Romi Bhakti Hartarto

43391796
romi-bhakti.hartarto@students.mq.edu.au
Public Finance Intervention in Education Market: Study Case of
Indonesia
This essay aims at analyzing the rationale for public sector intervention in
the economy by empashizing the theories that constitute why and when the
public sector intervention is necessary. By giving a relevant example in education
market, this essay will concentrate in providing economic framework through
market failure rationale. This essay will be divided into three main parts. The first
part discusses the market failure as the main reason of public intervention. The
next session focuses on the role of government in education market through
providing student loan. And the last one will evaluate the recent development of
higher education financing in Indonesia.
One prevalent theory that asserts the rationale for governmental
involvement in the private market is public interest theory. This theory suggests
that the government doing so in order to achieve economic efficiency and social
equity. Economic efficiency refers to situation in which there is no waste of
resources in the production and allocation process. When market can not deliver
efficient allocation of resources due to the presence of market imperfection,
market failure ensues. Market failure is generally caused by two main factors:
public goods and externalities.
Economists define public goods as satisfying two criteria: non-rival and
non-excludable. Non-rival implies that consumption of one person does not
diminish anybody else. Meanwhile, non-excludable means that it is not possible
to exclude anyone from consuming the good. Street lighting is such an explicit
case because once consumer enjoys the service then anyone else can freely
consume that good. The government will provide this service since it is
impossible for private company to coerce everyone to pay for a good that is nonrival and non-excludable. Provision of street lighting by private company will lead
to inefficiency. What about education?
Education seems satisfying none of the above criteria as a public good. It
is excludable for which a certain child can be excluded from any educational
opportunity. And it is rivalry in the case that if some children get any particular
attention from the teacher, then other children will obtain less benefit from that
teacher. Hence, it is necessary for the government to intervene in education
market by mitigating this access inequality. Eventhough education is not
considered as a public good in this sense, Tooley (2013) argues that it seems to
have externalities.
Economists define externalities as a cost or benefit applying to other
parties which is not directly involved in economic transaction. This in turn will
lead to inefficient quantity of the good or service delivered by the market since
the buyer and seller ignore this external cost and benefit. Hence, externalities
will give incentives for the buyer and seller to maximize their utility to over- or
under- production of the commodity based on the standpoint of society. Goods
with positive externalities exist whenever parties not involved in the transaction
receive the benefit. Since the benefit is not accrued to private transaction, those

Romi Bhakti Hartarto

43391796
romi-bhakti.hartarto@students.mq.edu.au
goods will be undersupplied. Hence, is there any presence of positive
externalities from education through schooling?
Cohn and Geske (1990) gave an overview which claims that an educate
bureaucrat is pivotal to incarnate democratic society. In other hand, an educated
worker is crucial for absorbing new technology to improve productivity. Education
also has a negative association with crime so that widespread education will
soothe the social turmoil. However, if parents disregard the above externalities
from education, education spending will drop beneath the socially efficient level.
Therefore, public policies are focused on educational attainment to increase
social welfare.
Poterba (1996) also supported the above argument by asserting rationale
why government intervenes in education market. It is mainly because the
recipients of education do not have any responsibility to decide how much
schooling they will undertake. It attributes to parents who bear the educational
cost. Hence, it is justified for the government to protect children from their
parents decision. This educational decision relates to capital market constraints
regarding their limit in credit access which causes them to underinvest their
children. The existence of fixed costs in educational provision also contributes to
their decision. As Peltzman (1973) stated, the free public school can encourage
parents to send their children to that place rather than their previously chosen
school since they do not have to pay tuition like in higher quality school. This
decision can alter the equilibrium level of educational spending into another one
with lower spending.
Poterba (1996) also appended redistributive concerns as important
rationale for public policies to intervene education market. In his argument, the
public sector must warrant the sufficient education access for all with price
subsidies as the main instrument. There are various price subsidies through
student loan programs which aim to alleviate the inequalities of access to higher
education and to warrant the contribution of higher education graduates toward
economic growth. Student loan programs take two types: government
guaranteed mortgage and income contingent loan (Chapman, 2006). Repayment
burden which represent the default risks becomes important aspect for potential
students while designing expectation to take-up loans. It is given as the
proportion of required graduates income to repay a student loan. The higher it
is, the more hardship for the debtors and the higher risks of loan default.
The government guaranteed mortgage takes the form of public sector
guarantees for commercial bank to provide educational loans. These loans
typically invoke fixed repayments with house mortgage. Eventhough the capital
market failure seems to be overcame, the problems of repayment hardship and
default emerge. The students with potentially low income in the future will be
reluctant to borrow due to fear of not being able to repay future obligations. Not
being able to repay future obligation will influence their credit reputation for
future borrowing. As a result, some prospective students with disadvantaged
background will not take this bank loan.
Another approach to student financing is income contingent loan in which
students can enrol in higher education by accepting condition to pay tuition

