Are college students drowning in debt? A new report argues that they are. The solution offered is to give some students more grants, so they don’t have to pay back loans, and to reduce merit scholarships in favor of need-based scholarships. But any reform that increases aid will only add to spiraling college costs and is unlikely to reduce the overall amount of student debt.
Kevin Carey and Erin Dillon, analysts at the Washington, D.C., think tank Education Sector, provide a useful compilation of changes in the kind and amounts of borrowing and the number of students who have borrowed for college. Drowning in Debt: The Emerging Student Loan Crisis finds that “college students are borrowing more and taking on riskier forms of debt than ever before.” The paper identifies several reasons for the surge and suggests steps that policymakers can take to address the problem.
In my view, Carey and Dillon put excessive blame on private lenders and for-profit institutions for the plight of students. But they do point out the fundamental problem. Even taking inflation into account, the price of attending a public university doubled over the last two decades. And the authors rightly observe that family income has not kept pace, leaving borrowing as the only option for college-bound students without scholarships.
This mismatch between income and tuition is what “drowns” most students.
Indeed, the problem is worse than Carey and Dillon say. Not only is the cost of college outrunning family income, but salaries for new grads have not grown as quickly as the cost of tuition. Therefore, extensive borrowing is less likely to pay off than it was two decades ago.
Despite their clear understanding of the problem, Carey and Dillon are misguided in thinking that more money will solve it. They are particularly concerned with low-income students. Thus their specific solutions are to provide students with direct cash—by transforming Pell grants (the chief federal need-based grants) into entitlements and raising those grants by the rate of inflation each year. (These are components of President Obama’s college-aid plan.). They also want to schools to reduce their “merit” scholarships and increase need-based scholarships.
Carey and Dillon don’t understand that the changes they recommend will be futile in stopping the college cost-price spiral. More federal aid will make it easier for colleges to raise their tuition. Secondly, shifting from merit scholarships to need-based scholarships—assuming that colleges will do that—will not necessarily reduce borrowing. The outcome is likely to be more middle-class students drowning in debt, with only modest improvements for low-income students.
Two recent papers support the first point, that federal aid will fuel more cost increases. In “Financial Aid in Theory and Practice: Why it Is Ineffective and What Can Be Done About It” Andrew Gillen explains that most government financial aid—particularly state aid and federal tax credits—contributes significantly to the upward cost spiral in college education. Because of universities’ tendency to “capture” all revenue above the cost of instruction, any aid to students—either in the form of grants or borrowing—could provide more cash for them to capture. George Leef summarizes Gillen’s thesis: “Like a dog chasing its own tail, the more the government tries to help students catch up with college costs, the more those costs increase.”
Gillen, research director for the Center for College Affordability and Productivity, explains that colleges are competitors that try to gain market share in their industry by increasing their prestige. Prestige allows a college to woo better students, hire better faculty, and raise more funds.
Federal financial aid simply provides fuel for this effort to raise prestige as long as that aid goes to students who, by whatever means, are already covering the existing costs of their education. Gillen notes that Pell grants, at their current levels, do not contribute to the problem, as long as their recipients cannot otherwise afford tuition. However, if those students borrow beyond the costs of instruction, or as Carey and Dillon suggest, receive significant additional aid—in amounts beyond the cost of instruction—colleges would be able to capture that as well.
A broader description of the mechanics of price rises in higher education can be found in Robert E. Martin’s paper, “The Revenue-to-Cost Spiral in Higher Education” from the Pope Center. Martin agrees that federal aid pumps up the funds available for colleges to use to seek prestige. His argument explaining why is complex, but in essence he is saying, first, that these schools lack the incentive of profit and, second, that they have no clear owner (they may be taxpayers, students, or alumni). As a result, they suffer severely from the principal/agent problem (a familiar term in economics). Administrators and faculty (the agents) can make decisions that benefit themselves, rather than the principals (such as taxpayers and students).
In addition to adding more funding to student aid, Carey and Dillon recommend shifting state and institutional funds from merit aid to need-based aid. That will do little to decrease the overall level of borrowing. Redirecting aid from upper- or middle-income families to poor families has several possible outcomes.
First, upper- and middle-income students may choose to attend less expensive universities. However, universities are unlikely to give up merit aid if they anticipate this consequence. Second, those students may substitute borrowing for merit aid. This outcome seems more likely; Carey and Dillon’s analysis shows that even upper-income students borrow significantly for college already, even with generous merit aid. Gillen notes that many unsubsidized loans go to students whose families make more than $100,000.00.
Carey and Dillon seem less concerned about middle- or upper-income students’ levels of dept. But in light of Gillen’s research, they should; it is those students’ borrowing that has the worst effects on escalating costs.
To cut the Gordian Knot of student debt, reformers must find a way to stop college costs and thus tuition from rising at geometric rates. The Alexandrian solution would be to simply command all colleges to become for-profit. The desire for profits would put pressure on administrators to focus on cost-cutting, while the need to attract customers would put downward pressure on the price of tuition. Ironically, the for-profit schools, against which Carey and Dillon inveigh because their students are such heavy borrowers, are the most efficient. For-profit schools keep costs to a minimum, and the fact that most of their students borrow money says more about the students they serve than about their costs.
Carey and Dillon come closer to an effective solution when they suggest that there should be better incentives for colleges to restrain prices. In his paper, Robert Martin is much more explicit about the incentives needed. For example, he identifies greater transparency as the first priority, because it would show how wildly off-the-mark much education spending is and prod policy makers and other outsiders to press for reducing costs. He also suggests other reforms, such as pay-for-performance contracts for faculty members and administrators.
The point here is that the turn toward excessive debt that we have seen over the last decade stems from—above all—the out-of-line increases in college costs. Rather than fuel the rise in costs, as increased federal aid will do, reformers should look for ways to reduce the amount of money going to colleges or to direct that money in ways that enhance productivity. Under the current incentive structure, administrators and trustees spend whatever they get. Let’s turn off the spigot.