May 8, 2012

Higher Education for All?

The federal government needs to rein in the business of making student loans.

In my last Defining Ideas column, Beyond Austerity, I argued that the quickest path toward job creation in the short run lies in the deregulation of labor markets. Politics aside, it costs nothing for government to remove the barriers that block job creation. As jobs grow, increased tax revenues are paired with decreased welfare expenditures. That sets the stage for another round of labor market improvements.

It is, however, a mistake to assume that long-term growth depends solely on these short-term improvements. Over the long haul, it is equally critical to develop the human capital of the next generation that will allow young people to enter technological and professional fields that depend more on brain and less on brawn. Unfortunately, high returns from human capital first require large investments in human capital—hence, the thorny question of how best to finance higher education.

 Epstein  
 Illustration by Barbara Kelley

One problem here is that banks find it difficult to lend money to future earners. No one knows for sure which students will be able to make good on their loans years down the road. But everyone knows that most students typically do not have today the collateral needed to back long-term loans. So what’s the best way to bridge the gap?

Today, the government is heavily involved in student lending, much of which goes through its Stafford loan program that makes fixed-rate loans to undergraduate and graduate students attending college at least half-time. But even before the federal government entered the market, people took other steps to help close that gap. First, they shopped for the best value in education. Of course, they did not have perfect information about their choices. But they had trips to campuses and access to third party sources to reduce their uncertainty. In financing their education, they relied less on their own credit and more on their parents who (at least when labor and stock markets were strong) helped finance that education by a combination of gifts and loan guarantees.

Many people and private institutions of means were alert to the financing gap, which they helped close with scholarships and other forms of financial aid. All these measures are still available. Their key advantage is that everyone involved in the process has a strong incentive to make those investments work. Monitoring student performance and student loans is not easy, but it is surely done best by those who have direct and close ties to the student.

Unfortunately, high returns from human capital require large investments in it.

The last entity that meets that description is, of course, the United States government. Through its Stafford loan program, it has become the biggest single player in financing higher education in the United States. The relationship is troubled on both sides as government lenders typically do not have much information about their borrowers. Nor are they skilled at monitoring student progress or in collecting on loans that fall into default.

The rational response to the dismal level of government performance would be to tamp down on subsidized loans. One way to do that is to raise the interest rate to reflect the added risk, which, in turn, would lead the most qualified students to get financial assistance from private sources where their favorable credit profiles could translate into better loan terms.

But President Obama has a better idea. In his recent speech at Washington-Lee High School, he turned to the role that the federal government should play in education. Predictably, he urged the Congress, including those stubborn Republicans, to keep the lid on these interest rates, which would otherwise double at the end of the year to 6.8 percent. Interest rates are low in this economy, so this figure may well be high, relative to risk—or it may not be, for some borrowers. But the President never wants to understand how a program should best work. He wants to lash out at everyone who stands in the path of an expansion of yet another government subsidy.

In this instance, the President launched a rhetorical war against those who oppose his plan. His first move consisted of this ill-concealed threat: “If colleges and universities can’t stop their costs from going up, then the funding they get from taxpayers, it should go down.” He did not say whether he meant that student loans could not be directed to certain institutions, or whether he wants to clamp down on other forms of direct federal support to colleges and universities. Either way, however, it is not going to work for government agents to scrutinize hundreds of colleges and universities to see which ones perform well. It is far easier for other market actors to decide whether the added services supplied by particular institutions with whom they deal are worth the extra money—something which they are much more likely to undertake if their own dollars are on the line.

Government lenders typically do not have much information about their borrowers.

To make matters worse, many of the financial problems faced by colleges and universities stem from the simple fact that they often lack control over their own budgets. Labor, both from faculty and staff, is a huge component of educational costs. Yet at every stage, the federal government sharply restricts the degrees of freedom that universities, like other employers, have in managing, hiring, and firing their employees. One conspicuous example is the federal requirement that colleges and universities abandon their time-honored system of mandatory retirement for tenured faculty. This is a classic case in which uninformed political actors override the judgment that every single college and university had adopted on its own.

