CHILE: Universities in transition

Major aspects of the structure and performance of Chilean university markets demand careful re-structuring in the years ahead. Although higher education exhibits a successful record of expansion, signs of fatigue can be clearly identified. Future growth of the Chilean economy requires faster productivity growth and the strengthening of international competitiveness, and this can only be attained on the basis of a much better-trained labour force. Chile also demands better political governance, which requires significant improvements in equity of access and quality in tertiary education markets.

The local innovation system - and universities within this system - should be carefully re-structured in the forthcoming years if better performance in growth and equity are to be attained. This paper concludes by listing several policy issues that demand consideration.

Chilean universities: early historical evolution

Two large universities dominate the Chilean tertiary education sector. Their market position has been significantly challenged in recent years by the competitive entry of many small and medium-size metropolitan and regional universities, both private and public, which are now trying to increase their participation in teaching activities and, to a much lesser extent, in applied research and development.

The University of Chile, created in 1843 by a merger of the Real Universidad de San Felipe de Santiago (1747) and the Instituto Nacional, emerged as the national university of a newly independent nation. Secularism and 19th century liberalism were central to the conceptual basis of this first university.

It did not take long before the strongly articulated local Catholic constituency succeeded in creating the Catholic University of Chile in 1888. The third university was founded by the Freemasonry movement in Concepción in 1919: in the following three decades, only six other universities were created, making a total of eight universities in the country.

The Council of Rectors of Chilean Universities (CRUCH) was created in 1954. At that point, Chile had some 20,000 university students. The eight universities were entirely supported by public funds, and entrance was free.

The military intervention of 1973 brought about a dramatic change of regime. Public resources for education contracted drastically, falling from 7% to just over 4% of gross domestic product between 1973 and 1980. The reduction in fiscal block grants forced universities to search for alternative forms of funding, and student fees became the obvious alternative. Together with this fundamental change in the financing of university services, the military authorities also de-regulated the market, allowing for the entry of private providers.

As a result, the structure and behaviour of university markets changed quite dramatically during the 1980s. In 1981, the military government forced the subdivision of the University of Chile into 17 legally independent universities operating across the country. Together with the eight 'original' universities, these 17 universities formed the new CRUCH. The de-regulation of university markets also promoted the creation of 22 new private universities and 23 professional institutes between 1981 and 1989.

While there was a rapid process of market entry during the period 1980-95, in the mid 1990s the rate of new entry slowed, and between 1995 and 2005 the number of universities and professional institutes of higher education actually contracted. This suggests a complex winnowing process in the industry.

Not all Chilean universities and teaching programmes have been accredited through peer-review examination. Accreditation involves six different areas of evaluation - institutional management, undergraduate teaching, research, postgraduate teaching, relationship with the community and quality of infrastructure - and can be obtained for two to seven years depending on the status attained by a university in each sphere. Only a handful of Chilean Universities, out of a total of 61, have received full accreditation in four or more of the these spheres, and for a period running from four to seven years.

Market entry strategies over recent years show that some universities have opted for what we call a 'low end' market entry strategy - expanding the number of teaching campuses they operate across the country, without serious concern for quality and accreditation - whereas a few other universities have opted for the opposite strategy, that is entering the market on the basis of high quality staff, state-of-the-art infrastructure and world-class teaching curricula.

In just a few cases, universities are trying to do both, developing state-of-the-art facilities in specific R&D areas - biotechnology, for example - and financing such activity through student fees, while acting as a low cost, low quality service provider in teaching markets. A frail accreditation system allows some universities to take advantage of their monopolistic market position.

Both of these entry strategies have occurred in Chilean university markets in recent years, with universities using different product differentiation efforts (for example, advertising and loans) to attract new students. The choice of a given university involves a considerable amount of irreversibility, with sunk costs and information asymmetries being quite significant.

Supply and demand for university services

The provision of funds for teaching and research activities

Universities finance their activities through a mixture of public resources, tuition fees, donations, research grants and revenue from services to individuals, firms and governments. Clearly the more notorious long-term transformation of the financial model underlying the provision of university services in Chile is the falling level of government block grants within total university revenue and the concomitant expansion of the relative share of revenue from student fees, competitive funds, contractual services and donations.

We now examine how each one of these alternative sources of revenue changed over time as a result of the transition to a market- driven environment.

