Is Student Debt Too High?--BECKER

Some members of the new Congress are claiming that the debt of students to finance their college education is too high, and that more generous federally funded student grants should be available. Reforms of the college loan program are desirable, but when placed in a proper perspective, college students generally receive an excellent deal on their student loans. Over 60 per cent of students who finished in 2003-04 college or graduate studies with a Certificate or a Degree had taken out a loan. This percent was highest at 70 to 80 per cent for students who received a professional degree, was also high for students who attended for-profit colleges, while the percent was lowest for students who graduated from two-year public institutions. This difference by type of college is partly explained by the fact that the fraction taking loans is much larger for students from families with low incomes since poorer students are more likely to go to for-profit colleges. Even after adjusting for inflation, the average student loan increased by about 50% in the decade prior to 2004. The average size of the loan for those with loans was about $15,000 for graduates in 2003-04 with Bachelor's Degrees, it was much lower naturally for those who received certificates or degrees after two years of college, and was substantially higher for those with Masters and other post-graduate degrees. Perhaps surprisingly, the average loan did not vary much between for-profit, other private, and public colleges. Although the debt of graduating students is not a minor burden, it is not usually a major one either, if the size of loans is related to benefits from college as well as to financial and other costs. Costs measured by tuition did increase at a rapid rate since 1980. According to calculations by Pablo Pena at the University of Chicago, tuition at private non-profit four-year colleges rose 140 per cent in real terms from 1980 to 2005, which means an annual rate of increase of over 3.5 per cent. Public schools charge a lot less but they too had rather rapid increases in tuition. Students who are from poor families have the most trouble paying for college, and obviously that burden gets heavier when tuition is higher. This helps explain the increase over time in both the fraction of students who take out loans, and the size of the typical loan. On the other side of the ledger, higher tuition over time was related to sharply higher financial benefits from a college education. The typical college graduate earned per hour about 50 per cent more than the typical high school graduate in 1980, and the gap is now about 95 per cent. Earnings of graduates with a professional degree or other post-graduate education grew even faster over time than did earnings of college graduates. The net benefits from graduating from college are determined by the higher earnings college graduates would receive over their lifetime compared to what they would receive if they started working after high school, minus tuition and any other costs of a college education. The data I have just given show that the increase in the earning advantage from a college education during the past couple of decades was far greater than the increase in tuition, so that average rates of return on a college education--a measure of the net benefit--increased greatly. In addition, various non-monetary benefits of a college education also grew over time. Probably the two most important of these benefits are that higher education increases health through the improvements it induces in lifestyles and medical care, and higher education also improves investments in the learning and behavior of one’s children. How big a burden is the average loan for college graduates who take loans, which is about $15,000 to $20,000? The net present value of the earnings of typical graduates of four-year colleges over their lifetimes after discounting future earnings and subtracting out tuition and other costs has been shown to be over $300,000 more than what high school graduates earn. Even a $20,000 student loan debt is small relative to such a large benefit. Put differently, if the only way to go to college would be to borrow $20,000 under a student loan program at the prevailing 7 per cent interest rate on these loans, the returns from college to a typical graduate would be big enough to allow the borrower to pay off the loan and have a lot left over. Of course, such loans would be a much greater burden for students who only received two years of college, perhaps because they dropped out of a four-year program, or because they received an Associate Degree. Such students do not earn nearly as much as graduates of four-year colleges. However, the burden of a fixed amount borrowed is not the right comparison since as I indicated, graduates of two year programs borrow much less than do graduates of four-year programs. In reality, the burden of what graduates of two year programs typically borrow is not much greater compared to their discounted earnings than the rather minor burden of the actual loans taken by graduates of four-year colleges. Within any category of graduates, earnings vary considerably by type of job-- teachers and clergymen earn a lot less than investment bankers--and by degree of success within jobs. Fixed interest loans are not the best way to borrow when loans are used for risky activities. Returns on higher education are rather risky, even after adjusting for how they co-vary with returns on assets. Businesses often borrow with the equivalent of equity to finance start-ups and other risky activities, where the equity pays off well if the venture is successful, and pays little if the venture fails. This suggests that student loans should not have fixed interest rates that require a fixed amount to be repaid per $1.000 borrowed, but rather should have the equivalent of an "equity" repayment system. That would mean that persons who earn very little repay little, while those who earn a lot repay a lot (per $1,000 borrowed). Requiring individuals who are repaying student loans to submit their income tax statements each year, so that lenders could document what the borrowers earned, could enforce such an income-contingent repayment system. The United States already has a small student loan program that allows repayments to be conditional on the incomes of borrowers. But a system with both fixed interest loans and income-contingent loans has a "moral hazard" problem. Students who expect to go into well-paying jobs would tend to borrow at fixed interest rates since that would be cheaper to them than repayments that rise with higher earning. A possible reform of the federal program that would reduce this moral hazard would be to shift entirely to an income-contingent system, where persons with student loans who earn little would repay relatively little, and those who earn a lot would repay much more. A full income-contingent loan program would not be without its own problems since it would attract students who expect to go into low- paying occupations, and repel students who expect to higher earnings. In addition, such a program would "tax" high earnings that would further discourage effort by high earners, and further encourage them to try to hide incomes. But it might work better than either the present largely fixed interest system, or a dual system that allowed both fixed interest loans and income-contingent loans, with the choice among these systems determined by students.

