In the last couple of years, there are more cries for universities to have more “skin in the game,” that is to say greater incentives to show improved performance. The distinguished banker and financial scholar Alex Pollock, now of the R Street Institute, has written frequently about this: he should have “Let’s have skin in the game” inscribed on his tombstone when he passes on.

The context in which “skin in the game” is most discussed is with regards to student loans. When students default on their loans, it imposes a cost on U.S. taxpayers. Many schools accept a large number of applicants that they know are extremely risky and unlikely to graduate. At some schools the six-year graduation rate is under one-third: there are at least two dropouts for every successful recipient of a bachelor’s degree. The admission and retention policy decisions of these schools ultimately impose a significant burden on taxpayers, as many of these dropouts simply do not repay their loans.

“Skin in the game” can work in various ways. Perhaps colleges could be made liable to repay at least part of the defaulted loan, maybe beyond a certain baseline expected default rate that arises from unanticipated adverse circumstances such as an accident or illness impeding an ability to work. A rule like this would impact most severely on schools with mediocre academic reputations, few endowment resources, and a high proportion of low-income, first-generation, and minority students.

Therefore a criticism of skin in the game is that it is inconsistent with the egalitarian view that higher education is a means to lessening economic and educational inequalities. But should the government be heavily subsidizing schools that fail to do what college should do–educate students well while helping them obtain productive remunerative employment? College dropouts are not only indebted but often perceived as failures. How is economic justice promoted by high numbers of college dropouts?

As stated in previous blogs, higher education needs more “creative destruction” to deal with the imbalance between high enrollments and the considerable but less robust needs of the American labor market. Skin in the game is one way of helping achieve needed downsizing.

The concept of “skin in the game” already applies to most students, who pay tuition fees and forego income-producing employment in order to attend school. The graduation rates are higher at private schools that on average are more expensive than at lower cost public schools. As a general proposition, where students have more skin in the game, they have greater incentives to graduate in a timely manner, four years instead of five or six years - or not at all. . One of the problems with free tuition proposals is that by largely removing skin in the game for students, they dull incentives to excel academically.

The use of skin in the game can go even further: to other members of the university community and even to whole institutions. As often is the case, Purdue University under President Mitch Daniels is leading the way. Purdue is investing in some of its own students through Income Share Agreements, previously discussed here. The school pays some or all the cost of attending Purdue in exchange for a share of post-graduate income. If students fare well after graduation, reflecting presumably skills taught at Purdue, the university benefits. Highly endowed private schools perhaps ought to devote at least a small portion of their endowment to similar programs.

In what is often regarded as the first great work in economics, Adam Smith noted that professors at Oxford University were more effective teachers when they had skin in the game. Students paid the professors fees –the more students a professor had, the greater his income. Today, by contrast, often professorial compensation has little correlation to clearly identifiable performance indicators.

A large portion of compensation of CEOs and other high-level employees in profit-seeking businesses comes in the form of bonuses, stock options and the like–employees clearly have skin in the game. We could do more of that in higher education as well, although admittedly it is difficult since the “bottom line” of universities is often difficult to define and measure. However, for higher education to become better, cheaper and more responsive to the needs of its customers and society, it needs sharpened incentives at all levels, that is more skin in the game.