234

ECONOMIC RECORD JUNE

© 2007 The AuthorsJournal compilation © 2007 The Economic Society of Australia

difficulties as a ‘robust’ explanation of Keynesianunemployment.

First, we need to know why a central bank wouldwish to peg the money rate of interest above thenatural rate. The tendered answer is that such apolicy confers on the financial system the stabilitythat central banks desire. This answer servesDocherty’s purpose both well and ill. It serves itwell in that if financial system stability doesrequire unemployment, then a central bank willbe antagonistic to full employment, and that spellsa hefty obstacle to full employment. In contrast, ifunemployment is the price of financial systemstability, then perhaps unemployment is a pricethat should be paid, and we are left with an estimateof the social irrationality of unemployment quitedifferent than that of Keynes.

The second difficulty is that central bank peggingof the nominal interest rate disables the Keyneseffect (and hence makes for an unemploymentequilibrium) only if expected inflation is exogenous,thereby leaving the real rate of interest pegged aswell. But expected inflation is not exogenous. Aslong as there is some elasticity in the expectationof inflation to the current price level, then thereexists some nominal wage that secures an expectedrate of inflation that leaves the real expected rateof interest equal to the real marginal efficiency ofcapital at full employment.

Thus, an exogenous nominal rate is insufficientfor a theory of unemployment. It is, however,sufficient for a theory of inflation. This, I believe,was the basic insight of Wicksellian theory (seeHicks, 1965, pp. 59–62). Any divergence betweenthe natural and the money rate of interest can bereconciled with full employment by an appropriateexpectation of inflation that is, in turn, associatedwith a certain actual rate of inflation. (This isfurther articulated in Coleman, 2006.)

Any review of

Money and Employment

must ceasebefore doing justice to the book’s many closelyreasoned passages on miscellaneous topics. Butthat brings me to my last remark; a remark aboutmethod. Docherty very pertinently notes of onepart of the General Theory that ‘As usual, Keynesmakes a systematic list of the possible influencesthe variable under consideration can have, andthen carefully considers each in turn’ (p. 96). Thissomewhat lawyer-like method of accumulating‘points’ or ‘possible influences’ has been bequea-thed by Keynes to post-Keynesians. Their literatureconsequently provides a spectacle of an endlessback and forth of replies, as one consideration ispiled upon another. This method is almost the

opposite of the method of modelling, that hasbeen known to economics since Ricardo, but inmodern form was crystallised by the attempts ofthe neoclassical synthesis to ‘distil’ the essenceof the complex liqueur served up by Keynes. Themethod of modelling (or ‘abstraction’) is almostthe opposite of the method of accumulating points,since abstraction consists of deliberate eliminationand disregard of almost all points.

The method of modelling supposes that fewconsiderations are critical, yet each of those subtlein operation. The method of points supposes thatsignificant considerations are myriad, but eachapparent in their operation. Which of these sup-positions is closer to the truth is moot. But the‘neoclassical’ method of abstraction at least holdsout the hope that the intellect can illuminateconclusively. The post-Keynesian method of pointsinstead raises the discouraging prospect of anunending journey that never draws closer to itsdestination.

William Coleman

Australian National University

REFERENCES

Coleman, W. (2006),

The Causes, Costs and Compensationsof Inflation: An Investigation of Three Problems inMonetary Theory

. Edward Elgar, Cheltenham, UK.Hicks, J. (1965),

Capital and Growth

. Oxford UniversityPress, Oxford, UK.

Kemp, M. (1949), ‘Interest and the Money Supply in Keynes’Economics’,

Economic Record

25

, 64–73.

XXXBook Review

reviewseconomic record

Reviews

Government Managing Risk: Income ContingentLoans for Social and Economic Progress

, byBruce Chapman (Routledge, Abingdon, Oxon,UK, 2006), pp. 264.