Comments

[dWj]

What you identify as a "moral hazard" problem is better labeled an "adverse selection" problem; insurance companies typically use basic demographics to charge different rates of different people, partially mitigating the problem, and I imagine allowing them to price different majors differently would allow a decent chunk of that problem to go away. There is, of course, a moral hazard problem as well, where students decide after the fact to pursue activities that are rewarding primarily in non-pecuniary ways because they face what amounts to an incremental income tax; this might require that such loans be kept to a smallish portion of the expected NPV of earnings over the repayment period.

As for the $300,000 figure, it raises the old debate as to how much of acquiring a degree is educational and how much is simply signalling; if the present value of the earnings of the average high school graduate with no college is $300,000 less than that of the average college graduate, presumably the actual value to the average individual is less than that -- the typical college graduate, had he not gone to college, might still have possessed the attributes that would have allowed him to earn more than the average person who didn't go to college.

On the whole, though, I agree with your stance -- it seems reasonable that students incur some debt in the building of their own human capital, or in any case is no great travesty.

(I borrowed money to attend the University of Chicago, and it was certainly worth it, whether financially or not.)

[igoldc]

thank you! very usefull things! you are nice!*_*

[Micah]

You are right, dWj. A few years ago, Prof. Andy Abbott reported in his "Aims of Education" address that, according to his research, being admitted to the University of Chicago is just as income-enhancing as taking the A.B. His point was that if you only wanted the money, you could drop out now, but if you wanted the life of the mind, you were going to have to go to class and participate in the life of the University. Nobody walked out.

[spencer]

What is the source for the statement that low income students are more likely to attend private schools.

Are you comparing apples to apples and/or comparing trade schools with 4 year degree school?

[N.E.Hatfield]

Anyone hear of the old "GI Bill" that created the first real mass enrollment in higher education. The military is in short supply of manpower right now. At least the ones that avail themselves of the oppurtunity have an education paid for and as far as I have seen, are more disciplined and know what they want and need to study. Perhaps this is the route and not the "Loans Game".

[nick]

The increase in financial benefits you attribute to college degrees could be the result of other factors. I would argue that some mixture of smart, hardworking, and rich people attend college. It is not surprising that people with these qualities eventually earn above average incomes. Conversely, no one would be surprised to learn that dumb, lazy, and poor people earn below average incomes. The divergence of incomes for these groups is based upon macroeconomic conditions which would apply regardless of degree status.

You say people become smart at college. I say smart people go to college.

The price of school is too high. University employees are being overpaid at the expense of students. My guess is most university professors would choose to stay in their current positions if, across the board, salaries for these positions were cut 10-20%.

The system of incentives that forces school boards and administrators to overspend needs to be examined. Realizing there is a problem is the first step to solving it.

[Loonie]

I am not convinced that raising the minimum wage will do anything for graduating students.
Learning to budget and save will do more for them.

[jehnidiah]

Don't forget that when taking into consideration how much college costs, you should not leave out the opportunity costs of having a job during those four years (or however many). At 25k a year, that adds another 100k lost for attending college.

[Anonymous]

"Students who expect to go into well-paying jobs would tend to borrow at fixed interest rates since that would be cheaper to them than repayments that rise with higher earning."

How is this a problem? The fixed rate would represent the 'cap' on the floating rate.

The larger problems is when the courses taken at university have nothing to do with a high income position taken after graduating.

Is the state going to charge me a high interest rate simply because I could not get a position as an engineer (degree field) and went back to programming? Is that really fair?

Again, the cap 'equalizes' this. Nobody should be paying more than about 10% interest on a student loan, regardless of income.

[Anonymous]

Some leftists criticize that "marketization" of education will make university merely a machine producing skilled labor to the business sector and undermine university education as a device promoting independent thinking.

Moreover, if students have to take lots of loans to have education, they will just care about marketable skills, rather than developing their soul and thinking.

