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Economic Outlook: For-Profit Failures Further Support Free Community College Plan

Your Student Government '13 to '14

New Research:

On Thursday (9/10), two researchers — Adam Looney of the Treasury Department and Constantine Yannelis of Stanford University — released an analysis of a new database that offers much more detail. It matches records on federal student borrowing with the borrowers’ earnings from tax records (with identifying details removed, to preserve privacy). The data contains information about who borrows and how much; what college borrowers attended; their repayment and default; and their earnings both before and after college.

the data suggests that many popular perceptions of student debt are incorrect. The huge run-up in loans and the subsequent spike in defaults have not been driven by $100,000 debts incurred by students at expensive private colleges like N.Y.U.

They are driven by $8,000 loans at for-profit colleges and, to a lesser extent, community colleges. Borrowing for both of these has become far more common in recent years. Mr. Looney and Mr. Yannelis estimate that 75 percent of the increase in default between 2004 and 2011 can be explained by the surge in the number of borrowers at those institutions.

It’s not hard to see why. The traditional borrowers from four-year colleges tend to earn good salaries out of college and pay back their loans, even during the recent years of economic weakness. The typical borrower who left a less selective four-year college in 2010 earned $35,000. For those leaving more selective colleges, the figure was $49,000. Those salaries obviously aren’t lavish, but they’re high enough to let most people meet their initial loan payments — and they tend to lead to bigger salaries in later years.

Borrowers at for-profit and community colleges, by contrast, earn low salaries — a median of about $22,000 for those exiting school in 2010 — and have had difficulty paying their loans.

The new findings are consistent with earlier data — such as statistics showing that default rates are actually lower among borrowers with large loans than among borrowers with small loans.

But the new data, which goes back two decades, shows how much the landscape of borrowing has changed. Today, most borrowers are older and have attended a for-profit or community college. A decade ago, the typical borrower was a traditional student at a four-year college.

Why did the face of borrowing change so rapidly in just a few years? During the recession, millions of students poured out of a weak labor market and into college to improve their skills. Historically, these students would have gone to community colleges. But with state tax revenues taking a nose-dive, community colleges were starved for funds and unable to expand capacity to absorb all of the new students. Students took their Pell Grants and loans to for-profit colleges. Enrollments at these schools spiked, and so did borrowing.

Behind the increase in for-profit college loan defaults is an underlying problem. How did these for-profit schools become so prominent so quickly? During the Great Recession, there was a spike in demand for schools where people could acquire marketable skills cheaply. This is exactly what economic theory told us would happen:

  1. With a larger pool of people looking for work (higher unemployment), employers could be more selective, requiring greater credentials for a given job than they otherwise would have been able to.
  2. As the labor market worsened, the “opportunity cost” of obtaining required skills (foregone wages) decreased.
  3. As people’s income decreased (both as a result of the recession, but also part of a long-term trend of stagnant median incomes versus increasing tuition costs), demand for the “inferior good” (in this case, for-profit and community colleges) increased.

Compounding the issue, many War on Terror veterans we’re returning home, with GI Bill tuition-assistance in hand but little idea of what to do with it.

At the same time, the recession resulted in lower tax receipts, and municipal and state budgetary restraints became more acute. Instead of increasing funding to deal with the predictable influx of students, community colleges faced budget cuts. The resulting surplus of students was readily snapped up by for-profit colleges.

For-profit colleges are, on average, four times more expensive than community colleges, and return poorer graduation rates and career outlooks. In other words, for every one student the federal government paid for to go to a for-profit school, it could have sent four students to community college. Furthermore, those four students would be more likely to graduate and have better career prospects.

People have different reasons for wanting to attend community college. Some people want to learn a specific marketable skill, with no intention of pursuing a bachelors degree (or beyond). Therefore, in order for community colleges to be eligible for new proposed federal subsidies, they should have to offer specialized vocational training programs.

For other people, community college is a stepping stone towards a more advanced degree. For these students, a free community college option would allow them to find out if “college is for them”, without taking out loans (I would argue that the absence of debt itself would lead to better academic outcomes). Another requirement for receiving expanded federal assistance should be making it easier to transfer community college credits to four-year college.

Of course, it is not solely up to community colleges whether four year institutions accept their credits. The Federal Government could, however, use the power of the purse and scale grant eligibility based on a four year school’s willingness to accept credits from community colleges. I bet community college credits would become more transferable if this were the case…

Perhaps some of these reforms are already baked into the Obama plan–if so, good. Either way the government, with the assistance of academic and private sector partners, should develop guidelines to help community colleges meet technical program and transfer-ease requirements.

With these requirements are met, community colleges could better serve their two target groups–returning adult-students looking for technical skills, and out-of-high-school prospective college students who think they want to pursue a bachelors degree, but do not have the conviction and/or financial resources to jump right into a four year college.

