Ethics & Public Policy Center

2015 Bradley Symposium: Remarks by Andrew Kelly

Published in 2015 Bradley Symposium on July 6, 2015


EPPC

“The Future Of Higher Education”

The Economics of College

The Four Seasons Hotel, Washington, D.C.

June 3, 2015

Speaker: Andrew Kelly, American Enterprise Institute

Presentation slides

Andrew Kelly

Andrew Kelly

Andrew Kelly: Thanks to Yuval for that kind introduction and the invitation to participate as well.

It is an honor to follow President Daniels.  You know he has been the President of a think tank.  He has been the Director of the Office of Management and Budget.  He has been the Governor of Indiana among other things.  But I would imagine actually that none of those jobs were as challenging or as controversial as being a reform-minded President on a traditional college campus.

Entitlement reform that is a cake walk compared to convincing the faculty center that they should measure student learning in a systematic way.  Balancing the state budget; yeah, try freezing tuition when state appropriates less money for your institution.

Kudos to you President Daniels for the good forward thinking work you are doing at Purdue.  If there were more leaders like you we’d probably have to have fewer panel discussions about the future of higher education.

I’m here to convince you of three things.  I am sorry I am going to inflict a PowerPoint on you.  I apologize for that in advance.  I told Yuval if I was the only one using PowerPoint that I wouldn’t do it but it turns out I am probably the only one I think.

So, three things.  First, college affordability in my opinion is going to be the defining middle class and working class issue of the coming decades.  And politicians who want to win better have something constructive to say about it.

Second ,when it comes to policy, the old way of doing things is not only failing but it is also making things worse.

And third, there is another way forward, one that can expand educational opportunity and is in keeping with conservative principles of choice, competition, and entrepreneurship.

So specifically what I am going to do today is answer three question.  Why higher education reform?  And I’ll talk about three trends that I think really crystallize why we need to be talking about this as an issue.  How did we get here?  I’m going to describe very briefly the sort of problems I see in the system and how we actually wound up in this predicament.  And what can we do about it?  And that is where I am going to lay out four big ideas that I hope we can discuss in more detail in the Q & A.

Why higher education reform?  Well. three trends, I think, are critical.

First, people know this trend: this is the trend in tuition, sticker price of tuition.  The black line is median household income; the blue line is private non-profit sticker price of tuition at private non-profit four year colleges.  And the red line is sticker price of tuition at public.  So you can see that the upward trajectory was steeper for privates in the mid 80’s and the early 90’s but then the public sector really took off over the past decade or so.

It has been trouncing family incomes and it has also grown faster than just about every other good or service in the economy as well.  And it is true that net prices, which is the price you pay after accounting for grants and scholarships, has grown less quickly than the sticker price.  That is important to note.  But there are two things to remember about that.

Number one, if family incomes have been flat or declining then it is still harder to keep pace even with moderate increases in net price.  Also, much of the moderation in net price increase was due to an unprecedented influx of federal money in the form of increased Pell Grant spending.  The size of Pell Grants basically doubled during the early years of the Obama administration.  So that has now plateaued and net prices have now started to climb again.  So that is the first trend to think about.

The second trend is the absolute returns to a degree; that is, the wages that recent college graduates earn. They’ve actually been flat or declining, and it has been that way for quite a while.  This is from 1970 all inflation adjusted.  This is for young men ages 25 to 34; the blue line is bachelor’s degree and the red line is associate’s degree.  And you can see since 2002 there has basically been a downward trend in wages for recent college graduates with bachelor’s and associate’s degrees.

And why is this important?  Well, because this means that you are paying more for a degree that in absolute terms is actually not worth as much as it used to be, which raises all sorts of questions about how you were able to pay for it and whether you were able to pay off your loans.

It is worse for people who have some college and no degree.  They earn even less.  They look a lot like high school graduates these days.  There used to be some return to taking some college classes.   Recent college dropouts actually look a lot like high school graduates.  And they often have debt.