Direct and indirect fiscal allocations

Breaking up the University of Chile into 17 different independent regional campuses in 1981 expanded CRUCH membership to 25 public universities. It is these 25 universities that receive Direct Fiscal Allocation (AFD), a block grant from the government aimed at covering operational expenses and an unspecified amount of R&D activities. AFD currently accounts for close to US$160 million annually. It represents nearly one-third of university revenue but there is a considerable variation across CRUCH universities in terms of how much each one receives.

Student fees have expanded strongly, accounting for another third of total revenue, again with a large variance across CRUCH universities. Public funding for R&D also comes from the National Commission for Science and Technology Research (CONICYT) and the Chilean Economic Development Agency (CORFO), while the Public Funding for R&D and the Superior Education Quality Improvement Project Ibero-American Network on Science and Technology Indicators (MECESUP) (and FIAC) provides resources for infrastructural investment and organisational upgrading. These sources together add up to another one-third of total university revenue.

During the period 1990-2005, from a regime in which CRUCH universities were largely financed through government block grants, Chile has gradually moved into an alternative regime in which other sources of revenue have become significantly more important.

AFD funds are distributed among CRUCH universities according to a fixed formula (political and without precise rules), which was established in 1981 by a legally enforceable decree (Decreto con Fuerza Legal, DFL) No 4. Eight years after establishing the formula, the government introduced a change allowing 5% of AFD funds to be allocated through competitive processes depending upon the number of papers each university published in ISI journals, the number of citations received and the number of research projects conducted. The available evidence shows that AFD resources have increased over time, but at a slow rate.

Besides AFD, the 1981 decree also created Indirect Fiscal Allocation (AFI), which is related to the quality of the students each university enrols each year. The best 27,500 students passing the university admission test are ranked and divided into five subgroups of 5,500 students each. The subsidy for the lower quintile is then determined with the remaining groups receiving that amount per student multiplied respectively by three, six, nine and 12 depending on their position above the lowest. This means CRUCH universities that attract students in the highest quintile receive 12 times more AFI per student than those that attract students from lower segments.

This resource allocation mechanism introduces a selection bias that is under strong criticism in Chile. Noting that students from private schools gain significantly higher scores in the university entry examination, AFI leads to a bias against low-income students, who tend to attain lower scores. It also involves a selection bias against institutes of tertiary education, which are crowded out by the best universities in the system.

Student fees and demand subsidies

As explained, about two-thirds of the total revenue of public universities comes from sources other than government block grants, with student fees forming a major part. Student fees are to a large extent covered by demand-side subsidies, but Chilean families absorb a large proportion of the cost of gaining access to university education.

Two public sector schemes stand out.

The University Credit Solidarity Fund (FSCU) is only available to students applying to CRUCH universities. It involves a low interest rate - 2% - and repayments can never exceed 5% of the recipient's salary. The FSCU is basically directed at the two lower quintiles of income distribution, and it is believed that nearly 80% of those applying for the FSCU actually get it.

State guaranteed loans, which are public sector-guaranteed, are also available to cover tuition fees and other expenses associated with university enrolment. These are somewhat more expensive options than the FSCU, with interest rates of 5%, and target students from higher income groups who can afford the more expensive option.

Although no hard information is available, local sources indicate that the percentage of non-performing loans is close to 40%, a much higher rate than in other countries. This might be taken as an indication that repaying the loans is a major problem for low-income families. Better solutions to equity of access should be explored.

Investment in infrastructure

Another important source of university revenue is the Fondo de Desarrollo Institucional, or FDI Fund. Close to 10% of CRUCH universities' fiscal resources currently come from this source.

The financing of R&D activities

Chile is not a big spender on R&D activities. Only 0.7% of GDP is only allocated annually for these purposes. Close to 70% of the total comes from government sources and only 30% from private firms. The current policy debate concerning innovation and technological change indicates that the government expects to expand R&D expenditure to the level of 1.2% of GDP during the course of the next decade and that it also expects the share of private sector R&D to increase considerably. Several policies are currently being implemented to attain these goals.

CONICYT, under the Ministry of Education, is the central public entity responsible for the management of R&D funds. The agency is an autonomous public corporation created in 1967 to promote scientific and technological research and the development of human resources. It has become increasingly important in recent years, having been made responsible for managing a large number of competitive funds for R&D activities, with the National Fund for the Development of Science and Technology (FONDECYT) being an important one of these.

