USA 18.9 -2.3 0.9 -4.7 2.1 14.9 13.7
Average 11.4 -1.5 1.1 -1.5 2.4 11.6 9.6
Source: Based on Blondal et al. (2002), Tables 3 and 4.

Taking these results at face value, it means that in spite of the explosion of higher
education in Europe and the high risk of unemployment among graduates, higher
education continues to be a profitable investment opportunity, both privately and

42
socially. This conclusion is based on the assumption that the 10% mark is well above
the yield of alternative private investment opportunities (say Bank deposits), and the
social opportunity cost of capital. This is a conclusion based on the criterion of
efficiency.

Bringing in a concern for equity, the above review suggests that higher education
public funding should not be equal across the board, e.g. tuition free for all students,
regardless of their socio-economic background. Lower SES students (defined with an
objective criterion, such as the tax return of the father) should receive a higher subsidy
relative to those coming from more affluent families, the latter required to pay tuition
fees. Although such policy is both efficient and equitable, it is very difficult to gain
political acceptance (Psacharopoulos, 2003).

The most efficient and equitable financing mechanism for higher education might be to
provide the initial fund for a student loan scheme. Student loans contribute to efficiency
because they provide incentives to students to choose subjects leading to employment,
and study harder. They also contribute to equity, in the sense that those who will later
enjoy higher incomes throughout their lifetime will pay themselves for their education,
rather than the general taxpayer.

In funding higher education, two additional issues should be taken into account.-
externalities and other levels of education.

What if the yet unmeasured social externalities of a higher education graduate far
exceed the narrow social returns to education?. Such case would call for a massive
public subsidization of higher education. But higher education is not the only ladder of
an education system. What if the social returns (narrow or social) for the lower levels of
education exceed those of higher education? This is still an open debate in the
empirical literature (Psacharopoulos, 1996).

Public finance priority should be given to the lower levels of education, e.g., to assist
those from a lower socioeconomic background to complete secondary school in an
industrial country, or primary school in a developing country. Indeed, the lower the level
of education assisted by public funding, the higher the efficiency and equity benefits.
Lower education level means going down to pre-school, as recently and forcefully
argued by Nobel Laureate James Heckman (Heckman and Masterov, 2005; Cunha et
al. 2005).

43
Since the early days of the economics of education, the issue of a possible trade off
between efficiency and equity in education arose (see special issue of the Journal of
Political Economy, 1972). This debate continues today. By attempting to serve equity,
education resources might be used in activities that are less efficient. On the other
hand, a possible efficiency-equity trade off exists only in cases where, at the initial
conditions, education resources are used in a fully efficient way hardly the case in the
actual world.

The evidence reviewed above points to the direction that high socioeconomic
background students have higher returns than low socioeconomic background
students. However, such evidence is based on a very small number of studies to draw
a definitive conclusion regarding the existence of an efficiency-equity trade-off in higher
education. Cleary, this is a fertile area for further research.

Of course this does not imply that one should not invest more in low socioeconomic
background students, but rather that one should build the proper conditions for them to
succeed in higher education. This could be achieved through targeted investment in
the earlier stages of education as well as mentoring and counseling throughout the
school cycle.

The consensus today is that all education systems operate at a point X in Figure 2, i.e.,
well inside the efficient production possibility frontier AB. So there is room for
implementing policies that move towards points to Z or Y, i.e., improving both efficiency
and equity (Psacharopoulos 2006).

Figure 2. The efficiency-equity trade-off

Equity
A
Y

Z
X

Efficiency

44
Combining efficiency and equity objectives introduces the issue of relative weights one
should attribute to the two components of social welfare. How does one arrive at the
values of the efficiency and equity weights? This relates to the political economy of
distribution and is left to politicians and voters.

In todays world there is an inertia syndrome in the public funding of education. Most
education budgets are managed by inertia, i.e., allocations in a given year are more or
less equal to last years allocations adjusted for inflation. This is tantamount to the
absence of any policy to serve societys efficiency and equity objectives. As our
knowledge progresses on what are the most effective ways to improve social welfare
by education, so our policies should be continuously fine tuned to the most effective
modes of public funding for education.

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48
Annexes

Annex Table A-1. The returns to higher education (%)

Country Year Private Social
Argentina 1989 14.9 7.6
Australia 1976 21.1 16.3
Austria 1981 4.2
Belgium 1960 8.7 6.7
Bolivia 1990 19.0 13.0
Botswana 1983 38.0 15.0
Brazil 1989 28.2 21.4
Burkina Faso 1982 21.3
Canada 1994 13.0
Czech Rep. 1997 8.9
Chile 1989 20.7 14.0
China 1993 15.1 11.3
Colombia 1989 21.7 14.0
Costa Rica 1989 12.9 9.0
Cyprus 1979 5.6 7.6
Denmark 1964 10.0 7.8
Dominican Republic 1989 19.4
Ecuador 1987 12.7 9.9
El Salvador 1990 9.5 8.0
Estonia 1995 10.3
Ethiopia 1996 26.6 11.9
France 1976 20.0
Germany (West) 1978 10.5
Ghana 1967 37.0 16.5
Greece 1993 8.1 5.7
Guatemala 1989 22.2
Honduras 1989 25.9 18.9
Hong Kong 1976 25.2 12.4
Hungary 1993 13.4 2.6
India 1995 18.2
Indonesia 1989 5.0
Iran 1976 18.5 13.6
Israel 1958 8.0 6.6
Italy 1969 18.3
Ivory Coast 1984 25.1

49
Japan 1976 8.8 6.9
Korea 1986 17.9 15.5
Lesotho 1980 36.5 10.2
Liberia 1983 17.0 8.0
Malawi 1982 46.6 11.5
Malaysia 1978 34.5
Mexico 1992 15.7 11.1
Morocco 1970 13.0
Nepal 1999 12.0 9.1
Netherlands 1965 10.4 5.5
New Zealand 1991 11.9 9.5
Nicaragua 1996 14.7
Nigeria 1966 34.0 17.0
Norway 1966 7.7 7.5
Pakistan 1991 31.2
Panama 1989 21.0
Papua New Guinea 1986 23.0 8.4
Paraguay 1990 13.7 10.8
Peru 1990 40.0
Philippines 1988 11.6 10.5
Puerto Rico 1959 29.0 15.5
Sierra Leone 1971 9.5
Singapore 1998 18.7 13.9
Somalia 1983 33.2 19.9
South Africa 1980 11.8
Spain 1991 13.5
Sri Lanka 1981 16.1
Sudan 1974 15.0 4.0
Sweden 1967 10.3 9.2
Taiwan 1972 15.8 17.7
Thailand 1989 11.8
Tunisia 1980 27.0
Turkey 1987 16.2 8.5
Uganda 1965 12.0
UK 1986 6.5
UK 1995 16.2 11.4
United States 1987 12.0
Uruguay 1989 12.8 10.3
Venezuela 1989 11.0 6.2

50
Vietnam 1992 3.0 6.2
Yemen 1985 56.0 24.0
Yugoslavia 1986 5.3 3.1
Zambia 1983 19.2 5.7
Zimbabwe 1987 5.1 -4.3
Mean 16.1 8.5
Source: Psacharopoulos and Patrinos (2004b), Czech Republic from Klazar et al. (2001),
UK 1995 from Dutta el al. (1999).

51
Annex Table A-2. Returns to investment in higher education over time (%)

Country Year Private Social

Australia 1969 13.9
Australia 1976 21.1
Brazil 1970 13.9
Brazil 1980 16.0
Brazil 1989 28.2 21.4
Canada 1960 17.4 14.9
Canada 1985 14.0 12.1
Chile 1960 6.8 11.6
Chile 1985 6.9 10.3
Chile 1989 20.7 14.0
Cyprus 1975 8.6 9.7
Cyprus 1979 5.6 7.6
France 1962 9.3
France 1976 20.0
Germany 1964 4.6
Germany 1978 10.5
Great Britain 1971 10.0
Great Britain 1971 7.0
Greece 1962 14.0 13.7
Greece 1977 5.5 4.5
India 1965 16.2 10.3
India 1978 13.2 10.8
Indonesia 1978 14.8
Indonesia 1989 5.0
Iran 1972 15.0
Iran 1976 13.6
Japan 1967 10.5
Japan 1980 8.3
Mexico 1963 29.0 23.0
Mexico 1984 21.7 12.9
Pakistan 1975 27.0
Pakistan 1979 6.3
Papua N.G. 1979 11.4 1.0
Papua N.G. 1986 23.0 8.4
Peru 1972 16.3
Peru 1985 9.3
Peru 1990 39.7

52
 Philippines 1971 9.5 8.5
Philippines 1985 14.0 13.3
Philippines 1988 11.6 10.5
South Korea 1967 5.0
South Korea 1986 15.5
Spain 1981 10.1
Spain 1991 11.0
Taiwan 1970 18.4 15.0
Taiwan 1972 15.8 17.7
Thailand 1970 14.0 11.0
Thailand 1985 21.9 13.5
Tunisia 1977 24.1
Tunisia 1980 27.0
United States 1939 10.7
United States 1987 12.0
Uruguay 1972 5.4
Uruguay 1979 20.0
Uruguay 1989 12.8 10.3
Venezuela 1957 27.0 23.0
Venezuela 1989 11.0 6.2
Yugoslavia 1969 2.6 2.8
Yugoslavia 1986 5.3 3.1
Source: Psacharopoulos and Patrinos (2004b), Spain from Vila and Mora (1999).

53
Annex Table A-3. Change in the returns to higher education over time (percentage
points)

Country Period Private Social

(Years)
Australia 7 7.2
Brazil 19 14.3
Canada 25 -3.4 -2.8
Chile 29 13.9 2.4
Cyprus 4 -3.0 -2.1
France 14 10.7
Germany 14 5.9
Greece 15 -8.5 -9.2
India 13 -3.0 0.5
Indonesia 11 -9.8
Iran 4 -1.4
Japan 9 -5.5
Mexico 21 -2.0 -10.1
Pakistan 4 -9.3
Papua N.G. 7 11.6 7.4
Peru 13 -7.0
Philippines 17 2.1 2.0
S. Korea 19 10.5
Spain 10 0.9
Taiwan 2 -2.6 2.7
Thailand 15 7.9 2.5
Tunisia 3 2.9
USA 48 1.3 -8.2
Uruguay 17 7.4
Venezuela 32 -16.0 -16.8
Yugoslavia 17 2.7 0.3
Mean 15.0 1.0 -8.2
Source: Based on Psacharopoulos and Patrinos (2004b).

54
Annex Table A-4. Returns to Higher Education by Subject (%)

Subject/ Private Social

Country
Agriculture
Brazil 16.0
Colombia 22.3 16.4
Greece 3.1 2.7
India 16.2
Iran 27.4 13.8
Malaysia 9.8
Norway 2.2
Philippines 5.0 5.0
S. Korea 16.0
Thailand 19.0 8.2
Social Sciences
Brazil 8.0
UK 13.0
Canada 10.8 8.8
S. Korea 16.6
Arts
Canada 4.0 3.8
Norway 4.3
UK 26.0 7.0
Canada 0.7 -0.1
France 2.9
India 14.3 12.7
Iran 20.0 15.3
Thailand 15.9 11.2
Venezuela 8.0
Economics
Belgium 9.5
Brazil 16.1
Canada 13.1 11.4
Colombia 32.7 26.2
Denmark 9.0
Greece 5.4 4.4
Iran 23.9 18.5
Norway 8.9
Philippines 14.0 10.5

55
S. Korea 20.6
Sweden 9.0
Venezuela 15.7
Engineering
Canada 23.0 11.7
Brazil 17.3
Canada 14.0 10.7
Colombia 33.7 24.8
Denmark 8.0
France 17.5
UK 9.0 5.5
Greece 12.2 8.2
India 21.2 16.6
Iran 30.7 18.2
Malaysia 13.4
Norway 8.7
Philippines 15.0 8.0
S. Korea 20.0
Sweden 7.5
Thailand 22.0 10.7
Venezuela 20.3
Law
Belgium 6.0
Brazil 17.4
Canada 13.6 11.6
Colombia 28.3 22.7
Denmark 10.0
France 16.7
Greece 13.8 12.0
Norway 10.6
Philippines 18.0 15.0
Sweden 9.5
Thailand 15.4 12.2
Venezuela 14.1
Medicine
Australia 12.2
Belgium 11.5
Brazil 11.9
Canada 21.6 17.2

56
Colombia 35.6 23.7
Denmark 5.0
France 12.6
Malaysia 12.4
Norway 3.1
Sweden 13.0
Thailand 13.8 5.4
Sciences
Belgium 8.0
Brazil 20.0
France 12.3
Greece 2.1 1.8
UK 10.0 6.5
Norway 6.2
Thailand 19.5 9.5
Venezuela 10.9
Source: Based on Psacharopoulos and Patrinos (2004b,) UK engineering from
Wilson (1983).
Note: Law includes law and economics, medicine includes health sciences,
engineering includes architecture.

57
3. THE DANISH FINANCING MODEL OF HIGHER EDUCATION

3.1. The Financing System

Denmark has three types of Higher Education Institutions (HEIs) administered by three
different ministries. There are 12 universities (under the jurisdiction of the Ministry of
Science, Technology and Innovation) and a large number of non-research based
institutions offering tertiary educations (under the jurisdiction of the Ministry of
Education). Finally, there is a third group of 20 institutions offering tertiary educations
within the field of culture (under the jurisdiction of the Ministry of Culture). Among these
a few offer educations on master level, conduct research and have PhD-schools.

The Higher Education institutional structure is in the process of transformation. The

Government wishes to reduce the number of institutions by merging universities and
public research institutions. The aim is to strengthen education as well as research and
thereby sharpen the profile of Danish universities and improve their competitive edge.
Also with regard to the number of other institutions offering tertiary education, the target
is to further reduce the number of institutions.

Financing of education and research are separated in Denmark. In general, the most
important source of funding for HEIs is the subsidies provided for by the state in the
annual appropriation acts (Ministry of Science, Technology and Innovation, 2003a).

3.1.1. Financing of education - the taximeter principle

Danish Higher Education (HE) receives funds from the Ministry of Education to provide
free education (fees have been introduced for foreign, non-European students and for
some courses tailor-made for adult education and the needs of the entrepreneurial
sector) through the taximeter system, which links funding directly to the number of
students who pass exams. The teaching component is based on a unit-cost principle,
where an amount of money is paid to the university for each student who passes
exams. The taximeter varies substantially between different fields of study and the
current tariffs are predominantly historically determined. There is, however, no direct
link between subsidies and consumption. Because of principles of lump sum granting
and the self-governing nature of the institutions, universities are free to re-allocate their
funds between education, research and joint expenses. The principles and incentives

58
of the taximeter principle are thus reflected to varying degrees (Ministry of Science,
Technology and Innovation, 2003a).

An important feature is that universities do not receive compensation for students who
fail their exams or do not take exams. The tariff paid per passed exam, the taximeter,
varies substantially between different fields of study, and has three components, which
includes costs of education and equipment; joint costs (e.g. administration, buildings)
and costs for practical training (applicable only for a few subjects). The current tariffs
are predominantly historically determined. However, taximeter-tariffs are adjusted
annually to balance the budget of the Ministry of Education. Currently, the basic tariffs
of university educations vary from 3240 EUR to 4.350 EUR for most educations in the
humanities and social sciences and from 5587 EUR to 8307 EUR for most educations
in natural sciences, technical and health science ((Ministry of Finance, 2005). These
figures are, according to the Rectors Conference, quite low compared to other types of
education in Denmark as well as to university educations in countries which the Danish
Government has expressed ambitions to compete with.

Although the taximeter grants and the associated subsidies are assumed to cover the
various types of expenses, there is no direct link between subsidies and consumption.
Because of principles of lump sum granting and the self-governing nature of the
institutions, the universities are free to move their funds between education, research
and joint expenses and internally, from one education function to another. In reality, the
universities distribute their grants according to their own internal principles, thus
reflecting the principles and incentives of the taximeter scheme to varying degrees
(Ministry of Science, Technology and Innovation, 2003b).

All Danes from the age of 18 are entitled to public support to continuing education,
regardless of social standing but with a reduction of the grant depending on the
income. The actual State Educational Grant for most students is app. 630 EUR/month
(with an income limit of 800 EUR/month) and the state guaranteed loan at app. 320
EUR/month (Ministry of Finance, 2006).

Quality assurance is achieved through different mechanisms. The Danish Evaluation

Institute (EVA) performs regular evaluations of the educational programmes. A
negative evaluation has no direct financial consequences for the institution, but in
principle the Minister for Education can intervene if performance is not improved.
Another counterforce to the erosion of academic standards is a long-standing system

59
of external examination. The main tasks of the external examiners are to ensure a fair
and equal treatment of all students; monitor nation-wide quality standards; advise the
institutions on the quality of the programmes, and annually submit a report to the
institutions of their impressions or critical points.

3.1.2. Financing of research at HEIs

Denmark has a two-tier system for resource allocation to research. The first tier is the
basic grants from the Financial Act allocated by the different ministries directly to the
institutions. The second tier comprises resource allocation from the National Research
Councils, strategic research programmes, foundations, R&D funds from the individual
ministries, and private funds.

The basic research grant is allocated as a lump sum to institutions. The level of the
basic grant is to a very large extent calculated on an incremental basis. Basic grants
are not earmarked for specific research purposes. Contrary to most of the other grants
and sources of income of the universities, basic grants are allocated to research as a
predominantly non-specific activity related funds. The distribution of the grants between
the universities is relatively permanent and based on historical aspects. Budgets are in
general characterised by the fact that they take into consideration factors such as
freedom of research, budget stability and historical traditions.

