Can someone explain this?

March 19th, 2012 at 9:23 am by David Farrar

Stuff quotes NZUSA:

The presumably has a few budding economists at its fingertips and has calculated putting interest on a $50,000 loan would see it grow to a $90,000 repayment, yet the extra value to the Government would be only $3000 out of the extra $40,000 paid.

So who would the extra $37,000 go to? Can someone in NZUSA provide their calculations, because on the surface,  I don’t see how this works.

Maybe they are saying that students would end up spending the $40,000 on goods and services, which would generate economic activity which would produce $37,000 of income for the Government? Any economists out there want to take a stab?

UPDATE: NZUSA have kindly responded:

The $50K becoming $90K if interest was added (and taking 15 years to repay instead of 8) was John Key’s. You’ll have to ask him where he got those numbers from.

According to IRD’s student loan calculator, to pay back a $50K loan in 8 years requires a salary of just over $80,000 – about twice the (university) graduate average. Of course as we all remember from 2005, IRD’s calculator doesn’t have income growth – or growth in the repayment threshold – built into it.

$70+2.5% gets a similar result.

The average graduate salary is around $40K. $45K – $48K if you believe the marketing on the NZ Immigration website. Not sure about salary growth rates in the midst of the Great Recession.

 The Net Present Value of $50K in 8 years is ~$29K; that of $90K in 15 years, is ~$32K. Hence $3,000. That’s at a 7% discount rate. Key’s interest rate seems to be higher than this, but it always was much higher than the actual cost of capital.

 These are terminal payments. Of course this is an unlikely scenario. However, since it depends on the actual cashflow, it is hard to know without the Prime Minister’s numbers. If the money comes quickly, high starting salary, low growth (to still get the repayment time), then the difference between the two would be greater, if it came later, lower starting salary with high growth, then the difference would be relatively smaller, especially if there was a break in payments – unemployment, travel overseas. These could likely be quite reasonably be factored in.

Okay this makes more sense.  What would be good is to model an actual scenario based on actual repayment times for say the average graduate. I don’t think any policy change is likely here (which will please NZUSA) but it would still be good to understand what the “cost” of no change is.

 

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19 Responses to “Can someone explain this?”

  1. Danyl Mclauchlan (1,065 comments) says:

    My guess – and this is just a guess – is that the government borrows the cost of the loan then lends it to the student at a higher rate, so the bulk of the interest payments goes to the financial markets where the money was raised from.

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  2. Uplander (46 comments) says:

    Doubt if that is the reason Danyl. At the present time the government goes to the market and borrows the whole $50000 and pays interest on it with little offsetting gain. By charging interest there are no extra costs that I can see.

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  3. Lloyd (125 comments) says:

    It’s a thing called BS Economics.
    The assumption is made that (1) students don’t get a well-paid job upon graduating and therefore (2) the debt climbs at a rate that outstrips repayments. Which is BS that completely ignores the experience of most graduates.
    The government gets the interest paid by the students, but has to pay interest on this money, because as Danyl rightly points out, this is largely borrowed money. Only a half-wit Minister of Finance would not pitch the interest rate to be paid on student loans at a rate higher than the cost of those funds…
    Student loans have transformed the university scene from when I did my first (Economics) degree in 1982, when the student body was largely white, middle class and boring, to the vibrant, multi-cultural group it is now (I am now an old git doing my doctorate at Canterbury). But student loans as a universally available resource caused the changes, NOT interest-free student loans!
    Interest-free student loans are fast becoming a luxury our country can ill afford and sophistry like the dodgy economics offered by the NZUSA does little to help that!

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  4. Dave Guerin (31 comments) says:

    They have assumed different repayment periods for a $50K loan for interest ($90K over 15 years) and no interest ($50K over 8 years). And they argue that the NPV of the interest option is only $3K above the no interest option. I assume they have done a simple discount over time of the amount repaid, but their release doesn’t include the discount rate or any workings. Personally, I can’t see how charging interest, which is specifically intended to maintain the NPV, could result in such a poor payoff.

    A minor problem with the calculation is that the median loan for tertiary education leavers was about $12,000 in 2008, but that just changes the magnitude for PR purposes rather than having any effect on the basic calculation (latest figures – see p.24 at http://www.educationcounts.govt.nz/__data/assets/pdf_file/0018/105552/Student-Loan-Scheme-Annual-Report-Oct-2011.pdf)

    NZUSA’s release is at http://www.scoop.co.nz/stories/WO1203/S00353/interest-free-loans-bad-economics-or-smart-investment.htm

    [DPF: Ta]

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  5. DT (104 comments) says:

    Hard to say DPF, the reporting is pretty bad here. I wouldn’t imply that the students are wrong (you obviously are): there could be assumptions driving this. Instead of attacking the students, this seems like bad reporting to me, since there are central details of this story not mentioned.

