Higher education in Australia is not a pure market. For domestic undergraduates, maximum fees, subsidies and soft loans all weaken price signals. These supports are unlikely to be abolished. Higher education is entrenched in the Australian model of the welfare state, with its widespread use of hybrid public-private funding and delivery of social services.

While higher education is not an economics textbook perfect market, its delivery can use market mechanisms. From 2012 to 2017 Australia experimented with a quasi-market ‘demand-driven’ funding system. Each university’s funding moved from a bureaucratically fixed amount to one based on how many domestic bachelor’s degree students they enrolled. The demand-driven system gave university and student choices a larger role in deciding who studied, what was studied, and where they studied.

Demand-driven funding ended for fiscal reasons in December 2017, but it attracted criticism on other grounds. Despite intellectual origins on the free market right, generally, pro-market people and organisations were among demand-driven funding’s critics. They saw declining admission standards as a fault of demand-driven funding, along with the budget costs that led to its demise.

The origins of demand-driven funding

Some institutions and practices on which demand-driven funding relied were in place long before it was introduced. Unlike public schools or vocational institutes, public universities were from their establishment independent of the government, legally and in most operational decisions. From 1974 universities were delegates of the Commonwealth government in deciding, through their admission processes, who received student subsidies and from 1989, when HECS was introduced, student loans. Prospective students already chose courses and universities through application systems designed to give them their highest-ranked preference. But the funding system was not organised to meet student demand. It allocated student places to universities, and sometimes also to fields of education or courses, based on historical, bureaucratic and political factors.

The idea that public funding systems could mimic markets in responding to demand owes much to the twentieth century's most influential free-market economist, Milton Friedman. He was an exponent of ‘vouchers’, using market mechanisms to allocate public funding. Although the left continued to view markets with suspicion, and the right continued to view public funding with scepticism, vouchers neatly married two major streams of thought in Western politics. Voucher policies recognised the political inevitability, if not the desirability, of public funding, while using market mechanisms to create competition between producers and minimise the supply and demand mismatches of centralised resource allocation.

Originally vouchers for Australian higher education were proposed by the Liberal Party. They first appeared in a Liberal higher education policy in 1987, and reappeared in a more comprehensive form in the 1991 Fightback! package, and made it as far as the Howard Cabinet in 1999 (I worked on the Cabinet submission). In 1987 the Liberal policy was for the government to award scholarships to students who could then take them to universities of their choosing. By 1999 the policy was to leave the government out of these decisions and to fund all accepted students – demand-driven funding is an uncapped voucher system. The 1990s Liberal voucher proposals combined them with market-set fees. This link between vouchers and deregulated fees was a political problem.

Demand-driven funding’s political breakthrough was a 2008 review, commissioned by Julia Gillard as education minister and chaired by a former vice-chancellor, Denise Bradley. Bradley’s report recommended lifting bureaucratic controls on the number and distribution of student places. But she separated the questions of how to distribute student places and how to set fees. This removed the most contentious element of previous demand-driven funding proposals.

In 2009 Gillard accepted most of Bradley’s recommendations. With Coalition support, funding caps were first relaxed and in 2012 abolished for bachelor’s degree enrolments in public universities. While most attention focused on the lifting of funding ceilings, removing de facto funding floors was also important. To maintain their enrolments and income universities faced new pressure to adapt what they offered to student preferences.

Enrolment changes under demand-driven funding 

When demand-driven funding ended Australia’s higher education system had evolved in ways a regulated system, with its focus on the political consequences of distributional decisions, could not have produced. Compared to overall enrolment growth between 2008 and 2017 of 38%, three universities more than doubled their enrolments and another eight grew by 50% or more. Some universities lost enrolment share, although none shrank below their 2008 absolute number of students.

The demand-driven system also altered enrolment patterns between courses. Health-related courses expanded the most, reflecting the high demand for health workers and previously unmet demand. Engineering enrolments grew with the mining boom, before dropping off after it ended. IT enrolments recorded above-average growth. In these respects, the demand-driven system worked as planned.

Although the demand-driven system directed enrolments to areas of need, it also produced graduates who were, at least initially, surplus to professional labour market requirements. The end of the mining boom saw young adult professional employment decline, which combined with larger completing cohorts produced poor graduate employment outcomes.

Debates on the scale of enrolment

The most persistent criticism of demand-driven funding was increased enrolments from less academically able students. Offers of student places to applicants with ATARs of 50 or below nearly quadrupled from less than 2,000 a year in 2010 to 7,620 in 2017 or nearly 7% of offers to applicants with an ATAR. Other students admitted through pathway and mature age entry programs must have had original school results in the lower ATAR ranges since offers to high-ATAR school leavers were near-universal before demand-driven funding. Selection requirements decline every time enrolments grow faster than population, as they did under demand-driven funding. The Australian newspaper and its columnists, usually sympathetic to market-based policies, regularly criticised this outcome.

Concern about publicly-funded ‘over-servicing’ is not restricted to higher education. Medical student places are the most regulated part of the student funding system because the government fears that increasing the number of doctors, who like universities are delegated decision-makers on public funding, will lead to more unnecessary Medicare-funded consultations. In medicine, however, reasonably objective tests determine whether services are clinically justified. In higher education, disagreements about its role and purpose leave more space for contestable judgments about which applicants should be admitted and therefore funded.

If universities are understood as institutions of high-level intellectual inquiry then they should be restricted to the top 10 to 20% of the age cohort. ATARs are not completely reliable measures of academic ability, but this suggests an ATAR cut-off of around 80. If universities are understood as utilitarian suppliers of qualified workers, the perspective of the Morrison Government’s Job-ready Graduates policy, the issue is less ATAR than the courses taken. Graduates in less vocational fields have relatively high rates of working in occupations unlikely to need their qualifications.