In 1982-83, the Chilean economy entered a deep recession triggered by the Mexican Moratoria and the drying up of most external sources of finance. GDP fell by 14% in 1982 and a major banking crisis unfolded in 1983. Fiscal resources diminished drastically and public expenditure was cut across the board.

Concomitantly, the government announced the implementation of a new policy regime that involved the transition to market-based allocation processes in the field of R&D expenditure. This change led to the creation in 1982 of FONDECYT, which runs an annual competition for R&D funds in which close to 500 projects are selected for financing, most of them from the largest six or seven Chilean universities involved in research. The University of Chile and the Catholic University are by far the major recipients.

According to a public presentation (Heyl 2008), CONICYT's total budget has increased from some US$80 million to nearly US$180 million. CONICYT therefore holds a prominent position within Chile's National Innovation System.

The demand for university services

Various forces have fuelled the rapid expansion in demand for tertiary education in Chile over the past three decades: on the one hand, the high rate of growth attained by the economy, particularly during the period 1984-98; on the other hand, the increasing availability of scholarships, grants and credits, both from public and private sources.

Enrolment in tertiary education increased fourfold between the early 1980s and 2006. It is important to note that such expansion was much stronger in the lower quintiles of the distribution, causing the access rate to university in the 18-24 group in the lowest quintile of the distribution to increase from 4% to 15% from 1990 to 2003. In the next lowest quintile it increased from 8% to 21%.

The period 1984-98, after the Debt Crisis of 1982, is frequently regarded as the golden age of the Chilean long-term growth process. An average rate of growth of 7% was attained, with many new firms opening up.

During the 1990s, industrial production underwent rapid technological modernisation in sectors such as copper mining, salmon farming, fruit and wine production, and the forestry industry. The new firms entering the market brought with them world-class computer-based manufacturing facilities, rapidly gaining international competitiveness. The new production facilities demanded more professional management as well as skilled manpower in a large number of disciplines. The strong signal coming from the production structure induced a rapid expansion of demand for tertiary education.

Tertiary education markets responded well to market signals by increasing the number of institutions providing teaching services. Ten new universities opened up between July 1990 and December 2005 (CNAP 2007). The total number of university students increased from 245,000 in 1990 to 435,000 in 2000. As mentioned, the rate of new student enrolment was well above average in the lower quintiles of income distribution.

A wide and heterogeneous middle class emerged, and the rapid expansion of university infrastructure created new opportunities for accessing university education as more demand-side subsidies facilitated market entrance for low-income groups. There occurred a virtuous circle of faster economic growth associated with productivity gains and a concomitant upgrading of human capital.

In more recent years - from 1998 to the present - the Chilean economy has suffered a significant slowdown in its long-term rate of expansion. From an annual average growth rate of 7.5% for the period 1984-98, the rate of GDP growth has fallen to an annual rate of 4%. This seems to be negatively affecting the process of social mobility and the functioning of university markets.

The dynamics of market functioning

Chilean university markets underwent major structural transformation over the past three decades. Issues of access, affordability, quality and accountability have been affected, and major questions remain unanswered concerning how university R&D activities and the production of public goods are to be financed in the present macroeconomic policy environment.

The current scenario can be characterised as follows.

Some 250,000 secondary students - of very heterogeneous cultural and family backgrounds - compete annually for admission at local universities. Some 150,000 are admitted to tertiary education.

The best 27,500 of these students receive AFI subsidy. Universities compete for the best students, offering them grants, scholarships and loans, as well as engaging in a great deal of advertising.

Two highly prestigious universities - the University of Chile and the Catholic University - jointly absorb close to 9,000 of the AFI students. Most of the students enrolled in these two universities - 95% - bring an AFI subsidy.

A second group of reputable universities picks up the next set of AFI students. In this group we find CRUCH universities - the University of Santiago, Chile, the Catholic University of Valparaíso, the University of Concepción - and also some private universities including Los Andes and Adolfo Ibañez. In these universities the percentage of AFI students is about 50%.

The remaining AFI students - close to 10,000 - are distributed among the other 40 universities in the system. Universidad Diego Portales, Universidad Austral and Universidad Catolica del Norte enrol some 35% of their students in this category.

At the 'low end' of the market, many small and poorly accredited universities provide lower priced (and lower quality) services to the remaining group of students. They receive few AFI students. It is in this area of the market that mergers and acquisitions have occurred in recent years, with small universities being acquired by both local and foreign investors. University markets are undergoing a major winnowing process, with more restructuring and rationalisation expected in coming years.