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  6. freedom101 (462 comments) says:

    Don’t get too excited. Free student loans is one of Labour’s “socialism by stealth” policies which National won’t touch. All Labour has to do is get into office periodically and introduce new entitlements, ratcheting up government spending and welfare dependency at each stage. There is then an ‘inter-regnum’ or pause until Labour gets back into office, and trend continues.

    National are caretakers for Labour socialism.

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  7. RightNow (6,643 comments) says:

    It is NZUSA president Pete Hodkinson’s assertion of Net Present Value calculation:

    … the longer it takes to come back the less it is worth. This is called a calculation of Net Present Value. Just as $50 won’t buy you nearly as much gas as it would 10 years ago, the value of money owned now decreases into the future”.

    NZUSA has calculated the Net Present Value using John Key’s own example (a $50,000 debt without interest taking 8 years to repay and that same debt turning into $90,000 and taking 15 years to pay off with interest). It is revealing. The extra $40,000 the student pays due to interest results in only an extra $3,000 in the value of that loan to the government.

    http://www.voxy.co.nz/politics/interest-free-loans-smart-investment-say-nzusa/5/117950

    I call bullshit on Hodkinson. His rationale supports charging more interest.

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  8. KiwiGreg (3,169 comments) says:

    I will pay $3000 now for $40,000 paid to me over 15 years.

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  9. GPT1 (2,087 comments) says:

    They got MUNZ to do the figures

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  10. JamesP (76 comments) says:

    Making the error of working from a zero baseline? Right now the “benefit” of each student loan to the government is not $3K or $0, it’s a fairly big negative number.

    Also this analysis doesn’t address how charging interest will change the student’s decision to get a loan in the first place. Right now it’s “free” money.

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  11. Nichlemn (63 comments) says:

    “It is NZUSA president Pete Hodkinson’s assertion of Net Present Value calculation:”

    Okay, so he’s using NPV as it applies to the government, but not students? Does anyone else see what’s wrong with this story?

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  12. unaha-closp (1,111 comments) says:

    There must be some calculation for flight risk. If a graduate can pay $90,000 to stay here or pay $0 to go overseas with the degree – that increases the chance that the student is going.

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  13. hubbers (221 comments) says:

    I can explain this.

    Everyone at NZUSA studied politics and not maths because maths won’t get you on the Labour party list.

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  14. Kimble (4,375 comments) says:

    Okay, so he’s using NPV as it applies to the government, but not students? Does anyone else see what’s wrong with this story?

    Yeah, that is complete bullshit. Pay the thing off over 40 years instead and the gain would be zero to the government.

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  15. PaulL (5,872 comments) says:

    It’s sort of sensible. They’re saying that if you have $50K debt, and the interest rate is set only at the cost of capital, then the govt still really only gets $50K back – discounted for cost of capital. The big assumption here is the classic “everything else being equal” – so they’re assuming that:
    – a loan with interest takes longer to pay back than one without – since the amount to be paid goes up
    – people don’t increase their payments when interest applies (no longer any incentive to maximise time to repay)
    – people continue to borrow the same amount (no reduction when the money is no longer free)

    I think the maths here is potentially sound given the assumptions, but the assumptions are not sound.

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  16. Colville (2,058 comments) says:

    I go with the simple explanation.
    Is a total bullshit fabrication.

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  17. pidge (53 comments) says:

    Hmm.

    Brutally simple repayment model in a spreadsheet

    Starting loan to student of $50,000
    Repayments and interest applied annually
    Government cost of borrowing 3%
    Student repayments of $5000 per annum
    Student repays over 10 years, total $50,000
    Net cost of government borrowing $8250

    Starting loan to student of $50,000
    Repayments and interest applied annually
    Government cost of borrowing 3%
    Student loan interest rate 3.5%
    Student repayments of $5000 per annum
    Student repays over 12.5 years, total $62,590, $12,590 in interest paid
    Cost of government borrowing $10791
    Net cost (profit) of government borrowing ($1798)

    Difference in cost to Government = $8250 – $1798 = $10,048 extra cost of borrowing
    Student loan repayment takes extra 2.5 years.

    Note – assumes no changes student loan interest or cost of borrowing, and the former student is so hopeless in their job that they never get a pay rise.

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  18. Uplander (46 comments) says:

    Pidge,
    Can’t get my head around the reasoning why Govt interest more when interest is charged.
    Surely gain to the Govt is $12590 which is the total interest paid by the student.

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  19. rg (197 comments) says:

    This is a classic case of using confusionism to hide the truth
    Truth interest on $50000 at is $1500 at 3%. If the student doesn’t pay it we the taxpayers have to. I don’t mind paying for my own kids education but I’m buggered if I want to pay for someone elses, especially if they are millionaires kids.

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