The problem is we have a lot of dropouts, as anybody who has looked at graduation rates can attest.  These are graduation rates by the institution you started at.  So if you started at a two-year public, just 40% of students finish some kind of credential — associate’s degree, bachelor’s degree, certificate –within six years.  This is for the 2008 cohort, the most recent data available.  It is from the National Student Clearinghouse.

It is not much better at four-year publics.  It is higher but we still have a little less than 40% of people who are not finishing or credentialed within six years and again taking on debt.

So you add up trend one and trend two and what do you have?  You have a lot of struggling borrowers.  These are numbers from the Consumer Financial Protection Bureau in 2013.  They looked at who was actively repaying their loans when they were supposed to be.  And essentially what happens is people who are in school or in the grace period don’t have to repay.  But if we include them all on the denominator then actually the rate of default or forbearance looks better than it actually is.  But if you look — I mean, 40% of people were not actively repaying down their loans in this latest cohort.

Struggling borrowers are the story for many politicians these days.

We usually stop, we have trend one and we have trend two and we usually stop there; right.  And we start asking is college worth it?  And then based on the cost and returns a lot of people have concluded no, it is no longer worth it.  It is too expensive and you don’t get much for it.

This was a high profile Newsweek article.  There are lots of magazine covers and book covers that I could have put up here that match this story line.

But this is where the third trend comes in and I think this is really important for the way we talk about this issue and we think about this issue.  And that is that high school graduates have had it even worse than college graduates.  You can see the green line is wages for people with high school diplomas and they’ve basically fallen off a cliff even more quickly.  Their labor market prospects have dimmed considerably since the 1970s, in large part due to hollowing out of middle-skill jobs and manufacturing and so on.

So as a result the wage premium attached to a college, despite the absolute returns, are down or stagnant or declining, the wage premium attached to it meaning the gap between your earnings and the earnings of a high school graduate have actually increased over time.  Same is true for associate’s degrees.

So what does this set up?  This sets up what I call the college conundrum.  This is what families face.  And the college conundrum is that some education after high school — and I should just stress here I am not talking about bachelor’s degrees, I’m talking about associate’s degrees, certificates, technical training, some kind of education post-high school — has become more important to economic mobility, but it is also more expensive than ever before, and it is also riskier than before because it is both more expensive, and completion rates have actually declined over time.

So this sets up what I call the Enterprise Rent-A-Car problem for a lot of people.  And if you’ve watched college sports you’ve seen the commercials, Enterprise prides itself on hiring BA college graduates.  And during college sports they profile former athletes who work and run their rental car counters.  So some of us see that, and I myself say, gosh four years of college to run a rental car counter.  Like college isn’t worth it anymore, is it?

But I think it is really important to think about parents, especially from middle-income and working-class families, for them it is a much more terrifying proposition which is: my kid can’t even work at Enterprise Rent-A-Car if they don’t go to college.

And so harping on the fact that too many kids are going to college I think is tone-deaf.  It is tone-deaf to the anxieties of the middle class.  And this is why it is a defining middle-class issue.  And we have to have something to say about it.

People feel trapped.  They can’t afford to go and they can’t afford not to; the cost of both have increased.

So how did we get here?  And I’ll march through these four problems quickly.  We need to know where we’ve been to know where we should head next.  I’m not going to do a full hour-long lecture on why college costs so much.  That would bore everybody to tears.  It is way too complicated to get into.  So I’m just going to highlight the four key pieces of the market that I think are problematic.

So the first is that we have a third-party-payer system and we have easy credit.

So federal aid, student aid programs started out with a noble purpose, that was to solve an under-provision problem.  There were poor people who would benefit from higher education that couldn’t get access to it because they faced financial barriers.  It was targeted, it was need based.

This has now turned into a large entitlement for anybody with a high school diploma and, in fact, for anybody’s parents who attend college.  There is a parent loan program you can now access if you are parents.