While this utilitarian view combined with structural change in the economy is consistent with enrolment growth, it under-explains the long-term increase in higher education participation rates around the world. Australia had already transitioned from an ‘elite’ to a ‘mass’ higher education system before demand-driven funding. From 30,000 students in 1950, the system reached nearly 600,000 government-supported students in 2008. Demand for higher education is driven by rising student and parent expectations and aspirations, which are often more general than aiming for a specific job. Political pressure means that these expectations are eventually met under a wide variety of funding systems.

A mass higher education system accepts that there are many reasons why people want to go to university. Some universities may only cater to some of these reasons, but the higher education system as a whole is pluralistic. The task of student selection systems is not to enforce any one of these reasons but, so far as possible, to match students with appropriate courses and to minimise the risk of adverse outcomes.

Selecting students

Perhaps surprisingly, until the demand-driven system university admissions were effectively unregulated. In 2012 a new national regulator, the Tertiary Education Quality and Standards Agency (TEQSA), was introduced. It regulates admissions standards that all higher education providers must meet. Initially, these required universities to check that applicants had ‘adequate prior knowledge and skills to undertake the course of study successfully’, later updating this to expressly mention academic preparation and require that there be ‘no known limitations’ to progress and completion.

In thinking about how student selection works and could be improved, we can turn to the twentieth century's second-most influential free-market thinker, Friedrich Hayek. So far as I am aware Hayek never wrote about university admissions, but his insights into the nature of knowledge are relevant. Even when we start with some broad principle of eligibility, such as ‘adequate prior knowledge and skills, determining who fits the definition is often difficult.

Specific rules such as minimum ATARs, or the other academic criteria that could be used to uphold admission standards, hit problems with the imperfect nature of prior measures of academic ability, the complexity of assessing broader aptitude for a course, hidden and fluctuating levels of motivation, and little or no knowledge of other things going on in the applicant's life that might affect their chances of success. Although proxy indicators help predict success or failure, we are only ever talking about probabilities.

How well a prospective student might do also depends on their course and university. Analysis of attrition rates shows that these differ, sometimes significantly, between universities after adjusting for a wide range of student and course characteristics known to affect levels of course non-completion. Rather than setting general minimum admission standards, TEQSA’s regulatory approach uses indicators such as attrition to assess potential breaches of admission standards, although it has never revealed what level of attrition triggers a regulatory response.

These processes reflect another Hayekian point, about markets as discovery mechanisms. Some of the knowledge needed for a good admissions decision can only be uncovered after the student starts, when all the different factors around the student's academic attributes, the student's broader life, their course and its teachers, and the wider university environment start interacting. Both sides of the transaction, the student and the university, learn from this experience.

Improving student selection

A Grattan Institute report I co-authored in 2018 argued that critiques of higher education selection focus too much on a university's decision to admit. Instead, a long process of mutual selection determines who is admitted to and retained in higher education. This process begins when ideas about future careers and post-school education start forming, officially starts with the student's application and the university's offer decision, then continues as applicants accept or reject offers, when students leave or stay at the census date when they incur student debt, remain or depart later in the first semester, and then pass or fail subjects.

Improved selection into universities and courses requires attention to all stages of this selection process, rather than expecting too much of university offer decisions. The Commonwealth and state governments have devoted more resources to career education, including a new National Careers Institute. My research shows that vocational education can be a better option for lower-ATAR males (something already reflected in enrolments), as stereotypically male vocational occupations often pay more than the jobs lower-ATAR male graduates take. Governments have promoted vocational education with advertising and free courses.

Census date management is also important to the mutual selection process. The census date is an unusual aspect of Australia’s higher education system, giving most students a free ‘try before you buy’ period, typically for about a month, before any charge is incurred. In 2014, nearly 10% of students who accepted an offer never finalised their enrolment or ended it before the census date. This is a large minority, but it should be larger. Many students do not understand the census date’s significance and unnecessarily pay for subjects they never seriously engage with. The census date’s name should be changed to something like ‘payment date’ to highlight its consequences. In addition to better-protecting students, this would sharpen the incentive for universities to exercise care with their selection practices. Students who leave before the census date create costs but generate no revenue.

While mutual selection processes can be improved, trial and error is inevitable. Experience reveals information that nobody could have known before applications or offers. The expectation that both students and universities can get it right the first time is unrealistic. We do not expect this when purchasing other services, or when making other big life decisions on jobs and relationships.

Conclusion

Higher education is an expensive publicly-funded service. It cannot be immune from fiscal constraints. Caps on university grants, imposed on Australian universities since 2018, are one way to achieve budget savings. Rules making people with low ATARs or other academic risk indicators ineligible for public support, as implied by criticisms of declining admission standards, are another.

But on Freidmanite and Hayekian grounds these approaches should be rejected. No neat empirical test shows which prospective student at the margins of suitability should be rejected and which accepted. Funding caps to exclude marginal students in practice affect students who are accepted by undermining the system’s coordinating mechanisms. Popular courses and universities cannot expand because their funding is capped; their prospective students must take second or lower-preference courses or miss out on higher education.

Higher education savings should come from reduced per-student tuition subsidies and increased repayments of HELP loan scheme debt. This was what the government proposed in 2017 – the demand-driven system ended only as a second-best option when these alternative savings were rejected by the Senate. Students may not face strong price signals, but they are paying the price of this policy error.

Andrew Norton is a Professor in the Practice of Higher Education Policy at the ANU Centre for Social Research and Methods.