Pumping More Subsidies Into Education Will, Predictably, Result In Student Debt

With all factors present, net tuition increases from $6,100 to $12,559 [and] the demand shocks — which consist mostly of changes in financial aid— account for the lion’s share of the higher tuition. These results accord strongly with the Bennett hypothesis, which asserts that colleges respond to expansions of financial aid by increasing tuition. In fact, the tuition response completely crowds out any additional enrollment that the financial aid expansion would otherwise induce, resulting instead in an enrolment decline. Furthermore, the students who do enroll take out $6,876 in loans compared to $4,663 in the initial steady state. The college, in turn, uses these funds to finance an increase of investment expenditures from $21,550 to $27,338. Lastly, the model predicts that demand shocks in isolation generate a surge in the default rate from 17 percent to 32 percent. Essentially, demand shocks lead to higher college costs and more debt, and in the absence of higher labour market returns, more loan default inevitably occurs. Our model also suggests that financial aid increases tuition at the bottom of the tuition distribution more so than it does at the top.  

Just as government-subsidised, easy money fueled a real-estate bubble in the 1990s and 2000s, boosting house prices while promoting unwise borrowing and lending, today government-subsidised easy money is fueling an education bubble — boosting tuition rates and reducing students’ incentives to choose education options smartly. Like the brokers who caused the subprime-mortgage crisis, colleges push naïve students to take on debt regardless of their ability to repay, because colleges bear no cost when graduates default. A true solution requires a new financing system where colleges retain “skin in the game.”  

The high delinquency rate is a symptom of a wider problem— a broken higher-education system. Colleges are paid tuition regardless of whether their alumni succeed. They face little incentive to control costs when those costs can be passed on to students who fund them with government-guaranteed loans that are available regardless of the students’ ability to repay.

Between 1975 and 2015, the real cost of attending a private college increased by 171 percent while the real cost of public universities rose by 150 percent. If the tuition, room and board, and other fees at a four-year private college in 1975 were projected forward to 2015, adjusting for the average inflation rate, the cost of college in 2015 would have been $16,213. Instead, the actual cost in 2015 was $43,921. A large share of rising college costs can be attributed to expanded administration, new non-educational services, athletic programs, and government regulation. Colleges have economised by switching to part-time adjunct faculty. The American Association of University Professors estimates that roughly three out of four college courses are taught by adjuncts.

The key to controlling costs and student-debt burdens is to require colleges themselves to have “skin in the game” so they have strong incentives not only to provide a good education, but also to safeguard the financial solvency of their graduates. With “skin in the game,” colleges will face pressure to control unnecessary costs and limit student indebtedness. Colleges will redouble their efforts to ensure that students graduate with the skills necessary to succeed in the job market. Resources will no longer be freely available for unnecessary, non-educational university spending.