In the 1970’s we made upper and middle class and then eventually upper-income families eligible for federal loans.  They used to be need-based then we sort of opened the flood gates in the late 70s.  That is why you see that increase in tuition among private colleges in the early 80s.

In the 1980s we opened up the loan program to parents.

In the 1990s we made that parent loan program, we took away the annual limits on how much you could borrow.  Now you can borrow up to the cost of attendance, unlimited borrowing up to the cost of attendance.  As long as you have a kid in college you can borrow money to defray the costs.

In the 1990s we created a host of tax benefits that disproportionately benefit upper income families.

And then in the 2000s because we weren’t quite finished yet we created a graduate student loan program, a federal graduate student loan program that allows again graduate students to borrow up to the cost of attendance unlimited amounts.  If you continue to enroll in graduate school you can borrow as much as you want.

As somebody who took eight years to finish their Ph.D. I know that the incentive is not there to really finish up your studies as quickly if you have access to these credit programs.

I think it is really important though to distinguish here for the purposes of thinking about tuition inflation and the perverse incentives between programs here.  So I think it is important to focus in particular on the loan program.  And within the loan programs on the parent plus and grad plus programs which have unlimited borrowing up to the cost of attendance.

Stafford loans for dependent students, you can only borrow up to $31,000 over the course of your career which is, you know, it is a substantial sum of money but it is not as much as you might think.

So spend we have.  And we have particularly spent a lot over the past decade or so.  The Obama administration has both increased the size of the Pell Grant program, spent a lot more on it, has increased the size of federal tax benefits.  And people are borrowing a lot more.

A lot of this has to do with the bump in enrollment, right.  More people are going to college.  But we are also spending more per person in federal aid.

Here is what we have to show for it over that decade, the net price of attendance for middle income families has gone up considerably.  This is the net price as a percent of your income.  So if you are attending a private four-year college as a middle income family you’re paying nearly 40% of your income after taking account of grants and scholarships; public doesn’t look much better.  It probably looks better at Purdue.

So what is the theory of action here?  Well as far as I can tell it is subsidize, watch tuition rise and subsidize some more.  It is what I have called you are trying to bail out a boat with a Dixie cup.  You can work really hard and stay ahead of it for a little while but eventually you get tired out and you get swamped.

So pouring money into a system with misaligned incentives is not going to change the incentives.

What is the problem number two?  We have inadequate quality assurance.  There is almost no underwriting on federal loans.  You get the same terms whether you are going to Harvard or Harvard Upstairs Medical College, it is the same basic idea, Joe’s Barber College, Jay’s Technical School.  And what happens is as a result lots of federal money flows to bad colleges.

This is from a study that I did where I looked at where student loan dollars for undergrads went according to the school’s graduation rate; six year graduation rate on the bottom, or I should say 150% time graduation rate.  So you can see 37% of our loan disbursements go to places that have graduation rates under 40% that graduate fewer than 40% of their students.

The regulatory triad which is sort of the three-pronged approach to regulating higher ed that is the federal government, accreditation agencies, and state governments is an ineffective gatekeeper when it comes to eligibility for federal aid.  And it also has a bunch of other problems that I’ll talk about.

This is sort of technical.  I can skip over this.  The main rule that the federal government has to hold schools accountable is called the Cohort Default Rate.  It basically says that if more than 40% of your students default on their loans within three years after they stop attending, whether they graduate or not, then you are kicked out of the program.

I said this to an audience of finance people in New York and they like could not contain their laughter.  40% default rate on a financial product is unheard of.  But as long as you are below the threshold and as long as people don’t default within that three year window you are held harmless, we don’t care as far as the federal government is concerned.  So just eight institutions were sanctioned in 2011; sorry and they weren’t even sanctioned, they were subject to sanction.  We don’t know whether they were actually sanctioned or not.  It is really hard to find any kind of information on who was actually sanctioned.

