Educated and Poor
The federal government should either stop investing in higher education or drastically change the way it does
Over 21 million wishful undergraduates are going to join college this year, hoping to hit a pot of gold (ie a job) at the end of their 4 year siesta.
After the Great Recession of 2008-10 there has been a lot of clamoring about the reliability of college as an indicator for future success, and overall worthiness of a college degree. In 2008-09, I spent a year looking at the college funding problem right when the subprime crisis hit as part of my graduate thesis, and wanted to go back and look at the problems again.
This analysis might not have the statistical rigor that the topic requires, but it does try to paint a narrative through publicly available data: that colleges and universities, especially non-elite ones, are robbing college-goers of a decent education. And this problem is perpetuated by governmental involvement in higher ed. It is the only important industry in the United States that has been increasingly socialized in recent decades.
This analysis serves a primer for people who are not well-versed on the topic as well as some of my own thoughts.In educational policy circles, this is called the Bennett Hypothesis: the theory that federal financial aid subsidies do enable colleges to raise their tuitions, a theory championed by former U.S. Secretary of Education William J. Bennett.
Why does the government subsidize higher ed?
On average, a typical high school student who graduates and goes on to college, will attain higher employment and earnings, 50-100% higher, and be less likely to end up in the criminal justice system, which also confers a cost to you and me ( i.e. the taxpayer).The graduate will also be able to contribute to the economy through payment of taxes and increase the overall productivity level.
- For every dollar invested by the government into education, the ROI (return) on it is calculated at $1.45 to $3.55, hardly a bad investment from a financial standpoint.
- Estimating on these variables, brings about a net benefit of $127,000 to the taxpayer over the non-dropout students lifetime.
- Each year on average 1.3 million kids dropout of school. If the US manages to decrease the dropout rate by 50% only, then the aggregate benefit to the public is nearly $90 billion/yr — or close to a trillion dollars after 11 years.
To put these figures into perspective,
- Apple is worth is around $450 Billion
- The market capitalization of all the companies on the New York Stock Exchange is a little over $16 trillion.
- The current US budget deficit is $973 billion
Apart from the often cited public good, the government provides cheap loans for individuals to go to schools to increase their earning potential and subsequently, it’s own tax reciepts.
Why do people go to college?
A college educated, bagpack slinging individual seems to be a good deal for the US government to invest in. However, just as important are individual motivations towards higher education: why an 18 year old would want to lock himself up in self-imposed exile for 4 years, toiling at the behest of a professor, without any meaningful form of income? More succinctly, is college education a good investment for the individual just as it is for the country?
So does it make sense to go to college. Given that there is a cost incurred (lost income and time) to an individual, the question for individual motivations is highly relevant; and can be explained by the increase in Net lifetime earnings.
Lets look at the stats shall we?
- Tuition and fees have increased drastically since 1980, for both 4-year private colleges/universities and 2-year private/public colleges/universities. The increase is about 120-130% in real terms.
- This increase in tuition is tempered by the general increase in college scholarships (esp at private schools); so the net increase is slightly less
- College costs are made up of tuition and foregone earnings from working right out of high school. In real terms, earnings of high school graduates have remained flat, therefore the overall increase in college costs remains near 50% since 1980
- The difference between financial gains of a high school graduate and a college graduate have almost doubled. In 1980s, the difference between their earnings was about 40%. Today, the difference is about 70% . There are other gains such as avoidance of criminal justice system etc. that are not taken into account.
- The unemployment rate for high school graduates is twice that of college graduates. For college grads, the rate grew from about 2% in 2008 to just under 4% at the end of 2012. For high school graduates, it grew from 5% in 2008 to over 10% in 2010, and fell back to 8.3% by end of 2012.
There is a sizable earnings gain and a lower unemployment rate, for people who go to college after taking into account how college costs have grown over the years. It is often said—particularly in support of public subsidies—that higher education is a public good that benefits society as a whole. This seems a difficult conclusion to support, however. The overwhelming bulk of the returns to an education surely accrue to the individual who receives it, whether we look at its consumption good aspects (such as learning for its own pleasures, socializing, or playing sports) or its production-good aspects (such as acquiring skills and contacts that will increase one’s expected earning power).