If properly tailored, a tuition-free community college plan would not greatly increase government spending. Rather it would be, in large part, a transfer of funding from for-profit (which rely almost exclusively–86% of revenue–on federal grant money to operate) to community colleges, in exchange for reforms that allow community colleges to better serve their students.

Some figures here might help put this “transfer” into context. Obama’s community college plan calls for $1.4 billion in funding in 2016 and $60 billion over the next decade. Compare this to the $32 billion the Department of Education spent on for-profit grants and loans from 2009-2010 alone

Isn’t better educating more people, for far less money (per person), exactly what student aid programs should strive for? Now, to be sure, pushing more people towards community college would increase the cost of the tuition-free plan. As many people have pointed out, to make the plan less costly tuition assistance could be reserved for less wealthy applicants with good academic records (high school grades and/or standardized test performance).

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Economic Outlook: Inelastic Demand, Imperfect Competition, and Price Regulation

Talk is cheap, which is why makes sense for business owners to claim prices will increase and / or mass layoffs will result if regulations are put in place. What this really means is that profits will fall, so it is worth it to talk (which, remember, is cheap), and hire lobbyists (which are relatively cheap for big business compared to the benefits they deliver) to support these claims.

In most cases, markets decide pricing. Increase prices, and people can substitute your good for a competitors. Lay people off to make a political statement, and you forego market-share that will be readily snapped up by competitors. In competitive markets, these problems tend to regulate themselves. While true Perfect Competition doesn’t exist in reality, some markets are closer to this ideal than others.

Under perfect competition, there are many buyers and sellers, and prices reflect supply and demand. Also, consumers have many substitutes if the good or service they wish to buy becomes too expensive or its quality begins to fall short.

When a good is necessary for living (healthcare) or for social mobility (college), imperfect markets can price lower income people out.

bls data

Base Year 1978 (Prices = 100)

Healthcare:

ACA–companies justify price increases:

Rate Review helps protect you from unreasonable rate increases. Insurance companies must now publicly justify any rate increase of 10% or more before raising your premium.

Price controls imposed as part of the ACA are at least partially responsible for the dramatic slowdown in healthcare cost increases over the past few years (the Great Recession was another major factor).

But since health insurance is a composite of a number of inputs, including cost of being seen by a doctor and cost of prescription drugs, each of these inputs would need to be regulated to keep health insurance costs down.

The current approach used to try to keep prescription drug prices down–naming and shaming price gauging companies–does not work.

College:

While a college education is not a silver bullet, it is an important element of the social mobility puzzle. As the graph above shows, college costs have skyrocketed in recent decades, leading poorer students to take on increasing levels of debt to afford a degree.

Those who complete their degree still tend to realize a strong return on investment, but the high (and increasing) debt burden is a huge stressor, which likely contributes to poor graduation rates (especially among lower class students). The combination of non-completion (and related low earnings) and high debt can result in an inescapable debt cycle.

A good proxy for the “necessity” of a good or service is it’s elasticity of demand:

Products that are necessities are more insensitive to price changes because consumers would continue buying these products despite price increases.

The availability of substitutes…is probably the most important factor influencing the elasticity of a good or service. In general, the more substitutes, the more elastic the demand will be.

Imperfect markets result in a lack of substitutes, as barriers to entry result in little competition. Policymakers can start with a matrix of competitiveness and necessity (elasticity of demand); goods and services that are both necessities and exist in highly imperfect markets are primary candidates for price regulation. Two obvious tools for regulating these markets are:

  1. Price controls (making companies justify price increases over a certain threshold)
  2. Tying federal funding to price oversight

 

Price controls may seem like a blunt tool, but they can actually be quite nuanced. Take the ACA’s “Rate Review”. A company can has an opportunity to make its case that a price increase is justified; if it justified is, the government will allow it. It is in no ones interest to see businesses fail in the name of price control regulation. Such failures hurt the economy, and undermine support for the regulatory policies that lead to their failure.

What is the American dream? Is it meritocracy and social mobility, or is it the freedom to charge whatever the market will bear regardless of the social cost?

Admitting their are limits to what perfect competition market models can achieve in the real world does not make you a socialist. It makes you a good economist and policy analyst. There is room for these industries to remain private and profitable. That does not mean we cannot regulate them in ways that make them work for society as a whole (considering the social benefits when they are widely available, and the social costs when they are not).

It is the job of politicians to identify these markets and call owners on their bluffs. Failure to do so reinforces power asymmetries that stifle social mobility. The Commerce Department’s mandate should be expanded to help balance the power asymmetry that exists between consumers and producers of necessities in the most imperfect markets.