The Worst of Both Worlds

When the federal government’s major student aid programs began in 1965 (a big component of President Johnson’s “Great Society”) the theory behind them was simple: college improved students’ human capital, so by making it more affordable, those policies would benefit the entire nation. We would get a better educated and therefore more productive and innovative labor force.

Opposition to federal student aid was negligible. The idea sounded so good.

Experience, however, has taught us that government programs almost never work out as well as expected and usually have harmful side effects.

If President Johnson had said, “Let’s subsidize students to go to college so that colleges can charge much more and students can decrease their learning effort,” he would have gotten no support for the legislation. Nevertheless, it seems that we have achieved both of those undesirable outcomes.

Regarding the increasing cost of higher education, in 1987, then-Secretary of Education William Bennett wrote an article for the New York Times, “Our Greedy Colleges,” in which he argued that federal student aid programs were responsible for rising tuition. Bennett argued that college officials, knowing that the government was putting more dollars in student pockets—dollars only spendable at accredited colleges—maximized their revenues by capturing those dollars.

That came to be known as the Bennett hypothesis and it was highly controversial. Many defenders of the education status quo scoffed at it, while some economists and education analysts found it persuasive and at least to a degree supported by evidence.

A recent paper published by the Center for College Affordability and Productivity gives the Bennett hypothesis a fresh look. Author Andrew Gillen writes that the original hypothesis was largely correct—federal aid does enable colleges to charge more–but was in need of three refinements.

Not All Aid is Created Equal. The student aid programs are not all the same, and the differences matter. What matters in particular is whether programs are targeted at low-income students. If they are, Gillen concludes that they lead to little or no increase in tuition because the schools that enroll those students, who otherwise probably wouldn’t have attended college at all, aren’t able to increase their charges across the board. On the other hand, aid programs that are universally available are likely to fuel tuition increases.

Selectivity, Tuition Caps, and Price Discrimination.  Just as aid programs aren’t all the same, so too for colleges. Some are very selective among applicants, while others will accept almost anyone. Some have tuition caps (most state schools do), while others are free to charge whatever the market will bear. And some schools practice price discrimination—that is, charging some students more than others based on ability to pay.

At schools where state government sets tuition limits, the effect of increasing aid, Gillen argues, is simply to allow schools to be more selective. Private colleges have far more leeway to raise tuition and since they learn a great deal about family finances through FAFSA (the student aid application form) they can adjust their pricing to individual students, including their student aid packages. Competition to enroll certain applicants, however, restrains this revenue-maximizing technique somewhat.

Taken together, those two refinements help explain why each dollar increase in student aid leads to less than a dollar in tuition increases.

The Dynamic Story. College leaders often say that they’re overwhelmingly concerned with the welfare of students—giving them the best education at the lowest possible cost. Many say that, but act as revenue maximizers, justifying tuition increases as necessary if the school is going to be able to give “the best education.” Let’s suppose, though, that some schools really did keep tuition constant even though they could charge more.

Gillen argues that the nature of competition in higher education puts great pressure on those schools to eventually raise tuition so they can “keep up with the Joneses.” That is, they’ll lose position in the pageant of prestige and student amenities that means so much in the competition for students. It’s true that on occasion we hear of colleges that lower tuition to attract more students, but more often, the “Chivas Regal” effect holds: Colleges that cost more are regarded as being better and draw more applicants.

Considering all that, Gillen concludes that his “Bennett Hypothesis 2.0” means that the major effect of our efforts at making college more affordable has been to make it more expensive.

Now, what about the impact of federal student aid on learning?

There is good reason to believe that college subsidies have had a negative impact on student effort. Just as individuals tend to take better care of property they have paid for than property they have been given, so it is with education. When people pay the cost of some educational endeavor (whether it’s just learning various “how to” manuals for your home, or undertaking a Ph.D.) they’re apt to take it more seriously than if other people are paying for it.

Aysegul Sahin, an economist with the Federal Reserve Bank of New York, came to that conclusion in her 2004 paper on the incentive effects of government subsidies for higher education. “Subsidizing tuition,” she wrote, “increases enrollment rates, however it also considerably reduces student effort.” That isn’t only true among marginal students, she found, but “even the more highly motivated ones respond to lower tuition levels by decreasing their effort levels.”

Sahin’s paper dovetails with the report on student effort by economists Philip Babcock and Mindy Marks. They found that the average amount of time that college students devote to their coursework has fallen greatly, from 24 hours per week in 1961 to 14 hours per week in 2010. They attributed the decline to falling standards, but standards may well have fallen precisely because students aren’t as willing to work. That, in turn, may be because they think other people are paying for it, as they often are.

Federal student aid has not only had the unintended consequence of lowering the effort of students in college, but has also had the unintended consequence of lowering academic achievement before college.

Professor Jackson Toby explained that connection in his book The Lowering of Higher Education in America (which I reviewed here). Toby wrote, “Most federal student grants and loans do not require strong academic credentials, and these flabby requirements enable underprepared students to attend college. Since marginal students know while they are still in high school that they will be able to be admitted and get financial aid at some college, they lack an incentive to learn as much as they could in high school….”

The Pope Center has often drawn an analogy between the housing bubble and what has been going on in higher education. Professor Toby’s point strengthens that analogy. Prior to federal intervention to make home ownership “more affordable,” people who wanted to buy a house had to work and save to accumulate enough for a 20 percent down payment. Credit was only allocated to those who had demonstrated their credit-worthiness.

Government intervention in housing finance destroyed the old system and its virtues. By 2005, almost everyone could get a mortgage and buy a house. We know how disastrously that has worked out.

By the same token, prior to federal intervention in student aid, students in high school had strong incentives to excel so that they would have a chance at college if they wanted it. And because they paid most of the (much lower) cost, they took their studies more seriously if they eventually enrolled.

The virtues of the old education system were undermined by easy federal money in exactly the same way easy federal money undermined the housing finance system. Now we have far more students going to college, spending a lot more on it, but many learn little or nothing. Instead of getting the imagined benefit of a more educated population, we have only managed to create an enormously bloated higher education sector that graduates many people with lower levels of knowledge and skill than used to be expected of high school students.

It’s time to pull the plug.