Monday, July 16, 2012

Making Higher Education Affordable?

Recently President Obama brought the discussion of the rising cost of a college education to the forefront of national debate. His concern is valid, because the cost of a college education has risen approximately four times faster than inflation and student loan debt now tops $1 trillion, surpassing total credit card debt. And default rates have also risen to record levels, leading some economists to believe that the student loan market constitute another unsustainable credit bubble. But, his solution of increasing government subsidies to "make college more affordable" ignores and even exacerbates the very causes of the the unprecedented surge in the cost of higher education.

First, we must acknowledge that student loans are primarily a subsidy to the university-industrial complex. The university enjoys all of the benefits, but bears none of the risk associated with student loans. If a student defaults, they along with tax payers bear the costs. This has provided incentives for universities to encourage under-qualified students to enroll, with little concern for the economic viability of their course of study and for their capacity to pay back their student loans. The parallels between the surge in mortgage debt that preceded the collapse of the housing market and the rise of student loan debt are many. Banks readily issued so many risky mortgages, only because they were able to bundle and sell them off to third parties, such as Fannie Mae. And universities thoughtlessly facilitated the increase in risky student debt, because third parties would bear the cost. In both cases, seemingly endless credit and government initiatives encouraged lenders and borrowers alike to loosen standards. This partially explains why only 59% of students enrolled in four year programs complete them within 6 years. For African-Americans the figures are even more concerning; only 40% graduate. We can assume that if college administrators had to share at least some of the costs associate with loan defaults they would be more conscientious about allowing students to undertake risky educational and financial decisions. This is especially true in the context of credential inflation and wage stagnation, which has led to diminishing returns for investments in bachelor's degrees with the exception of degrees in high demand fields, such as medicine, mathematics, engineering, etc. 

Second, divorcing the disbursement of student loans from sound economic logic has proven to be costly for students and tax payers alike. A French Literature major with terrible credit is just as able as a medical student with excellent credit to amass $100,000 in debt, even though the risk that the former will default is far greater. At a quick glance the egalitarian idea of offering uniform interest rates for all students is appealing, but upon further thought, its flaws become apparent. Interest rates convey vital signals to borrowers, lenders and the general public about the potential risks and rewards that an enterprise entails. They are relatively higher for riskier borrowers, not because of the "greed" or "malice" of a lender, but in order to provide incentives to the individual and across the market to focus resources on endeavors that possess a greater likelihood for success. Flatten interest rates and you eliminate valuable market signals and predictably the unsound use of capital will become more commonplace. 

Third, government subsidized loans are clearly a major factor in the unsustainable inflation of the cost of higher education. Businesses naturally seek to increase profits by raising the cost of the goods and services that they offer and will do unless they are held in check by market forces. When the rise in the costs of a particular item begins to surpass the capacity of consumers, demand for it will naturally decrease and consumers will respond with increased efficiency and substitution. For example, when the cost of gasoline rises beyond my financial capacity, I will limit my consumption of gasoline through a more judicious use of my car and by using more public transportation. And when demand for petroleum sufficiently contracts, prices begin to go down and firms seek more efficient means of production. Only with the proliferation of of subsidized loans have universities been able to increase costs without facing a natural decrease in demand. These principles also hold true  for affiliate monopolies, like the textbook cartel and student housing, which are notorious for fleecing students. According to the Bennett Hypothesis, "increases in financial aid in recent years have enabled colleges and universities blithely to raise their tuition, confident that federal loan subsidies would help cushion their increase". So, President Obama's calls for even more favorable loan terms, will not lead to more "affordable" education, but will simply grant an unsustainable credit bubble a temporary reprieve from a much needed market correction. 

