Monday, February 17, 2014

The Myth of Excess Enrollments in College-Becker

The print media and the blogosphere have many discussions of the high and rising cost of attending college, the debt burden weighing on college students, the fact that the average real earnings of college graduates have risen only slowly during the past 40 years, and the difficulty young college students are having in getting good jobs. The conclusion frequently reached is that too many high school graduates seek a college degree, and that these graduates have been sold a bill of goods about the value of a college education.

The facts cited are generally correct, but the conclusion about the low value of going to college is completely wrong. The fallacy stems from believing that earnings from a college education determine the benefit of a college education. The truth is that the benefit is determined by the earnings from a college education relative to what earnings would be if a person stopped her education after high school. A first approximation to this gain in earnings for the typical person is given by the difference between the average earnings of college and high school graduates.

A recent study by the Pew Research Center conveniently brings out some facts that have been known, but are worth repeating. The study looks at changes over time in the ratio of the earnings of the average college graduate aged 25-32 relative to the average earnings of high school graduates of the same ages. They divide successive cohorts into Millennials (born after 1980), Generation Xers, Baby Boomers, and older Silents (b orn between 1928 and 1945). The study finds that young college graduates earned on average about 24% more than young high school graduates in the Silents generation, but this percent difference increased to about 47% in the Boomers generation, and now young Millennial college graduates are earning more than 60% than young Millennial high school graduates.

The study understates the trend in the earnings of high school graduates by including persons with a graduate equivalence degree (GED), whose numbers have grown in importance over time. Studies by Heckman and others show that the GEDers should be treated as high school dropouts, not high school graduates, since their earnings are similar to those of dropouts.

The recession hit the earnings and employment of college graduates, but it hit even worse the earnings and employment prospects of high school graduates. As a result, the recession actually increased the gain from graduating from college.

While the price level adjusted average earnings of college graduate grew slowly over the 45-year period of the Pew study, the average real earnings of high school graduates and dropouts actually fell over this long time period. This is why the gap between earnings of college and high school graduates grew by so much. Graduating from college paid off very well not in absolute terms but relative to the alternative, which is the only way to measure the gain from college.

Of course, the change in the cost of attending college also has to be considered before one can conclude that college is a good investment. And college tuition has grown at an unusually rapid rate over the past 35 years. Nevertheless, college remains a good investment after netting out the cost of tuition from the higher relative earnings of college graduates. The Pew study also asked young Millennial college graduates whether they felt college was worth the significant financial cost. About 90% of these young graduates said college had either already paid off (83%) or will pay off in the future (8%). Such confidence in the value of their college degree even holds for the two-third of these Millennials who borrowed money to help pay for their schooling.

Over the past 45 years the fraction of young persons who graduate from college has greatly increased, although the rate of increase slowed during past 20 years. That the returns from college increased even though many more young persons are completing college implies a powerful growth in demand for college graduates over this time period. The growth in demand for college graduates is related to the development of the Internet and other technologies, the growth of the service sector, and globalization. High school graduates can no long count on getting good jobs in manufacturing.

The study also shows that the fraction of college graduates with student loans grew quite rapidly over time as tuition rose rapidly and as government-supported loans became more readily available- 66% of Millennials took out loans vs. 43% for Baby Boomers. The burden of these loans is usually exaggerated since most graduates can easily finance their loans from the higher earnings they receive. Graduates who borrowed a lot and are earning relatively little are the ones who face a loan burden. The best way to help such college graduates is to have a repayment system whereby individuals who earn more pay back more, while those who earn less pay back less.

Such an income-contingent loan program works best when graduates face risk to their future earnings that they cannot predict very well. As a way of dealing with risk it works not so well when future earnings are more predictable. In particular, it favors graduates in low paying fields, like K-12 teaching- and hurts graduates in well-paying fields, like business or finance. On the whole, an income-contingent system is probably better than the present fixed repayment system, but it is not a panacea.

Article Source: Beckner Pesner Blog
Image Source: WikiMedia

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