Is college overpriced?
We are constantly barraged by shocking headlines of how expensive college is and how student loans are crippling our future workforce, by burdening them with unpayable amounts of debt, and not producing the quality of students that our economy needs. Peter Thiel has been quite vociferous on this, noting that:
In any market, if things are overpriced, demand should simply shift to reflect the current reality, and supply would adjust accordingly. However, data shows that enrollment is increasing just as much as the college costs are increasing. So it seems that even though college is getting more expensive, people are readily buying the product it sells. However, that has a lot to do with how the system is setup to fund education rather than intrinsic demand (more on that below)
Rising costs
The main drivers for increases in attendance costs are direct government intervention in the market AND the rapidly rising Tuition and fees that colleges charge:
The overall rise in costs, can be attributed to colleges, which have kept on increasing costs of attendance despite their being little financial reasoning to do so. The increase in the cost of going to college does seem to have much to do with the government providing ‘cheap’ money to borrowers.
A Closer look at College funding
As Becker points out:
The main problem in the college bubble debate is the way the system is setup to finance education. You can have the dream, its achieveable, and here is a loan to help you out. An overwhelming majority of higher ed is financed by government-subsidized loans, and the government always has an incentive to give out more loans to make sure that more people continue to make college a priority (as I detailed above)
A lot of people smarter than me have wrote scathing critiques of the system, detailing in the process how the college bubble mirrors the real estate one: government subsidies towards educational loans, keeps rates at an artificially low level, lowering barriers to entry and flooding the market with ‘cheap’ money. The government continues to push rates to artificially low levels leading to a higher-than-normal level of demand.
The colleges and universities are responding to this ‘cheap’ money by making record level of investments in amenities,instruction and administration in order to attract and manage more students. Since no one is really pressuring them to keep these costs low, the universities continue to make these investments.Education and related expenses showed the smallest amount of increase when compared with all other expenditures made by colleges and universities.
Can this rise be attributed to bloated salary packages for educators? Here are some trends in faculty compensation which clearly show that the rise in tuition and fees is not mainly due to increase in wages of professors and other educators
However, there is a clear rise in employment of “other professionals” which include human resources specialists, accountants and auditors, computer specialists, counselors, librarians, and coaches. Most likely, the highest paid public school employee is the football coach!
So most of the rise in tuition and fees is not being put towards attracting a better faculty, but rather wages to compensate people in support and glamor functions. This is a really bizarre trend since colleges do not seem keen on improving their actual product (education) they sell, and have no incentive to do so.
Consequences
Essentially, the government, by way of student loans, is giving out cheap money to universities to fund their administrative and development costs. Money here is essentially exchanging hands from the federal government to the colleges and universities in the form of student loans, which are in turn used to pay for massive expenditure increases not related to actual education. Universities are in turn spend on building facilities and employing people, all extraneous functions which come at the cost of providing a better education.
By subsidizing college education for students, the federal government is effectively subsidizing the cost of borrowing for colleges and universities
The federal government keeps making these loans due to self-interest, knowing that a more educated populace brings in more taxable income than a less educated one. Even though politicians talk about HigherEd as a public good, and the President’s speeches on education have major populist overtones, the fact remains that a paternalistic government has devised an educational financing system to maximize its own gain (there are more ways that the government benefits from providing cheap loans but for purpose of this analysis lets keep it to the relevant one above).
Since only 1/3rd of the US population has a college degree, coupled with artificially low lending rates, the net positive returns from a college education will continue to encourage healthy demand . Given that the median US household has experienced wage stagnation, there are more individuals that desire (and need) a college education in order to climb the wage ladder. On the supply side, the US higher educational system is tapping into this need for increased wages, and the government’s unkempt exuberance towards education, by playing the system for its own means. Since most of the expenditure is not towards graduating better students and helping them succeed, there is a pretty big societal opportunity cost: US colleges on average will continue to graduate students who are ill-equipped to handle the changing job market because that is not what they focus on. Until there are checks and balances in place on how universities spend these funds, the status quo of bad education will be maintained. Half of the students will dropout before completion anyways, deeming the cost/loan impediment to be too burdensome.