Social engineering got a bad name in the westwhen George Bernard Shaw announced on hisreturn from the Soviet Union in the 1930s that hehad ‘seen the future and it works’. Its reputationwas restored by the commitment of postwar govern-ments to free universal education, which was seennot only as a means to personal advancement butalso increasingly as a key contributor to economicgrowth and productivity. Indeed, it would be hardto think of any single policy measure that hasmore effectively combined the pursuit of equality

2007 REVIEWS

235

© 2007 The AuthorsJournal compilation © 2007 The Economic Society of Australia

of opportunity with broader economic and socialgoals. The matter becomes more complex, however,with higher education, given its high cost perstudent, restricted availability and individualisedearnings benefits for graduates, particularly in highstatus professional disciplines such as law andmedicine. For these reasons, many governments,including Australia’s, now favour some form oftuition charge as a contribution by students to thecost of a university degree and an investment ontheir part with future returns. The problem, asBruce Chapman points out in his illuminatingnew book

Government Managing Risk

, is that leftto itself,

[T]he higher education system will not be able todeliver either fair or efficient outcomes. Highereducation is a market characterised by significantuncertainties for students, and high risks forprospective lenders. For good reasons banks willnot be interested in providing loans to helpdisadvantaged students to cover tuition and withrespect to income support needs. Governmentintervention is therefore necessary. (p. 7)

It was in proposing a solution to this problemthat Professor Chapman made his unique andinfluential contribution to Australian public policy,the Higher Education Contribution Scheme (HECS),which was introduced by Education Minister JohnDawkins and the former Labor Government in1989. Although controversial at the time, HECS isnow firmly embedded in the higher educationlandscape, and is attracting interest from policy-makers around the world. The purpose of thisbook is to restate and elaborate the rationale forHECS, to review its implementation in Australiaand internationally, and to explore new policyfrontiers where the principle behind HECS –income contingent loans (ICL) – might arguablyhave broader application.

In essence, according to Chapman, an ICL entailsprovision of finance or, more generally, economicassistance, which is required to be repaid when andonly if borrowers experience ‘propitious futurecircumstances’. Thus, unlike normal bank loans, theinstrument gives significant weight to borrowers’capacity to pay, and its major advantages can betraced to this feature, including protection againstdefault and ‘consumption smoothing’. Chapmanidentifies four types of ICL and their differentoperational consequences. First, ‘risk-pooling’,based on the so-called ‘Yale Plan’ of the 1970s, ischaracterised by a fixed total debt for the popula-tion contracting into the scheme. Here, students

who sign up to debt repayment take on responsi-bility for unpaid debt, hence transferring defaultrisks and costs to non-defaulters and increasingthe repayment obligations of the latter group. Themain problem with this approach, highlightedearlier by Nerlove, is that it may give rise to aform of ‘adverse selection’ and ‘moral hazard’,whereby potential defaulters are more attracted tothe scheme than others with better income prospectswho in turn are encouraged to minimise the extentof their repayment obligation.

This leads Chapman to favour a second alternativeform of ICL which he distinguishes as ‘risk-sharing’.In this approach, which became the conceptualbasis of HECS, ‘borrowers are obligated to pay amaximum amount, with the extent of the obliga-tion being unrelated to the debt repayments ofothers. That is, the risks that an individual’s debtis not repaid in full – the costs of income con-tingent payments – are shared with taxpayers andnot other debtors as is the case for risk-poolingICLs’ (p. 43). Chapman draws on a substantialbody of research on the return on human capitalinvestment, including models based on expectedutility maximisation and rates of return calcula-tions, to argue that ‘the effect of ICLs on welfare,even given a significant range of risk aversion,is relatively small compared to their benefits interms of minimising the effects of uncertainty’(p. 45). In particular, he makes use of recent work byQuiggin (2003) showing that educational financ-ing schemes with income contingent repaymentsprovide a mixture of consumption smoothing benefitsand insurance against the uncertain outcomes ofrisky educational investments, and enhance welfarerelative to the alternative of upfront fees yieldingthe same revenue in present value terms.

The other forms of ICL noted by Chapmanare graduate taxes and ‘human capital contracts’.Graduate taxes are criticised as a less flexibleinstrument designed not so much for cost recoverybut primarily to raise money from the directbeneficiaries of higher education, with limitedallocative efficiency. On the other hand, humancapital contracts are a new and largely untestedvariant with private firms providing loans in whichpayments are tied to the borrower’s income.Advocates such as Palacios claim that theseinstruments would promote efficiency in the highereducation market by increasing the informationavailable about future earnings with respect todifferent universities and fields of study. The con-tracts would therefore reflect market expectationsof students’ future earnings, creating an observable

236

ECONOMIC RECORD JUNE

© 2007 The AuthorsJournal compilation © 2007 The Economic Society of Australia

‘market value’ for different types of education ordifferent cohorts of individuals. According toPalacios, this information would also create amarket instrument for measuring the value of theinsurance implicit in an ICL, thereby introducinga market measure of the extra returns that govern-ments should ask students to pay to compensateaggregate expected losses on a risk-sharing ICL.The jury is out on this approach.

