A Note on Higher Education, Credit Constraints, and How We Think About Government Spending and Inequality

Recently, a blogger at Esquire responded forcefully to a David Brooks column on the two kinds of inequality. The author, Charles P. Pierce, makes a number of claims:

Then there is what you might call Red Inequality. This is the kind experienced in Scranton, Des Moines, Naperville, Macon, Fresno, and almost everywhere else. In these places, the crucial inequality is not between the top 1 percent and the bottom 99 percent. It’s between those with a college degree and those without. Over the past several decades, the economic benefits of education have steadily risen. In 1979, the average college graduate made 38 percent more than the average high school graduate, according to the Fed chairman, Ben Bernanke. Now the average college graduate makes more than 75 percent more.

Ah, you might say, this is all my balls. Shouldn’t we at least mention here that many people do not go to college because they can’t afford it? Shouldn’t we mention that the reason they can’t afford it is that nobody has any fking money anymore? Shouldn’t we also mention that the reason nobody has any fking money anymore is because of economic policy that enabled unbridled corporate avarice, whereby all the jobs got shipped out of Scranton and Des Moines and off to Shandong and Inner Mongolia? This left us with a Potemkin national economy within which our primary products are new financial instruments through which the 1 percent can steal what’s left, thereby further guaranteeing, again, that nobody has any fking money anymore.

This last section is worded carefully: “many people do not go to college because they can’t afford it.” This is an important claim. Given that the United States has 313 million people, there is no doubt some truth to it. But is this really the main driver of why more students aren’t attending college?

Recently, Joshua Goodman of the Harvard Kennedy School used data from Massachusetts to weigh the role of credit constraints, i.e., the question of whether or not students aren’t enrolling in college because they can’t find the money to pay for it. He begins by noting why it’s tough to determine if credit constraints are playing a big role:

If low income students are ﬁnancially constrained, public subsidies to reduce college costs may improve the efﬁciency of human capital markets, an argument for increasing ﬁnancial aid. If low academic skills or school quality explain enrollment gaps, then increasing ﬁnancial aid may be ineffective or inefﬁcient and public funds may be better used trying to raise academic skills or improve school quality.

Goodman concludes that credit constraints do play a role:

That inclusion of skill controls greatly reduces intended enrollment gaps is already a well-established result. The persistence of such gaps within non-poor school districts is a new ﬁnding that strengthens the argument for the existence of credit constraints, albeit for a relatively small eight percent of the low income student population. These estimates are remarkably similar to the roughly 10 percentage point gaps found by Ellwood and Kane(2000) and Belley and Lochner (2007) between the lowest income quartile and the average of the upper three quartiles.

These numbers do suggest some good news for Massachusetts. Conditional on skill, low income seems a relatively small constraint and more than 50% of the lowest skilled graduates enroll in some form of college. This may be due to the fact that the state has a highly-developed postsecondary market, with 30% more colleges per 15-19 year old than the rest of the nation on average. Perhaps more importantly, it has college options available at a wide range of price points. As of 2004, there were 15 community colleges with an average annual tuition of $3,500, as well as 7 state colleges with an average annual tuition of $5,400. The state spent an average of about $7,700 per full-time equivalent student enrolled in public postsecondary institutions, the sixth highest of any state. That credit constraints seem small is at least partially due to this extensive state support for higher education. The overall enrollment gap would, for example, be larger if not for the existence of inexpensive two-year community colleges, as seen in Table 4.

The bad news for Massachusetts lies in its student body’s skill distribution, where low income is nearly a guarantee of low skill. The evidence presented here has three implications going forward. First, any further ﬁnancial aid that Massachusetts plans should target low income students with medium to high academic skills, possibly through four-year public colleges, if the goal is to most efﬁciently raise postsecondary education levels. Second, the state should consider devoting more of its budget to remedying the skill gap present by the time low income students reach high school, a reallocation that might be ultimately more effective at raising college enrollment rates than increased ﬁnancial aid. [Emphasis added]

Massachusetts is of course very different from the United States as a whole. As Josh Barro has argued, one of the main difference is that Massachusetts has a relatively effective state government, e.g.,

Given that Massachusetts has seen relatively slow growth in tax revenues since 1980, it is unsurprising that education spending per pupil has also grown more slowly than the national average. In 2007, Massachusetts public schools spent $12,857 per K–12 student, much less than the $16,163 spent by New Jersey but more than the $9,669 all states spent on average. Those figures represent an 85 percent increase for Massachusetts since 1980, a 139 percent increase in New Jersey, and a 95 percent increase nationally.

As I will discuss in the next section, most student demographic groups in Massachusetts are outperforming their peers in New Jersey on the National Assessment of Educational Progress exams. Remarkably, they are achieving this outcome though the state is spending less than New Jersey not just overall, but also within school districts with high levels of need.

That is, we have reason to believe that public money is spent better in Massachusetts than it is in some other states. This is very significant. If the United States as a whole is more like Massachusetts than New Jersey, we’re in good shape. If we’re more like New Jersey than Massachusetts, we’re in trouble. In Massachusetts, at least, it seems that constraining tax revenues has led to greater organizational discipline in the public sector. The state government is spending somewhat more on effective educational programs than it is on less valuable public projects.