Accreditation I’ll get into a little bit more detail in a second but it is a process of peer review essentially.  It is built on a conflict of interest. Faculty from the neighboring college down the street come and review your programs and say hey, you look a lot like us and this looks great, you know, you are approved.  Terrific.  So no surprise, the GAO did a study of this, they found that only eight percent of schools were sanctioned and just one percent lost their accreditation.

We know there are a lot of bad colleges.  We know that there are more than one percent.  Bad colleges maintain access to federal aid.

Problem number three, we have imperfect consumer information.  This is actually from an article in the Atlantic by a friend and colleague of mine where she said wouldn’t it be great if we had a nutrition facts kind of approach to college.  It just warned you, it said like look you are going to take on a lot of debt and you are not going to earn anything and you are not going to graduate so just be careful here.  You can still go and consume it if you want to.

What’s the problem?  We have very imperfect date or non-existent data in some cases on costs and outcomes for students.  You don’t know what the likely return on your investment is a priori.  It is hard to tell so in fairness it is an experience good.  You are not going to know until you actually get in it, until you actually enroll whether the college is right for you in some cases.

But we could do a better job.  We could collect better data on how graduates fair in the labor market.  Are they actually able to pay back their loans and so on.

So limited ability to judge cost and quality, what does that do? Well, it blunts market discipline.  People can’t really effectively vote with their feet.  Colleges can promise you all sort of things.  You have no way to validate whether their promises are accurate and you continue to invest in bad programs.

Problem four, this is a big one.  And I think Dr. Tabarrok will probably talk about this.  This is the existing system creates barriers to entry that limit competition in a way that is not allowing competitors in to actually offer a better product at a lower price.

So right now colleges are moving, thanks to advances in technology, colleges are moving from a logic of scarcity to one of abundance.  And what I mean by that is that in the past it made sense to bundle things together because smart people were scarce and books were scarce and talented students were scarce so we brought them all together in one place, put them on one campus.  And we rationed access to that; couldn’t have everybody coming in.

But thanks to advances in technology ProctorU will allow you to take an exam from your own house.  It will monitor whether you are cheating or not.  It will make sure you are not sort of looking up the answers on the internet.  Mozilla Open Badges, anybody can go on there and create an open badge with assessments attached to it that says you have completed this task and here are the skills they proved in completing it; EdX and Udacity, two of the massive open online course providers; and then General Assembly, which is not online at all, it is an in-person immersive set of courses on web development and different kinds of professions.  All these things are operating on the periphery.  But guess what, the accreditation system keeps new entrants out, acts as a moat; just says, nope, sorry, you are not coming in here.  You don’t look like a college.  You haven’t attracted enough students for us to approve you.  You don’t award degrees.  If you don’t award degrees you can’t get accredited; degrees or certificates, can’t get accredited.

So what happens is accredited schools can get access to federal aid, these guys can’t, so if you are a student and you are choosing between paying out of pocket for something versus paying nothing, getting a free education at the community college down the street, you are going to choose often the free option.

So faced with these problems what has been the progressive response?  It has been more of the same.  It has been more of the same tired answer.  Now we’ve moved on to expanding income base for payment programs and loan forgiveness.  This is one of my favorites, this is one of those companies that advertise that you pay them and they help you access things that are federal programs that you are entitled to anyway.

But this is what’s happened.  So income based for payments says if you qualify to pay your loan payments to your income you are going to pay 10% of your income and then after 20 years we are going to forgive your loans.  If you go into the public sector we will forgive your loans after ten years.  And public sector by the way includes non-profits like my own and others; so very loose definition of public sector forgiveness.

The best part is guess who is eligible for loan forgiveness and income based payment, graduate students who have access to unlimited borrowing.  So what happens to graduate school tuition, it goes through the roof.  And we start paying for it as taxpayers, pay for all that loan forgiveness.

Loan refinancing, Elizabeth Warren’s proposal, she wants to allow everybody to refinance at lower rates; massive, inefficient program that would not target the money to the borrowers that need the help the most.

