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HECS for the unemployed: a finance answer to mining’s decline

Together with the government, the banking sector could play a role in easing the transition for mining workers. Tony McDonough/AAP

A decade of strong mining revenue growth has seen workers disproportionately located in the “mining states” of Queensland and Western Australia. With mining investment now waning, workers drawn by in the resources boom are increasingly facing poorer prospects.

Faced with scarce employment opportunities, some must relocate. To ease the pain, policymakers should consider income contingent loans (ICLs).

A strong advocate of the potential for the use of ICLs, economist Joseph Stiglitz has argued they are an efficient (and low transactions cost) way of implementing equity contracts for human capital.

In a recently published book, co-authored with Bruce Chapman and Tim Higgins, Stiglitz argues:

“While it seems natural to link ICL with investments that increase the value of human capital — most notably education — there is no necessary reason to limit it to such investments.”

In fact, ICLs could be used to not just finance tertiary education income support, but drought relief, community investments into social and community projects, the payment of low level criminal fines, legal aid expansion, the purchase of energy efficient devices, and extensions of paid parental leave.

ICLs essentially offer insurance to borrowers against both consumption hardship and default, advantages which are unavailable through the use of traditional mortgage-type loans.

Income contingent loans could be used for retraining and relocation expenses, partially insured by the federal government and collected via the income tax system.

The loans could be provided by private financial institutions, using their likely comparative advantage in selecting and screening borrowers. Establishing the details of an ICL would naturally come after a lot of institutional negotiations, but we can flag one possible scenario.

How it could work

Workers in a particular area or industry deemed eligible by the Commonwealth for an ICL would be allowed to enter a competitive financial market where intermediaries offered different packages, much as they do in the current market for loans.

Contracts would be for workers with prospects for employment, but no definite job on offer. These workers might need a period of retraining, with significant related costs.

The advantage of involving private financial institutions is that they might offer more effective screening than central government screening. A government/private partnership would reduce, but not eliminate, default risk, but at the same time encourage greater private sector involvement in the financing of retraining than would otherwise be the case. If designed well, such an arrangement could be revenue neutral.

Apart from more effective screening, another advantage of the use of private markets for these loans is that, unlike the funding of higher education where very few students can provide collateral, some of the potential ICL recipients will have collateral to post, and the menu of contracts available should be more nuanced, to reflect this.

The loans would be for worker education expenses, technological purchases relevant to the workplace and removalist fees. Importantly, though, the biggest need for those in retraining is for income support, up to a reasonable cap. There is a case for including education expenses for some family members who wish to retrain, since these people often bear significant external costs of a move.

The collection of the loan repayment would occur through the tax system, in the event that the worker, or any family member in receipt of assistance, went above a HECS-style income threshold. Until such a threshold was reached, the debt would grow at an interest rate determined in the market for these contracts and, as in HECS, the loan would never be repaid if the worker failed to exceed the threshold.

It is feasible and inexpensive for the government to collect debts for retraining purposes which take the form of income support for mature aged workers. Since the repayments would be collected via the income tax system, there would obviously need to be a financial agreement between the Commonwealth and the relevant institutions in which the loan is repaid at a set rate over time by the government.

There is already a precedent for this type of arrangement: in 1994 the government instituted the Special Supplement Loan Program designed to increase financial resources going to Austudy recipients with the initial outlays provided to students coming from the Commonwealth bank.

Managing risk

One key risk factor is that, unlike the recipients of higher education funding, the ICL recipients may be mid- or late-career workers with a relatively short working life left. The relative attraction of the scheme for those wishing to retire at the earliest date possible (adverse selection) and the change in behaviour of those who, having taken out a loan, then decide on an earlier-than-planned retirement (moral hazard) will increase the exposure of the insurer, that is, the Commonwealth, to losses.

There are, however, options to reduce this risk. As already discussed, the use of private financial intermediaries taps into their skills for screening loan applicants, using credit scores and similar tools.

In addition, the insurer (the Commonwealth) would have the power to determine eligibility at a global level – for example limiting entry into the ICL market to all workers in a particular company that shuts down. The total number of ICL offers could depend upon the fiscal position of the Commonwealth at any point in time.

And lastly, the Commonwealth could carefully choose to offer ICL market entry to workers whose labour market position was clearly the result of an outside development, rather than a hard-to-unravel combination of choice and external circumstances.

This is an edited version of a submission by Gordon Menzies and Bruce Chapman to the Financial System Inquiry, which is due to report on July 15.

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