To be clear, much depends on whether public institutions are working well. Spending more money on poorly-functioning public institutions isn’t going to yield the same result as spending more money on well-functioning public institutions. More money won’t suddenly turn a poorly-functioning agency into a well-functioning one. There appear to be other mechanisms at work, among them the presence or absence of some source of financial discipline, the presence or absence of the ability to impose organizational discipline, e.g., restrictive work rules can hamper public sector managers in their efforts to streamline programs or to deploy human resources more effectively.

Notice that one thing Massachusetts does is offer a variety of different price points for public higher education. One strategy for making college more accessible is creating new public colleges and universities that are more efficient than traditional schools, e.g., schools like Western Governors University, recently profiled by John Gravois in the left-of-center Washington Monthly, one of the country’s leading champions of innovative higher education strategies:

Western Governors differs in several respects from the crush of online schools that have mushroomed in recent years to serve working adults like Robinson. For one thing, unlike the Phoenixes, Capellas, Ashfords, and Grand Canyons that plaster America’s billboards, Web sites, and subway cars with ads, Western Governors is a nonprofit institution. That means no $100 million marketing budget, and no 30 percent profit margin. For anyone actually enrolled at Western Governors, the biggest difference is simply its price. The average annual cost of tuition at for-profit universities is around $15,600. Tuition at Western Governors, meanwhile, costs a flat rate of just under $6,000 a year.

The reason Western Governors can offer this kind of tuition (which is often, in practice, even cheaper than it looks; more on this later) is because of its signature twist on the idea of a university—a feature that sets it apart not only from its for-profit competitors, but from virtually every other institution of higher education in the country. This innovation allows WGU to offer its students a college degree that is of greater demonstrable value than what its for-profit competitors offer—and do so for about a third the price, in half the time.

So what is WGU’s big innovation?

By gathering information from employers, industry experts, and academics, Western Governors formulates a detailed, institution- wide sense of what every graduate of a given degree program needs to know. Then they work backward from there, defining what every student who has taken a given course needs to know. As they go, they design assessments—tests—of all those competencies. “Essentially,” says Kevin Kinser, a professor of education at the State University of New York at Albany, “they’re creating a bar exam for each point along the way that leads to a degree.”

As a result, students only spend as much time as they need to master the relevant material. The school is not built around a traditional campus infrastructure. Rather, it is customized to the needs of individual students.This radically reduces the cost of offering a high-quality education.

Baumol’s cost disease tells us that in some sectors (a symphony orchestra, to name the most famous example) productivity can’t really increase the way it can in manufacturing widgets because we need the same number of people to do the same job as did in decades past. As wages rise in sectors with productivity improvements, however, we need to raise wages in sectors with stagnant productivity so that those sectors can attract workers. The genius of WGU is that it demonstrates that education actually can achieve significant productivity increases. That is, we can use fewer people to offer people a better education.

This leads us to another important point. If we accept that many U.S. students don’t attend college because they can’t afford it, what is the right strategy to make college more affordable? Pierce has thoughts on this matter:

But, ah, you might say, what we have here is a great argument for vastly increasing and simplifying federal student loans, and for forgiving student debt, because what passes for data in this column clearly indicates that a college degree is critical to avoiding certain social pathologies that are at the root of our genuine inequality, and not the fact that nobody has any fking money anymore. No, you probably guessed by now, Your Honor, it’s values again. And, of course, not those values that we hoped our financial barons would have that would make them realize that stealing everything that isn’t nailed down is not good for America. Nope, it’s all those poor people humping again.

Pierce seems to believe that it is obvious that more money, e.g., more generous federal student loans, would solve the relevant problem. There is, however, another way of looking at this issue. As Vance Fried has argued, there is reason to believe that capping federal student loans would actually make college more affordable. This is a counterintuitive view, but he explains it well:

No matter the state’s policy on subsidies, a lower borrowing cap will be better for students because it will direct them to institutions they can afford and blunt the ability of schools to raise prices. It will also be highly beneficial for taxpayers. On federal loans, taxpayers are stuck with the bill for any defaults. According to the Congressional Budget Office, the federal direct-loan program costs taxpayers 12 percent of the amount lent. With the 2009–2010 direct loans amounting to $97 billion, the cost to the taxpayer is close to $12 billion.

Lowering the cap will reduce the cost of the federal loan program since less money will be lent. It will also lower the cost by improving loan quality: low-balance loans have lower default rates than high-balance loans.

This sounds harsh. Directing students to institutions they can afford sounds suspiciously like directing poor kids to lower-quality schools. But as WGU suggests, the problem is that many schools are growing more expensive without offering a higher quality of instruction. Fried does an excellent job of explaining why this is happening. Basically, schools are seeking to maximize their profits, including “non-profits.” For “non-profits,” “profits” are extracted from undergraduate education to subsidize programs unrelated to offering high-quality undergraduate education, featherbedding, managerial compensation. That is, tuition money paid by undergraduates, and subsidized by taxpayers, isn’t just used to educate undergraduates — rather, it is used by those who run universities to achieve various other objectives.