Romi Bhakti Hartarto

43391796
romi-bhakti.hartarto@students.mq.edu.au
charges contingent on their future income. Employers collect the payments
along with the income tax and there is no repayment obligations until the
debtors earn certain amount to repay the debt. Hence, it is really difficult for the
graduates to avoid repayment and it is impossible for the debtors to experience
repayment hardships once their income is enough to repay the debt. According
to Chapman (2013), income contingent loans must meet three minimum
conditions to be successful: accurate record-keeping of students liabilities, a
sound collection mechanism, and accurate way of determining the actual
incomes of students. The latter requirement is not met in Indonesia due to
inadequate capacity. So, how are the features of loan scheme in Indonesia?
Apparently, Indonesia does not use any higher education student loans
system. Parents bear the largest part of higher education cost. Friawan and
Wicaksono (2013) explains that their expenditure depends on the degree
enrolled, the study program, the higher education status, and the location. And
the higher education institution itself sets the tuition fee, including public
universities especially after reformation in 1999 which required all state
universities to be incorporated from government bureaucracy. Education cost for
higher education usually consist of tuition fee, books, lodging, transportation,
and other personal expenses. The estimated total expense borne by parents and
students ranged from Rp23.8 milion to Rp27.9 million at public universities in
2009-10 whereas Rp64.3 million at private universities. With this high level of
expense, students from poor family can not afford the higher education service
so that government is responsible to assist disadvantaged students through
scholarship scheme.
The government has allocated 25 percent of total government scholarship
to students at private universities while the students of public universities still
benefit larger. There are three types of scholarship offered to disadvantaged
students: for academic achievements; fuel subsidy reduction scholarships; and
sport and cultural activities achievements. The government formulate certain
criteria for recipient students and manage the allocation of the funds through the
universities. The scholarship nominal is Rp250,000 monthly per students to cover
the tuition fee and living allowance.
The universities also collaborate with private enterprises, foundations and
alumni networks, to grant scholarships for disadvantaged students with various
schemes and additional criteria. For example, Tanoto Foundation address its
scholarship to bright students with leadership skills but confronting financial
limitations. Approximately 300 undergraduate students and 50 graduate
students from six public universities have been granted Rp500,000 monthly for
living allowance and Rp3 million per semester for tuition fee with this
scholarship.
In conjunction with scholarships, the government also attempts to design
student loan program targeted to disadvantaged students which covers their
tuiton fees. Indonesian Student Loan was introduced in 1980 but due to the high
default rate until 95 percent, this program has been terminated. Poor
management is the main cause of this failure. The banks were unable to keep