However, two aspects offer a somewhat varied picture of the static characteristics of
the basic research grants. First of all, the grant is affected by fluctuations in the overall
framework conditions of the Ministry of Science, Technology and Innovation, which
includes the general demands for higher efficiencies and more savings presented by
the Government in connection with the annual Finance Acts. Secondly, new research
grants to the universities are to an increasing degree distributed according to models
relying on activity parameters. This means that there is a certain degree of intra-
university re-distribution of the funds and that part of the grant contain some degree of
activity dependency to create expedient incentives. Each year 2% of the basic grant to
public institutions such as universities is retained for productivity improvements. This
share is returned to the universities via the 50-40-10-model (Ministry of Science,
Technology and Innovation, 2003b). Allocation of resources is made as follows: 50%
according to educational grants, 40% according to subsidised research and 10%
according to the number of awarded PhD degrees.

60
In addition to the basic grants, the universities have considerable revenues partly in the
form of subsidies from research councils (an essential part of the second tier is the
research council system which plays an important role in the external funding of the
Danish universities), the EU, private foundations and donations etc., partly in the form
of operating income obtained in return for services they have sold on market terms.
Both groups of revenues are dependent on performance as the size of these revenues
is directly related to the ability of institutions to attract subsidies from external sources
in competition with other research institutions and to sell services on market terms. In
2004, app. 35 percent of the total research funding was external funding. The level of
the external grants varies between the different research areas with health, technical
and natural sciences attracting the greatest share. In addition to these sources of
external grants, funding can also be achieved from private funds, firms and
organisations. In 2004, app. 13 percent of the total research funding came from private
funds, firms and organisations (Danish Centre for Studies in Research and Research
Policy, 2006).

3.2. Financing System and Higher Education Policies - The Formal

Relationship

In terms of financial management Danish HEIs have during recent years been
characterised by economic decentralisation, and an increased application of activity
steering incentives. The University Act from 1993 introduced economic decentralisation
for the universities, and this principle has been further emphasised in the most recent
University Act from 2003. The intention of the decentralisation is to promote economic
responsibility and make better use of resources.

In Denmark, there is no straightforward link between the financing system and the
institutional strategies. The universities sign development contracts with the Ministry of
Science, Technology and Innovation. However, a university development contract is
not a legally binding document and differs from a classic development contract in the
sense that there is no automatic relationship between reaching the set targets and the
grants awarded. But even though, there is no direct link between the funding system
and institutional strategies, the funding system has an impact on institutional strategies
in several ways. Firstly, the taximeter system steers the institutions towards the
preferences of the students and secondly the earmarking of competition funds for
research forces the institutions to focus on politically prioritised research areas.

61
 3.2.1. Financing of education

The intention of the taximeter system linking money to student activities - is to give
HEIs an impetus to demonstrate user-friendly behaviour towards the students. In order
to achieve the highest grants, universities need motivated and qualified students that
pass their exams and complete their education in the period of time prescribed for their
studies. Key-arguments for the system have been: to promote efficiency, and to induce
educational institutions to become more results-oriented and customer-focussed; to link
the allocation of grants to educational production; to avoid erosion of standards; to
implement a system that is simple, fair, transparent and automatic and finally to
promote quality-competition among HEIs (Ministry of Research and Information
Technology, 1998).

3.2.2. Financing of research

The basic grants are research appropriations allocated to secure the core research
activities of HEIs. Basic research grants are allocated on the basis of considerations
such as budget-stability, freedom of research and historical traditions. Budget stability
enables institutions to plan and steer the research activity. However, a small part of the
basic grants are already now activity-dependent, and further changes in the direction of
increased activity-dependency can be expected in the near future.

A number of overall targets for the allocation of external grants were stated in relation
to latest reforms: to ensure quality of research through open competition; to simplify the
organisation and structure of councils, bodies and especially programme committees to
provide researchers with a better overview of application options; to ensure with a
stronger management that strategic research is implemented on its own terms and that
cross-disciplinary efforts within all areas of research are taken into consideration; to
continue to ensure support of basic research activities and at the same time ensure
support of strategic, application-oriented research.

3.3. Effects of the Financing System on Higher Education

3.3.1. Financing of Education Effects of the taximeter system

The strengths and weaknesses of output-based funding have been discussed

repeatedly in relation to the Danish taximeter-system and a number of investigations
and evaluations of intended and unintended consequences of the system have been

62
carried out in the last decade. It is argued that the taximeter principle is a funding
system, and that accordingly it is not the main aim of the system to directly regulate the
quality of education. Instead, quality should be safeguarded by other measures.
Nevertheless, the debate on quality is often linked to the taximeter system.

The first major evaluation of the taximeter-system was performed in 1995, where the
Ministry of Education asked the Danish Evaluation Institute to assess whether the
taximeter-model had any negative effects on educational quality. It was concluded that
no negative trends could be found in the most recent evaluations of the study
programmes. In 1998, a second and much broader evaluation of the taximeter model
took place. The evaluation covered higher education institutions as well as other parts
of the educational system and other government sectors where the taximeter-principle
was applied. Also in this evaluation the overall conclusions were positive. It was
emphasised that as a result of the reform, the management of the education sector had
improved considerably, resulting in an increased focus on value for money.
Unprofitable activities were more rapidly discontinued, and the institutions had
improved their ability to adjust and take new initiatives. It was also concluded that
institutions seemed to be more inclined to provide a good service to their students.

In addition, it was emphasised that most institutions considered the quality of their
teaching programmes to be the decisive factor in the competition process. These
effects were found to be more pronounced at the vocational colleges than at the
universities. One of the reasons could be that university funding is less affected by
fluctuations in the number of active students, since taximeter-grants cover only about a
third of their total revenues. In spite of these conclusions, the critique of system has
continued, and as a consequence further evaluations have been carried out. The most
recent evaluations have been carried out in 2004 and 2005, but the conclusions of the
previous evaluations have more or less been repeated in the recent reports.

3.3.2. Financing of research - intended and unintended effects

Basic grants

Strengths and weaknesses of input-based and output-based funding types have also
been debated repeatedly in relation to the funding of research at HEIs. Basic research
grants secure the institutions long-term planning and steering of activities. Furthermore,
the basic grants enable institutions to initiate research, which cannot find support

63
elsewhere. Basic grants enable the institutions to maintain buildings, infrastructure etc.
through periods of falling revenues from other sources. Nonetheless, the Danish
allocation of basic grants has been criticized because it lacks direct incentives for
efficiency, relevance and societal impact. In addition, there are no mechanisms
assuring that the funding finds the way to the institutions where the highest quality is
produced.

External grants

The Danish allocation of external grants has several intended effects. Competition is
expected to raise accountability, efficiency and quality, and by earmarking some of the
grants there is a possibility of directing research, not only towards certain areas, but
also towards certain operational principles such as inter-disciplinarity, transdisciplinarity
etc. However, a weakness of the system has previously been that research funding
had become far too complicated - with a jungle of special allocations and committees,
resulting in bureaucracy. Researchers have had to deal with a complex and non-
transparent system. In addition, the system was criticised for lacking overall
management and coordination. A main aim of the most recent reform of the Research
Council system was accordingly to attain a simplified and strengthened structure.
Whether this objective has been achieved yet is early to conclude but nevertheless
disputed in the debate.

Other unintended effects have in particular been mentioned in relation to the

earmarked funds. It has been claimed that strategic research programmes may harm
basic research and that an unintended effect could be that the quality of research may
be weakened, when funding systems prioritise politically defined areas. The increased
time and resources spent on applications and reporting are also some unintended
effects discussed as well as the feeling of a constant re-orientation towards shifting
short term aims. Furthermore, when the content of research programmes increasingly
gets formulated in political and administrative settings, research runs the risk of getting
politicised and that the programmes do not match a qualitative research potential,
because the funds are being allocated on the basis of political/administrative criteria
rather than scientific quality.

However, in a comprehensive evaluation of these questions, the opinions on the

strategic research programmes as a whole among the stakeholders were positive. In
general, no signs of damaging effects on basic research were found. Similarly, it was

64
emphasised that no weakening of quality norms or short term change of direction could
be observed. These conclusions were reached in 1995 and were only valid for a
number of the large strategic programmes. Since then, no major evaluations have been
carried out, but the discussion of the unintended effects has continued. In particular the
usual small size of the programmes has been criticised. It is argued that competition,
regarding narrow research programmes often is too limited in a small country like
Denmark, resulting in lower research quality. This creates uncertainty with regard to the
quality of the programmes within the research community and with regard to the
legitimacy of the programmes.

Finally, it should also be mentioned as an unintended effect that external grants, due to
low overheads and demands of co-financing, tend to tie the basic grants and thereby
limit the strategic decision making of HEIs.

3.4. Strengths and Weaknesses of the Financing System -

Stakeholders Views

3.4.1. Financing of education:

Quantitative data (based on a survey conducted summer 2006)

In general the majority of the stakeholders are positive towards the taximeter principle
as such. However, app. 1/4 of the respondents disagrees with the statement that the
taximeter system functions well. Likewise app. 1/3 of the respondents agrees with the
statement that the taximeter system should be replaced by another system. Finally,
app. 2/3 of the respondents agrees with the statement that the system could be
improved and should be supplemented with other mechanisms. With regards to the
question of whether the existing system forces the institutions to lower the standards
with regards to exams, a large minority (35%) of the respondents agree strongly or
partly with this statement, while 44% disagree.

Interviews

The patterns in the quantitative data are largely supported by the data gathered
through interviews. In general the stakeholders are positive towards the taximeter
principle as such. It is accordingly emphasised by many that the system has clear
advantages as it states direct demands to institutions on quantity and indirect demands

65
on quality issues. Despite its shortcomings several stakeholders mention that a better
system yet has to be presented. However, the stakeholders also point to a number of
problems in relation to the existing Danish system, and in general it is the impression
that there is room for substantial improvements. It is in particular emphasised that:

There are no direct incentives to pursue quality and relevance. On the contrary,
some state that the system has opposite effects.

The element of competition is (too) limited, not least as a consequence of

lacking information for students. This weakens the incentive mechanisms.

The system tends to fail less popular courses, which however are important
seen from a societal perspective. A bad year in terms of students has financial
effects on institutions for years to come.

There is limited degree of freedom and difficult conditions for change of

research direction.

Significant dissatisfaction with the actual rates. The basic rates have been
repeatedly cut during the last decade, and there is also, according to
stakeholders, a lack of balance and clear rationale in the allocation of the rates
between different educational fields. However, a share of the reductions in the
rates has been returned to the universities in form of special funds.

A number of external stakeholders including the Confederation of Danish Industries

and the Danish Innovation Council recommend that development funds for HE are
allocated as a supplement to the taximeter-system to encourage change and
innovation. One suggestion is to link the allocation of these supplementary funds to the
university development contracts as well as to systematic evaluations.

3.4.2. Financing of research

Basic grants

Quantitative data (based on a survey conducted summer 2006)

28% of the respondents disagree with the statement that the basic grant ought to make
up a larger proportion of the total funding. At the same time, however, a large majority
of the respondents (68%) agree with the statement that there ought to be a stronger

66
linkage between scientific production and funding while 10% disagree. Likewise 72% of
the respondents agree that there ought to be a stronger linking between achieving
university development contract objectives and funding.

Interviews

Also here the qualitative data support the quantitative data. In general the stakeholders
emphasise the importance of basic grants for HEIs. The arguments are:

Basic grants secure a stable budget and enable long-term planning

Basic grants are important for structural changes and the quality of basic
research

Basic grants allow flexibility in relation to changing conditions and adaptability to

new research areas and innovations.

Some stakeholders also point to problems with the existing allocation of basic grants. It
is in particular emphasised that:

The rationale in the allocation of basic grants in relation to quality, scientific

production or achievement of contractual objectives is not straightforward

Lacking use of performance parameters weakens existing incitement

mechanisms and limits quality assurance

Allocation of resources based on historical reasons makes it difficult for newer

universities to build a stronger research environment and be competitive.

While the stakeholders agree on the above mentioned general viewpoints, there are
some differences in opinions with regard to the optimal balance between internal and
external funds. HEIs are not surprisingly more in favour of a large share of basic
grants, than external stakeholders. The Danish Rectors Conference emphasise that
the basic grants are the foundation of strategic actions and the fundament to their
ability to offer a broad spectrum of education throughout the country. Furthermore, they
argue that an apparent large share of basic grants is tied to co-financing of external
projects, so that in reality the amount of free funds is more limited than supposed. This
observation is supported among others by the Danish Advisory Council of Research
Policy. However, there is a general openness among all stakeholders including the

67
HEIs to the idea of linking the allocation of basic grants to performance parameters,
even though many emphasise that the formulation of these parameters will be a very
complex task.

External grants

Quantitative data (based on a survey conducted summer 2006)

Half of the respondents agree with the statement that if the proportion of competition
funds increases there is a risk of political steering of research while 28% disagree.
Similarly, app. 2/3 of the respondents agree with the statement that an increased
proportion of external funding leads to more short term employment and problems with
long term planning of research and staffing.

Interviews

The views of the stakeholders concerning the competition funds as expressed are
more of a mixed bag, and do not completely support the scepticism noticed in the
quantitative data. In general the importance of competition is stressed, but the
proportion and the terms and conditions related to it are highly debated. On the one
side, the stakeholders in general point to a number of advantages in relation to the use
of competition grants, namely that competition:

Raises quality, when grants are given to broad areas and in large shares. In
particular, the model of the Danish National Research Foundation seems to be
popular with relatively large allocations, a long time horizon and a bottom up
approach in the selection of research areas. However, this model has been
most fruitful in relation to certain scientific areas.

Involves higher attention to relevance and applicability.

Offers an alternative possibility of research funding, which cannot be funded

internally.

Strengthens collaboration.

On the other side, the stakeholders point out the weaknesses in the use of competition
grants:

68
 Competition grants are often (too) narrow in scope and do not promote
originality, creativity and novelty.

Not all scientific areas have the same possibilities of attracting competition
funding.

Applying for competition grants is resource demanding and time-consuming.

An increasing proportion of competition grants limits the possibilities of long

time planning for the HEIs.

Despite a recent reform of the system, quality assurance needs to be improved.

There are major problems with the embedment of competition grants.

Competition grants often only contribute marginally to long-term institutional

objectives.

Universities get forced to focus on areas where funding is available rather than
on areas where they have high competence.

Strategic management of universities moves from the institutions to funding

agencies.

With competition grants follows increased bureaucracy and administration.

Low overheads, which imply that institutions often cannot afford to attract
external funds.

In general, there appears to be a strong consensus among the stakeholders regarding

the advantages of larger and longer-term grants. Similarly, stakeholders state that the
low overhead rates seem to be an important barrier in the existing system. However,
there are also important differences of opinions among the stakeholders. An issue is
whether a strong emphasis on the frontier research areas of ICT, biotechnology and
nanotechnology should be pursued, or whether more country-specific priority fields
which reflect Danish specialisations and strength positions should be prioritized. So far,
the Danish Government seems to be in favour of the former strategy. One example of
this tendency is the so-called High Technology Foundation mentioned above, which
has a special focus on nanotechnology, biotechnology, ICT and the border-areas

69
between these fields. The emphasis on the strategy of picking the winners by
focusing on the same target-areas as most other countries has however been
mentioned as a dangerous path to follow by various actors such as the OECD and the
Danish Bankers Association. The critics argue that it is a risky strategy to target a few
selected areas at the expense of broader growth potentials. No one can predict the
growth of tomorrow, it is argued, and instead the efforts should be directed at creating
optimal frame-conditions for research in general. Yet, other stakeholders argue that the
small size of Denmark and the limited funds available necessitates a focusing on a
number of selected areas.

3.5. The future of the Danish financing system

Even though Danish HE already has seen a number of important changes in recent
years, there are strong indications that further major changes targeting the funding
system of HEIs will be implemented in the near future a number of these changes will
most likely be decided within 2006. As mentioned above the funding of the second tier
of HE research has recently been changed through a major reform of the research
funding system, and also the universities in general have been reformed with an aim to
increase the universities autonomy and self-governance. The latter reform has not
directly targeted the HE funding system, but the changes definitely have consequences
for funding decisions as the act calls attention to the universities new appointed
management to make strategic selections of research and education and give high
priority to these areas.

In addition to these reforms a number of further systemic changes can be expected

soon. The Danish Government has recently in connection with the work of the so-called
Globalisation Council chaired by the Danish PM presented a number of objectives. The
most important of these are listed below:

Basic funding will be distributed to universities according to the quality of

research.

From January 1, 2008 basic funding of will be based on an evaluation of the

institutions' ability to reach objectives given in a university development
contract.

70
 The quality of university research will be evaluated by international,
independent panels.

University education will be evaluated and controlled by a new external

accreditation institution. The Ministry will no longer provide criteria for university
courses.

Universities will have more autonomy with regard to recruitment of researchers

(e.g. salaries, the number of professors and the possibility of recruiting "super
professors" within the frame of their own budget).

Universities will annually compete for large, long-term research projects.

Research councils will give priority to large investments in infrastructure,

especially facilities that are used by several institutions.

More public funding will be allotted to strategic research of importance for the
development of society, e.g. in the areas of the environment, energy and health.
Private co-funding will be encouraged.

As much as 50 percent of public R&D funding will be competitive by 2010 (as

opposed to 1/3 today). The funding will cover all costs, overhead included.

Public R&D investments will reach 1 percent of GDP within 2010. The private
sector is expected to provide funds equivalent to 2 percent of GDP.

In particular the objective that a higher proportion of university financing in the future
should be allocated based on performance parameters has attracted special attention.
Firstly, the basic grants are supposed to be linked to the development contracts of the
HEIs, and secondly a significantly greater proportion of the research funding as a
whole is supposed to be allocated through competition.

Furthermore, the Government intends to simplify the taximeter system substantially. It

is worth noticing, that one of the most criticised aspects of the taximeter system the
difference in rates between different educational areas - has been given no attention in
the otherwise comprehensive recent Globalisation Strategy.

In addition to these Government statements, a high profile Commission of Welfare has

recently proposed changes towards greater tuition fees (for foreigners), and stronger

71
incentives in the allocations from the State Educational Grant and Loan Scheme.
These recommendations follow a recent change in legislation, which states that tuition
is free for all EU/EEA students as well as for students participating in an exchange
programme, but that all other students have to pay tuition fees from 2006 and onwards.
Some observers see this as the first step towards a more widespread use of tuition
fees.