In any case, for Chapman, speculation about theviability of other approaches is less interesting orimportant than whether HECS itself has worked inthe way originally envisaged, notwithstanding variousmodifications over the period of his 1989–2004case study, which occupies much of his attentionin the book. Evidence is amassed from a varietyof sources to demonstrate that the impact of HECS,as well as associated developments, was generallypositive from the viewpoint of both efficiency andequity. In particular, the introduction of HECSdoes appear to have facilitated aggregate increasesin higher education participation through the provi-sion of additional places by the Government,without detrimental effects on participation bystudents from lower socioeconomic groups, althoughabsolute increases were higher for relatively advant-aged students. Significantly, this is confirmed bynew data in the

Higher Education Report

(2005),published by the Department of Education, Scienceand Training (DEST). Nevertheless, the readermay have wished to see more on the challenges stillfacing Australian higher education. For example,given that participation still lags similar OECDcountries, how can it be improved further, particu-larly for those from poorer family backgrounds?At what point does the prospect of debt relativeto anticipated future income become a barrierto entry? Should differential tuition charges nowoperating for ‘discipline clusters’ be based on thereal cost of courses, prospective returns for gradu-ates, incentives related to national skill needs, orsome combination of these? And, above all, howcan Governments in Australia be persuaded totreat HECS as augmenting the core public fundingof higher education rather than substituting for it?

Finally, in the second half of the book, Chapmanis joined by a number of distinguished co-authors– Linda Courtenay Botterill, Richard Dennis, ArieFreiberg, Joshua Gans, Stephen King, John Quiggin,Ric Simes and David Tait – who consider theapplication of the principle of ICLs to other policyareas. These include drought relief, criminal repara-tions, social and community investments, and loansfor low-income households, and in each case it is

argued credibly that the ICL characteristics ofrisk-sharing and capacity to pay produce superioroutcomes to current arrangements. Nor does theseemingly infinite reach of this principle stopthere. An epilogue refers to research in additionalareas such as paid maternity leave, financing ofelite athletes, immigration and even the funding ofresearch and development. Indeed, this last pos-sibility has been taken up as a realistic prospect bythe Business Council of Australia in their recentreport on innovation,

New Pathways to Prosperity

(2006), which may herald the next opportunityfor the ICL to prove itself as an effective socialexperiment. In the meantime, Chapman’s book isthe definitive study of the concept and practice ofICLs and an indispensable source of these furtherdevelopments.

Roy Green

Macquarie Graduate School of Management

REFERENCES

Business Council of Australia (2006),

New Pathways toProsperity

. Business Council of Australia, Melbourne,Vic. [Cited 20 March 2007] Available from: http://www.ske.org.au/downloads/New-Pathways-to-Prosperity.pdf.

Department of Education, Science and Training (2005),

Higher Education Report 2005

. Australian Government,Canberra, ACT. [Cited 20 March 2007] Availablefrom: http://www.dest.gov.au/NR/rdonlyres/5213D64C-C3BA-4D8A-B139–7906281D27AD/15276/HigherEd2005Full.pdf.

Quiggin, J. (2003), ‘The Welfare Effects of Income-contingentFinancing of Higher Education’, Working Paper No.428, Faculty of Economics Australian National Univer-sity, Canberra, ACT.

XXXBook Review

Short title running head: reviewsAuthors running head: economic record

Reviews

Personnel Economics in Imperfect Labour Markets

,by Pietro Garibaldi (Oxford University Press,Oxford, UK, 2006), pp. xviii + 258.

Personnel economics is the application ofeconomic analysis to the study of human resourceswithin the organisation. This relatively new sub-discipline, based mostly on the work of EdwardP. Lazear, was introduced in business schools in theUSA only about a decade ago. The earliest text-books were also written by Lazear (1995, 1998).Garibaldi informs us that personnel economics‘is becoming a standard course in business and