The Old College ROI

Today I ran across a graphic from The Economist in March 2015 that shows the return on investment (ROI) to different college majors by level of selectivity of the college the student attended. The charts show that while college pays, it does not pay the same for everyone. More specifically, it does not pay the same for every major. Engineering and math majors have high ROIs, followed by business and economics majors. Humanities and arts majors have lower ROIs on average.

If you’re underwhelmed by the realization, you should be. After all, it’s really common sense and something I’ve written about before here. But it’s a fact that seems incomprehensible to so many (for starters, count the number of votes Bernie Sanders has received). This is imCollege ROIportant because college education is subsidized not by degree, but by the expense of the school the student chooses. An arts major at Stanford is paying the same tuition as the engineering major–and likely borrowing just as much money–but their returns on investment for those educations are vastly different. Put another way, the value of those degrees are very different, even if the price of the degrees is the same.

Interestingly, though, the ROI by degree does not change much based on the selectivity of the school (typically a measure of quality). Looking at each of the degree types, there is very little obvious correlation between selectivity and ROI (taking into account financial aid; i.e., based on net-cost not listed tuition). While students from more selective schools may earn higher starting salaries, the higher cost of their education means they are getting no better return on their financial investment than students of similar majors at much less selective schools.

This suggests that the market for college graduates is actually working pretty darn well when you take into account students’ degrees (i.e., the value of the human capital they develop in college).

It also suggests we should reconsider federal policy for student loans. If we insist on continuing to subsidize higher education (and all the ills that creates), at least we could do it more intelligently by tying loan amounts to degree programs rather than tuition levels.

How Federal Student Loans Increase College Costs

A recent paper by researchers at the Federal Reserve Bank of New York shows how increases in federal student loan programs–intended to make college more affordable–actually increase the cost of college. As with other markets, when the supply of money available to pay tuition increases, the price of tuition rises. The abstract reads:

When students fund their education through loans, changes in student borrowing and tuition are interlinked. Higher tuition costs raise loan demand, but loan supply also affects equilibrium tuition costs—for example, by relaxing students’ funding constraints.To resolve this simultaneity problem, we exploit detailed student-level financial data and changes in federal student aid programs to identify the impact of increased student loan funding on tuition. We find that institutions more exposed to changes in the subsidized federal loan program increased their tuition disproportionately around these policy changes, with a sizable pass-through effect on tuition of about 65 percent. We also find that Pell Grant aid and the unsubsidized federal loan program have pass-through effects on tuition, although these are economically and statistically not as strong. The subsidized loan effect on tuition is most pronounced for expensive, private institutions that are somewhat, but not among the most, selective.
But the effects don’t stop with rising tuition. This increased demand for college education also exacerbates income inequality by inflating the supply of college graduates. (See this piece by George Leef for a full overview of both the NY Fed paper and the income inequality effects).
It’s not rocket science. It’s pretty simple supply-and-demand stuff, actually. No matter how good the intentions, policies that ignore these effects tend to do more harm than good. In this case, generous federal student loan programs not only lead to increases in tuition that result in even higher loans, but reduce the earning power of graduates (on average) and decrease their ability to repay those loans. A pretty perverse circle of effects indeed.