The bottom line is that even though no precise model for a future financing system has
been presented yet, major changes will very likely be implemented in the near future.
The Government has invested a large amount of prestige and effort in the project of
transforming Denmark into the most innovative and competitive nation of the world
within the next decade. Most major stakeholders as well as the political opposition
appear to have accepted the premises of these changes, so it is difficult to imagine that
the announced changes will not be carried out in one form or another.

An important issue in Denmark has been the overall level of financing of HE. In
particular the Barcelona objective of spending 3 pct. of GDP on research and
development by 2010 has recently been the subject of intense discussion in Denmark.
A number of key stakeholders have expressed strong dissatisfaction with the level as
well as the rate of funding for the coming years. Among others the Confederation of
Danish Industries and the Coordination Committee, which represents all key actors of
the public Danish research system, have lately issued a strong critique of the progress
towards the objective of the Barcelona declaration. However, the Government has on
April 4, 2006 with its "Welfare Initiative" presented a financing plan which satisfied most
of the critics. The Minister of Science, Technology and Innovation promised DKK 10.9
billion to R&D for the period of 2007 to 2010 (EUR 1.5 billion). However, in order to
reach the 1 percent objective Denmark must be able to get more out of the EU funding.
Furthermore, a major political task still lies ahead before the funding plan becomes a
reality, as the negotiations of the funding have been linked to a number of far-reaching
welfare reforms, where the funding apparently will be dependent on the outcome of the
negotiations. The same goes for a large number of the additional initiatives in the
Globalisation Strategy. Coming political negotiations will decide the exact outcome of
these proposals.

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 3.6. Conclusions

The financing system of Danish HEIs is in a phase of transition. More or less all
aspects related to financing have been reformed recently or will be reformed in the
near future. The existing Danish system with the taximeter system, the basic grants
and the external grants as the three main sources of financing for the HEIs, has a
number of strength and weaknesses and a number of intended and unintended effects.
The taximeter principle as such is by the majority of stakeholders perceived as
reasonably well-functioning. It is emphasised by many that the system has clear
advantages as it states direct demands on quantity and indirect demands on quality,
and despite its shortcomings several stakeholders state that a better system yet has to
be presented.

However, the stakeholders also point to a number of problems in relation to the existing
Danish system, and in general the impression is that there is room for substantial
improvements. It is in particular emphasised that there is a problem with the actual
taximeter-rates. First of all, the basic rates have been repeatedly cut during the last
decade, even though some of these resources have been returned to the universities
as special funds, and secondly the system has been criticised for lack of balance and
clear rationale as regards the rates allocated between different educational areas.

With regards to the basic grants there appears to be consensus about the importance
of this aspect of the financing system. It is emphasised that the basic grants provide
budget security and enable long-term planning. In addition, the basic grants are
significant for structural changes and are the foundation for HEIs possibility to be
flexible and adaptable to changing conditions. Finally, these grants are important for
the support of basic research and improvement of its quality. A number of stakeholders
also point to problems with the existing allocation system of basic grants. It is in
particular emphasised that the lack of use of performance parameters weakens
incentive mechanisms and limits quality assurance. Another important unintended
effect mentioned is the apparent large share of basic grants tied to co-financing of
external projects. Accordingly, the factual amount of free funds at HEIs is not on the
assumed level.

Finally, the analysis reveals a number of advantages and disadvantages in relation to

the use of competition grants. It is acknowledged that competition raises quality, when

73
grants are given to broad areas and in large shares, and that competition enhances
applicability and collaboration. However, the stakeholders also stress a number of
weaknesses in relation to the existing Danish allocation of competition grants. These
grants target often areas that are too narrow in scope and do often not promote
innovation, creativity and novelty. It is argued by many that an increased proportion of
competition grants (as it is expected to be introduced in the near future) will limit the
possibilities for long-term planning for the HEIs and force them to focus on areas where
funding is available rather than on areas where the institutions have a high
competence. A consequence might well be that strategic management of the
universities will be moved from the institutions to the funding agencies and
organisations.

Another key issue in relation to the allocation of external grants is whether a strong
emphasis on the frontier research areas of ICT, biotechnology and nanotechnology
should be pursued, or more country-specific priority fields which reflect Danish
specialisations and strength positions should be prioritized.

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4. FUNDING REFORMS IN DUTCH HIGHER EDUCATION

4.1. Introduction

This chapter includes a case study on funding in the Netherlands. It particularly

analyses the funding mechanisms applied for teaching, research and student financing
in higher education. The chapter takes particularly an analytical perspective on the
developments in public funding in Dutch higher education. As such it analyses funding
policies in terms of the objectives aimed at and the outcomes reached. The outcomes
can involve governmental, institutional and student behaviour.

The chapter draws on various sources and study methods. First it heavily relies on the
wealth of publications available in this area. This provides basic descriptions of the
model, but in turn also reflections on the funding model by a number of authoritative
councils, analysing bodies and commissions. Second, a number of stakeholders have
been interviewed to provide their reflections on Dutch higher education funding policies
and their implications for the working of the Dutch higher education system.

The analysis of funding in Dutch higher education consists of three basic parts. First a
description of the funding models for teaching, students and research. Second a critical
analysis of the public funding policies based on advices and opinionating from various
stakeholders and some interviews with some major stakeholders. The third part of the
study includes a critical reflection combining all information from various sources.

4.2. Funding in Dutch higher education

4.2.1. The Dutch higher education system

In the Netherlands education is compulsory up to the age of 16. After the completion of
basic secondary education, pupils can follow one of two main pathways: either the
VMBO path towards vocational education, or the HAVO/VWO path towards higher
education. These routes are the official ways of qualifying for entry into higher
education. The five-year HAVO programme gives direct access to the hogescholen
(HBO). The six-year VWO programme prepares pupils for entry into university
education, though VWO-graduates may also enter HBO-programmes. Figure 1 shows
the basic structure of Dutch education.

75
 Figure 1: The Dutch education system

U n ive rs ity H ig h e r
(W O ) p ro fe s s io n a l
(H B O )

U p p e r s e c o n d a ry v o c a tio n a l (M B O )
P re -
G e n e ra l u p p e r
u n ive rs ity
s e c o n d a ry
(V W O ) P re p a ra to ry M B O (V M B O )
(H A V O )

G e n e ra l lo w e r s e c o n d a ry e d u c a tio n

P rim a ry e d u c a tio n

The Dutch higher education system is a binary system and consists of 13 universities
and around 50 hogescholen8. The hogescholen enrol about two-thirds of the total
number of Dutch higher education students. Besides the 13 traditional research
universities, a number of small designated institutions are part of the university sector: a
university for business administration, four institutes for theological training and a
humanistic university, as well as several international education institutes. These are
formally part of the higher education system, but are usually not included in the
educational statistics and only to a limited extent are they influenced directly by overall
higher education policy. Next to hogescholen and universities, higher education in the
Netherlands is also provided through the Open University, located in Heerlen. The Open
University offers a wide range of courses, which may lead to both formal university and
higher vocational education degrees. No other formal sectors of post-secondary
education exist in the Netherlands. However, the Netherlands has a large number of
private (not publicly funded) teaching institutes and organisations that offer recognised
certificates, diplomas and degrees in various professional fields like accountancy,
business administration, etc. Quite often these are structured as `external studies' in the
sense of correspondence and or distance learning courses with limited face-to-face
interaction.

8
Outside the Netherlands, the hogescholen are officially allowed to promote themselves as universities of
professional education.

76
Traditionally, universities have offered either four-year programmes or five-year
programmes in science and engineering. Since 2000, all new entrants enrol in the new
three-year bachelor programmes. In addition to the bachelor programmes, one- or two-
year masters programmes are offered. The traditional length of the HBO programs did
not change with the introduction of the bachelor-master system and the four-year HBO
programs now officially lead to bachelor degrees.

With regard to access to higher education, we can state that most programmes and
institutions in Dutch higher education require only the minimum entrance requirement
of holding a qualifying secondary education qualification and so there is open access.
However, to enter particular higher education programmes, e.g. in science and
engineering subjects, hogescholen and universities often require prospective students
to have passed secondary education examinations in particular subjects, like
mathematics, physics, biology or chemistry. Only in a very limited number of
programmes is the number of study places restricted, requiring selection procedures to
choose and allocate the applicants. All students in Dutch higher education have to pay
tuition fees, which are basically charged at a uniform tariff in the public institutions.
Private institutions can set their own tariffs. All fulltime students on recognised
programs, both at public and designated institutions, are eligible for student financial
support from the government.

4.2.2. Funding flows in Dutch higher education

Before discussing funding in detail, Figure 2 presents a picture of the main funding
flows to the 13 publicly funded Dutch universities.

Figure 2: Relative size of funding streams for Dutch universities (year 2003)

Tuition fees 5,5%

36%
Basic funding teaching
M (First flow of funds) 68% U
(incl. acad. hospitals)
I 64% research N

N I

I V
Research council funding 5,3%
S (Second flow of funds) E

T R
R Market oriented activities 12%
S
I (incl. Other income)
(Third flow of funds) I
9%
T
26% 74%

public sector private sector 77

Apart from the tuition fees, there are three major funding flows that constitute the
revenues of Dutch universities. The first flow or the basic funding provides the regular
core funding for teaching and research for universities and the hogescholen. The
university is free to spend the grant as it wishes (the lump sum principle), provided it is
for teaching and research. The size of this grant depends on a formula discussed in the
previous chapter. The research part of this block grant is roughly two-thirds of the total
block grant.

The second stream refers to research grants provided by the Dutch Research Council
(NWO). NWO offers competitive funding on the basis of research proposals from
university researchers. The third stream funding concerns the revenues from contract
activities, consultancies and research commercialisation activities carried out by the
research universities and the hogescholen. Often, income from interest, university
bookshops, student restaurants et cetera is also included. A large part of the third
stream activities refer to knowledge transfer in the sense of research carried out for
industry, government and other public sector organizations. A slightly smaller part
refers to contract teaching for companies (and individuals such as the MBA
programmes offered by the research universities), short courses, and lifelong learning.
However, the largest part is contract research carried out for government and not-for
profit organizations.

4.2.3. Funding teaching in Dutch higher education

Within Dutch higher education, the allocation model for public teaching funds differs
between universities and hogescholen. Therefore the discussion on both models will be
separated in sections 1.3.1 and 1.3.2. Currently a new funding model is being
developed that envisages to allocate teaching funds equally for universities and
hogescholen. This model of learning entitlements is described in section 1.3.3.
Furthermore, research funds are allocated in a separate way to universities. This will
be discussed on section 1.4.

Teaching funds for teaching in universities of professional education

For most hogescholen, funding is only based on the teaching load. For the hogescholen
that specialise in performing arts, funding is based on the number of first year students
admitted (after selection). Teaching load is a function of the following:

78
 the number of enrolled students

the number of (bachelor) diplomas awarded

the number of years graduates have been enrolled

the number of dropouts

the number of years dropouts were registered in the institution.

There are two funding tariffs rates for full-time students: one for programmes with a
strong practical character and a 20% lower one for programmes with a social science
(so-called gamma) character. Previously there were six, so-called profiles. There are
slightly higher rates for students in teacher training. Until January 1998, part-time
students were funded at a rate of 75 per cent. From that date on, the tariffs for part-time
students have been raised up to the level of full-time students.

The funding rates are not applied to the number of registered students, but to an
estimate of the teaching load (`student demand'). This teaching load is a multiplication of
enrolment and a so-called dynamic demand factor. The formula for the latter is as
follows:

dynamic demand factor = [ DG x 4.5 + DO x 1.35 ] / (TG + TD)

where:

DG = the number of degrees awarded (during previous year)

DO = the number of students that have dropped-out (during previous year)

4.5 = the normative funding period for graduates (4.5 years)

1.35 = the normative funding period for drop-outs (1.35 years)

TG = total period (in years), during which graduates have been registered before
graduation

TD = total period (in years), during which drop-outs have been registered

The dynamic demand factor can be interpreted as the ratio of the normative funding
period and the actual registration period for graduates and drop-outs. In case graduates

79
or drop-outs take more time before leaving the hogescholen , the operation of this factor
implies that the hogescholen receives less funding. In case an institution would be able
to bring down the time to degree or the time to drop out, this will only affect funding if the
graduation (or success) rate rises simultaneously. This is due to the fact that total
enrolment also decreases along with shorter periods of stay. A hogeschool thus has two
options to raise its funding amount:

1. through a permanent rise in numerical success rates

2. through a rise in student intake.

However, both options bring along larger costs for the institution. In any case, the funding
formula intends to stress performance, especially in terms of graduation rates. In the next
chapter we will discuss the impact of the increased performance orientation on the
behaviour of higher education institutions. One effect is that it stimulated institutions to
become more creative with registering students and claiming public funds for students
who hardly enjoyed educational services.

Public funds for university teaching

Brief history
Until 1960, Dutch universities were funded on the basis of reimbursement in which
negotiations between the government and individual universities was crucial (Koelman,
1998). Since 1960, operational grants were directly linked to the number of registered
students. Through the so-called ATOOM-model (Official Technical Consultation on the
Distribution of Funds) universities received a lump sum budget for personnel and
material expenses. Also research funds were included in this budget. This model was
replaced in 1978 by the ITT-model (Intentional Objectives and Allocation) because the
government wanted to have a less direct link between student numbers and research
funding. This was established by making part of the funding a fixed floor. In addition,
the number of students included in the formula for flexible funding was limited to the
number of standard-course-length students. As such, students who took longer to
complete their programme were excluded from the formula.

In 1983, the ITT model was replaced by the PGM-model (Positions-Funds-Model). In

this model it was aimed to further loosen research and services from the teaching
component. For teaching the main driver was the number of standard-course-length-
students plus a fixed floor. The research part of the funding model was independent of
student data. The research funds were allocated on the basis of national research

80
objectives and the proven quality of research (conditional research funding). For
material expenditure there was a separate funding model (OLM). Next to the PGM and
OLM lump sum models, there were specific investment and other budgets through
which universities could receive additional earmarked funds.

Due to many refinements the PGM model became a very complex model without
transparent incentives. Therefore in 1993 the HOBEK-model (Higher Education
Funding Model) was introduced. This model consisted of three parts: teaching (23%),
research (64%) and interweavement which expresses the relationship between
university teaching and research (13%). The actual allocation is the result of a formula
based on norms (prices and tariffs) and funding bases (registered students, degrees
and doctorates). Regardless these funding bases, universities had complete spending
freedom. The allocation rules were substantially simplified compared to the previous
model. Also the tuition fees universities received from students were no longer
calculated for in the funding formula. The research component, which is relatively large
with 64% of the total budget, was subdivided in 4 parts: a basic allowance (15%), a part
for doctorates and designer certificates (9%), a part for research schools (1%), and a
part for strategic considerations (75%). The latter was basically a historically
determined stable part and reallocations based on differences in quality and social
relevance never took place.

The current PBM allocation model

The current university allocation mechanism is known as the PBM model, that is
performance-based funding model (in Dutch: PrestatieBekostigingsModel). PBM is
operational from the year 2000 on, and since 2004 is also called the PBM/BAMA
Model, after the bachelor-master degrees. It is a distribution model, that means it is not
an open-ended allocation model. Basically this means that the Minister of Education
(or rather: Parliament) determines the total budget for the university sector and
subsequently distributes this budget across the individual universities according to a
set of fixed rules (a formula). Apart from the PBM allocation, the universities receive
allocations for academic teacher training, for academic hospitals, and for
unemployment benefits paid to former university employees. From 1994 (HBO
institutions), respectively 1995 (universities) on, the lump sum allocated also includes
the funds for capital costs (for the institutions property, i.e. buildings and equipment).
From that year on, HBO institutions and universities own their buildings and land.

81
The PBM allocation consists of a teaching component and a research component. We
will describe the research component later. The teaching component has the following
parts:

(a) fixed amounts for each university. This is a basic allocation to guarantee a
minimum teaching capacity for each university, independent of the number of
students. The allocations have a historical basis and the large and relatively older
universities receive a larger allocation compared to the smaller ones.

(b) diploma-based allocation and serves as an incentive to increase the universities

efforts in making students complete their programmes.

(c) new entrants allocation and reflects the idea that students base their enrolment
decisions on the quality of the programs offered by the university.

(d) allocation for facilities related to training in veterinary sciences and dentistry.

From the total amount available for the teaching component, allocation (d) for
veterinary science and dentistry facilities (i.e. laboratories and equipment) is
subtracted. The remaining budget is distributed across the parts (a), (b) and (c). The
relative shares are 37%, 50% and 13%. Table 1 provides the basic characteristics for
the teaching component.

Table 1: PBM/BAMA teaching characteristics for 2004

PBM compartment Tariff / base Share in lump

sum (in %)
teaching component:
new entrants 2,600 low 13%
3,900 high
Diplomas 11,500 BA-low 50%
17,300 BA-high (excl. medicine)
20,800 BA medicine
5,800 MA-low
8,700 MA-high (excl. medicine)
31,200 MA medicine

basic allocation Historical 37%

total for teaching 100%
component
Source: CHEPS (on the basis of information included in the Ministry of Education budget)

82
PBM derives its name from the fact that half (i.e. part b) of the teaching component is
based on performance, which is measured in terms of the number of (Bachelor and
Master) degrees granted. On the basis of the number of new entrants (i.e. first year
enrolments), 13% of the teaching budget is allocated. In the past, a two-year moving
average was used for the number of degrees and new entrants in order to avoid
fluctuations in financial flows. Nowadays, the number degrees warded in the period of
(say) September 2001 August 2002 determines the diploma allocation for the Budget
2004 while the number of new entrants on 1st October 2002 determines the 2004 new
entrants allocation.

As visible in the table, funding tariffs account for differences in costs of training
programmes. There are two tariffs applied to the number of new entrants and degrees,
distinguishing between two categories of students and diplomas, namely:

1) programmes in arts, humanities, law, social sciences, and languages;

2) programmes in science, engineering, agriculture, and medicine (including dentistry,

pharmacy and veterinary science).

