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University of debt

2 July 2014 By Edward Hadas

The fast increase in loans to pay for higher education is a trend that is moving in the wrong direction. The idea that borrowing should play an important role in financing higher education, now standard thinking in the United States and the United Kingdom, is financially dangerous and economically wrongheaded.

Overall, American households are deleveraging. Most notably, U.S. mortgage debt outstanding has fallen to 51 percent from 71 percent of GDP since the end of 2008, according to survey data from the New York Federal Reserve. However, over the same period the ratio of student loans to GDP increased to 5.7 percent from 4.3 percent. The $1 trillion now outstanding is economically significant. In England, the ratio of student loans to GDP is only about half as high as in the United States, but the 80 percent increase over the last five years has been even faster.

For the financial system, the growth is simply bad news. The last thing highly leveraged economies need is an expanding category of debt. Worse, student debt makes the financial system less secure and more complicated, thanks to high default rates and complex repayment terms. Also, student debt, like all debt, distorts behaviour. Heavily burdened new graduates are likely to delay such adult activities as buying houses and having children.

Few people would argue with these negative effects. But after decades of increased borrowing to pay for almost everything – housing, cars, holidays, government spending – it seems natural to use the credit system to put off paying for just one more desirable thing until some fine day when more money is available.

Defenders of education loans sometimes claim that the investment brings returns, for example the higher incomes which a degree will usually produce, only over time and so deferring payments makes economic sense. For student loans, however, the argument is confused.

The way to look at education financing is from the perspective of the whole society, not the cashflow of individual borrowers. Socially, most of each year’s crop of new graduates is needed to keep the economy running at a steady pace. Their education is a consistent operating expense of the economy. It follows that it should be paid for out of the current national income.

Borrowing is more defensible for what might be called incremental students, the graduates who will improve, not merely maintain, the economy. Even if the case for debt financing is better for this group, though, it seems silly to focus too much on a relatively small cohort. In any case, it is not the students who should do the borrowing. The gains they produce will be shared throughout the economy. The debt taken on their behalf should be socialised – borrowed by their universities or by the government.

Of course, if education is to be funded without individual borrowing, the cash has to be found somewhere else. That sounds daunting, but developed economies all manage to provide elementary and secondary education without much cost to parents. They could easily do the same for universities.

The first step is to throw off the illusion of debt-think. Debt cannot magic away the hard reality of spending. Borrowed money may be repaid in the future, but it is spent in the present. Higher education, or anything paid for through debt, makes use of today’s resources. The key decision is not how education will be financed, but how many resources will be dedicated to it.

That may mean a reduction in the resources dedicated to higher education. However, tuition payments could not cover even the leanest imaginable system. Self-financing may have been possible a half century ago, but now the so-called Baumol Effect precludes that easy solution. Economist William Baumol pointed out in the 1960s that the increase in real wages which accompanies a rise in overall labour productivity makes labour-intensive activities like advanced education increasingly expensive.

However, the same increase in productivity also frees up more resources. The trick is for society to find a way to pay. Charity can help. American universities in particular already rely extensively on donations. However, when voluntary funds fall short, it is fair to make the socialisation of expenses compulsory – with taxes.

Today’s government-designed student loans with income-dependent repayment rates already look like an ungainly form of tax, and certainly feel like a tax to borrowers. Of course, a conversion from a system of tax-like loans to an arrangement of grants and taxes would be politically unpopular. Many American voters want to shrink the government, not add something like $200 billion to its expenditure.

The prejudice against state payment was socially acceptable when people were poorer and fewer of them went to college. Now though, higher education has become a public good. No amount of debt-think can take away the public’s responsibility for paying for it.

 

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