Will Student Debt Cloud Millennials’ Economic Outlook?

While the United States has witnessed a slow but steady economic recovery since the recession’s end in 2009, a few dark clouds continue to cast a shadow on growth. One of those clouds is the burden of student loan debt.

Debt from student loans among Americans totals nearly $1.2 trillion as of the first quarter of 2015, according to the Household Debt and Credit Report prepared by the Federal Reserve Bank of New York. That total has tripled since 2004.

Student loan burdens may be particularly troubling for the Millennial generation (those born between roughly 1980 and 2000), who carry a substantial portion of that debt — and since many of them entered the workforce during a time of economic slowdown, that means they may be less prepared to pay down what they owe.

That’s according to a recent research report, “Millennials and the U.S. Economy: The Kids Are All Right (Or Soon Will Be),” which examines how younger consumers are faring in today’s economy. The report, prepared by senior economist Beth Ann Bovino of Standard & Poor’s (S&P), finds both potential good news and bad news in the outlook for members of the Millennial generation.

On the bright side….

The good news: the Millennial generation is “the most diverse and educated generation in American history” — more than 60% have attended college, a significantly higher proportion than among older generations.

According to Bovino’s forecasts, it’s likely that the slow start many Millennials have experienced in their careers is an unfortunate hangover of the fact that many were just entering the workforce when the recession struck. Their earnings are likely to pick up as the economy gains steam.

That means that while Millennials have been slower than earlier generations to get married and start raising families, they’ll soon make up for lost time and enjoy better job opportunities, higher wages and start investing in homes and other big ticket items.

The darker timeline….

But the S&P study also explores a “downside scenario” that could take place if the economy remains stagnant. In that scenario, wage growth would be slow to catch on, and since Millennials have higher student debt burdens (the study notes that they carry about 60% of the $1.2 trillion total), they would be forced to cut back on spending in other areas.

That downside dynamic could have serious implications for the larger economy. As Millennials see their budgets pinched by high student debt, they may be less likely to make significant capital purchases like homes and cars, and they’ll delay settling down and starting families. That cramped spending among younger consumers could reduce U.S. GDP growth by $49 billion per year in the next five years, the report notes.

Jason Gold, director of global government and public policy for McGraw Hill Financial, explains the effects in more detail in a recent piece for U.S. News and World Report.

“While the absolute numbers are staggering, the concern around student debt should not be systemic default, but the mighty flow of untapped economic potential among young borrowers it is delaying or diminishing,” Gold writes. “Millennials are forced to allocate less income towards housing, autos and the general consumption that drives our economy, with heavy debt blocking their path to prosperity, despite an impressive academic resume.

“Practical job opportunities and workplace experience are elusive,” Gold continues. “Millennials are forced to live at home with their parents for longer, to accept less pay for a job, and work fewer hours in many cases all while being educated at high levels and carrying the debt burden of that education.”

A separate study published in 2014 by the Federal Reserve Bank of Philadelphia adds an additional wrinkle to the discussion: heavy student debt loads may have a negative effect on small business launches.

In that study, researchers combed through Census data and consumer credit statistics and found a correlation between lower rates of small business start-ups and high levels of student loan debt. That finding suggests that student debt could have a negative impact on entrepreneurship if individuals are unable to take on the risk of additional debt to start a small business.

“We need to be concerned about the long-run economic effects of greater student debt,” one of the Philadelphia study’s co-authors, Brent Ambrose of the Smeal College of Business at Pennsylvania State University, tells the Wall Street Journal.

Would more competition help?

Would greater competition help to bring down the cost of student loan debt? It’s possible.

The U.S. student loan market has traditionally been a hybrid of federal loans (administered through the U.S. Federal Student Loan Program) and private loan offerings. But in recent years federal offerings have grown to command a larger share of the market — in 2011–2012, only about 7% of student loan volume was from private sources, according to a 2014 Brookings Institution study — and many financial institutions have gotten out of the student loan business, citing the difficulty of competing with government loan programs.

That dynamic suggests the market could be ripe for innovation, as new players seek ways to provide competitive lower cost loans. And more competition would almost certainly be to the benefit of borrowers.

Individuals can benefits despite macro risks

Of course, not all debt is bad. We’ve written before about the virtues of consumer credit, and how it can be used responsibly as part of an overall financial management plan to help consumers achieve their goals.

And it’s important to recognize that student loans can be a net positive for many people, since a college education can set them up for improved job prospects and earning potential. A 2014 report from the Federal Reserve Bank of New York, for example, emphasizes that higher education is a “worthwhile investment” for many individuals since it can lead to a career-spanning “college premium” in earnings.

The S&P study, despite its exploration of the potential downside scenario, does end on a hopeful note:

“In the end, while the burden of student debt will eat into the purchasing power of many young Americans for some time, we expect the continuing recovery in the U.S. economy to afford this generation the eventual opportunity to transition into the traditional definition of full adulthood — and in a virtuous circle, begin to buy the houses, cars and other big-ticket items that will further stimulate economic growth.”

A college education is still, for most people, worth the cost (and it’s a good idea for parents to look at tax-advantaged savings vehicles, like 529 accounts, to invest for their kids’ education and ease the debt burden). But the possible downsides of excessive student loan debt should stand as a warning to aspiring students — and a reminder that all debt must be approached wisely and responsibly.