There is a separate higher tariff that applies to students in medical sciences.

83
The envisaged learning entitlements model
Within the whole debate to make higher education more efficient, to stimulate students
to complete a degree within a shorter period and to limit the current problems of
administrative abuse of funding principles, a new funding mechanism has been
proposed in 2004. As from 2007/08 onwards, it is envisaged that higher education
institutions will be funded on the basis of learning entitlements, a sort of vouchers.
From then on individual students will get a limited amount of learning entitlements
which they can use to attend higher education institutions for half year periods. For a
university bachelor programme of three years they will receive 8 learning entitlements
(the nominal duration of a programme plus one additional year. For a master
programme they will receive 4 learning entitlements, thus the nominal duration of 1
year plus one additional year. In the period a student uses learning entitlements, they
have to pay the nationally determined tuition fee of 1506 per year. If students do not
complete the programme within this time frame of their learning entitlements, then the
institution can charge them an institutional tuition fee up to 3000 per annum. The
whole operation basically comes down to an instrument for the government to limit the
right to publicly funded higher education.

The learning entitlement system is sold to the public as to allow students greater
flexibility and opportunities to determine themselves what programme and parts of
different programmes suit best to their own profile. Next to that, a major advantage to
the system are that the new system provides a stronger signal to students that
attending higher education is an expensive privilege. The limited educational budget
also urges students to make better and more critical study choices. In addition, it is a
step forward in the direction of demand driven funding that better serves the wishes of
an increasingly democratising student population (Jongbloed, 2005).

4.2.4. Current funding of research in Dutch higher education

The research component of the current PBM/BAMA funding model consists of five
parts:

a) an amount for each university depending on the number of Ba and Ma diplomas. It

is 15% of the research component. It expresses the connection between teaching
and research and reflects the teaching performance per university.

84
b) allocation for dissertations and designer certificates. As such, Dutch universities
receive a premium for each postgraduate degree, i.e. PhD, designer certificate9
(based on two-year averages). For PhDs, two funding rates apply: the tariffs for
science PhDs are twice as high as social science PhDs.

c) allocation for research schools. From the early 1990s onwards, Research Schools
were established to make researchers and PhD students from different universities
in the same discipline cooperate. These funds are allocated proportional to the sum
of parts (a), (b), and (e).

d) allocation for excellent research schools: From the year 1999, the Minister of
Education allocates funding to a limited number of research schools that are
regarded as excellent. This is part (d) of the PBM research component. Six schools
all of them in the natural sciences receive extra funding for a limited period.

e) strategic considerations allocation. The bulk (67%) of the research component

consists of fixed allocations per university based on historical reasons.

Table 2 provides the basic characteristics for the research component.

9
A two-year degree awarded in engineering.

85
 Table 2: PBM/BAMA research characteristics for 2004

PBM compartment Tariff / base Share in lump sum (%)

research component:
basic allocation Ba/Ma diplomas 15%
2,700 (BA-low))
4,000 (BA high)
8,000 (BA-medical)
5,400 (MA-low)
8,000 (MA-high)
5 16,000 (MA-medical)
PhDs 41,700 12%
83,400
designer certificates 69,500
research schools Historical 3%
top research schools Strategic choices 3%
strategic considerations Historical 67%
Total for research component 100%
Source: CHEPS (on the basis of information included in the Ministry of Education budget)

It is good to note that, despite of the way the teaching and research components of
PBM are distributed, the PBM allocations are made to the universitys central
management who then will decide on the internal allocations.

The strategic considerations component is interesting. The name derives from the
original plan that the Minister of Education would base his research allocations on the
quality of a universitys research and an assessment of the relevance of a universitys
research for society. However, this plan was never realised, partly because of the
consequences this would have in terms of reallocations between universities and the
ensuing unemployment benefits. Another important reason was that a reshuffling of
research funds would be a major intrusion on the universitys autonomy. So far, the
universities have been successful in avoiding any reallocations within this component
for more than 15 years, although some (relatively new and expanding) universities
have sought to get a higher strategic considerations allocation. Therefore, unlike for the
teaching component, the major part of the research component is still distributed
mainly on the basis of historical reasons.

86
 4.2.5. Tuition fees and student financial support in Dutch higher
education

Next to the funding of higher education institutions, the funding of students is important
in the Netherlands. Basically, all Dutch students have to pay tuition fees and can be
eligible for student financial support. Both will be discussed in the following sections.

Tuition fees
In the Netherlands, students in publicly funded higher education have had to pay a
uniform tuition fee, regardless of the costs related to different study programs, since
1945. The government annually sets the tuition rate. During the 1980s university
students paid slightly higher fees than students in the HBO sector, but in the early
1990s this was equalized again. Students make their tuition payments directly to the
higher education institutions, which have full autonomy over this revenue stream. In
2003, tuition fees made up about 17% of institutional revenues in the HBO sector and
about 5.5% in the university sector about 15% of the overall university teaching
budget (Tweede Kamer der Staten-Generaal, 2003). This demonstrates that public
subsidies to higher education are considerable and private contributions moderate.
Figure 2 shows the development of the level of tuition fees in the Netherlands since
1945.

Figure 3: Development of tuition fees (, in current prices and in real 2000-prices)

1600

1400

1200

1000

800

600

400

200

0
45

50

55

60

65

70

75

80

85

90

95

00
19

19

19

19

19

19

19

19

19

19

19

20

in current prices in 2000-prices

Source: Ministerie van OCW, time series.

The real value of the fees declined in the 1945-1971 period. In that period students had
to pay NLG 200 (91) per academic year in nominal terms. After an initial increase to

87
NLG 1,000 (454) in 1972 - 1973, the level was set at NLG 500 (227) between 1974
and 1980. Since then, tuition levels have gradually increased up to almost 1445 in
2003/04. Figure 2 shows that particularly in the period since 1986 the increases in the
level of fees often exceeded the rate of inflation. As a result, a larger share of the costs
of higher education has been gradually shifted to students and their families, which
indicates that the Dutch government did not use the instrument of tuition reduction to
expand access to higher education. As such, tuition fees have become an issue of
continuous discussion. Proponents argue that tuition fees constitute a fair private
contribution to the costs of higher education, which brings the individual students
considerable future rewards (monetary as well as non-monetary). But the opponents of
fees argue that these harm access, particularly for those from lower socio-economic
backgrounds. This has led to many heated political debates about who has to pay the
costs of a steadily growing higher education system. As a good Dutch tradition, such
debates generally end in compromises that include moderate annual tuition increases
accompanied with a full compensation of lower-income students through the system of
student financial support.

The major discussions on tuition fees in 2002-2003 related to the issue of differential
tuition fees. The Ministry of Education, Science and Culture took up the discussion for
a number of reasons: to allow institutions to charge higher contributions in return for
enhanced quality programmes, and to make particular subjects like science,
engineering and teacher training more attractive. However, in the first case opponents
fear that this would harm access for poor students, and in the second case it is
questioned whether abandoning the equity principle, not to mention the public costs
involved, can be justified by the expected number of extra students attracted to the
desired programmes.

An interesting recent development has been to experiment with allowing institutions to

develop programmes that offer additional quality for which they are allowed to ask
higher tuition fees. Up to now, a few of such programmes have been accepted by the
Ministry of Education.

Student support
Since 1945, successive Dutch governments gradually developed a system of student
support, though with a change of focus over the following six decades (De Regt, 1993).
In the early days the major drive was to open up opportunities for small numbers of
talented low-income students. Between 1956 and 1972, economic growth and the

88
general tendency of democratisation changed the focus to opening opportunities for all.
This period laid grounds for the massification of higher education, though student
support remained limited to small bursary and loan programs. Financial support
consisted mainly of tax benefits and family allowances for students parents. Due to the
oil-crises of the early 1970s, the actual implementation of a far-reaching student
support system was postponed. As a result, we can conclude that until 1986 there was
the willingness to expand students opportunities but due to limited government
resources, student support was not a very active instrument in encouraging access to
higher education. Nevertheless, participation rates considerably increased during this
period and the gender imbalance to a large extent disappeared. Most recently the
number of female students is slightly higher than the number of male students.

A new relatively generous system of student aid was implemented by the Student
Finance Act (WSF) in 1986. This system transformed all indirect support like tax
benefits and family allowances into direct financial support to students themselves. The
system established a compromise between students access and financial
independence, transparency and simplicity of the system, and affordability for the
government (Hupe en Van Solm, 1998). The major characteristics of the system that
still largely is in place are reflected in the following basic elements:

A basic grant (basisbeurs) for all full-time students, varying between students who live
with their parents and those who do not;

A means-tested supplementary grant for a limited number (about 30%) of students;

Loans that can be taken up on a voluntary basis, carrying a below-market interest

rate;

Parental contributions or students own income. The parental contributions are

strongly interrelated with the (parental) means-tested supplementary grants and
loans;

Finally, students can earn up to 10,527,57 per annum (in 2006) before they start
losing any of their grant entitlements.

All components together add up to a given amount that students are expected to need
for study and living costs according to annual estimations of the Ministry of Education,

89
Culture and Sciences. From this perspective, no (fulltime) students should face any
financial barriers for entrance into higher education.

Changes within the current student financing mechanism

After 1986, on the basis of demographic developments the government expected a
decline in the number of students and thus believed that a relatively generous system
for students would be feasible from the viewpoint of public finances. But the opposite
happened, and partly as a result, a large number of additional changes have taken
place since then (Vossenteyn, 2002):

Tuition fees were increased in real terms.

Basic grants were reduced several times due to growing numbers of students and
limited public budgets.

Supplementary grants were increased to compensate for tuition increases, inflation,

and reductions in the basic grants. This is to guarantee access for students from
disadvantaged backgrounds (about 30%, based on a means-test).

The duration of grants was reduced in two successive steps (1991 and 1996) to the
nominal duration of courses (4-6 years).

Student loans gained in importance. As with supplementary grants, student loans also
covered reductions in the basic grant, increases in tuition fees and inflation. In
addition, students have been permitted to replace (assumed) parental contributions
with student loans since 1995.

Performance requirements were imposed. Since 1993 students had to meet

performance requirements in order to remain eligible for grants. Under the so-called
progress-related grant (Tempobeurs) students had to pass 25% of the annual study
credits otherwise their grants would be converted into interest-bearing loans (Hupe
and Van Solm, 1998). In 1996, the progress requirements were intensified through
the performance-related grant (Prestatiebeurs). Since then, all grants have been
awarded initially as loans and only if students pass 50% of the exams in the first-year
and complete their degree within the nominal duration of the programme plus 2 years
(6 or 7 years in total) are their initial loans converted into a grant. In 2000, the time-
limit to complete a degree was relaxed to 10 years for all programmes, particularly to

90
 allow students to be involved in extra-curricular activities like student activism and
part-time work (Ministerie van OCenW, 1999).

Due to the developments addressed above the emphasis on parental contributions

and students own resources gradually increased. In addition, students expenditure
patterns have gone up, exceeding the standard budget available through student
support. Finally, students seem to be debt averse. Consequently there is more
pressure on parents and students who are more likely to have part-time jobs
(Vossensteyn, 1997).

Most of the changes implicitly meant budgetary reductions and were aimed at
encouraging students to pursue more efficient study patterns. Furthermore, the focus of
the support policies have shifted: from opening up opportunities for lower income
groups until the mid-1980s, followed by creating a basic income provision for all
students in 1986, after which the system reverted once again to supporting
underprivileged students. The impact of all changes in the student financing system on
student choice and students enrolment behaviour will be discussed in Chapter 2.

4.2.6. Other financial mechanisms

Other changes that had an impact on the financial position of higher education
institutions included the growth in higher education as well as the introduction of
redundancy policies in the early 1990s. Until then, when staff got unemployed they
went into general social welfare arrangements of which the costs were fully taken by
the government. Since the early 1990s, all employers are responsible for the
redundancy wages to be paid to unemployed staff for as certain period (dependent on
the length of the employments contract). This means a serious additional cost to
employers, also to higher education institutions, forming another incentive to become
more efficient.

Growth in Dutch higher education was substantial in the 1970s and 1980s and became
more gradual in the 1990s. Nevertheless increasing student numbers were not met by
equal growth in funding. This implicitly meant a continuous efficiency gain in Dutch
higher education. Relative funding levels per student gradually decreased.

An interesting development has been that capital works have been transferred from the
Ministry of Education to the higher education institutions in 1993/1994. Since then the
HEIs are the owners of their land, estate and buildings. At first sight this made the

91
institutions much more flexible in their capital expenditures and taking better
considered choices with respect to investment works. However, it appeared after about
a decade that the deal might not have been that well for universities as they faced
major investment requirements in order to maintain their buildings. Some institutions
did not put aside enough capital to pay such bills, other institutions, particularly
relatively new ones, found themselves in a situation where almost all their buildings
required renovations at the same time which was not foreseen at the time the contracts
with the government were signed.

Since the early 1990s higher education institutions are no longer following the general
employment conditions for civil servants but can negotiate their own terms of
employment with the unions. This has provided higher education institutions more
flexibility in terms of the attractiveness as an employer, but also puts them into a
position of finding flexibility within the limited budget provided by government.
Regardless of this fact, the HEIs managed to develop more flexible employment
conditions without demarcating too much from the general civil servant conditions.

4.3. Impact of funding arrangements: opinions of various stakeholders

Most interesting of all changes in the funding arrangements is to see whether these
had an actual influence on the operation of the higher education system. The first way
too look at this is to reflect on a few general developments in terms of the growth of the
higher education system in terms of student numbers, public funds available, average
duration of study and the success rate in higher education. A second way is to look at
the discussions around one of the most interesting phenomena: the transition to a
performance based higher education funding system. We will conclude with a number
of stakeholder opinions on Dutch higher education financing.

4.3.1. Some general trends

An interesting phenomenon has been that during the growth of the higher education
system, the basic funding has not increased simultaneously. In the period 1980 to
2005, the number of students in higher education increased from about 372.500
(155500 in universities and 217000 in hogescholen) up to about 561.500 (205000 in
universities and 356500 in hogescholen). This development is shown in Figure 3.

92
 Figure 4: Development in student numbers

400000

350000

300000

250000
WO
200000
HBO
150000
100000

50000

0
1950
1953
1956
1959
1962
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
Source: CBS

With regard to the public expenditure on higher education, one can see in Figure 4 that
the government over the last 15 years reduced its relative expenditure as a proportion
of GDP. Allowing for inflation, the states contribution to research and education
combined in 2003 was at the same level as it was in 1983.

Figure 5: Development in public funds for higher education as a % of GDP

1,20%

1,00%

0,80% publ exp on HE as % of

GDP
0,60%
public exp HE (KC) as % of
0,40% GDP

0,20%

0,00%
90

92

94

96

98

00

02

04
19

19

19

19

19

20

20

20

Source: CBS and OCW, Kerncijfers.

If we combine the information from on student numbers and expenditure for higher
education, the broad picture shows that higher education institutions had to become
much more efficient. They had to train substantially increasing numbers of students
with more or less stable budgets. Next to the financial need to operate more efficiently,

93
the government also developed specific policies to stimulate institutions and students
to get a degree and getting it in a reduced time. Funding on the basis of numbers of
degrees and the performance related grants are eminent examples of this.

A way to see whether higher education indeed became more efficient is to look at date
on time to degree and success (or drop out rates) are scarce and complex in terms of
definitions. Nevertheless, to get some broad idea, Dutch data from the National
Statistics Agency (CBS, 1994-2006) show the following picture.

Table 3: Success rates in higher education

HE sector Cohort Degree after 6 years Degree after 9 years Degree after 11
years
Universities 1961/62 17% 51% 56%
1970/71 17% 45% 50%
1983/84 43% 59%
1988/89 41% 58%

Source: CBS

Table 4 provides a quick look into the time it takes students to complete a programme.
One can see that this has reduced considerably over time.

Table 4: Duration to get a degree (in number of months)

HE sector Cohort Months to get a

degree
Universities 1970/71 85
1983/84 70
1995 (graduates) 66
2004 (graduates) 64

Hogescholen 1995 (graduates) 53

2004 (graduates) 51

Altogether, these general overviews indicate that the higher education system has
become more efficient.

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 4.3.2. The impact of greater performance orientation in the funding HEIs

Maybe the most interesting phenomenon in recent Dutch financing policies has been
the increased performance orientation by funding both higher education institutions and
students partly on the basis of their outputs and achievements. This transition will be
discussed separately for both teaching and research funding.

Performance elements in teaching funds: effects

As described in the previous chapter, the funding model for teaching is partly output-
driven since 1993. This means that the allocation for each university depends on the
degrees granted to students (BA, as well as MA degrees), the number of new entrants
per university, and the number of PhD degrees.

The output orientation in the funding models was to stimulate greater efficiency in
Dutch higher education by encouraging higher education institutions to put more effort
in the success rates of students and to reduce the time to degree. Of course there has
always been a fear that putting more emphasis on the number of degrees could also
lead to degree inflation, practically coming down to plain reduction of quality standards.
However, that maybe natural implication has always been counterbalanced by the
development of a quite elaborate quality assurance mechanism since the late 1980s in
the Netherlands.

A more unexpected effect of the performance orientation in the funding model has
been one of administrative creativity. Higher education institutions seek ways in which
students can be put in categories that provide them the highest funding tariffs. As such
there have been discussions on whether or not all science programmes should be
funded on the basis of tariffs originally meant for engineering programmes. Also it was
interesting to explore the frontiers of when a student who entered a programme in the
2nd or 3rd year could still be counted as a new entrant and what type of graduates could
all be included for full graduate funding. All of this creative behaviour however takes
place within the limitations of a fixed funding budget. As such, the institutions just tried
to get a larger share of the total budget that was anyhow fixed by the Ministry of
Education. Thus creativity could only go at the expense of colleague institutions with all
the counterbalancing mechanisms that are latent in micro-systems.

