How Student Aid Chases Its Own Tail

With the Obama administration pushing for major changes in federal college aid policy, this is an apt time to stop and ask how well the current policy works. Obama’s plans may be pushing us 180 degrees in the wrong direction.

Here’s the conventional wisdom regarding government student aid: the cost of college keeps rising, so government must provide students with enough financial assistance to make it possible for them to attend. Without government aid, many prospective students wouldn’t be able to start and complete their college degrees.

If you look at things that way, the federal government’s assortment of financial aid programs has been quite successful, since the percentage of high school graduates going on to college has remained fairly stable for many years, despite the rapid escalation in tuition and other expenses.

There is, however, another way of looking at it. Those who are familiar with the unintended consequences of government programs will probably find this way persuasive.

Andrew Gillen’s new paper “Financial Aid in Theory and Practice: Why it Is Ineffective and What Can Be Done About It” argues that government financial aid contributes significantly to the upward cost spiral in college education. Like a dog chasing its own tail, the more the government tries to help students catch up with college costs, the more those costs increase. If that’s the reality, then federal student aid programs are not a success, but have merely been shoveling money into college and university coffers.

The key to understanding college spending, Gillen contends, is to view schools as non-profit competitors that try to gain market share in their industry by increasing their prestige factor. Unlike for-profit enterprises, where the executives improve their companies (and themselves) by maximizing profits, the executives in higher education—college presidents—improve their schools by enhancing their perceived prestige. The more prestigious a college, the better the students who apply, the better the faculty who can be hired, and the better the fundraising opportunities.

And the key to increasing prestige turns out to be spending more money.

That’s because “The Bible” for college leaders (the U.S. News and World Report rankings) is heavily weighted toward the size of a school’s budget. The costlier the inputs, the better the educational product is assumed to be. That makes college presidents ravenous for money, but not much concerned about efficiency. Given their incentives, bringing in more funds is far more attractive than cutting out unnecessary spending. Gillen quotes Cornell professor Ronald Ehrenberg who says they’re “like cookie monsters…They seek out all the resources they can get their hands on and then devour them.”

Therefore, higher ed leaders will try to increase tuition as much as they can. When a state or the federal government increases the amount of student aid, thus putting more college dollars in student pockets, higher ed leaders see the opportunity to help themselves to some more cookies.

This isn’t a novel argument and Gillen acknowledges that, citing work as early as 1980. What is novel, I believe, is that he clarifies how schools play the aid-gobbling game (and why some can’t). He introduces a concept familiar to economists—price discrimination—and applies it to higher education.

Price discrimination is a tactic for maximizing revenue by charging different customers different prices based on their ability to pay. The government’s financial aid system makes this a breeze for colleges by providing them with FAFSA data showing the degree of family resources students have behind them. They can increase prices for students who can afford to pay more and give tuition discounts to keep students who might not be able to afford the school.

Gillen puts his point this way: “Specifically, aid will fuel increases in spending when it is given to students whose ability and willingness to pay is in excess of current costs at the school.” If the student body at a college includes a fair percentage of students from more prosperous families, the administration can increase tuition to rake off much of an increase in financial aid that government makes available to those students. That money will be spent in the pursuit of more prestige. Politicians will then point to the tuition increases are the reason for still more government aid.

A dog gets tired chasing its own tail and eventually stops, but in the college financing business, the energy comes from taxpayers, who aren’t allowed to stop paying.

If it’s true that the current federal financial aid system does much more to help college presidents participate in the “arms race” of prestige spending than to enable students from poorer families to afford college, how should politicians change the system?

Gillen advocates that student aid programs be reformulated so that they only assist low-income students. College leaders, he argues, won’t be able to use price discrimination to skim off aid targeted just at students who are just at the edge of being able to afford to attend.

If that could be done, it would make sense. The problem is that once people have gotten used to government subsidies of any kind, it’s politically very hard to take them away. The current system spreads a lot of money around, much of it going to students who don’t really need it to afford college. The Pope Center’s Jenna Robinson wrote about the phenomenon of federal student aid helping to subsidize nice lifestyle spending. Protests from middle-class families who feel entitled to federal money for college might doom Gillen’s proposal, but that is not a criticism of his analysis, of course.

My only quibble with the paper is that Gillen seems to accept that standard belief that putting more students from poorer families through college is a worthy goal. At no point, at least, does he question that. I can see good reason why Gillen wouldn’t want to; he has enough controversial arguments without raising another one that is tangential. So I will raise it.

Financial aid should not only be targeted just to students who wouldn’t otherwise be able to afford higher education, but it should also be targeted at those who are really apt to benefit from college. As I have often pointed out, the U.S. has so oversold higher education that we now find large numbers of college graduates doing jobs that can easily be learned by people without any educational credentials.

If Congress ever gets around to seriously rethinking its student financial aid programs, it should look at targeting aid more wisely, both with respect to need and to academic ability.