Debt or equity? Options for funding higher education

National Review, Oct 20, 2008 by Kevin D. Williams

WHY does college cost so much? And where can I get some money to help pay for it? Those two questions turn out to be intimately and perversely related.

College is expensive because we are willing to pay for it. This is true for firstgeneration college students struggling through state universities and for statusobsessed children of Upper Suburbia burdening themselves and their families with serious debt as they press onward and upward through Princeton (school motto: "You would not believe how much this costs!") or Haverford (school motto: "No, not Harvard--Haverford!").

College education is one of those touchy products whose price increases far faster than the rate of general inflation. Another such product is health care. And that's no surprise, because education and health care have something in common: Consumers don't usually pay for them directly. In economics this is called a third--partypayer problem. When a health--care consumer considers a procedure, he doesn't ask: How much does it cost? He asks: Does my insurance cover this? Likewise, a would--be Ivy Leaguer doesn't ask, "Can I afford this tuition?" but "Can I get financial aid for this?"

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But in higher education there's a big difference between the price tag and the price. Big Ivy may be asking $50,000 a year, but that rate is paid by a relatively small number of chumps. (What did you think legacy admissions were for, genetic continuity?) You wouldn't know it from reading the course catalogues, but the people who run these universities are not fools. They know that most people can't lay down a quarter--million dollars over the course of four years. But they also know that Uncle Sam, who has a soft spot for college students and a terrible fear of their taxpaying parents, is in the loan business. The government hasn't acquitted itself all that brilliantly in its involvement in other kinds of loan operations (Fannie? Freddie? Who?), but the college--loan racket is hugely popular, as free money usually is. "It's not free money!" students will protest. "We have to pay it back!" That is true. But the interest on these loans is heavily subsidized, both during studies and after graduation. Recent graduates who doubt that should see if they can finance a $50,000 car at the same interest rate, on the same terms, as they financed $50,000 worth of learning.

College administrators know that they can ask much more than people are willing or able to pay because Uncle Sam will step in and bridge the difference between what families have and what colleges are asking. They also know that many of the popular magazine rankings are based on educational inputs, not educational outputs, so spending an extra $1,000 per student each year can send a college up the charts, even if that money is heaped up on the quad and set on fire--or put into undergraduate diversity seminars, which amounts to the same thing.

Contrary to Michelle Obama, who talks as though it had been some kind of hardship to repay money that people lent her to better her life, a subsidized loan is a gift--free money. Considering the payoffs of a college education, this is a wonderful gift indeed. Even if it comes from Humble U, a college degree (as distinct from a college education) is a magical door--opener; there are many jobs and benefits in this world that are for most purposes off--limits to those without a bachelor's degree. As there are basically no substitute goods in this market, it's no surprise that demand for education is relatively inelastic.

But the more money that is available for financial--aid grants and loans, the more colleges will charge. In this sense, financial aid isn't really aid to students but aid to university administrators, who are ingenious in devising new ways to increase their burn rates. Some of the better public universities don't even need tuition revenue at all. Hans Mark, when he was the chancellor of the University of Texas system in the 1990s, caused an uproar by letting it slip that Texas uses tuition mostly as an enrollment--control mechanism. As a percentage of the cost of educating an undergraduate, tuition is pretty small beer. But by charging tuition, and by charging higher tuition at the flagship schools and lower tuition at the satellite campuses, state schools create a modest market mechanism to manage enrollment. The alternative, of course, is rationing, which is essentially what the elite private schools do.

The economics of undergraduate education are not going to change. Too many politically powerful interests have too much at stake in the status quo. Undergraduates are revenue sources, and much of the money that they bring to school with them gets siphoned off for things that have nothing to do with undergraduate education but everything to do with the interests of college administrators and faculty: funding new programs and, more important, underwriting the costs of careermaking research for faculty who may never teach an undergraduate class. Whether the money is coming from tuition, financial aid, or direct government support of universities, undergraduates are cash cows--but there may be a better way to milk them.