The situation became worse when internationalisation became more dominant. Dutch
higher education institutions became really active in teaching foreign students.
However, some institutions started claiming funds for students they hardly provided any

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educational services, like foreign students predominantly educated abroad but also
given a Dutch degree. Some institutions were quite ingenious in designing
constructions that could lead to Dutch funding for students that hardly required and
teaching input. This phenomenon became known as the HBO-fraud in 2001 and the
issue was investigated by a special Committee on Accountability (Schutte et al., 2004,
2005). The Committee found that most higher education institutions were not guilty of
unintended bookkeeping with foreign students. However, a number of higher education
institutions (30% of the universities and 70% of the hogescholen) were found to have
cheated the system in one way or another. As a result, 3.6 million of public funds
allocated to universities was reclaimed and 43.6 million was reclaimed from a number
of hogescholen. These amounts of money have been claimed at the expense of other
higher education institutions. The Committee also stated that higher education
institutions have financial autonomy but should also be more open in the way they
spend public money in liaison with all kinds of private and international partners. The
Committee recommends a stricter supervision of the administrative processes in higher
education institutions, to better check the information flows that drive the funding
mechanism and to sharpen the behavioural- and professional codes of conduct. Finally
the Committee suggests clearer norms in the funding arrangements and provide
clearer limits of autonomy.

Performance elements in research funds

The changes in the funding model for distributing the basic, first stream funding,
combined with the (still relatively modest) increase in the research council funding and
the research funding by means of other (competitive) grants have resulted in almost
60% of the total university research funding now being performance-based.

Basic funds for research

As explained in the previous chapter, also the allocation of research funds to a
substantial degree depends on performances. First of all, the education-related
research allocation, which expresses the fact that research is a prerequisite for university
teaching, is driven by the number of masters degrees and, to a lesser extent,
bachelors degrees. About 15% of available research funds falls under the heading of
diploma-based allocations.

The second component in the research funds is an allocation based on the number of
PhD degrees and (for technical universities) the number of postgraduate designer

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certificates awarded. Some 12 % of the total research allocations is based on the
number of doctorates and designer certificates.

The third and fourth component in the research funding is allocated for research
schools and excellent research schools, both to reward excellence. The research
schools compartment is relatively small: 6% in total.

The fourth and most important part of research funding is called the strategic
considerations compartment (SCC). This originally was intended to fund research that
is relevant to society or the national economy. Although the education ministry and the
universities agreed that quality and social relevance are to play an important role in
allocating this component, the universities took the view that a reshuffling of research
funds would be a major intrusion into the universitys autonomy. So far, the universities
have been successful in avoiding any reallocations. Therefore, this part of research
funding is still based mainly on historical allocations with the traditional and largest
universities receiving a relatively larger share. Over the years there has been a lot of
discussion to make this component much more dynamic and open for performance
measurements.

Though the basic ides of the strategic considerations component was strongly opposed
by universities and therefore implicitly aborted since the late 1980s, university faculties
were much more focused on generating research output and revealing that output, as a
means of justifying the public funds granted to them. A negative effect of the system
was its contribution to the idea that, for academics, research is the most important part
of a university's activities and the main determinant of a university career (Jongbloed,
2006). From 1993 on, the universities have agreed to have their research programmes
examined in a system of peer review (i.e. by international committees of independent
experts in the respective disciplines). Originally these research assessments were
carried out every six years under the auspices of the Association of Universities in the
Netherlands (VSNU. A few years ago, the assessment system was modified to reduce
the administrative workload for institutions and researchers and to place more
emphasis on the management of research. Today, it is up to the university to arrange
the assessment, seek out the review committee and whether or not to include
benchmark institutions in the peer review. However, despite of the increased autonomy
for the Dutch universities in this respect, all universities agreed to adhere to a uniform
evaluation approach developed by the Academy of Sciences (KNAW), the research

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council (NWO) and the VSNU. The reviews assess the quality of research programmes
in terms of academic quality, scientific productivity, scientific relevance and scientific
long-term viability. The assessments produce ratings and the assessment reports are
published which performs an important accountability function and forms an input in
universities research policy. However, unlike in the United Kingdom, the results are not
used as inputs in the Ministrys decisions on research funding.

All of this means that approximately 40% of the current total funding of university
research is still not directly related to performance, mainly being the Strategic
Considerations Component (SCC). This situation led to the current fierce debate about
the 40% budget share that is independent of performance should be brought down to
increase the performance element even further. Doing so would make the funding of
university research more dynamic, i.e. less dependent on allocations made on a
historical basis and more dependent on, for instance, ratings that express the quality of
a universitys research. Quantitative ratings and indicators like the amount of
competitive research grants, bibliometric indicators or prizes won could be included.

An important input in the discussion to make research funding more dynamic was the
ministerial course set out in the Science Budget (Ministry of Education, Culture and
Science, 2003) to create more focus and mass in academic research. To strengthen
the governments idea to integrate more competition and incentives for stimulating a
more dynamic research landscape the Education Minister installed an independent
commission, the Dynamics Commission in July 2005. This Commission, known as the
Commission Chang (named after its chairman Hans Chang, the director of the Dutch
Research Councils FOM division) released its proposals for dynamising research in
2006 (Commissie Chang, 2006). The Commission recommends 17 measures to
improve the quality and the dynamics of university research. A first group of these
measures can be implemented right away and include issues like becoming more
transparent and work harder on communicating their research performance more
clearly to their stakeholders and funders. It is also suggested to link funds (internally) to
the outcomes of research evaluations). A second set of measures require an extra
public commitment of 1 billion Euro per year for new research objectives and priorities.

An interesting aspect of the Commissions work was to investigate how research

assessments are utilized at the various levels within the universities (Jongbloed & Van
der Meulen, 2006). A series of interviews were conducted with key players in a number

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of Dutch universities. The main findings first showed that the system of external
research evaluations in the Netherlands is quite effective. University leaders explicitly
take into account the quality and productivity of the research groups output. Twelve
years from the start of the system of research assessments in the Netherlands, the
evaluation of academic research is an essential part of the apparatus for accountability,
governance and management in universities. Research assessments have completely
been internalized in and by universities. All Dutch universities use a uniform protocol
that covers the internal procedures for planning, preparing, carrying out and following
up on research assessments and integrate them in the universitys planning and control
cycle that covers the yearly cycle of strategy, planning, budgeting and monitoring of the
teaching and research activity of the universitys departments and research units. Also
all universities all explicitly strive for the highest, to be excellent or very good.
Sometimes underperforming research groups are merged with successful ones to
spread the success formula. Financial incentives are used to encourage better
performance or to help an underperforming unit change course. Furthermore, many
universities strive to create fewer, larger (often multidisciplinary) research units where
the best researchers co-operate and produce high quality output that has the potential
to reap economic rewards as well. This nicely fits with the Dutch governments policy
goal of focus and mass, all carefully choosing their areas of excellence. They make
use of research assessments as tools in making their choices for particular areas of
strength and building their research profile (see also Salerno et al., 2005). But high
marks in research ratings do not automatically translate into higher budgets for
research groups. Excellent research creates a situation of high trust and goodwill for
the group in question and this eventually will pay off. In addition, excellent groups often
see their budgets grow through research council grants and externally funded research
contracts. Often, the universitys internal resource allocation model is placing a
premium on every competitive research grant brought in, which leads to problems of
matching funds. In many Dutch universities, the increasing matching obligations (due
to research council grants and European framework projects) are dangerously reducing
the universitys room to maneuver and to set their own research agenda. It is estimated
that 50% of universities research income now comes from research council or other
contract funding. As a rule, research subsidies cover only 54% of the total costs (Ernst
& Young Accountants, 2004) which implies that universities will have to add
84 eurocents to every Euro of research subsidy they receive. This all has to come from
the Strategic Considerations Component (SCC).

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Finally, all Dutch universities somehow explicitly link research performance to their
internal allocation models, but many use different models and parameters. From
interviews it also became clear that, these days, the universities human resources
policies are very much performance-based and a tenure track system is being
prepared. By carefully organizing and structuring research groups, universities try to
create the required financial room to appoint new (young) professors. This system will
often be supported by a monitoring system that keeps an eye on the quantitative and
qualitative research performance of research staff. Norms are being implemented for
the number of articles by scientists in peer-reviewed journals even for a discipline like
law (e.g. in Leiden University). The professionalisation of supervision of PhD
candidates is also a part of the HR policy repertoire.

Altogether one can conclude that higher education institutions become much more
businesslike. However, whether all of this is the result of changing funding paradigms
remains the question. There are also other developments, like creating a quality
culture, internationalization and international competition, large democratization and
the development towards accountability that drive such developments.

Indirect research funding through the Research Council (NWO)

The indirect research funding by means of grants from the research council NWO is
also competitive and thus performance based. NWOs mission is to promote and raise
the quality and innovative content of fundamental scientific research at Dutch
universities and research institutes and to stimulate the dissemination and use of
research results. NWO encompasses all scientific fields and it provides grants for top
level research and research equipment and to co-ordinate research programmes on
the basis of open competition. NWO grants represent 11% of total research revenues
in universities. However, during the 1990s and 2000s some attempts have been made
to transfer part of the strategic research component of the basic funding to the budget
allocated through NWO. Though these attempts were not successful, NWO funds have
gradually grown due to adding new research money to the NWO budget instead of to
the basic funding budget. In 2006, an amount of 50 million of basic research grants
will be redistributed across the universities according to each universitys success in
terms of winning research council grants (NWO) and selected competitive research
contracts in the third stream of funding. For five universities the reallocation will be in
the order of half a million Euros (plus or minus), but for some of the more

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entrepreneurial ones (like Twente and Nijmegen) the additional budget lies closer to
one million.

Contract research
One of the biggest changes in Dutch funding for higher education has been the
turbulent growth of contract funding (third stream activities). Contract research in
universities covers about a quarter of all research. Contract research includes all
research activities that are funded by third parties, thus not through the official basic
funding channels from Ministry of education and research councils (NWO and KNAW).
The contractors can be private but also public organisations, thus companies,
business, non-profit organisations and government authorities.

Interestingly, a recent trend is that Dutch government more often decides to allocate
public research funds through specific grants that seek to stimulate particular forms or
areas of research instead of adding extra budget to the general research funds
allocated to universities through the basic research funding mechanism. This may be a
strategy to make new funds for research more dynamic and to keep it outside the
strategic considerations component or the NWO budget, but such a strategy is not
made explicit. We can mention a number of such programs that provide public contract
funds to universities: IOP, BSIK, Innovation Platform and Smart Mix. In most cases, the
Ministry of Economic Affairs is (one of) the provider(s) of the project funds. The IOP
programme is the Innovation-Oriented Research Programme which awards grants to
innovative technological research projects at universities and other non-profit research
organizations within public-private research programmes. The BSIK programme
focuses on areas of excellence (backing winners concept). BSIK is a competitive fund
to strengthen the Dutch research infrastructure, spending part the governments
revenues of natural gas exploitation.

The Innovation Platform is an official group of distinguished politicians, researchers and

businessmen who since 2003 want to strengthen the innovative capacity of the
Netherlands through a long term strategy to create room for excellence, ambition and
entrepreneurship of individuals and organizations. The Innovation Platform has a
substantial budget (100 million) to develop a number of selected projects that help
achieve the given objectives. One of the projects includes setting the innovation
agenda for 2010-2016.

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Another initiative is the introduction of a new funding instrument, the Smart Mix. This
funding instrument will come into operation in 2007. The governments science budget
allocates a total of 100 million in additional research subsidies for research programs
submitted by consortia of business enterprises, non-profit organisations and knowledge
institutes (primarily universities). The programmes that meet the criteria of
strengthening focus and mass in excellent research and removing the knowledge
gap will receive subsidies out of this special funding instrument. It emphasises the
governments wish to stimulate science that has social and economic relevance - that
contributes to the innovation or valorisation agenda.

Another form of interesting contract research is sponsored by charity organisations.

Many of these non-profits are working in the medical fields. Although their effort is
relatively low when compared to the research system in total, charity funding is
targeted to a few areas in the medical sciences, so it often will have a considerable
impact in these fields. E.g. in the field of chronic lung diseases like Asthma and COPD,
about 15% of research is funded by charity. Funding is allocated on a competitive
project base.

4.3.3. Impact of tuition and support policies on student enrolment

behaviour

Until the mid 1980s, student financial support was relatively moderate or poor in the
Netherlands and thus could not be expected to generate massification in higher
education. Nevertheless, rapid expansion of higher education happened during the
1960s and 1970s, also reducing the gender imbalance to a large extent. These
developments seem to be the result of general societal tendencies rather than active
access policies.

However, the introduction of a relatively generous system of student support in 1986

could be expected to boost access and participation, although its purpose was to
guarantee equal access for all students regardless their backgrounds. There has been
a number of studies on student choice behaviour that also looked at the potential
relationships between financial support and participation. However, most of these
studies indicated no clear relationships between changes in student finance and the
composition of the student body (De Jong et al., 1991; De Jonge et al., 1991).

Also the deterioration of student support, particularly during the 1990s has been
studied for its impact on access to higher education (Vossensteyn, 2002). The gradual

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shift towards cost-sharing in the Netherlands might be expected to have led to changes
in student enrolment behaviour, for example in terms of lower participation, the choice
of cheaper (shorter) or easier study programmes or higher study progress. However,
hardly any such changes in student choice seem to have occurred. Only a few
tendencies can be indicated.

First, the introduction of study progress requirements, which meant a serious cultural
change, had only a temporary effect on participation in higher education. Initially, the
number of new entrants to university studies decreased slightly, some (potential)
students postponing actual enrolment and some university-qualified candidates
entering HBO-programs (De Jong et al., 1996). However, within a few years, the
traditional enrolment patterns appeared again.

A second interesting development is that, regardless of the growing emphasis on

loans, the number of students actually taking up loans decreased substantially, from
40% in 1991 to about 15% in 1997 (De Vos and Fontein, 1998). One reason is that
since 1992 interest has been charged. However, take-up rates have gone up slightly
since 2000 to about 24% in 2005. Instead of acquiring student loans, students prefer to
take part-time jobs which enable them to avoid accumulating debts and even to
upgrade their standard of living. Moreover, students are also willing to borrow outside
the student loans system, either from family or by having a bank overdraft. Many even
take up flexible and temporary loans from private banks to cover extraordinary
expenses, such as computer equipment or holidays (Kerstens and De Jonge, 1999).

With respect to the impact of tuition fees most studies show that the real increases in
tuition fees did not seem to impact on access in terms of enrolment patterns. Student
choice behaviour in general seems to be price inelastic! Such price-unresponsiveness
dates back to the 1980s and continues into the 1990s (Oosterbeek and Webbink,
1995). A simulation model showed that even substantial tuition fee increases will hardly
affect enrolment rates, except for students from lower socio-economic families
(Sterken, 1995). Furthermore, a recent survey by Fels et al. (2000) indicated that
students would not change their preferences in cases where tuition fees were either
increased or reduced by 450.

Some simulation studies paid attention to the problem of a declining interest in science
and engineering studies. They found that guaranteeing students a job after graduation
and increasing engineers salaries would have a stronger influence in attracting extra

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students to these studies than increasing scholarships or reducing tuition (De Jong et
al., 2001; Fels et al., 2000). In fact some universities of technology have
experimented with giving students additional scholarships but this did not attract extra
students.

All in all, various studies, covering different time periods, all come to the conclusion that
student choice is not so much affected by financial incentives, except for students from
disadvantaged groups. This more or less confirms the findings of international studies
on student choice (Heller, 1997; Hossler et al., 1999).

4.3.4. External opinions on funding issues

In this section we provide some opinions of major stakeholders in higher education on

the funding issues. We separate there between general funding issues, the funding of
teaching, the funding of research and student financing. The results are based on
official reports, policy advises and interviews with major stakeholders.

External opinions: general ideas

Over the course of time, many stakeholders have developed their own opinions about
the funding strategies for higher education. Many of these opinions have formed one
way or the other input for the development of the system as the Dutch policy making
process normally includes contributions of most important stakeholders and tries to
come to a system that suits most opinions.

Interesting and special stakeholders however always are the Ministry of Economic
Affairs and the Ministry of Finance. They have a key stake in the financial viability of
higher education and also in the outputs reached with all public funds going into the
system (accountability). As such, these ministries have stimulated debates on tuition
fee differentiation, greater emphasis on student loans (with an income related
repayment mechanism) and more demand driven funding. In a recent paper, the
Ministry of Economic Affairs (Moons en Petri, 2006) suggest that higher education
needs to be challenged to become more attractive and excellent with greater diversity
and more enthusiasm of students. They propose to allow more entrepreneurship,
privatisation and performance orientation. As such they recommend, amongst other
things, to make it easier for higher education institutions to be established or disappear,
to allow tuition fee differentiation and greater selection. In terms of funding, the Ministry
of Economic Affairs proposes to stronger fund the number of new entrants and
students, to increase private contributions through tuition fees and, to prevent social

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exclusion, to introduce a system of social loans which students repay only when their
future income is sufficient. Finally the plea for a stronger focus on non-traditional (older
and non-native) students and to invest in primary and secondary education in order to
prepare more people for higher education. With regard to funding levels they
recommend fixed amounts of public subsidies for students who entered the system at a
given moment.

External opinions: funding for teaching

The Education Council (Onderwijsraad, 2003) looks at funding issues related to
teaching programmes from a responsibility point of view. What can be regarded as a
public responsibility and what as a private responsibility? In this perspective, they
regard a stronger responsibility for bachelor than for master programmes. The main
criteria for public funding should be effectiveness (social relevance), accessibility and
quality. In other words, higher education study programmes should meet minimum
quality standards, lead to graduates that are employable, and students should have
easy access to higher education in terms of financial issues but also in terms of
regional spread of higher education institutions. The Council prefers the current funding
mechanism in which higher education institutions are funded over a system in which
students will be funded. They do not prefer a demand driven system. The Council
further suggests that performance funding has a slight preference over input-funding.