[Daniel Lukeq]

Another moronic argument by the judge. As long as you accept that post-secondary education should, at its core, be the privilege of the elite, there's nothing wrong with the idea of requiring most students to become indebted to finance their education. But why not advocate the idea of free post-secondary education? That's what most other advanced Western democracies have done. Look at the level of education in America as compared to the rest of the developed world. Of course, the system we have in America has the effect of reinforcing the class system which obviously suits the patrician judge just fine.

[Dawnson]

In China, the loans to student are often called policy loans and many students,especially from poor district,can't get loans to go to college.But why the loans can't be implement by commercial ways?Because in China the trust system hasn't enacted.Most students go to work far away from their colleges and it takes a lot of cost to claim or suit for colleges .So I think the experience of your country can give us many stimulates.

[Jack]

Breaking news! Senator Kennedy is working on a bill that will facilitate loans coming directly from the colleges. With a Fanny Mae sort of government guarantee and with many colleges having land bank assets or balance sheets second only to the Pope's or Walmart's? the loans could be just a just a points or two above inflation.

Poor bankers losing the biz? Well they've still got the credit card schemes, fee income, now insurance, and I suppose can help guys like KKR round up the funds to take outfits like Home Depot private.

[Ben]

I think the market has broken down in several ways,

1) Cost has little to do with the quality of the school, Harvard does not cost much more than the average private school

2) The government determines how much a student should pay, and then provides financial aid for the rest.

3) School collude on their private financial aid offers to students.

4) The cost of school depends on supply and demand. School capacity is elastic, but much of the elasticity come from a reduction in quality (more TA's, larger classes) and by inflating the demand with cheap loans it takes away the school's incentive to lower costs.

Bascially schools act like monopolies...

[Ben]

I don't understand the equity argument. I think its pretty clear which majors will pay big dividends and which ones won't. Whats to stop the high paying majors from taking personal non-governmental loans? Doesn't this really bound the amount the high paying majors can subsidize the low paying majors. And whats to guarantee the system is self sufficient?

Equity works with business's because its difficult (impossible) to predict the winners in any meaningful sense.

[lc]

Free Education doesn't exist. It is just a question of how you pay for it.

In Western Europe, students are not forced to pay the full fees to cover tuition and taxes are levied on the population to cover the shortfall. But you still have to pay the fees it is just a question of when you do it, do you do it when you go to college or do you do it when you are working after college.

The US has the highest average education attainment in the world.

http://www.nationmaster.com/graph/edu_ave_yea_of_sch_of_adu-education-average-years-schooling-adults

As for which majors will eventually pay big dividends, I don't think you can predict that. I know lots of English and philosophy majors who went on to being investment bankers, consultants, etc...who have very large incomes. The volatility of income is higher, but if as an investors you are getting a little piece of lots of people it might still be quite attractive to buy 2% of the future income of all Harvard English majors. I would bet at least a few of them go on to careers making very high incomes.

[Joel Pinheiro]

State-financed student loans raise a host of problems. How much to charge for them? What to do about those students who cannot afford to pay them back? How much of State budget should be directed to such subsidies of people's education? How much financing would be the "socially optimum"?

These problems are all insoluble. It is impossible to arrive at "correct" responses from the framework of governmental action.

Suppose 1000 dollars are taxed (that is, taken by force) from someone in order to finance the education of a young and bright college graduate.
Now, most people recognize the blatant injustice of this transaction: why should one, having done nothing wrong, be forced to pay for the education of someone else?

However, it is impossible to deny that education brings with itself many positive externalities. An educated man improves the life of all those around him, and is less of a burden to all. However, how are we to compare these with the alternative uses of the resources? Afterall, if the person had kept his 1000 dollars to himself, he would have spent them in many different ways, each of them possessing its own externalities.

Furthermore, suppose that the people of my street think it would bring a huge benefit to our neighbourhood if I were to pursue post-graduate studies in Harvard.
But going to Harvard is very expensive, as far as I know.
If my neighbours think that the benefits, the externalities, that my Harvard doctorate would bring them surpass the costs of sending me there, they can easily agree on their own accord to raise the money, each donating a part, and by doing this they will all win.
If however, my neighbours have not done so, and when presented with the idea of paying for my further education feel no urge to raise the money, then this is a pretty good indication that, on my neighbours' own estimation, the positive externalities of my Harvard doctorate do not surpass the costs of tuition.

Of course, this is a very particular example, but the reasoning behind it can be applied to other degrees of education and to other geographical locations.

By taking people's money by coercion away from them and using to pay students to attend expensive colleges is a very bad use of scarce resources. Unsurprisingly, its economic results are disastrous: an inordinate amount of money is spent on college degrees, many of which bring little if any benefit to anyone (including the student) while at the same time the real needs and desires of each person are neglected.

The optimal amount of State-financing for higher education is 0.