At the 'high end' of the market, a slow process of consolidation and discipline diversification seems to be taking place, involving a small number of private universities such as Adolfo Ibañez, Los Andes and Diego Portales. These universities are gradually opening up new careers, trying to capitalise on their already high prestige. Their fees are higher than those charged by the University of Chile or the Catholic University, but their enrolments continue to grow rapidly among high-income groups. They are in the process of incorporating high quality faculty, mostly PhDs recently returning from graduate studies at US or European universities. It is interesting to observe that they 'buy out' faculty from the University of Chile and the Catholic University, pushing their salaries upwards.

Private universities are non-profit organisations by law, but they frequently operate under the aegis of real estate companies that own their land and physical infrastructure, which they rent back to the university. Private universities - low and high end - constitute highly profitable businesses.

Research and innovation activities are still in an incipient stage. R&D activities are mostly financed and performed by the public sector. Basic and applied academic research is partly financed by government block grants, but CONICYT is increasingly participating in the field through various competitive funds.

One-third of CONICYT resources go to FONDECYT, a programme that annually finances close to 450 R&D projects carried out by researchers in local universities. The University of Chile captures close to 40% of these R&D projects. CONICYT also administers the Science and Technology Development Research Fund (FONDEF), the Millennium Scientific Initiative (ICM), the BASAL Programme for Science and Technology Centres of Excellence, and other competitive funds financing R&D activities.

Policy on this front seems to be changing, as CONICYT favours larger and more basic R&D projects, incorporating risk-sharing mechanisms with private firms and prestigious R&D laboratories. The BASAL Programme - prototypical of the above - has an annual budget of close to US$12 million and has a five-year duration. Eight different R&D programmes were approved in the areas of astrophysics, climatology, mathematical modelling, aquaculture, plant-insect interactions, aging and regeneration, mining technology, and stress depression and addictions.

While our research indicates that a successful institution building process is in the making, it also highlights that major unresolved problems remain and will have to be tackled by government in the near future. The paper concludes with a brief review of some of these issues that demand policy action.

Concluding remarks

Our study offers a description of the structural transformation suffered by the Chilean university system in the transition from a government-regulated regime to a market-driven competitive environment. The process started three decades ago and was originally undertaken with the expectation that the "invisible hand" of markets could successfully handle the long-term transformation of the education sector without the need for further regulatory measures.

Many aspects of market functioning have changed over the past two decades. Together with the outstanding success of the process, it is now increasingly apparent that many new questions of market access, affordability, quality and accountability have emerged that demand further public sector intervention in the near future.

Market access

The population accessing university education has increased dramatically over the past 20 years, with the proportion of 18-to 24-year-olds entering university rising from 15% to 38%. Although this should be seen as a clear indication of success, there is still considerable room for improvement on this front. It is important to note that market access has increased more rapidly in the two lower quintiles of income distribution.

Yet Chile appears as an outlier in international comparisons when we consider the extent to which households finance access to university education. Student fees are quite high relative to per capita income, and public subsidies do not entirely cover enrolment costs. The high percentage of unpaid loans constitutes a clear indication that fees and financing mechanisms should be carefully reconsidered in the not-so-distant future.

Quality of services

A second area demanding attention is quality of education. Education markets are highly imperfect. There is a great deal of information asymmetry between supply and demand for tertiary education. Because of this asymmetry and as a consequence of weak accreditation requirements, there has been a rapid rate of 'low end' market entry over the past two decades, significantly affecting quality standards. Low quality service providers are forced to abandon the market through mergers and acquisitions from stronger universities that then proceed to re-structure them and to upgrade their quality, but this is indeed a slow process if we are concerned with consumer protection and educational quality.

Although an accreditation system already exists in Chile, the quality upgrading process seems to be proceeding at a slow pace. Performance-based agreements are being signed by MECESUP and various CRUCH universities, and this will certainly help to attain a gradual improvement in university performance, but much more needs to be done, particularly at the 'low end' of the market, where low quality of services is quite evident.

Increased institutional development funding would appear to offer high returns at this stage. Performance agreements may work for many purposes, and have the appeal of being to some degree competitive. However, as accreditation requirements become stronger, there is both the need for upgrading good universities - with which Chile is well endowed - and the potentially more complex issue of the large number of local universities that have not been adequately accredited so far. Market forces may eventually sort this out, but it will take considerable time. Institutional funding and further regulatory surveillance of accreditation practices would seem prudent.

