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Private-Sector Solution to Rising College Tuition, Student Debt
With the federal Department of Education now overseeing $1.2 trillion in student-loan debt, attention has been driven to the cost of tuition at our institutions of higher education. While it may appear that the causation runs from higher tuition to student debt, it’s more likely that it runs the other way.
When the federal government attempted to increase the number of low-income homeowners by requiring banks to increase the percentage of their loans to low-income households, and by purchasing mortgages through Fannie Mae and Freddie Mac, the result was a sustained increase in housing prices and a vast expansion of mortgage debt. We’re pretty well aware of how that ended up.
We should not be surprised that, as the federal government expanded its role in higher education through Pell Grants and loans to students without regard for their ability to pay the loans back, tuition has risen. Over the past 30 years, tuition has risen by 146 percent at private four-year colleges, to $31,231 (in constant 2014 dollars). The increase for in-state tuition at public four-year institutions has risen 225 percent, to $9,139.
If the government subsidized the purchase of bicycles, encouraged people to purchase bicycles, and gave out below-market loans without a credit check to people who bought bicycles, we would expect the price of bicycles to rise. It shouldn’t be rocket science to see that federal government intervention in the higher-education market has been a factor in increasing tuition costs and is a large factor in the increase in student debt.
(The college at which I teach, Hillsdale College, receives no government money, and its students do not receive any government money, whether it be loans, grants or any other form of subsidy. Even though the latest Princeton Review included Hillsdale among the best colleges in the country, its tuition is about two-thirds that of the average private college.)
A problem with higher education is indeed the ability to finance the acquisition of what economists call human capital — skills and learning that increase one’s ability to produce. There is little collateral for a lender, unlike with mortgages for example. The solution to this problem is not providing loans to anyone who might want to spend some time in college, but rather to implement what Milton Friedman termed “human-capital contracts” some 60 years ago.
Under a human-capital contract, people could invest in the education of college students by paying the tuition of students in return for a claim on the earnings of the student upon graduation. While Friedman discussed this in a 1955 paper, the idea goes back at least to 18th-century political economist Adam Smith. This method of dealing with the inability of low-income individuals to purchase higher education would direct educational resources into the areas that provided the most benefit. Entrepreneurs would seek out high school students who have drive and talent, but are now confined to those in our urban centers with no way to obtain a college education other than by ftaking on debt that is very large relative to the current income of their family.
One can imagine a market developing whereby investors could purchase a pool of contracts, thus reducing the risk that an individual student may not finish school or will fail to find employment upon graduation. High school students will have greater access to higher education and a greater incentive to perform well in order to find investors for their human-capital contract. Rather than graduating with an average student-loan debt of more than $35,000, students will share their incomes for a fixed period of time. One might also note the incentive for owners of the human-capital contract to assist graduates in finding employment.
College-tuition costs that are the unintended consequences of government action have led to proposals for greater government involvement in our education system, such as plans put forth by Democratic presidential hopefuls Hillary Clinton and Bernie Sanders for taxpayer-funded “tuition-free” college. Rather than more government intervention, a market for individuals to invest in the education of those willing to share their future income will not only lead to greater efficiency, but also to the expanded ability of low-income students to obtain a college education, as well as the increased independence of our colleges and universities.
Published in Economics, Education, Education
When you know the government will hand out loans willy nilly, it’s only a smart business decision—since that’s how most colleges are run nowadays—to raise tuition prices.
“One might also note the incentive for owners of the human-capital contract to assist graduates in finding employment.”
Indeed, one might find that the human-capital contract investors would often be employers of the graduates.
It is inevitable that progressives would denigrate this arrangement as indentured servitude. However, it is in fact both ingenious and benevolent.
Any scheme like this that avails itself of the wonders of the “invisible hand” is bound to be far more resistant to unintended negative consequences.
Why do you call the tuition escalation an “unintended” consequence of government involvement? It steers money to leftists, helps central government keep tentacles in peoples’ lives and increases dependency. This and so many other counter-common-sense government interventions are not accidents, they are part of the leftist goal to centralize all.
If we don’t see and admit these things, we cannot overcome them.
I like much of this but, wouldn’t this also result in pressure for students to major in careers with the highest initial income upon graduation? What investor is going to want to invest in liberal arts majors, who might not achieve maximum income for years after graduation after their contract has expired, when they could buy contracts of STEM majors that would likely pay off bigger?
Also might it not incentivize students to defer higher paying jobs until after their agreement expires so that they can keep more of their income themselves?
When I went to law school in 1979-82 (private university), the limit on student loans was $5,000/year. Tuition? It just so happens it was $5,000/year. Last time I checked (and it has been a few years, I admit), the limit on student loans was $30,000/year. What had happened to tuition at my school? It had risen to $30,000/year.
Coincidence? As they say: we report, you decide.
aka indentured servitude? But seriously, how is the collateral any different between a traditional loan contract and a human-capital contract? I am still paying the loan from the fruits of my limited time. How could a lender better enforce one of these contracts versus a student loan?
The difference would be that rather than government providing a loan to anyone who meets a standard set out by the political process, individuals would be effectively purchasing equity in someone’s human capital. A nice piece on this is by Miguel Palacios, a Cato Policy Analysis from 2002, http://www.cato.org/publications/policy-analysis/human-capital-contracts-equity-instruments-financing-higher-education.
Got it, but couldn’t an individual investor (not government) be able to do the same thing through a variable interest rate? I’m still not convinced that there is really any difference, except in one case the lender and borrower know the repayment terms at the beginning, and in the human capital contract they do not, because it depends on earnings.
The main difference seems to be a perceived ability of investors in human capital contracts to vary the terms of the contract depending on characteristics of the student, the course of study, and the school the student attends. Government does not allow this with the current loan program, or in mortgage lending, and I can’t see this being allowed in human capital contracts.
I do think that there is value in signaling the value of different schools and majors through the terms of human capital contracts. But the current job market is also signaling the same thing after graduation.
The private sector solution is to get the government entirely out of the picture and see what happens. This is one example, we can think of others but not everything or probably the biggest things.
This is a pretty radical departure from where we are now. I think this is attractive compared to where we are, but I am not sure why it would be considered preferable to a system of private loans by the borrowers.