External opinions: funding for research

An important external stakeholder in the area of research is the Advisory Council for
Science- and Technology Policy (AWT). This Council in recent proposals argues for a
funding mechanism that forms a solid basis for basic research, that allows excellence,
that rewards the right performances and that is transparent and simple. But higher
education also has to face a number of challenges in creating more focus and mass, to
put more emphasis on the valorisation of knowledge, to maintain research capacity and
stimulate young researchers and to keep matching problems manageable. To reach
these goals, the AWT, suggests to better align all contract research funds from
ministries (particularly the major funds of the Ministry of Economic Affairs like Bsik,
TTIs, IOPs and the Smart Mix), to increase degree related research funds, to reduce
the matching obligations and not to further dynamise the basic research funds, only to
make the strategic considerations component more transparent.

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External opinions: student financing
The current developments towards larger private contributions in the form of higher
tuition fees and a greater emphasis on student loans is objected by student unions as
they fear a reduction in access to higher education, particularly by students from
disadvantaged backgrounds. Nevertheless, political parties and ministries aim to
further develop into this direction. The current funding proposals allow higher education
institutions to demand higher fees (up to a maximum of 3000 per annum) from
students who run out of learning entitlements. To provide students more financial
flexibility however, students will be enabled to borrow the total amount of tuition fees
next to the current level of student financing that is available (that includes a tuition fee
compensation). This means an improvement in the financial position of students, but
can lead to higher debt ratios. Data on student borrowing show that most students will
not run into high debts (Ministerie van OCW, Informatie Beheer Groep). Nevertheless
there is a general fear with some political parties and in the media that higher private
costs and student loans can lead to a serious problem of debt aversion. Current figures
on student borrowing however show that increasing numbers of students take up
student loans, particularly because the borrowing conditions are recognised to be
favourable (IB-Groep, 2006).

4.4. Critical summary

In this report the Dutch case study on higher education funding reforms has been
presented. This case shows a substantial number of reforms by changes in funding
mechanisms for teaching research and student financing. However, the financial
reforms do not stand by itself. Also many other elements in higher education policy
have been changed, like the introduction of quality assurance and accreditation,
structural reforms with respect to the nominal length of studies, a modernisation of
university management and governance structures, the development of
internationalisation policies and multiple changes in the environment of higher
education.

Both because of these other developments and because of difficulties to measure one-
to-one relationships between changes in the funding mechanisms and institutional or
student behaviour it is difficult to indicate the exact impact of changes in the funding
mechanisms. Nevertheless, if one takes a more long term perspective, some
interesting observations can be made:

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 First of all, the funding mechanisms have shown a general tendency towards full
spending freedom of higher education institutions, a change from funding based on
claiming public funds to lump sum funding, a change from input to output funding, a
development towards greater simplicity and transparency, and a change from open-
end funding to a closed budget that is distributed on the basis of relative
performances (Onderwijsraad, 2000).

Second, there has been a substantial decrease in the real value of funds available for
higher education. Public funds absolutely have not kept pace with the substantial
growth of higher education in terms of student numbers and staff. In quite some
years, public budgets for higher education have not been corrected for inflations,
whereas salaries continued to follow national trends. All of this means that higher
education institutions have had to make continuous efficiency cuts.

Third, with regard to teaching one can state that dropout rates and average duration
of study have decreased over time. We have seen that public funding and student
support policies were aimed at reducing student dropout and duration of study, but
these could also have been influenced by changes in course structures.
Nevertheless, one could state that using a multitude of policy instruments shorter
nominal study programmes, more flexible learning paths and structures, greater
student inputs in teaching matters, and financial incentives for students and
institutions to stimulate degree completion and reduce the duration of study have
led to increased efficiency in the education process in the long run. Of course
particular instruments can always be improved and it is difficult to measure the
impact of one specific mechanism.

Regardless of greater efficiency in the education process, quality does not appear to
have suffered. Over the past 15 years the quality assurance mechanism does not
show significant problems. In general, quality reviews show satisfactory results, only
in a very few cases some particular programmes were regarded of low quality and
were urged to improve their teaching programmes. In most cases, quality has been
integrated as a natural fact of academic life. Nevertheless one could argue that in
some cases the pressure from performance objectives and accountability gradually
pushes teachers to latently decrease standards. One example could be the
decreasing test scores of freshly educated teachers in calculation tests over time. But
one could counter argue that they gained considerably in didactical skills.

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 As for research, it looks that greater emphasis has led to improved performance of
academics. Dutch researchers show productivity levels never shown before in the
Netherlands in terms of publications, patents etc. Some argue this is the success of
investments that have been made decades ago and that Dutch science will collapse
soon due to a serious decline in research investment over the past decades.
However, this theory already is known for at least 10 years and the big collapse still
did not happen.

With regard to student financing one can see that shifting a greater part of the costs of
higher education to students and their families by means of tuition fees and a greater
emphasis on student loans does not have a strong influence on student enrolment
behaviour. Particularly not if students from lower income groups or other socially
deprived groups are compensated by grants and scholarships. Nevertheless one can
also see that negative publicity around this type of issues may have a negative
impact on the willingness to take further steps on the (necessary) road of privatisation
and cost sharing. Issues like debt aversion and fear of tuition may become an
obstacle if ideas about tuition fee differentiation, abolishing basic grants, and income
contingent repayment become a reality. Therefore careful well targeted information
provision and communication are an area in which the higher education sector has to
invest.

References

Commissie Chang (Commissie Dynamisering) (2006), Investeren in Dynamiek. Eindrapport

Commissie Dynamisering. Deel 1 en Deel 2. Amsterdam: Joh. Enschede.

CPB (Centraal Planbureau) (2003), Prikkel de prof. Een analyse van de bekostiging van
universitair onderzoek. Den Haag: Centraal Planbureau.

Ernst & Young Accountants (2004), The scope of matching. A study of the effects of matching
of subsidies (indirect funding) and contract funding on the room for strategy development in
Dutch public knowledge institutions (AWT Background Study).

Jongbloed, B. (2005), Leerrechten: worden we er wijzer van?, in: Tijdschrift voor Hoger
Onderwijs en Management, Nr. 3. 2005, pp. 56-62.

Jongbloed, B.W.A (2006), On smart rules and smart mixes: New modes for the funding of
university research in the Netherlands, Paper for the 19th Annual CHER Conference
Systems Convergence and Institutional Diversity?, 7-9 September 2006, Kassel,
Enschede: CHEPS, University of Twente

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Jongbloed, B., Huisman, J., Salerno, C. & Vossensteyn, H. (2005), Research Prestatiemeting.
Een internationale vergelijking. Volume 113 Beleidsgerichte Studies Hoger Onderwijs en
Wetenschappelijk Onderzoek, The Hague: DeltaHage, pp. 1-86.

Jongbloed, B. & van der Meulen, B. (2006), De follow-up van onderzoeksvisitaties. Onderzoek
in opdracht van de Commissie Dynamisering.

Jongbloed, B. and C. Salerno (2004), De bekostiging van het universitaire onderwijs en

onderzoek in Nederland. Modellen, themas en trends. AWT working document; posted on
www.awt.nl.

Koelman, J.B.J. (1998), The funding of universities in the Netherlands: Developments and
trends, in: Higher Education, Vol. 35, pp. 127-141.

Ministry of Education, Culture and Science (2003). Wetenschapsbudget 2004. Focus op

Excellentie en Meerwaarde. (translation: Science Budget 2004) The Hague: Ministerie van
Onderwijs, Cultuur en Wetenschap.

Moons, S.J.V. en M.M. Petri (2006), Hoger onderwijs: een stelsel met voeten zonder vleugels,
in: Tijdschrift voor Hoger Onderwijs en Management, Nr. 4, 2006.

Onderwijsraad (2000), Onderwijsbeleid sinds de jaren zeventig, Den Haag: Onderwijsraad.

Onderwijsraad (2003), Bekostiging hoger onderwijs, advise, Den Haag: Onderwijsraad.

Schutte et al. (2004), Eerlijk delen, Onderzoek naar onregelmatigheden in de bekostiging van
het hoger onderwijs en het middelbaar beroepsonderwijs, Commissie Vervolgonderzoek
Rekenschap, Utrecht.

Schutte et al. (2005), Eerlijk delen II, Voortgezet onderzoek naar onregelmatigheden met
bekostiging bij zeven onderwijsinstellingen en afrondende beschouwingen, Commissie
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Heller, D.E., Student Price Response in Higher Education, An Update to Leslie and Brinkman,
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5. THE FUNDING OF THE UNIVERSITY SYSTEM IN THE REGION of
VALENCIA, SPAIN

5.1. Features of the Valencian university system

In Spain, university funding depends basically of regional governments. Central

government is responsible of the students aid system and of research funding (in this
case in addition to the EU and to regional own research programmes). For this study it
has been selected the Region of Valencia because it was the first in implementing a
funding model and it has more experience in the use of incentives.

The Valencian Regions university system (SUCV) is made up of five public

universities, two private Catholic universities and several private centres which teach
university studies and are affiliated to the public universities.

The vast majority of university places are available at the five public universities. In
2004-2005, a total of 137,580 students were enrolled at these universities whilst the
private sector had a total of 9,748 students on its books.

A large part of the problems and circumstances that characterise the higher education
system in Spain are also relevant to the public university system in the Valencian
Region. This is particularly true in the case of the total number of students in the
university system. Numbers have levelled out as a result of a reduction in the
enrolment of new students in higher education. This situation lies in sharp contrast to
the trend of the last 25 years in which the Spanish university system in general and the
Valencian system by extension underwent accumulative annual growth of up to 6%. As
the main reason for the decrease in new students is a drop in the birth rate, the current
situation is not likely to change over the next few years.

This situation affects all public Valencian universities but is having a greater effect on
the two newest public universities - the Jaume I University in Castelln and the Miguel
Hernndez University in Elche. Both these universities underwent higher growth rates
during the boom but current stagnation has meant that the number of students has
levelled out over the last few years.

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The reduction in the number of students as a result of demographic reasons has led to
low-demand degree courses with even fewer students. Strangely enough, the number
of degree courses on offer has risen at a time when the total number of students has
decreased. This, in turn, has had an effect on financing as the funding system is linked
to the number of students enrolled at the universities.

Moreover, the distribution of students by subject areas has changed considerably over
the last few years. The major trends detected some years ago as to future labour
market needs finally seem to have found, many years later, their reflection in the
university system situation.10

Over the last ten years, changes have materialised in a steady decrease (although
trends point to a levelling out of numbers) of Social and Legal Science students whilst
Technical degrees have increased their share of undergraduates considerably.

Table 1 Subject areas as a percentage of the total number of undergraduate

places.

Area 1995 2005

Humanities 15% 9%
Legal-Economic Sciences 43% 43%
Experimental Sciences 9% 7.5%
Health Sciences 8% 9%
Technical 25% 31.5%

The greatest reduction has been in Humanities. Experimental Science degrees have
also fallen slightly in relative terms over the period.

As we will discuss later, the funding system, which was put into practice in 1994, has
encouraged some of these changes thanks to its differential funding criteria for degrees
in different subject areas.

10
The so-called Sweeney Report, which analysed the Valencian university system, was put together at
the request of the Valencian Regional Government (Generalitat Valenciana) in 1993. The report pointed
out the need for more so-called short cycle or three-year degree courses and more technically-based
degrees which would be better suited to the needs of the Valencian economic environment.

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 5.2. Funding Valencian universities

Until the 80s, Spanish universities were funded by the central government. At the
beginning of the 80s a decentralisation framework was set up in which the Spanish
regions were given the job of financing the public universities in their territory. In 1986,
the Valencian Region became one of the first regions to manage its own university
system. This put the region at a disadvantage on a medium-term basis. The initial
funding Valencian universities were given was the amount they had previously received
from the central government which later turned out to be less than the amount given to
other regions which received university management responsibilities at a later date.

From 1986 onwards, we can talk about three periods in the funding of the Valencian
university system: 1987-1993, during which negotiated procedures of annual increases
were applied to university funding; 1994-2003, with the implementation of pluriannual
funding models based on the application of formulas and from 2003 to the present-day
in which successive extensions of the previous model, distorting some of its most
important advantages, have been implemented.

During the first period (1987-1993), the funding model was similar to the system used
by the central government. During this period, each universitys annual subsidy was
fixed by bilateral negotiations with each university and the Regional Government,
based on an expenditure need indicator, such as the number of students enrolled at
each university. The funding available after covering the annual university funding
commitment was distributed discretionally according to new funding needs that the
universities manifested, for example, the creation of new degrees and other
exceptional situations.

After a period of negotiation, which began in 1993, between the universities and the
Regional Government, important changes were introduced into the system aimed at
effective planning of the Valencian university system: a map of degree courses which
staggered the implementation of new degrees over time according to the systems
general needs and to future demand, a funding plan which ensured a stable inflow of
public finance for the universities, transparently shared out between the universities
using the same criteria for all concerned and an investment plan which provided the
system with the buildings and facilities required to offer top-quality service.

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It is important to point out that under this new approach the funding system became an
essential management tool for the university system and provided universities with
financial autonomy. It substantially increased the systems public and private resources
and established mechanisms to improve quality in higher education.

Funding for Valencian universities, after the introduction of the new financing system,
came from four different sources: the subsidy from the application of the funding model,
the tuition fees paid by the students, income from research contracts and projects and
funds to finance infrastructures and equipment. We should mention that the grant
system partially funds the expenses of an ever smaller percentage of university
students.

5.3. The pluriannual funding system of Valencian universities

In 1994, the pluriannual programme for funding the Valencian university system was
put into practice. This system continued to be used, albeit with several modifications,
until 2003. The features of this system include:

1. Funding uses formulas as a basic tool to calculate the current subsidy each
university receives from the system which has a finite time limit.

2. It is based on an estimate of the theoretical teaching and basic research costs.

3. It does not share out the total subsidy fixed by the Regional Government. The
yearly budget required to cover the models estimates are decided through the
model itself.

4. The system is the same for all the universities. This means that the calculation
of the initial subsidy a specific university receives is always the same as long as
the objective conditions of the expenditure needs, measured by the real
demand for each degree, remain the same.

5. The system includes specific incentives to improve the quality of teaching,

research and management.

6. It specifically excludes funding of investments in universities. This is catered for

in a separate system.

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It is important to mention that this was a pioneering system at the time. It broke with the
traditional systems used to finance Spanish universities and had wide-ranging effects
on funding. Later on, other regional governments began to implement changes in their
funding systems in an aim to make them more objective and also introduced formula-
based funding and contract funding systems.

In practice, the funding programme was developed in two stages: 1994-1998 and
1999-2003. A third stage exists in which successive extensions of the model, which
have deviated somewhat from its initial objectives, have been implemented. Although,
both stages share the same basic philosophy there are considerable differences
between them which must be stated.

5.3.1. The first funding programme (1994-1998)

The development of the first funding programme

The first funding programme for Valencian universities (1994-1998) set out two types of
objectives: financial objectives and academic objectives. The financial objectives aimed
to radically change the way the funding system worked to provide all universities with
an equal, stable, transparent, pluriannual financial framework which was based on the
estimated costs of giving a particular degree course. Moreover, a priori it envisaged the
participation of each university body, i.e. its governing bodies, the students and the rest
of the private sector in funding the university system.

The system only had to fund current expenditure - investment was catered for under its
own plan which was developed according to the needs of the moment and to forecast
demand for degrees by universities.

The most relevant academic objectives were firstly to improve the systems efficiency
and quality so that universities were better able to cater for societys demands and to
increase the internal efficiency of universities, to reduce the drop-out rate and the
average time undergraduates took to finish their degree by defining an incentive
system and introducing improvements into the information, management and
accountability systems.

The first programme also included a series of predictions for the future evolution of the
system. These predictions centred on the future size of the system, the distribution of

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the courses on offer by length of degree and subject areas and the geographical
distribution of supply and demand.

The regional subsidy that each university received was made up of three elements:
basic funding without conditions attached, a second goal-oriented funding component
and a third component linked to improving quality.

Basic funding.

Basic funding made up the main body of the subsidy which had no conditions attached
that each university received. This subsidy was obtained by calculating the standard
average cost of giving a particular degree course.

One of the major differences the model introduced was that the calculation of the
different costs assigned to each degree was based on the resource needs each one
had. These also varied according to the experimental nature of each degree,
measured by the quantity and quality of the practical curses that it involved. In order to
simplify this calculation, the model divided the degrees into five experimental levels
and assigned each of these levels a resource needs coefficient. Under this system,
health science degrees were the most costly and humanities degrees were the least
costly.

Once the average cost for a degree was established, the model distributed the costs
among the different funding sources: students, the private manufacturing industry and
the public sector so that the subsidy became the part which was not funded by the
other two sources of income.

Goal-oriented funding

The second funding component was linked to a series of objectives. The initial version
of the model put forward three objectives: to increase success rates by reducing the
average time undergraduates took to finish their degree, to supply university degrees
more suited to demand and to encourage classes to be given in the regions own
language.

Compliance with these objectives meant an increase in the basic funding received or a
reduction in this funding as a penalty for not having reached minimum compliance.

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Additional funding to improve the quality of teaching and research

The third funding component was made up of a group of specific-purpose resources,

aimed at funding quality-related programmes, including plans to create a stable body of
research staff, educational innovation programmes and funding for doctoral excellence
programmes.

Results of the implementation of the first funding model

The most important results of the implementation of the first funding model can be
summarised as follows:

a. The funding Valencian universities received rose sharply as a result of the

implementation of the funding model. The fact that funding was no longer subject to
the Regional Governments annual decisions but to the evolution of degree costs
and the number of students enrolled, gave funding a sharp boost. In fact, the
Regional Government subsidy grew by 57% from 1994-1998 in nominal terms.
However, total university funding in terms of regional GDP did not grow as fast as a
result of the other funding components involved, such as tuition fees and grants,
which in real terms remained stagnant. In short, university funding went from 0.64%
of regional GDP in 1994 to 0.71% in 1997. We should also bear in mind though that
at the start of the 90s, university funding only accounted for 0.53% of regional GDP,
according to different sources.

b. The results of goal-oriented funding were very different. Universities tried hard to
comply with some of the objectives laid down in the model. In fact, universities
began to supply degrees more suited to demand during the period. Nevertheless,
funding to promote classes given the regions own language fell by 26%. During the
first few years of the new model, the universities were penalised for not complying
with the objective of reducing the drop-out rate. However, efforts were made to turn
this component around and during the last year of the implementation of the plan,
universities managed to obtain extra funding in this area.

c. An important effect of the model, which is a result of supplying degree courses

more suited to student demand and to the fact that technical degrees received
greater per capita funding, was the sharp increase in the number of these degrees.
At the start of the plan, technical degrees accounted for 21.4% of the total number

117
 of university places. By the end of this period, this figure had risen to 30% whilst the
figures for degrees in other areas fell by the same proportion.

d. The participation of each university body in funding evolved somewhat differently to

expectations. Public funding rose and accounted for 73%, which was lower than
forecast. The percentage of funding from tuition fees also dropped although this
decrease was compensated by the increase in the resources universities obtained
from private contracts and investment project funding.

