Sunday, November 1, 2009

Education Serial Malinvestment

I was reading a post from Mish the other day about education malinvestment and wondered if I could model it. But first let me re-post the letter that started Mish off.

When I attended law school at George Washington U in 1969, the tuition was $1,900 a semester. I worked my way through and had no debts when I began to practice law.
Later, student loans became the norm. The loans were subsidized, encouraging students to become indebted rather than build sweat equity in themselves. Student loans also took parents off the hook for saving to pay for their childrens’ education. The result was still more government dependency.

Screwing up the marketplace with subsidies, drove up the price of education, encouraged institutions to grow based on government support, and placed undue emphasis (economically) on higher and frequently useless education.
We should expect the higher education market to suffer a similar fate to the real estate market, where subsidies, encouraging people to buy what they could not afford (and did not need) led them to a result that, when compared to their investment in time and treasure, was uneconomical.
Eugene Holloway

It seems like a very logical argument, but then I wanted to check what the real price was by inflating via CPI, and also comparing median household income for college graduates in 1969 to today.

He said that it cost 1,900 per semester and the price level has risen 487.52% since them, so in terms today that is $9,262.88. This is 617 dollars per credit hour assuming a full time course load of 15 credits. In my last year in my MBA at a private university the tuition was 1,040 a credit hour so even controlling for inflation the price for a graduate education has risen faster than other prices. [The premium is 68.56%] However, this is only one side of the puzzle, we also need to see what the income level has risen to as well.

With an advance degree the Census shows that in 2000 earned 55,242. The historical data set is not great for tracking down incomes by levels of education. However, in 2000 the median household earned 41,990, so there is a 31.56% premium for the advanced degree. The data set only goes back to 1975 but keeping the same premium when the 1975 median income was 11,800 is $15,524 for an advanced degree. When we inflate the salary so as to make an apples to apples comparison we then find out that the 1975 graduate salary would be $51,705. So there has been an increase in return to attaining a higher degree, but the premium here is 6.84%.

The veil of prices is very tricky. It is easy to allow yourself to look at an old bill and then compare it to one today, but you have fooled yourself since prices of goods and services including most importantly the wage portion of services have increased over time. On this basis, people who have an advanced degree today are better off than those that gained one back in the early 1970s.

Master’s Degree Cost: 64 credits









After tax Monthly Income



Student Loan Cost



% of Monthly Income



As you can see it becomes a little gray as to whether it is a good choice or not. It is a high amount of your disposable income but I also assume that it is paid back in 15 years, whereas these loans can be strecthed to 30 and even 40 years in some cases. It also depends on your cynicism to decide if getting a good job is more like winning a lottery than merit and skills based.

However, this recession might not be the same as previous versions. Salaries might plummet due to the supply of willing labor that hunts for employment. It will be interesting to watch this unfold over the next few years to see if this cohort of graduate students did make a bad economic bargain by going into debt to gain further education.

One of the key teachings that I received during my MBA was from my grouchy advanced finance teacher, by advanced I mean he taught the investment course and the futures & options course. Basically, he called us all idiots. He said and I quote, you make a bargain and you go into debt. You have a certain amount of payments to make at certain times. That's fine. However, you have no idea what your income is going to be. You could have a high-flying job and then get laid off. You may never attain the MBA salary, but it does not matter you still have that debt. The debt does not care and you have to pay it each month. The key is to keep your debt as low as possible so that when fate invariably intervenes with your income statement you can still make those payments until better economic times come back.

On to the model.

Here is the basic supply and demand curve shown along the price and quantity axis.

The government hopes by subsidizing the student loan market, which is a noble cause because having a better educated workforce not only makes for a better electorate but also is one of the only way that advanced economies can continue growth, will increase the supply of schools offering education.


What we are seeing is an inducement for people to take on more education and the price rising. (This is not scaled at all, just showing the move.) So more students are getting degrees but Harvard can only hand out so many a year, thus, the cost must rise.

In truth what is happening is a little of both. Anectdotal evidence when I was obtaining my undergraduate degree at the University of Florida, the only "real" choices in the state was there or Florida State (that is if you did not get into Florida). Now, however, there are comparable educations offered at Central Florida, South Florida, there is a new university in Southwest Florida. So the state system has expanded to accept more students but prices have still risen. So the way I see it, I would model it like this...

How do I know this is correct? Here is the student population for each year of undergraduates and graduates.

You can see that even though prices have gone up by about roughly 60% the undergraduate population has grown by 238.36% and the population of the graduate students has risen 322.46%. Except for the total US population has grown over time as well, so we would need to control for that as well.

So the number belie Mr Holloway's argument and augment mine. Yes, prices have risen but the median salary for college educated workers has risen as well. The population is better off than it was before. The aggregate numbers of students has grown almost 3x as much the price difference meaning that higher learning schools are responding to the inducement to take on more students via financial aid, but it also shows that the demand is rising as well because of the government's program.

As I stated above and in other posts there are only a few "things" in an economy that can improve GDP and the standard of living for a country. For advanced countries there are even less because they will have already exhausted some of their natural resources and fully employed their labor. The last main way to better itself is through technology inlcuding the advancement of knowledge to have a better trained work force that is more productive.

While any program can invariably be run better; the Federal Student loan program has been a success on the whole for students have made use of it.

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