Still a Good Investment?
In recent months many pundits and scholars have repeatedly claimed that higher education's current economic model is unsustainable. Some have even analogized the economic landscape of higher education to the housing bubble that helped precipitate the recent Great Recession. According to these advocates, the increased availability of federally-subsidized guaranteed student loans has unduly enhanced the demand for higher education, increased tuition and made college less accessible. As evidence, these pundits, including Jeff Selingo at the Chronicle of Higher Education, point to high tuition --- sometimes over $40,000 per year at some institutions --- as well as large debt burdens borne by some graduates of American colleges and universities. Indeed, as Selingo and others have pointed out, Americans now hold nearly $1 trillion in student loan debt, an amount greater than the debt for car loans. Moreover, two scholars affiliated with the Mercatus Center, Antony Davies and James R. Harrigan, recently argued that "the Higher Education Bubble Will be Worse than the Housing Bubble," repeating similar arguments made in a previous essay. Even George Will has jumped on the "Higher Education Bubble" bandwagon, pointing out that "[t]uitions and fees have risen more than 440 percent in 30 years as schools happily raised prices — and lowered standards — to siphon up federal money." (See here). An Op-ed in today's San Diego Tribune, by Dan Bauder, joins this chorus, which also include Glenn Reynolds, and others (see here and here).
Thus far, efforts to analogize the economic condition of higher education to the housing bubble are not persuasive, for several related reasons.
First, pundits overstate the price of higher education and the impact of that price on access to college. True, many private universities, like the fictitious Faber college that John Blutarski (pictured above) attended, have sticker prices of $40,000 per year and above. (Though many also provide generous financial aid to needy students.) However, prices at public universities, which educate most of America's college graduates, are much lower. As previously explained on this blog, even the University of Virginia, an elite public university, charges tuition and fees of only $12,224 for Virginia residents. At William and Mary, another elite public university, the figure is $13,570. Tuition and fees at the University of North Carolina at Chapel Hill are lower than at either of these schools: a mere $7,008. (Of course, such students must also pay room and board, but individuals must incur these expenses whether or not they attend college. Thus, room and board is not an actual cost of attending college.) Moreover, these figures apply only to students who pay full price; many public universities offer generous financial aid packages, sometimes paying 100 percent of the cost of attendance, including even room and board. At UVA, for instance, students from families with incomes at 200 percent of the federal poverty line or less attend UVA for free, unless they have family assets of $75,000 of more. Given the federal definition of the poverty line, a student in a family of 7 that earned $70,000 per year would attend UVA for free; so would a student in a family of four that earned $46,000 per year. Students from familes whose income exceed the 200 percent of poverty threshold but still demonstrate financial need receive a mix of grants and loans and thus pay less than the sticker price. Most individuals who incur significant debt to attend private universities could have instead attended a public university and thus incurred significantly less debt or no debt at all.
Second, and as previously explained on this blog, higher education is an investment in human capital, an investment that can increase the economic productivity of students who incur such debt. Indeed, according to one recent study discussed here, individuals with a college degree earn an average of $2.27 million over their lifetimes, compared to just $1.30 million for individuals who simply complete high school. This million dollar gap between the lifetime earnings of college and high school graduates reflects the market's assessment of the value of higher education. This basic economic fact undermines any analogy between higher education, on the one hand, and houses and cars, on the other, the latter of which do not enhance the productivity of their owners. Moreover, the increase in lifetime earnings attributable to a college degree dwarfs the average debt --- $23,000 --- incurred by that subset of individuals who do borrow to finance a portion of their education. In short, a college education is a very good investment, one that society should encourage.
Third, those who invoke rising tuition as evidence of an unsustainable bubble financed by debt ignore the fact that tuition at public and some private universities pays only a portion of the full cost of the education provided. In the case of public universities, states still provide subsidies, albeit subsidies that are lower than they once were. Moreover, tuition at many public universities, while higher than it once was, is still a tremendous bargain, with UVA, William and Mary and UNC serving as prime examples. To be precise, these institutions charge tuition and fees that is about one third (or in UNC's case, one fifth) the price of attending private universities of similar caliber. (For instance, Boston College, ranked 31st in U.S. News, charges tuition and fees of $42,204, while Tufts, ranked 29th, charges $42,962). UVA, UNC and William and Mary rank 25th, 29th and 33rd, respectively.) It's no surprise, then, that, as previously explained on this blog, applications to schools like UVA and William and Mary continue to rise.
Fourth, these criticisms also treat previous tuition levels as a baseline for comparison, on the implicit assumption that such levels reflected a well-functioning market for higher education, a market subsequently distorted by widely-available and subsidized student loans. However, as Nobel Laureate Gary Becker has explained, and as previously explored on this blog, the market for higher education financing is characterized by a market failure. In particular, the background legal framework prevents individuals who invest in education from granting creditors a security interest in their most valuable asset, namely, the human capital that a college education creates. (A creditor cannot "foreclose" on an individual's college degree if the individual defaults on a student loan.)
Such a market failure will of course lead to under-investment in higher education and thus demand for such education that is lower than what a well-functioning market would produce. According to Becker, federal student loans overcome this market failure, thereby ensuring that investment in higher education better replicates that which a well-functioning market would produce. These additional investments would, of course, predictably manifest themselves as increased demand for higher education and higher tuition. In other words, while the ready availability of subsidized loans may well be responsible for rising tuition, that result may merely confirm that the federal loan program is counteracting a market failure and thereby assuring optimal investments in human capital. That's not a bubble; that's progress.