5.3.2. The Valencian public university systems second funding model

(1999-2003).

The second funding model (1999-2003) maintained the same general objectives as the
first one but added a new element. A series of plans were defined, with the general
objective of promoting a quality system. These plans included what was undoubtedly
the greatest innovation of the new model, in terms of its importance in practical terms:
the definition of quality objectives for the system so that the increased funding obtained
by each university was linked to compliance with the previously established objectives
and the creation of a university quality agency which aimed to promote quality and
excellence in university teaching, research, services and management activities.

Structure of the second model

The proposed structure of the second model was a step forward compared to the first
model. According to the second model, the total amount of current funding given to a
university was determined by a combination of four elements: fixed funding, basic
funding, compensatory funding of costs as a result of changes in state and regional
legislation and goal-oriented funding.

Fixed funding
This was a part of the subsidy which was the same for all universities, set initially at
1.2 million and inflation-linked on a yearly basis.

Fixed funding financed each universitys basic overheads and the minimum scale factor
of certain degrees. The forecast for this type of funding was for it to account for 1.25%
of current university funding.

Basic funding
This was the largest funding component and was used for the day-to-day running of the
universities. It was made up of three parts: an ordinary subsidy, university tuition fees

118
and the universities own resources, i.e. the funds they obtained from the exploitation of
their assets and from contracts and other income.

Basic funding was based on the same concept of effective cost as used in the first
model. However, it involved two basic differences: it reduced the parameters used to
calculate the cost, which thus increased the subsidy per student and it included the
price of maintaining facilities and buildings in the cost components.

The amount of the subsidy per student was obtained by taking the income from tuition
fees and the universities own resources away from the cost, just like the first model.

Goal-oriented funding
One of the second models most innovative contributions was the introduction of goal-
oriented funding using a series of indicators. The general aim of this funding was to
introduce improvements in the internal management of university institutions, so that
quality standards improved over and above the standards required to obtain basic
funding.

The model featured 15 objectives. Six of these were teaching-related, three were
related to R&D, one was related to post-graduate studies, one to employment, one to
innovation, one to management and two to culture. These objectives were measured
using 31 indicators.

The maximum amount of funding available via this procedure was 10% of total current
funding, as we mentioned above. A transition period of five years was established, up
to 2003, to reach this percentage.

One important feature of goal-oriented funding was that the objectives and maximum
and minimum values of the corresponding indicators were negotiated between each
university and the Regional Government. In practice, this turned goal-oriented funding
into la carte funding and resembled a contract funding system more than a
homogeneous funding model.

Compensatory funding costs as a result of changes in state and regional

legislation
This section added funding from changes in state and regional legislation which
modified some of the elements that made up the cost of universities or reduced some
of their sources of income.

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As a result of the forecasts, the structure of the different current funding sources is
shown in the following table:

Table 2 Forecast final share of the different funding sources

Funding component Instruments Percent. of total Percent. of

funding GDP

Fixed funding Fixed subsidy 1.25 0.0125

Basic funding. Ordinary subsidy 68.75 0.6875
Tuition fees 15 0.15
Own resources 3 0.03
Changes in state and regional Compensation subsidy. 2 0.02
legislation.
Goal-oriented funding. Subsidy conditioned to meeting 10 0.10
objectives
100 1.00
Source: Pluriannual funding programme for the Valencian public university system 1999/2003.

In the forecasts for the second plan, it is easy to see that the funding contributed by the
Valencian Regional Government, made up of fixed funding, basic funding,
compensation from changes in state and regional legislation and goal-oriented funding
accounted for 82% of the total, compared to the funding from other sources which only
totalled 18%. This contribution was higher in the first plan.

In practical terms, this meant a drop in the specific weight of the two private-sector
funding components. In the case of tuition fees, the second model foresaw a reduction
in the specific weight of this source of income from 17% of total current funding account
to just 15%. Own resources generated by the universities had to account for at least
3% of the total.11

An important feature of the second plan was the financial commitment shown in the last
column of the aforementioned table, in which the resources obtained from the different
funding sources to finance current expenditure had to add up to 1% of GDP.

11
This 3% was the minimum figure each university had to obtain. As the public funding they received was
obtained by taking this 3% away from the cost of the degree, this was a huge incentive for universities to
increase their income above this percentage.

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Results of the implementation of the second plan
Although the second funding plan officially finished in 2003, in practice the plan was
successively extended until the new model was implemented.12 Thus, the results
analysed from the 1999-2005 period. 2005 was the last year the extensions of the plan
were applied.

The first point to be mentioned is the dramatic increase in funding as a result of the
implementation of the model from 1999-2005. Funding rose from 297 million to 626
million, i.e. an increase of 110% in 6 years.

However, this growth was not as good as initially forecast as far as goal-oriented
funding was concerned. This source of funding, which in 2003 should have reached
10% of the total, only reached 4.7% of total current funding in 2005. In addition, the
way the different objectives set out in the model were interpreted and the way the
variables which represented them were measured gave rise to controversy between
the universities and the Regional Government.

Funding from private sources was inconsistent. Tuition fees rose but way below the
rest of the funding elements because the number of undergraduates has levelled out
and the fact that yearly increases in these fees have been capped.

Academic tuition fees are set by the Regional Governments but their yearly increase is
limited at national level by the University Coordination Council. In fact, the result of this
capping meant that the increase in tuition fees was actually lower than the increase in
the total cost per student in Valencian universities. Thus, tuition fees as a percentage
of the total amount of university funding fell over the period. They accounted for 17.9%
of current funding in 1999 compared to just 11.6% in 2005.

On the other hand, funding from research projects, contracts and other sources
obtained by the universities rose by over 150% and represented 11.1% of total current
funding in 2005.

This dramatic increase is a result of several factors. Firstly, there has been a
considerable improvement in the relations between the social fabric and universities,
which has increased the number of co-operation contracts between companies and
institutions. However, this is a concept which must continue to grow over the next few

12
Successive extensions of the model have meant that in practice universities have received the same
funding as in 2003 with only slight variations and a yearly inflation-linked increase.

121
years. Secondly, the economic stability that the funding model brought with it also
brought stability to the teaching staff and improved their research production. Thirdly,
the financial incentive set out in the funding model aimed to encourage universities to
use this vehicle. The fact that universities only had to contribute 3% of the income they
obtained from this source means that they could use any excess finance they managed
to generate as they wished. This allowed them to carry out their own research and
technological dissemination policies.

Another interesting fact to note is that the model did not achieve its objective of
providing 1% of regional GDP to the current funding of Valencian universities. In 2003,
the models objective year, current funding represented 0.85% of GDP. In 2005, this
figure rose to 0.93%.

To what extent did the forecasts of the second plan as to the participation of the
different sources in the current funding come true? The following table shows that the
systems evolution did not evolve as expected in the second programme. The
Valencian Regional Government subsidy which covered the fixed subsidy, the ordinary
subsidy, compensation for the changes in state and regional legislation and goal-
oriented funding, rose to account for 77.4% of total current funding, a percentage which
is quite far from the 82% initially forecast, mainly as a result of the fact that goal-
oriented funding did not reach the forecast percentage.

122
 Table 3 Funding source shares as a percentage of the universities total current
funding

Source of funding 1999 Plan Forecast 2005

Fixed subsidy 1.6% 1.25% 2.1%

Ordinary subsidy 68.6% 68.75% 64.5%

Cost of changes in state and regional
legislation 1.5% 2% 6.0%

Goal-oriented funding 1.8% 10% 4.7%

Funding model total 73.4% 82% 77.4%

Tuition fees 17.9% 15% 11.6%

Income from contracts and projects 8.7% 3% 11.1%

Total private income 26.6% 18% 22.6%

Total current income 100.0% 100% 100.0%

Funding/GDP 0.74 1% 0.93%

On the private funding front, tuition fees, as we mentioned above, only accounted for
11.6% of funding, way below the 15% forecast in the plan. However, this shortfall in
growth was compensated by the positive evolution of the income that universities
obtained from contracts, projects and other activities. This source of funding became
more important, as a result of increased research activities and technology transfer of
the universities in their environment. In fact, recent indicators show a significant
improvement in the research excellence figures in some Valencian universities.

5.4. The grant system

The grant system has not been decentralised and competences have not been given to
the regional governments. However, we should mention that the regional governments
have implemented different measures to supplement the state-run system.

The state-run system basically hinges on the Ministry of Education and Sciences
general grant system through which the majority of university student grants are
awarded, with the exception of the Basque Country which has its own system.

123
The major features of the grant system are:

A. It is a centralised system and is convened just once for the whole of

Spain, apart from the Basque Country as mentioned above. The total
resources allocated to the grant system are established at central
government level and are included in the corresponding items of the
Spanish state budget. The requirements to obtain a grant and the
amount of money awarded are the same for the whole of Spain.

B. The system is intransigent as far as the types of grants are concerned

because it is highly specific. The student cannot choose between
different types of grants. It is, thus, an inflexible system.

C. The grant system is made up of non-refundable subsidies which imply

no commitment in return from the beneficiaries.

To receive a grant a student must fulfil a series of economic conditions based on

his/her family income and academic conditions linked to compliance with specific
objectives on the number of subjects or credits enrolled in and passed.

When this programme was introduced it significantly increased both the percentage of
beneficiaries and the average amount of the grants awarded to each student. However,
the programme has become outdated and the introduction of alternative methods is
currently being studied.

Other programmes have also been introduced alongside the general grant system
although they have not had as much impact. These plans include student mobility
programmes between both Spanish and foreign universities.

Student mobility programmes between Spanish universities began in 2003. They

consist of a monthly payment to students who gain a place in a university located in a
region which is not that of their family residence and a one-off payment for travel
expenses. During the 2006-2007 academic year, 2,010 students all over Spain and 162
in the Valencian Region have been awarded this grant. These figures give some
indication of the low impact the grant programme has had on student mobility.

The Erasmus programme accounts for the majority of travel expense grants to foreign
universities. This European mobility programme has become more and more popular

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over the years, even though state grants have done little to encourage the programme
given the limited amount of money awarded per student. In 2005, 3,029 Valencian
students took advantage of this state programme. The Regional Government set up its
own grant programme for students with low family incomes to supplement the Erasmus
grants. Around 25% of students on the Erasmus programme benefited from this
programme, which pays students between 60 - 90 a month, according to the country
they are studying in.

As the figures show, the system, as a result of the limited amount of money awarded,
has very little impact on student mobility decisions. However, international mobility is
increasing thanks to the Erasmus programme and to the widespread consensus on the
advantages of studying part of a degree course abroad and in a foreign language.

There is also a state-run programme of low-interest loans for university students. This
subsidy entails a reduction in the interest rates students are required to pay on their
loans as well as a grace period. Sureties are provided by the students and
management of loan repayments is entrusted to private banks. The programme has
had little success. Only around 1,500 students in the whole of Spain benefit from the
programme each year.

5.5. Investment plans

Valencian universities implemented two investment plans during the two stages of the
funding plan. These investment plans aimed to improve the systems infrastructure and
equipment facilities.

These two plans did not coincide in time with the funding plans. Instead they ran in
parallel according to the annual investment figures authorised by the Regional
Government which are shown in the table below.

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 Table 4 Investment plans. Authorised yearly amounts (in thousands of euros)

1995 1996 1997 1998 1999

I Plan 69,900 94,004 83,477 83,933 59,497
II Plan 44,850
Total 69,900 94,004 83,477 83,933 104,347
2000 2001 2002 2003 Total
I Plan 31,040 9,481 7,112 4,398 442,845
II Plan 46,303 66,613 75,552 37,467 270,787
Total 77,343 76,094 82,665 41,865 713,632

As we can see, considerable investments were made until 2000, the year in which
annual figures began to fall, even though total investment figures continued to be very
high. These efforts drastically improved the situation of Valencian universities without
doubt. However, a large percentage of the investments in the second plan was
financed by the universities themselves. This resort to debt may stunt current funding
growth because an important part of future resources will have to go on paying the
existing debt.

Despite these problems, current funding and the teaching and research infrastructure
of Valencian universities have undoubtedly improved as a whole. This is reflected in
the increase in the quality of teaching and research.

5.6. The external opinion on the Valencia funding system.

In order to know the opinion of different people with expertise in the funding model, a
questionnaire divided into four sections was sent to several persons responsible of
economic matter in Valencian universities. Some of the most relevant opinions are
includes in this section:

1. What is your opinion of the total amount of resources available to the

university system in your region?

In 2006, spending as a percentage of GDP was more than 1%. I believe that this is
comparable with many European university systems and I consider it to be an
acceptable subsistence level, although it is far from ideal.

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At the end of the 1990s, the objective was to allocate 1% of the Valencian
Regions GDP to funding the university system. Although this objective has been
reached, it is clear that at present university funding is not able to fulfil the
requirements of the current demands of society.

Very good progress was made during the 1999 2003 period. However, advances
have not been made since then.

2. At current resource levels, to what extent will your university be able to

meet the challenges of the knowledge society and the Lisbon strategy?

Funding will not be the main problem. In my university, rigid rules and regulations,
the lack of versatility of university institutions and the complex decision-making
system are much greater threats than any foreseeable lack of financial resources.

It will be difficult to reach the objectives with regard to the knowledge society and
obviously very difficult to reach the objectives of the Lisbon strategy, which set
economic activity levels in the area of R+D+I which would mean tripling current
levels.

It will be very difficult to fully achieve the ambitious objectives that have been set.
Priority would have to be given to certain measures concerning quality and
internationalisation.

3. Which areas would require greater investment?

Research and the mobility of university human resources (not only students, but
also administrative and service staff and teaching and research staff) are areas
which are likely to require a greater amount of resources in the future both in
absolute terms (a greater quantity) and relative terms (a higher percentage).

Attention needs to be given to basic and applied research, including technical and
administrative support to manage funds which generally come from a competitive
environment. These funds are used to invest in human resources and scientific
equipment, whose management requires agility, versatility and considerable rigour
when it comes to ensuring accountability.

Student and staff mobility is inadequate. In general, the percentage of students

who study abroad is way below the desired figure (not enough students study

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abroad during their time at university). Teaching and research staff go abroad more
often, but this is unprecedented for administrative and service staff, thus making it
impossible to set a benchmark and introduce good practices which exist in the
management of foreign universities.

With specific reference to teaching, the areas of communication, health, social

studies and teacher training should be strengthened.

4. What do you think of the current structure for financing universities?

I feel that the model which has remained unchanged since 2003 was essentially
the right one for funding higher education, but totally inadequate for funding
R+D+I.

5. What do you think of the proportion of public-private funding?

I believe that the majority of funding should come from public sources. Expenditure
on higher education is an investment which generates a high degree of social and
economic dynamism.

I consider it to be unbalanced and socially unacceptable. There should be

considerably more private contributions from those in the middle/high income
bracket and at the same time more programmes to provide grants and help with
tuition fees.

The percentage of private funding for higher education in Spain is very small. I
believe that one of the most important aims for the coming years must be to
significantly increase private funding.

6. What is your opinion of contributions from students and companies?

Companies still continue to keep their distance from universities, in my opinion

because universities have still not managed to get university students hooked.
When they finish their studies, graduates flee from university in search of a job.
From that point onwards, as soon as graduates start work, they forget about their
university and as a result there is very little technology transfer.

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With regard to companies, although their level of participation has increased, it is
still insufficient. Low contributions from companies can be explained by their small
size and the fact that they specialise in low technology sectors.

The contribution from students is low, but socially it is difficult to change that
situation.

Students should contribute more to the public system via tuition fees and at the
same time the grant system should be changed and more financial assistance
should be available to guarantee equity and equal opportunities and to improve
performance.

7. What is your opinion of the distribution of funding for teaching and

research?

I think it is adequate and acceptable. Another issue is the fact that there are
people who do not carry out research.

I feel that the resources allocated to teaching are essentially adequate and are on
a par with other countries in our competitive environment.

The amount of resources allocated to university R+D+I services is, however, 50%
of the average amount in the 15-state EU, and less than 25% of the amount in
countries which have the greatest presence in emerging markets with high
technological added value (USA, Japan, Finland, Sweden, Korea, etc.).

In general terms, the number of students is decreasing and the quantity and
quality of research undertaken in universities is increasing. Considering the current
requirements, the majority of universities allocate part of the resources they
theoretically receive from and for teaching to fund their research activities.

8. What do you think of the current model for allocating public funds to
universities?

In light of the experience so far, I feel that the model needs to be reviewed. In
general the correct approach has been taken, except that expenses have been
excessively standardised. Goal-oriented funding has not developed its full potential.
We were moving in the right direction, but.

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I feel that the distribution has been good with regard to funds allocated to teaching,
but not with regard to research.

We are working on a provisional basis with an obsolete resource allocation model

to which patches have repeatedly been applied. The model was designed for a
mass university system with more homogeneous universities in which the main
variable is the number of registered credits with corrections according to the
theoretical and practical content of the degrees. Given that the Valencian public
university system has a wide range of universities in terms of size, age, structure,
organisation and specialisation with regard to both teaching and research, the
model is rigid and unfair. For that reason, corrections are necessary in order to
continue using the model.

9. To what extent does it promote performance, effectiveness and efficiency?

I do not think it has a great deal to do with performance, but perhaps more with
effectiveness and efficiency.