R&D and innovation spending

A third issue demanding policy changes is how to finance and expand R&D activities. This involves, on the one hand, expanding fiscal resources allocated for this purpose and, on the other, graduating a much larger number of PhDs and graduate students per annum, capable of adequately using such resources. International comparisons indicate that Chile is well behind world standards on both aspects.

If the ratio of R&D to GDP is to be increased - as the government has announced - in the course of the next decade, universities will be required to expand their graduation of doctoral students. As stated in a recent document by an Academic Commission of the University of Chile: "The country has to set itself the goal of graduating 100 doctorates per million inhabitants by 2020, or 1 700 new doctorates annually." (Allende et al 2007)

Growth of FONDECYT has stalled. It will need to increase again, and funding will have to be provided to support the expansion.2

AFD and AFI

AFD and AFI block grants could probably be improved upon with performance-based criteria based on the number of students being enrolled, discipline mix, quality of teaching and R&D, etc., taken into account in the allocation of resources. As accreditation and industry restructuring become more advanced, university expansion will likely benefit from block funding being dependent upon the quality of services universities provide.

AFI is an interesting and unusual incentive that rewards quality, but it clearly has many unfavourable effects upon equity and market structure. Alternative mechanisms supporting quality without negatively affecting equity are used in many countries and could be considered by Chilean authorities.

Expanding R&D expenditure to the extent proposed by the National Council for Innovation for Competitiveness will have an important impact on university operations. New risk-sharing mechanisms between private firms and university R&D laboratories and institutes will need to be explored to encourage the private sector to participate more actively in export-oriented innovation activities.

Institution building and strategy co-ordination

Our enquiry shows the complex way in which economic and institutional forces have co-evolved in this transition from a state-regulated regime to a market-driven model of tertiary education. At no point did a 'master plan' exist indicating how the transition was to take place. Several forces came together to globally transform the industry. Some of the forces that supported the process of expansion in the 1990s seem to be waning, with the economy now expanding at a considerably slower pace than in the past and the university sector showing signs of fatigue.

The current innovation agenda is interventionist and proactive, spurring commercialisation in the private sector, and in funding and stimulating applied research in universities. New institutions and funds, new cooperative forms of interaction between the public and the private sector, different approaches to research financing and technology diffusion in the economy have been introduced. These may be oriented to commercialisation in specific markets and sectors, but also draw on horizontally expanding capacities in tertiary education and R&D activities.

This seems to be a time for reflection, design and collaboration. Natural- resource based production and export prospects remain good, assuming a gradual resumption of global economic growth. Further diversification of the production structure - that is, the opening up of new export-oriented sectors of economic activity - is needed if the country is to increase its rate of economic growth.

It seems likely that further government leadership will be required to encourage industry to move in this direction. Research-oriented universities should explore new mechanisms to integrate themselves into the long-term growth strategy recently proposed by the CNIC.

Chile wants to move to a phase of "technological deepening" in its production structure and of more public goods production and dissemination in areas such as health, environmental protection, energy, desertification and urban development. The creation of new technological and institutional capabilities should be a matter of state concern.

Adequate macroeconomic management is important, but it seems equally important to proceed with experimentation, learning and structural transformation at the micro and regional level, to create markets, institutions including tertiary education, domestic production and technological capabilities the country presently lacks.

* Jorge Katz is a professor of development economics in the faculty of economics at the University of Chile. Randy Spence is President of Economic and Social Development Affiliates in Toronto, Canada.

* This is a slightly shortened version based on Katz, J and Spence, R ("Chilean Universities in the Transition to a Market-driven Policy Regime," from OECD (2009) Higher Education Management and Policy, Vol 21, No2, 2009: www.oecd.org

* The article is reproduced with permission.


References

Allende, J et al (eds) (2008), Analisis y Proyecciones de la Ciencia Chilena 2005, Academia Chilena de Ciencias, Santiago de Chile.
Consejo Nacional de Acreditacion (CNAP) (2007), El modelo chileno de acreditacion de la educacion superior: CNAP 1999-2007, CNAP.
Heyl, V (2008), presentation, Comision Nacional de Investigacion Cientifica y Tecnologica (CONICYT), Santiago.