(It should be noted here that there is an additional reason that a purely private market would result in underinvestment in higher education. Simply put, because national and state governments levy taxes on incomes, individuals do not capture the full benefits of their investments in human capital. As a result, private investment in education will be less than optimal; direct state subsidies and student loans can help ensure the appropriate magnitude of investment.)
Fifth, $1 trillion is admittedly a lot of debt. But it is important to put this number in some perspective. This figure represents all the debt that students have accumulated over the years; the usual term on a federally-guaranteed student loan is 10 years, By contrast, the nation's annual GDP in 2011 was about $15 trillion, or $13.3 Trillion in 2005 dollars. Over the past ten years, GDP has totaled over $130 trillion in 2005 dollars. (Go to this website, which allows one to construct a GDP time series in real 2005 dollars.) Thus, student debt constitutes a tiny fraction of the nation's economic productivity during the period in which the debt was accumulated and will remain so even if GDP remains flat for the foreseeable future. Moreover, and as previously explained on this blog, one third of college students graduate with no debt whatsoever. For those students who do take on debt, the average indebtedness upon graduation is $23,000, less than the cost of many minivans. Finally, the median indebtedness of college graduates is even lower, just under $20,000 according to one source.
Sixth, there is no doubt that many recent graduates of America's colleges and universities are struggling to pay various debts, including student loans. Many apparently attribute this struggle to the cost of higher education and the resulting debt itself. However, there is a more fundamental explanation for this economic distress, namely, a struggling national economy. As previously explained on this blog, the current economic recovery compares quite unfavorably to the last recovery from a deep recession, in 1983-1984. College graduates can only reap the benefits of investments in human capital if good jobs await them once they earn their diploma. If the current recovery was creating jobs at the same rate as the 1983-84 recovery, resulting in more than 400,000 jobs per month (compared to less than 100,000 per month over the past few months), one suspects that concerns over the "student debt crisis" and "higher education bubble" would be muted.
Seventh, none of this is to say that higher education is perfect and above the need for the reform. For instance, college completion rates are too low at some institutions. Moreover, some contend that schools should focus more financial aid on students in the middle class. Others argue that professional schools are pricing themselves out of the market; this post has focused on undergraduate education. There is always room for improvement in any industry. However, proof that institutions could better allocate their existing resources does not establish the existence of an unsustainable bubble.
Fourth, these criticisms also treat previous tuition levels as a baseline for comparison, on the implicit assumption that such levels reflected a well-functioning market for higher education, a market subsequently distorted by widely-available and subsidized student loans. However, as Nobel Laureate Gary Becker has explained, and as previously explored on this blog, the market for higher education financing is characterized by a market failure. In particular, the background legal framework prevents individuals who invest in education from granting creditors a security interest in their most valuable asset, namely, the human capital that a college education creates. (A creditor cannot "foreclose" on an individual's college degree if the individual defaults on a student loan.)
Such a market failure will of course lead to under-investment in higher education and thus demand for such education that is lower than what a well-functioning market would produce. According to Becker, federal student loans overcome this market failure, thereby ensuring that investment in higher education better replicates that which a well-functioning market would produce. These additional investments would, of course, predictably manifest themselves as increased demand for higher education and higher tuition. In other words, while the ready availability of subsidized loans may well be responsible for rising tuition, that result may merely confirm that the federal loan program is counteracting a market failure and thereby assuring optimal investments in human capital. That's not a bubble; that's progress.
(It should be noted here that there is an additional reason that a purely private market would result in underinvestment in higher education. Simply put, because national and state governments levy taxes on incomes, individuals do not capture the full benefits of their investments in human capital. As a result, private investment in education will be less than optimal; direct state subsidies and student loans can help ensure the appropriate magnitude of investment.)
Fifth, $1 trillion is admittedly a lot of debt. But it is important to put this number in some perspective. This figure represents all the debt that students have accumulated over the years; the usual term on a federally-guaranteed student loan is 10 years, By contrast, the nation's annual GDP in 2011 was about $15 trillion, or $13.3 Trillion in 2005 dollars. Over the past ten years, GDP has totaled over $130 trillion in 2005 dollars. (Go to this website, which allows one to construct a GDP time series in real 2005 dollars.) Thus, student debt constitutes a tiny fraction of the nation's economic productivity during the period in which the debt was accumulated and will remain so even if GDP remains flat for the foreseeable future. Moreover, and as previously explained on this blog, one third of college students graduate with no debt whatsoever. For those students who do take on debt, the average indebtedness upon graduation is $23,000, less than the cost of many minivans. Finally, the median indebtedness of college graduates is even lower, just under $20,000 according to one source.
Sixth, there is no doubt that many recent graduates of America's colleges and universities are struggling to pay various debts, including student loans. Many apparently attribute this struggle to the cost of higher education and the resulting debt itself. However, there is a more fundamental explanation for this economic distress, namely, a struggling national economy. As previously explained on this blog, the current economic recovery compares quite unfavorably to the last recovery from a deep recession, in 1983-1984. College graduates can only reap the benefits of investments in human capital if good jobs await them once they earn their diploma. If the current recovery was creating jobs at the same rate as the 1983-84 recovery, resulting in more than 400,000 jobs per month (compared to less than 100,000 per month over the past few months), one suspects that concerns over the "student debt crisis" and "higher education bubble" would be muted.
Seventh, none of this is to say that higher education is perfect and above the need for the reform. For instance, college completion rates are too low at some institutions. Moreover, some contend that schools should focus more financial aid on students in the middle class. Others argue that professional schools are pricing themselves out of the market; this post has focused on undergraduate education. There is always room for improvement in any industry. However, proof that institutions could better allocate their existing resources does not establish the existence of an unsustainable bubble.