Some of these objectives, like funding valuable research, are indeed important, and possibly deserving of subsidy. But if so, the subsidy should be transparent and direct, not laundered through programs that are meant to benefit students — and in particular poor students we want to help achieve upward economic and social mobility.

One way to achieve this goal would be to replace most existing higher education subsidies with what Andrew Gillen calls “Super Pell Grants.”

The first step is to determine the cost of providing an education. Note that this is not the cost of providing an education at a particular institution, but rather the cost in general of providing an education. In The $7,376 “Ives”: Value-Designed Models of Undergraduate Education, an earlier CCAP publication, Vance Fried estimated that a first rate education could be delivered for $7,376 per year.

Alternatively, we could examine the total actual expenditures of schools. A new report by the Delta Project determined that in 2006, per FTE student education and related spending (this is known as the “full cost of education” and includes instructional spending as well as an allowance for other costs) varied from $33,234 at private research schools to $10,835 at public masters’ schools. The median student attends a public research university, which had education and related costs of $13,819 per student. We will use this figure and the corresponding figure for two-year schools of $9,184 as our baseline. In 2008 dollars, these work out to $14,758 and $9,808 respectively. Thus, the cost of educating a student at a four-year school is about $15,000, and the cost of educating a student at a two-year school is about $10,000. We’ll call these figures C*.

As an aside, an extremely good case can be made that in the absence of proof of educational differences, the baseline should be the spending of the lowest cost provider – e.g. the public masters’ figures. Since we do not measure the output of schools, there is no way of knowing if they are providing any worse of an education than top spending schools, so why should we pay more for something without knowing it is any better? Using those figures would also encourage high spending schools to come up with output measures to try and justify their high costs, something that they currently resist tooth and nail. However, for the purpose of this illustration, I conservatively chose to use the median spending figure, which is certainly defensible given that half of students already attend schools that spend that amount or less.

In the second step, the government figures out what each student can afford to pay. This is already being done, and the figure is called the “expected family contribution” or EFC. While this formula is undoubtedly in need of revision (the “current formula absorbs student earnings from work … at a very high rate of 50 percent,” 67 which is outrageous), there is no reason in principle that it could not be fixed and amended for these purposes. Importantly, the government should not share this information with the schools – there is little to be gained by facilitating price discrimination.

Next, simply take the difference between the two, and have the federal and state governments provide “Super Pell” grants for as much of the difference as they can.

Think about how this works. If you raise subsidy levels to whatever tuition set by colleges and universities, have we not given colleges and universities a good reason to keep raising tuition as high as they can? And if the “solution” is to keep raising subsidies to help make college more affordable for students, what we’re actually doing is shifting the burden from students and their families to all taxpayers. Perhaps this would be fine if only members of the top 1% were net contributors to public coffers, but of course that’s not quite true. Many middle-income families are as well, including some with children who will eventually want to attend college. It is important to ask where tuition money is actually going. Is it going to programs that actually benefit students who need a lift or is it not?

This is why it is actually important to scrutinize the claims made by colleges and universities. Some of our interlocutors treat the rising cost of higher education as a natural phenomenon like the weather that can’t be helped. All that can be helped is whether or not we are decent and humane and increase taxpayer-funded subsidies to pay for the regrettable but inevitable phenomenon of rising tuition.

Another approach is the one taken by states like Massachusetts and by WGU, i.e., to find ways to deliver a better education and lower cost, and to create incentives in the system to make productivity improvements more rather than less likely.

Pierce is upset about the fact that David Brooks cares about values. There is, however, a simple reason to care about “values.” People with large extended kinship networks are better positioned to take advantage of subsidized education. This is true if the subsidies are high or low. In many communities, credit constraints aren’t the main thing keeping young people out of college. Rather, it is a sense that preparing for and attending college is not a worthwhile investment — that the opportunity cost of remaining out of the workforce is too high relative to the potential benefits. To understand what I’m talking about, check out Katherine Boo’s excellent 2007 article on then-superintendent Michael Bennet’s efforts to (inter alia) aid poor and working class Mexican American students in Denver, Colorado. Making college free might change the picture. But as we’ve seen in the case of insecticide-treated nets, there is reason to believe that at least some cost-sharing increases the perceived value of a given good or service.

All of this substance aside, it is easy to miss David Brooks’s important point: the things that really bother Americans don’t primarily relate to upper-tail inequality, i.e., the gap between the median person and the person at the top. Will Wilkinson does an excellent job of discussing the idea that a focus on inequality is actually a distraction from things that matter, many of which Brooks cites in his column.

It is literally unimaginable that I will change the mind of anyone at Esquire with this post. It’s fairly obvious that we’re engaging in very different kinds of inquiry here. Regardless, I hope I’ve clarified at least some of the relevant issues. It goes without saying that I could be wrong about a lot of this, but all I want to convey is that the idea that increasing subsidies for higher education is the best strategy for class disadvantage is not obviously true.