The system seems to be perpetuating its own self-destruction. Colleges will continue to increase costs; and the federal government will continue to subsidize them: in the end the people who want to get educated will suffer by being burdened by loans for a product that over promises and under delivers.
The level of student debt in the US has reached $1 trillion , increasing at at rate of over 10% per year.
The total US debt is around $17 trillion.
Shades of the mortgage crisis
This is a quote by Alan Greenspan in relation to the sub-prime mortgage crisis. I think it can very well be used to illustrate what is happening in the education loan market since 2010. By cheapening the cost of borrowing due to a misguided conception of greater good, the federal government (the supplier) is providing loans to people (the borrowers) who cannot afford to to pay them back since they will be ill-equipped to find jobs that allow them to do so.
In 2010, due to a failure of banks to lend to students in wake of the sub-prime crisis, the US government decided to step in and fill in the gap. In my masters thesis in 2009, I had argued that this was the only possible course of action, as bank lending was dependent on securitization of student loans, which was not possible given the recessionary climate of 2008. That is exactly what happened, and is the reason for the uptick in new student loans in 2010 in the graphic above.Had I know better.
Macroeconomic considerations
As student loan indebtedness increases, it has the effect of decreasing future consumption. Evidence from the New York Federal Reserve suggests that students who graduate with high levels of debt typically defer major purchases such as cars and homes. As a result, US macroeconomic growth “could” slow. At the very least, student loans will dampen recoveries in the housing and auto markets. If this trend persists, in the long run, changes in consumer behavior may create some sort of structural change in these markets as well.
The most troubling part of this whole thing is the large increase in default rates
Students are being duped into borrowing larger amounts to fund the expenditures of colleges, taking on debt that is getting harder to repay which will inevitably have a sizable macroeconomic effect on their future economic decisions and productivity. The worse part about it seems to be that we are stuck in a vicious cycle and there seems to be no easy way out.
Broader economic consideration taken into account, the system is ill-construed and does not incentivize the colleges to provide education.
Current Developments
The economist reports that:
This hardly seems like the right thing to do. It is easy to game such rankings by graduating higher number of students through grade inflation. Again the focus does not seem to be on how well the students are getting educated, or on a thorough evaluation of teaching methods; rather the government continues to utilize perfunctory variables to evaluate colleges.
It seems like the government is moving towards more regulation and entanglement in the Higher ed financing market. It is quite ludicrous that the government intervenes in the market to regulate a problem that was originally created by government intervention.
A lot people will say that MOOC’s (such as Coursera and Udacity) are the solutions; or at least some combination of MOOC and brick and mortar colleges. This post already been too long to analyze that as a solution. However, it’s hard to look towards MOOC’s (which essentially decrease costs) towards a solution, when the actual problem is the avoidable and undue increase in college price. It would probably lead to professors getting fired (already happening) which I don’t think is the right solution, since they were never part of the problem.
Notes
In the research paper “Does Federal Student Aid Raise Tuition? New Evidence on For-Profit Colleges”, the authors comprehensively argue that:
This means that Higher education institutions that receive money from the federal government though loans, are consistently more expensive and most of this money goes towards administrative excess. Anyone interested in a more thorough statistical analysis should read the aforementioned paper.
Sources
Stats:
http://trends.collegeboard.org/
http://nces.ed.gov/programs/digest/d11/tables_1.asp#Ch1Sub7
Articles and Papers
Building the stock of college-education labor
Does Federal Studetn Aid Raise Tutition? New Evidence of For_profit Colleges
The True Cost of High School Dropouts
Economic Value of Opportunity Youth
On the Future of Our Educational Institutions
The Rise in College Tuition and Student Loans