Increased state spending, there has been just a repeated call for that.  Governor Daniels may have some thoughts about that.

Also progressive responses to regulate more; the Obama administration spent a long time trying to regulate colleges more heavily with gainful employment first of all for the for-profit colleges and college ratings.

And now with the free college proposal people hear that and they say oh, that is free college and what does that have to do with regulation?  Well if you read it carefully and you read the ideas carefully what this is is a move away from the market, it is a move away from a voucher based market where people can take their voucher to any provider they want, public, private, for-profit and a move to direct federal control, direct federal funding of institutions which conservative reformers need to resist this wholeheartedly.

So also it is worth noting just before I segue to my solutions and I swear I’ll be brief with those these solutions are premised entirely on the existing set of institutions and the existing set of financial aid programs.  There is no — there is very little creativity here.

This just says let’s supersize community colleges.  Let’s make them free and have everybody go.  But demands have changed massively.  The world has changed and our approach needs to change as well.

So what can we do?  So four solutions quickly and I’ll zip through them.

So we need to give colleges a great stake in student success, and the way that I’ve proposed that we do this, I know others in the room have talked about this as well, is to give colleges skin in the game.

Colleges essentially originate loans.  You can’t get a student loan unless you are affiliated with a college and you enroll there, but they bear none of the risk.  They bear little of the risk if you fail.  Only if you get near that threshold do you bear any of that risk.

So what would this proposal do?  This would put colleges on the hook for a share of the loans their students aren’t repaying.  They’d have to think twice about enrolling people they know are not going to be successful.  They have to think about offering a lot of programs that are not going to lead to good jobs and so on.  It sets a basic standard but colleges have the flexibility to make it.  It is not a top-down regulatory approach that says you have to do the following things to improve.  It says we are going to hold you to this standard and you are going to have to get there.

We need power consumers with better data on costs, outcome and value.  Those are public goods in my opinion.  They help the market work.  They help serve taxpayer interests and family interests.  So in my opinion the feds are sui generis in their ability to collect these data.  States could try, but in terms of return on investment and how do people fare in the labor market.  States can collect some of it.  And some of them are doing it.  But they can’t follow people across state lines.  So it is an inefficient approach.

And you can prevent misuse by legislating prohibitions.  And I think the key here is to collect these data, open it up to a set of third parties that can make lots of customized rankings and ratings; actually measure what colleges do, not just the selectivity of their admissions process.  That is how we rank colleges now.  We say oh, how good were your undergraduates that you brought in?  How good are your inputs; right, which is nonsense.

Three we need to lower barriers to entry.  I would imagine Dr. Tabarrok will talk about this as well.  We have an opportunity to redefine what education looks like, who can offer it.  We’ve done this a lot in the past.  We created land grant colleges as President Daniels referenced.  We created community colleges.  We created research universities.  We’ve been through rounds of reinvention and the problem right now is we are just showing a tremendous lack of imagination as a policymaking community.

So my idea is to create a parallel path.  Think about the charter school movement.  Charter school policy allows new entrants into the markets to offer the same product.  The horse trade would apply there too; organizations that want access to this new pathway would get more flexibility about how they offer education in return for transparency and accountability.

And then last, and I know this is an idea that is near and dear to President Daniels’s heart as well, we need to create space for private financing.  And the idea that we’ve proposed before is what is called an income share agreement where investors would front the money for education in return for a fixed percentage of somebody’s future income over a fixed period of time.

What does that do?  Well, it aligns the incentives of the lenders or the funders with the incentive of the students.  The funders only reap a return if the students are successful.  So the funders are going to help people navigate toward programs that are likely to lead to a positive return on investment and so on.

But critically, we need to resolve important regulatory and legal questions around the enforceability of these contracts and where would it be, which institution would regulate at the federal level so there is a federal role here for policymakers.

So those are four big ideas.  I look forward to discussing them.  Sorry to inflict a PowerPoint on you but thank you for your time.  Appreciate it.

Applause

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