Romi Bhakti Hartarto

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romi-bhakti.hartarto@students.mq.edu.au
track the graduates after giving the loan. They even presumed this loan as
merits from the central bank.
In the next development, Sampoerna Foundation as private institution
regenerated student loan program in 2006. The foundation collaborated with
Bank International Indonesia (BII) and International Finance Corporation (IFC) as
creditors. It is a risk-sharing scheme where BII acts as an administrator of the
program along with supported fund from IFC. The motivation to provide student
loan program is the inability of potential students to access the college because
of very large up-front fees.
Eventhough the student loan does not need any collateral, the parents
play as guarantor in which they must have minimum annual incomes of Rp40
million. The loan provided ranges from Rp10 million to Rp200 million and the
monthly interest rate charged by the bank is 1.5% with repayment period from
six months to three years. This loan scheme resembles to mortgage loan where
the parents must repay the loan each month after the first loan distribution. After
its introduction in 2007, the program only reached very few recipients, which was
15. It is particularly because the banks still consider student loan as very risky
and no incentive for the banks to lend money for student loan scheme.
However, with the financial assistances described above only six percent
of total enrollment who were covered from government or non-government
sources according to Directorate General of Higher Education in 2009. Hence, the
scholarships were unable to benefit the most disadvantaged ones. It is because
many students from the poorest background already left the education system
before attaining the higher education. And since most of the scholarship
schemes are granted after enrollment, the opportunity for children from the
poorest background to pursue higher education is limited. According to World
Bank, the gross enrolment ratio in tertiary degree was only accounted for 25% in
2010. Hence, it is necessary to improve the financing scheme in order to expand
the coverage. Shifting part of the scholarships for direct financial aid to the
potential secondary level graduates can be the solution for more enrollment
opportunities in tertiary degrees.
In conclusion, the government intervention in private market is necessary
when market failure exists. Market failure is caused by public good and
externalities. Public good is non-rival and non-excludable in which the
consumption of one person can not prevent others to consume that good without
diminishing availability. Although education is not categorized as public good, it
seems to have externalities, or external benefits to other parties which are not
directly involved in market transaction, like educated bureaucrat for democratic
society or educated worker for productivity improvement. Hence, the role of
public policy is needed to increase educational attainment for social welfare. The
government can use price subsidies as the main instruments through student
loan programs. Apparently, Indonesia does not use student loan scheme
anymore due to the high default rate. The government has allocated various
scholarship schemes to disadvantaged students in tertiary degree but the
coverage is still small because most of them are granted after enrollment.

Romi Bhakti Hartarto

43391796
romi-bhakti.hartarto@students.mq.edu.au
Hence, it is essential to move part of the scholarship for direct financial aid to
expand the coverage.
REFERENCES
Chapman, B. (2006), Government Managing Risk: Income Contingent Loans for
Social and Economic Progress. London: Routledge.
Chapman, B. (2013), Higher Education Financing and Inequality, The Critical
Role of Student Loan Scheme Design: Illustrations from Indonesia, Vietnam
and Thailand, in Human capital formation and economic growth in Asia and
the Pacific, London: Routlage, pp. 79-101.
Cohn, E., and T. Geske, (1990), The Economics of Education. 3d ed. Elmsford, NY:
Pergamon Press.
Friawan, D. & Wicaksono, T. Y. (2008). Recent Developments in Higher Education
in Indonesia: Issues and challenges, in Financing Higher Education and
Economic Development in East Asia Edited by Shiro Armstrong and Bruce
Chapman, Canberra, Australia: ANU E Press, pp. 159-87.
GLA Economics (2008), The Rationale for Public Sector Intervention in the
Economy II, London: GLA Economics.
Human Development East Asia and Pacific Region (2010), Indonesia: Higher
Education Financing, Document of the World Bank.
International Finance Corporation (2006), Sampoerna Student Financing Facility:
Summary of proposed investment, Washington, DC: International Finance
Corporation.
Peltzman, S. (1973), The Effect of Government Subsidies-in-kind on Private
Expenditures: The Case of Higher Education, Journal of Political Economy,
81:1-27.
Poterba, J.M. (1996), "Government Intervention in the Markets for Education and
Health Care: How and Why?," NBER Chapters in: Individual and Social
Responsibility: Child Care, Education, Medical Care, and Long-Term Care in
America, pp. 277-308.
Tooley, James. (2002) "Government and Education, The Changing Role of
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in
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