Prof. Becker suggests a new method of financing (with problems of its own, as he acknowledges), and Judge Posner suggests that the level of subsidies be not allowed to grow. Both are valid and good suggestions, but they fail to deal with the root of the problem of this State program: its very existence.

[Jack]

Joel! Analytical method? 9.2 Conclusion? Considerably lower!

Currently the largest amount "taken from us by force?" is a military budget that is not only larger than that of all of our "enemies" combined, but ALL countries combined.

The second largest chunk is that of the interest on our burgeoning D E B T (not counting ANYthing for principal) being paid to our creditor nations, apparently due to the actions of the "me-generation" who like to spend but not to pay their debts.

I wonder if you could run these priorities through your program too?

Also, just to check your philosophical basis, I wonder if you'd favor selling off NY's Central Park to elevate it to it's "highest and best use" for luxury condos and upscale shopping centers? What do your neighbors think about paying the costs of national parks?

BTW most student loans are used not for "expensive colleges" but simply "colleges".

[Vadim I.]

thelastpsychiatrist wrote:

"..then there would be an increase in earning power with every year of college completed short of graduation. In other words, 3rd year dropouts should earn more than 2nd year dropouts. But they don't."

Looking at drop-outs is misleading. Being a drop-out sends a negative signal that the student doesn't have a certain mixture of characteristics that are useful for work (patience, intelligence, dedication, perseverance etc). It should not matter a lot at what stage the student "shows" this lack of skills just like it shouldn't matter if a felon was convicted a year ago or two years ago [not that drop-outs are felons by any means but both are examples of negative signals for employers to act on]. To the extent that the third-year drop out acquired more skills and lasted longer than a one-year drop out, there could still be some small difference but it might be overshadowed by the identical "bad signal" factor.

However, it makes sense more sense to look at co-op or summer earnings of students in Nth year.

Some evidence like (Google shows others):
http://www.kettering.edu/employers/co-op/docs/Wage_And_Benefit_Survey.pdf

shows that incremental earnings during 4-year college increase over time even before getting a degree.

[Joel Pinheiro]

Aggressive wars are an even worse use of resources than State-financed education.
That does not make the latter any less harmful, though.

[Half Sigma]

Not everyone who graduates college gets a job such that the education was worth the investment. And education is statistically bad deal for people who don't get their degree.

The availability of loans only allows colleges to raise tuitions even higher. Without student loans, colleges would be forced to find some way to make education more affordable.

[Mark B.]

The real question should be: Are faculty salaries too high?

[Half Sigma]

"The real question should be: Are faculty salaries too high?"

Too high for faculty who spend 45 hours per week teaching students? Or too high considering that they teach two classes (6 hours) and spend the rest of their time doing stuff that has nothing to do with educating students.

[Jack]

Joel:

Aggressive wars are an even worse use of resources than State-financed education.

.......hmmm would that include K-12? And a belief that "the market" as Posner seems to believe will result in our having the optimum number of college grads or tech trained people to "compete" with India, China and others? Posner does a fine job of giving us a glimpse into a well furnished living room as a middle clase family cooly weighs the options for their kid maximising income, but admittedly leaves the "messy" human stuff of doing very worthy jobs but which don't pay worthy salaries.... to others. Perhaps government intervention on a case by case??

Here's a real worlder for you: The current crop of teachers are largely women who when they entered teaching school had few other options (Some will recall Sandra Day O'conner not being offerred a job in law after graduating Stanford with honors?) and those "boomers" are retiring in droves right now. Today women, as men have many other options, and taxpayers are VERY reluctant to raise teacher pay. Real word question: Do we trust that "the market" will send a signal, in time? that taxpayers will pony up the needed funds to attract young teachers? Or, should we take a peek to see if the system is providing the number of teachers required (fairly simple math) and make it a bit easier if there is a shortfall?

The real question should be: Are faculty salaries too high?

..... hmmm good question and the corollary may be "are college students and their parents rational?" if the answer is yes, I assume that having to pay tuition with real family dollars or loans should reward the efficient school whose education is a "good buy" with more students and keep a brake on salaries?

Jack

[Half Sigma]

"hmmm good question and the corollary may be "are college students and their parents rational?" if the answer is yes, I assume that having to pay tuition with real family dollars or loans should reward the efficient school whose education is a "good buy" with more students and keep a brake on salaries?"

Actually, it's rational for consumers of college education to have a very low price elasticity of demand, because the rewards of attending the prestigious college for outweigh the additional costs.

It's rational for consumers to care only about the prestige of the institution rather than the quality of education. Better to spend $200,000 for lousy education at Harvard than to get a free education at some no-name school even if the no-name school might actually have better quality education.