I have always favoured the use of demand models for higher education, given that
they at least promote efficiency. To further encourage performance and efficiency,
a greater percentage of funding should be linked to students who finish their
degree in the time set in the syllabus and the extent to which graduates are able to
find suitable employment.

I think to a very small extent. It depends on whether we are talking about teaching,
research or management. Furthermore, goal-oriented funding represents less than
10% of total resources and this has never been analysed or corrected, despite the
fact that it has repeatedly been established that the system does not work
efficiently.

10. To what extent has it changed the behaviour of universities?

It has changed the information systems (the quantity and homogeneity of data
available since 1999 have been invaluable sources of knowledge for determining
decision-making processes and for planning university policy) and it has
professionalized university management.

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I think that the funding models have definitely helped to establish institutional
perspectives in the medium term and these have encouraged rational use of
resources and helped to promote more organised growth.

I think that for public Valencian universities, pluriannual funding models have had
very beneficial effects. The management of resources, degree courses and
research has been professionalised, both internal and external information has
taken on a great deal of importance, links with society have been increased, etc.
The simple fact of having a resource allocation model allows medium-term planning
because estimations can be made regarding the resources available in the future.

11. What, if any, are the negative effects of the model?

Certain inconsistencies exist between ordinary funding and the effects of goal-
oriented funding and in some cases these come into conflict. For instance, funding
improves according to academic performance, yet students who repeat a year bring
in more money.

The potential of goal-oriented funding has not been fully exploited.

There are no measures in place to correct errors which seriously affect the quality
of teaching. These include the excessive amount of time required by students to
finish some degrees, a marked lack of performance in some subjects and degree
courses, etc.

12. What are the most noteworthy positive effects?

The information available, the existence of a recognised framework, the planning

and programming opportunities and coordinated operating processes.

It has fostered a demand-oriented approach and has allowed the institutions to

carry out medium-term planning.

Helping medium-term planning, professionalizing management, increasing the

quantity and quality of information, making this information more widely available
etc.

It has also helped to strengthen all types of links between universities in the
system.

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13. What can we learn from the model?

That it can bring universities in the Valencian Public University System together.

A model which is well managed by the government and by the universities can
definitely promote efficiency, efficacy and quality. A model which is badly managed
by the government and by the universities is little more than a medium-term
funding guarantee.

Excessive rigidity must be avoided: different universities cannot be dealt with in the
same way.

Goal-oriented funding must be continually reviewed and improved.

14. To what extent does the funding system increase equity, performance,
etc.?

I do not think the system takes these aspects into account very much. In my
opinion, equity has never been one of the objectives of the system.

Although I think that the funding system is not the most suitable means of
achieving this, there could be improvements in performance, efficiency and
effectiveness, if the system was well designed, there was enough relevant
information and if realistic and achievable objectives were set for the system as a
whole and for the various different universities which it comprises.

5.7. Conclusions

a. The implementation of an objective, transparent funding model, based on a

formula to calculate the funding of each university, which was the same for all
the institutions, brought with it a series of positive results for the Valencian
university system. The first and most significant result was the spectacular
increase in public funding of universities, even though the explicit objective of
providing universities with 1% of regional GDP has not quite been reached.
Public funding increased 2.8 times in nominal terms from 1994 to 2003, the last
year the plan was applied, excluding investments.

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b. As a result of this increase in public funding, the public share of current funding
rose from 71.1% in 1994 to 78.2% in 2003. The figure was even higher if we
take into account the funding of the different investment programmes carried
out.

c. As a result of this growth and of the freeze in relative terms of tuition fees,
income from this source fell to 11.4%, way below the forecasts the various
different plans had made. This relative decrease means that students have little
idea of the real costs of university education.

d. The grant system also became less important. The number of beneficiaries fell
steadily over the years as a result of the conditions required to be awarded a
grant. In the case of the Valencian Region, the system covered 20.4% of the
students enrolled in the 1992-93 academic year. Ten years later, in 2002-2003,
the percentage had fallen to 17.2%.

Moreover, as this system offers very limited types of grants, in practical terms
this does not provide additional funding for universities because what they
receive is simply compensation for the tuition fees the students do not pay. In
the 2002-2003 academic year, the average compensation per grant student in
the Valencian universities was only 526. This is one of the aspects of
university funding that requires urgent attention.

e. Programmes to increase student mobility were relatively successful on the

international exchange front, but not in mobility between Spanish universities.
The grant system is not a relevant incentive to mobility, which means that
people with low income are excluded from the advantages of mobility
programmes because grants do not cover the total costs of expenses. The
grant system is undoubtedly one of the tools that must be reviewed urgently, if it
is to have any kind of bearing on the Spanish university system.

f. The goal-oriented funding which appeared in the two applied versions of the
system yielded uneven results. During the first period (1994-1998), the
improvement in certain indicators, such as adapting university courses to the
degrees demanded may have been a combined effort of greater student
demand for technical degrees and the improvement in public funding for this

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 type of degrees. In fact, non-technical universities began to modify their courses
to include technical degrees and thus, improve their funding.

g. During the second stage of the model (1999-2003), the introduction of a list of
objectives which was too far-ranging and the differences that appeared
afterwards over how to measure them meant goal-oriented funding reached
much lower levels than initially expected, i.e. 10% of total funding as specified
in the model objective.

h. One important aspect of the model was that it introduced greater budgetary
control. The universities were able to work with a pluriannual financial
framework which allowed them to plan their workforce and distribute their
resources between teaching and research. At the same time, universities also
developed internal expenditure control mechanisms to transfer and apply the
financial discipline imposed by the funding model to their own internal
structures.

i. The system brought about changes in the courses available at universities in

order to adapt them to student demand. Technical degrees accounted for 25%
of the total number of university places in 1995. By 2005, the figure had risen to
31.5%. Humanities degrees were the worst hit and fell from 15% of the total
share to 9%.

j. Investment was extremely important during the period and made a visible
difference in the amount of buildings and equipment in Valencian universities,
which are now comparable to the majority of European universities. A new
investment plan is currently being negotiated to complete the infrastructure that
is still needed.

k. Funding was not significant in university entrance mechanisms. In fact, the

system did not particularly improve the incentives for student entrance nor did it
introduce new mechanisms in the grant system to allow students with low
income to go to university.

l. The system initially introduced an incentive to improve the number of graduate

students as a percentage of the total number of undergraduates. This bonus
increased or decreased funding to universities based on their efficiency in terms

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 of the number of graduates that finished their studies in a previously established
time limit. In the second version of the model, this objective became one of the
31 variables which made up goal-oriented funding. The indicators available
seem to show that, contrary to forecasts, the graduate rate is not improving in
Valencian universities.

m. Employability did not appear in the funding model until 1999 and was only part
of goal-oriented funding, which as we have mentioned, represents a small part
of university costs. However, in the last few years, universities have started
some job policies aimed at their students, such as increasing work experience
in companies, creating employment offices and promoting job forums between
companies and universities.

n. The quality of education has improved over the last few years, or at least quality
understood as quality in the means available for educational activity. On one
hand, student numbers per group have dropped steadily as a result of
decreasing demand and of the increase in the number of teaching staff thanks
to the additional finance provided by the funding system. Facilities also
improved considerably during the application of the investment plan. However,
there is no proven evidence to show that the quality of the results has improved.

o. The ability to attract funds has risen considerably. The system has created an
important incentive for funding via contracts or the provision of services, given
that any income over 3% of current funding are resources that the universities
are free to do as they like with. As we mentioned above, universities have
begun to encourage this type of resources because they generate an important
financial profit in a system which offers little flexibility over the remaining
expenditure. This has strengthened research structures and the appearance of
new mechanisms, such as the Research Institutes, which channel and manage
the resources obtained more efficiently than the university organisation.

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 EXECUTIVE SUMMARY

Higher education funding: the current situation

At present, most European universities are not competitive on a global scale with the
institutions of our major competitors; neither in access for European students population,
nor in attractiveness for third country students, nor in excellence of education and research.
The necessary reforms cannot be accomplished within the current levels and patterns of
investment. The funding gap between European universities and the universities of our key
competitors should be bridged to overcome this.

The total (public and private) investment in higher education in the EU in 2001 is 1.3% of
GDP, compared to 2.5% in Canada and 2.8% in the USA. The three highest-spending EU
countries are Denmark (2.8%), Sweden (2.3%) and Finland (2.1%). To close the spending
gap with the USA, the EU would have to commit an additional 140 billion per year.

Higher education funding: the role of the EC

The need for a substantial increase in investment in human resources was raised in view of
reaching the Lisbon Goals: The lack of a clear upward trend in public expenditure on
education and training, and a deficit in private funding in key areas for the knowledge
economy, calls for a smart combination of targeted public investments and higher private
contributions. The price of investing in education and training is outweighed by high
private, economic and social returns.

The Communication Mobilising the Brainpower of Europe: enabling universities to make

their full contribution to the Lisbon strategy gave a comprehensive overview of the role of
universities in achieving the Lisbon Goals and it provided suggestions for a modernisation
agenda. The Communication underlined that closing the funding gap with our main
competitors is a core condition for achieving the Lisbon Strategy. It called upon Member
states to have fiscal rules enabling and encouraging partnerships between business and
universities, also to provide continuing strength to universities.

In "Time to move up a gear", the European Commission's 2006 Annual Progress Report on
Growth and Jobs, the aim for the EU to devote at least 2% of GDP to higher education by
2010 is reconfirmed. By the end of 2007, universities should be allowed and encouraged to
seek complementary private sources of funding.

On 23/24 March 2006 the European Council called on the Member States to facilitate, in
line with national practices, universities' access to complementary sources of funding,

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 including private ones, and to remove barriers to public-private partnerships with
businesses.

In May 2006 the Communication Delivering on the modernisation agenda for universities:
education, research and innovation established nine strategies for the modernization of
European Higher Education. One is the need of to reduce the funding gap and make
funding work more effectively in education and research. For reaching this goal, the
Commission proposes that the EU should also aim, within a decade, to devote at least 2%
of GDP (including both public and private funding) to a modernised higher education sector.
Member States should therefore critically examine their current mix of student fees and
support schemes in the light of their actual efficiency and equity.

The EC has issued in September 2006 the new communication Efficiency and equity in
European education and training systems. This new communication remarks that there
has been a steady growth in student numbers and a widening of the expectations placed
upon European universities, but funding levels have not risen accordingly. At the same time,
the expansion of student numbers has not increased equity as it has mostly favoured
individuals from higher socio-economic groups or those whose parents attended higher
education. [..] As a result of inequities earlier in the education cycle, pupils from
disadvantaged backgrounds often do not achieve the level of qualifications needed to
access higher education. Even those that do are often reluctant to consider going on to
university.

The problem of equity in access to higher education is becoming a relevant issue for the
future of European higher education. The most generalised assumption is that a free or
low cost system of higher education will allow people from lower socioeconomic
background a high access to higher education. Nevertheless, facts do not support this
assumption and the main determining factor in higher education participation is still parents
socioeconomic background. On the other hand, there is evidence of significant private
returns on higher education and tax systems do not compensate this advantage for those
accessing higher education. Consequently, a low cost higher education is actually
regressive from a social point of view. The Communication states: Evidence also suggests
that the market effects of tuition fees may improve the quality of teaching and management
in universities, and reinforce student motivation. Clearly, the development of tuition fees
without accompanying financial support for poorer students risks aggravating inequity in
access to higher education. In conclusion this documents states: Free access to higher
education does not necessarily guarantee equity. To strengthen both efficiency and equity
Member States should create appropriate conditions and incentives to generate higher
investment from public and private sources, including, where appropriate, through tuition
fees combined with accompanying financial measures for the disadvantaged. Specific

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 actions at school level are also needed. Higher education institutions should offer a more
differentiated range of provision and incentives to meet increasingly diverse social and
economic needs.

Higher education funding: the rates of return

Higher education appears to be a profitable investment opportunity for individuals compared

to other private investment opportunities, as well as for societies at large compared to social
opportunity costs. The analysis of existing evidence about rates of return reveals some
basic patterns:

o The returns to education are higher in developing relative to advanced industrial

countries a reflection of the relative scarcity of human capital in poor countries

o The private returns exceed the social returns a reflection of the public
subsidization of higher education.

o The returns to higher education have been rising in most dynamic economies in
recent years a reflection of the increased demand for educated manpower to
complement advances in technology

o There exists wide differentiation of the returns by university faculty a reflection of

the relative demand and supply for graduates

The returns to education have implications regarding equity questions too. It is well known
that high socioeconomic background students have a much better chance of entering higher
education; additionally, there is limited evidence showing that they also obtain higher
returns than low students from lower backgrounds. Regressive income redistribution effects
of public financing of higher education have been documented in many countries. Hence,
improving equity through HE will require targeted investment at earlier educational stages
as well as mentoring and counselling throughout the whole school cycle in order to facilitate
low socioeconomic background students, first, to enrol and complete higher education, and,
second, to succeed later in the labour market.

Higher education funding: some examples of funding models

The reforms related to the funding of higher education depict two common major trends as
funding-related means to increase efficiency and equity without quality loses.

First, there is a general tendency towards increasing spending autonomy leading to full
freedom in the internal allocation of resources of HEIs

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 Second, there is a development towards greater transparency and simplicity in the
funding mechanisms, with an emphasis on the accountability of HEIs performance

Basic funds allocated through objective formulae are perceived as capital to HEIs for long-
term planning, for their adaptation to changes in the demand, and for the outcome and
quality of teaching and basic research. This type of mechanism states direct demands on
the amount of funds required and indirect demands on the quality in higher education.
Because of principles of "lump sum" granting and the self-governing nature of HEIs, the
basic funds allocated through transparent formulae represent to HEIs increased freedom to
re-allocate their funds between teaching, research and other expenses. However, the
elements included on the formulae and the formulae themselves vary substantially between
countries, between fields of study within a country, and over time. Moreover, the impacts of
this mechanism depend on whether it operates on and open-end or on a closed budget
basis, and on whether input or output indicators dominate in the distribution formulae.

The move from open-end to closed budgets not only establishes bounds to the claims for
the allocation of extra resources to higher education, but also enhances productive
efficiency of HEIs, especially when funds are distributed on the basis of performance. This
type of mechanism forces HEIs to use internal instruments to guaranty budgetary
discipline, and urges them to closely monitor for the performance of their academics in
order to keep current funding or to gain extra resources.

Output-based funding systems enhance efficiency since there is no direct link between the
subsidies received and the actual expenditure of HEIs, thus providing incentives for
adapting the provision of higher education to social demands and for efficient educational
production. As a consequence, HEIs are willing to improve their productive efficiency to gain
extra resources that increase funding autonomy.

Funding based on objectives improves the efficiency in the education process, since the
lack of use of performance indicators in the allocation of funds weakens the mechanisms
specifically intended to enhance educational productivity. Accuracy in the formulation of key
objectives becomes capital for the effectiveness of this funding instrument.

Competition for external research funds stimulates more dynamic research agendas by
promoting applicability and quality of the results obtained from academic research. If
competitive research funding is focused in the right areas, competition among researchers
and HEIs would increase reflection, originality, creativity, and innovation, thus raising the
social value of research outcomes. Additionally, HEIs would further increase their factual
possibilities of autonomy and self-governance by gaining competitive research funds.

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 The need for extra resources, as well as the realization about the private returns to higher
education being higher than the social returns, highlights the need for a shift from public
budgets to private sources in higher education financing. A greater share of costs is to be
asked of students and their families by means of tuition fees and student loans since HE
graduates are the main beneficiaries of higher education. At the same time, a greater
emphasis is placed on HEIs market oriented activities such as research contracts and
consultancy as founding sources.

Higher education funding: searching the right balance between equity and efficiency

At this moment, if both efficiency and equity are to be enhanced in European countries, and
public expenditure can not be largely increased, only a better balance between public and
private funding of higher education could be helpful. It is within this situation that European
universities should look to raise private funds through three main sources:

Tuition Fees. Establishing or increasing tuition fees is a topic currently being debated in
many countries. Charging or increasing tuition fees, however, has proved to be a very
difficult policy from a political standpoint since it challenges many of the fundamental
precepts of egalitarianism and could raise conflicts with students. On the other hand, the
different levels of taxation in European countries produce different approaches to this
question.

Research and Service Contracts. Another source of private funds for European higher
education institutions has been sought through privately contracted research and related
services from industry. These activities seem to be on the rise in all countries. The
incorporation of private research and contracts is nevertheless slowed by many of the
traditional legal and structural factors of highly state centralised university systems.

Fund raising. A third opportunity for universities to raise private funds comes from
voluntary support. However, with some exceptions, most European universities have not
seriously sought voluntary support until the present.

Public funds must be granted to higher education institution in such a way that
effectiveness, efficiency and quality are promoted. In this sense, funding tools that have
been experimented in some countries are the following:

Formula base funding. In many countries public funds are delivered to institutions as a
lump sum based on a set of variables related to costs but also to basic outcomes. These
experiences have shown a positive effect on institutions and on their results.

Performance funding. Performance funding is the generalized way for funding research
but it is less usual for funding teaching activities. In some countries a portion of the funds

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 granted to higher education institutions are linked to the achievement of certain
standards which were previously agreed between public authorities and institutions.

Competitive and targeted funds. Financing targeted teaching activities or setting up

programmes for financing educational activities in a competitive way among institutions
must be explored. In this case, the possibility of establishing a broad European
programme, similar to the research framework programmes, for developing quality and
competition among European institutions for developing excellence should be
considered.

In many countries we find that the level of democratization and participation in higher
education of different socioeconomic groups has improved significantly, though children
from families in the bottom of the income distribution are underrepresented in higher
education. Results from several European countries confirm that the base for equity in
higher education is not in entrance, but in previous environmental conditions of the
students. Complete equality could only be reached if out-of-school influences vanish.
Although this problem is not easy to solve, it seems evident that it should be undertaken in
earlier stages of the educational process. In consequence, public economic efforts should
concentrate on pre-higher education in order to guarantee equity in higher education.

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