Evidence indicates that  these same forces have allowed the proliferation of inefficiency. While other sectors of the economy continuously strive for greater efficiency, i.e. to increase output, while minimizing cost of production and administration, the exact opposite has occurred in the university-industrial-complex. For example, in 1993 universities had a total of 31.4 employees per 100 students, by 2007 it has risen to 35.5. This increase is even more pronounced in administration; during the same period of time, the number of administrators per 100 students increased by 39.3%. While total increases in per student spending have increased by 34.5%, administrative costs per student have increased by a shocking 61.2%! Absent of massive government subsidies and market barriers, no sector of the economy can simultaneously decrease efficiency, increase costs and lower the utility of their product, without facing a decline in demand.

"That may be true," you say, "but never the less, education is a vital public good worthy of government subsidies."  I am in complete agreement, in fact I strongly believe in the intrinsic value of the pursuit of knowledge, culture and intellectual inquiry. But, the policies being pursued to achieve these aims are engendering increasingly negative, unintended consequences. Among the most notable consequences, is a malinvestment of capital, time and energy, whose principle consequence is greater debt and a growing mismatch  between academic pursuits and skills demanded by the labor market. For example 317,000 waiters and 80,000 bartenders possess a bachelors degree, presumably in a field of study in which supply greatly exceeds demand. The fact that nearly a third of college graduates are working in fields that do not require a degree is also indicative of credential inflation. Perhaps more telling is that a survey of 1,123 manufacturing executives found that "67% of companies had a moderate to severe shortage of available qualified workers" and "The report estimated 600,000 jobs (related to manufacturing) nationwide were going unfilled because of a lack of qualified candidates." For example, California Steel Industries has been struggling to fill a vacant positions for an industrial maintenance mechanic, even though the pay is $64,000 plus health benefits. Most interestingly, "these workers don't need college degrees, they need at least two years of specialized training plus strong math, reading and writing skills." 

The principle policy implications of widespread skills mismatch, credential inflation and rising student debt are: Not everyone should be corralled into a traditional four year degree. High schools should encourage individuals who are not academically inclined to explore skilled trades in which there is a real demand for labor, rather that let them drift towards low wage service positions. And perhaps more generous tax incentives should be granted to employers who offer onsite training to new employees. This approach is more cost effective for students and tax payers alike. And those who pursue a four year degree should only amass debt in the development of skills and certifications that the labor market demands. Those who seek intellectual and cultural enrichment through the pursuit of liberal arts should do so in cost effective community colleges. Regarding the granting of student loans: universities should bear at least some of the cost associated with loan defaults; this  will ensure that they are more conscientious in the admissions process and less inclined to allow students to amass unsustainable debt in the pursuit of studies that offer poor economic returns. And the government cannot continue to exclude sound market principles and risk management practices from the process of granting tax payer subsidized loans. To put it simply loans with a high risk of default should not granted as readily and at the same interest rate as those funding low risk educational endeavors. And lastly, the cost of education will o

Analyzing the numbers, I cannot help but see the strong parallels between student loan debt and the formation of a debt driven housing bubble, which was brought on by the federal government's drive to expand home ownership. In both cases state intervention was purportedly undertaken for the benefit of Americans of limited means, while in reality the greatest beneficiaries were powerful corporate interests. In the former example, banks were the beneficiaries of a government sponsored expansion of mortgage debt and in the present, the university-industrial-complex has profited handsomely from student loan debt. And in both cases, easy access to cheap credit allowed for a price spiral. As with the end of the era of loose housing credit, market driven rationalization of student loans will result in a relative decline in the demand for a four year college education. This may be painful in the short run, but over time it will force institutes of higher learning to offer more affordable and economically viable options. And more importantly, when credit binges come to an end, consumers begin to rationalize their investments and use of debt. The overarching policy lesson is: no matter how well meaning its authors are, policies that detach the financing of education from market forces are fraud with hazards.  If I am correct, the college bubble will burst or at least deflate, leaving many, but certainly not all graduates with a devalued asset and a heavy debt burden, with tax payers footing much of the bill. And even if you are not a debt ridden history major, it should be clear that history is repeating itself.