The point here is not that all professors who reach 65 or 70 years old are incapable of doing academic work. It is, rather, this: how can colleges and universities set up incentives for them to work up to their potential? Tenure may well be needed to preserve academic freedom. But it serves that objective well if faculty members, on a routine basis, rotate into retirement, without fear of arbitrary dismissal. Those who remain productive are able to secure new contracts at other universities. Those who are not have accumulated enough in pensions and social security to cover their retirement.

Guaranteed employment meshes poorly with open-ended retirement because it dulls the incentives to perform that are kept in place by people who know that they have to return to the market for their next job. Free up institutions of higher education from these burdens, and performance will improve. Do it with other forms of regulation, and the improvements will expand.

The President, however, never thinks of the efficiency of various institutional arrangements. He always thinks that added subsidies are a zero-sum game in which the gains to the winners exactly counterbalance the losses to the losers. That assumption plays nicely into the President’s rhetoric of class warfare where the choices are all too obvious. The first choice is easy: either keep the interest rates down or hand another windfall to the “millionaires and billionaires” who pay, the President falsely tells us, lower tax rates than middle-class workers, many of whom pay no income tax at all. His logic always assumes that it is possible to look at each contested tax expenditure in isolation from the overall tax system, so it is better, in his thinking, to take the money out of the hides of the rich than to subsidize student loans at the expense of, say, women’s preventive health care. Do these pairwise comparisons, and it is clear just who will win every time.

In a sense, the economic situation is worse than we thought.

What is missing in his argument is how the aggregation of these choices work in the long run. Matters of distribution never operate in isolation from the system as a whole. At some point—and it is a point that we have already passed—high marginal tax rates contribute to the decline in investment, which in turn leads to a decline in job creation throughout the economy, and a reduction in the funds available for other programs. The President, for example, noted the decline in support for higher education in many states. He did not mention that pension funds for public employees have first dibs on those dollars.

For the President, bad economic news never has any structural antecedents. Nor, for all his concern with the future, does he understand that the job creation engine is at best in neutral. At Washington-Lee, he talked about the purported success of job creation in his administration, even though the 8.1 percent unemployment rate is as low as it is because a large number of potential workers have dropped out of the market, so that overall labor market participation is down. That decline reduces the tax revenues needed to fund various schemes, so that the downward cycle continues unabated. The investment that we are supposed to make in long-term human capital will, almost by definition, not be able to turn this market around in the short run.

Yet, in a sense, the economic situation is worse than we thought. Even if the President was making the right investments in human capital, they would only start to pay off years from now. If, as there is every reason to fear, subsidized loans misdirect long-term investment, then the nation faces a double whammy that further dampens the overall prospects for an economic recovery. It makes no sense to argue in terms of absolutes by insisting that the national interest is to ensure that a college education “is available to everyone and not just a few at the top” (in the President’s words). There is a lot of ground between the education of the few elites and college for all.

The success of any educational program lies not in the grand opposition between the few and the many. It lies in making a set of sensible decisions that, on average, seek to improve the overall productive capacities of a nation. For some young people, it means finding ways to get them a set of skills that make it possible to hold down a regular job and learn the life-skills needed for steady advancement. For others, the goals should be far higher.

President Obama’s uncritical exhortations for universal higher education make it only harder to match the individual abilities and skills of students with the job opportunities they need. The implicit subtext of the President stresses two themes that could prove the undoing of this nation. The first is centralized control over educational resources through expanded federal loan programs. The second is the constant exhortation to increase the size of transfer programs through ever-higher taxes on the rich. It is this very toxic combination that has made the current recovery so feeble. 


Richard A. Epstein, Peter and Kirsten Bedford Senior Fellow at the Hoover Institution, Laurence A. Tisch Professor of Law at New York University, and senior lecturer at the University of Chicago, researches and writes on a broad range of constitutional, economic, historical, and philosophical subjects. He has taught administrative law, antitrust law, communications law, constitutional law, corporate law, criminal law, employment discrimination law, environmental law, food and drug law, health law, labor law, Roman law, real estate development and finance, and individual and corporate taxation. His publications cover an equally broad range of topics. His most recent book, published in 2013, is The Classical Liberal Constitution: The Uncertain Quest for Limited Government (2013). He is a past editor of the Journal of Legal Studies (1981–91) and the Journal of Law and Economics (1991–2001).


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