THE STUDENT LOAN DILEMMA

By Karl Arnold Belser
20 May 2014



The economic future will depend, among other things, on the education and financial strength of the cohort of people with ages between 20 and 40. Specifically it appears that the student loan policy of the United States has mis-allocated resources, which has affected this cohort and in turn may depress future growth in gross domestic product (GDP) and the housing market. This mis-allocation has resulted from lack of understanding on how to analyze the return on investment (ROI). The issue is somewhat complicated , and I will try to clarify it in the following paragraphs.

The one-hour long podcast Bryan Caplan on College, Signaling and Human Capital articulates the issue very well. Here is a summary from the Econtalk website:

Bryan Caplan of George Mason University and blogger at EconLog talks to EconTalk host Russ Roberts about the value of a college education. Caplan argues that the extra amount that college graduates earn relative to high school graduates is misleading as a guide for attending college--it ignores the fact that a sizable number of students don't graduate and never earn that extra money. Caplan argues that the monetary benefits of a college education have a large signaling component rather than representing the value of the knowledge that's learned. Caplan closes by arguing that the subsidies to education should be reduced rather than increased.

Human Capital means acquiring a skill that can be used in one's career. Signaling means that a college diploma shows that a person is intelligent and trained to think adaptively in whatever field the student chooses.  

I note that education in the United States has de-emphasized learning a trade or skill, which is the development of human capital. The Maker Movement is a reaction to counteract this trend. I suspect that the high unemployment rate for people in the age 20 to 40 cohort might be due to a lack of skill, i.e. human capital.


The argument for education is that the average income increase is about 83 percent for all graduates compared to those with just a high school education.

This generalization is deceptive because most of the increase in income comes from engineering, science and finance majors. I note that these disciplines have a large component of human capital.


Next, the students that do not receive a diploma get only a marginal increase in income. Hence it is likely that the money spent on education can never be recovered. Further if the student gets a student loan, the student may be encumbered for the rest of his or her life because under current law one cannot discharge a student loan with bankruptcy.

Lastly, the probability that a person with low SAT scores will graduate from college is small.  So one does have a leading indicator as to whether borrowing money would be a good investment.  A rational person would say the ROI is too poor to merit sending a low SAT child to college. A wiser choice might be to send the child to a trade school to develop human capital. However, society today looks down on the trade professions, which social pressure is de-motivating.

Zero Hedge had two recent articles showing the financial disaster that student loans has caused. The first is What the Fed Won't Tell You About Student Debt. The second is Net Worth of College Grads With Student Debt is 20% Less Than High School Grads With No Debt. Here is a quote from the Pew Foundation that quantifies the student debt issue.

About four-in-ten U.S. households (37%) headed by an adult younger than 40 currently have some student debt—the highest share on record, with the median outstanding student debt load standing at about $13,000.

An analysis of the most recent Survey of Consumer Finances finds that households headed by a young, college-educated adult without any student debt obligations have about seven times the typical net worth ($64,700) of households headed by a young, college-educated adult with student debt ($8,700). And the wealth gap is also large for households headed by young adults without a bachelor’s degree: Those with no student debt have accumulated roughly nine times as much wealth as debtor households ($10,900 vs. $1,200). This is true despite the fact that debtors and non-debtors have nearly identical household incomes in each group.

One  conclusion is that college education is appropriate if you can afford it without taking on debt. This might mean that the rich will continue to remain rich because they can afford education without any debt penalty. Another is that the ROI is definitely worth a student loan for high SAT score students in engineering, science and finance.

The Five-Thirty-Eight blog had an interesting article showing the consequences of high student debt - Developers See A Future With Fewer Picket Fences and More Leases. I have heard that the millennium generation prefers to live in apartments in the city center and  to have no car. This may actually be a response to economic necessity rather than preference.

I see this student loan burden as a mega-trend foreshadowing lower economic activity with a decrease in the rate of home purchases. This mega-trend is consistent with my suspicion that the world has entered an era of more-or-less steady state economy. It might turn out that wealth will be inherited in the future as it was in the epoch before 1800.

I think that wealth preservation will be critical for the benefit of one's children and grandchildren as it was in feudal times.  The book Capitalism in the Twenty-First Century by
Thomas Piketty comes to a similar conclusion based on wealth inequality.
   
Last updated May 21, 2014
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