America’s education bubble

Making student loans more affordable could be detrimental to the economy

 
Mohamed El-Erian
Author: Mohamed El-Erian
January 13, 2016

One of the fundamental purposes of government is to advance important public goods. But, if not handled carefully, the pursuit of significant social goals can have unfortunate economic and financial consequences, sometimes even leading to systemic disruptions that undermine more than just the goals themselves.

Mohamed El-Erian

This happened a decade ago in the US, with the effort to expand home ownership. It has been playing out more recently in China, following an initiative to broaden stock-market participation. And it could happen again in the US, this time as the result of an attempt to improve access to funding for higher education.

Cause and effect
In the first case, the US government eagerly supported efforts to make mortgages more affordable and accessible, including the creation of all sorts of ‘exotic’ lending vehicles. The approach worked, but a little too well. The surge in debt-enabled demand to drive up real-estate prices, while the banks’ greater willingness to lend led many people to purchase homes they couldn’t afford. The collapse of the subsequent bubble – a major contributor to the 2008 global financial crisis – nearly tipped the world economy into a multi-year depression.

In China’s case, the government hoped that broader stock-market participation – achieved through efforts to bolster equity prices and promote lending for investment – would make citizens more open to pro-market reforms. Again, the approach proved too effective, and a bubble formed.

Now, the government is trying to counter the risk of a disorderly deleveraging that would damage the Chinese economy and produce significant knock-on effects for the rest of the world. America’s effort to expand access to student loans – a fundamentally good initiative, aimed at enabling more people to pursue higher education – carries similar risks. Fortunately, there is still time to do something about it.

Universities are often slow to adapt their curricula to the economy’s needs, while new technologies and business models are exacerbating the winner-take-all phenomenon

No one doubts that investment in education is vital. Numerous studies have shown major returns for individuals and societies alike. Higher levels of educational attainment improve overall economic wellbeing and prosperity, lower retirement burdens, and enhance social mobility and satisfaction. The unemployment rate for college graduates in the US, at 2.5 percent, is roughly one-third the rate for those without a high school diploma. What policymakers must determine is how to invest in education in ways that maximise these benefits, without creating new risks. This is where the US risks falling short.

Over the last 10 years, the combination of higher tuition fees, more student enrolment and greater reliance on loans has caused the stock of outstanding student debt to nearly triple. It now stands at well over $1.2trn, more than 60 percent of which is held by the bottom quartile of households – those with a net worth of less than $8,500.

Today, seven out of 10 post-secondary students graduate with debt, with the total volume exceeding debt from credit cards and auto loans combined. Moreover, student loans constitute 45 percent of federally owned financial assets.

Making matters worse, the return on investment in education is falling, because the economy is growing slowly and changing rapidly, making it difficult for some graduates to secure employment that takes advantage of their knowledge and skills. Universities are often slow to adapt their curricula to the economy’s needs, while new technologies and business models are exacerbating the winner-take-all phenomenon.

Battling for investment
If the return on investment in education continues to decline, the servicing of student loans will tend to crowd out other consumption and investment outlays, especially given that student debt has considerable seniority in the capital structure. In this scenario, the risks of default and delinquency would rise, along with financial insecurity and general instability, all of which would exacerbate the inequality trifecta (income, wealth and opportunity).

The good news is that, though some 10 percent of borrowers already face repayment problems, the macroeconomic and financial tipping points remain some way off. But this is no excuse for complacency; it merely provides time for a concerted effort to implement measures that will ameliorate the destructive trends stemming from student loans.

The work to be done
First and foremost, US politicians need to take full responsibility for economic governance, seeking not only to boost growth, but also to avert a reduction in long-term growth potential. After depending on unconventional monetary policy for far too long, the US Congress needs to adopt a more comprehensive approach, with measures aimed at improving worker training and retooling, modernising education curricula, and incorporating transformational technologies more effectively into the economy. Increased infrastructure investment, better corporate-tax policies, and an updated budgetary approach are also needed.

For their part, universities – which have benefited considerably from the wide availability of student loans – should rein in their costs, while offering more direct financial aid funded through philanthropy. Some universities have already adopted ‘no loan’ policies; students’ demonstrated financial need is met entirely with grants financed by the university and other donors.

Not all universities need to go this far – and most can’t, because they lack large enough endowments to cover the costs. But a broader move in the direction of non-debt financing of higher education is needed.

Efforts could also be made to encourage households to save more, starting earlier, for education. Student loan disclosures should be made more transparent, thereby enabling applicants to make responsible decisions, with lower-cost two-year community colleges serving as a useful stepping-stone to a traditional college education. And more could be done to expand income-based repayment schemes.

None of these measures will be easy. But if implementation continues to lag behind realities on the ground, the challenges will be far greater down the road. As borrowers’ growing debt burdens limit their financial flexibility and productive contribution to the economy, the policy emphasis will shift from mitigating future risks to reducing indebtedness directly through loan forgiveness and bailouts. That would raise thorny issues of fairness and misaligned incentives, and could ultimately have the perverse effect of reducing educational access.

Mohamed El-Erian is Chief Economic Advisor at Allianz

© Project Syndicate 2015

  • michael1234

    DEFINITELY!!!!

    Cutting students debt and allowing them higher quality of life with more money to put into the economy or save for retirement is AWFUL for the economy!!!

    Our young people, our students, are the future of the economy.

    When I see articles written about how it’s a good idea to make sure our students and young people are more straddled with high interest loans when they are just starting out in the world, it tells me that the author is at least a little bit out of touch.

    Authors analogies were nonsense. His “solutions” were the standard “tell people to save more” nonsense Ive heard a thousand times.

    Sorry, Mohamed, you live in the clouds. And your also at the age from the looks of it where even if the sky fell like you probably think its going to, you will be well into retirement by then anyway, and if you have kids, and you’re not super rich, then you’ll need them to take care of you.

    So it’d be in your best interests to make sure our students and our young people are set up for success and not failure. Because every single argument against free education or lower student loan rates is nothing more than a desperate attempt to make sure THEIR lives are wonderful, and screw the students.

    But that thinking only hurts the students, and the retired, and everyone else in between.

    That is, unless you’re a one percenter, which I’m pretty much 99.9% sure that this author is. Unless he is just a shill for one, which is equally probable.

    Again though, aside from your fancy rhetoric and doom-and-gloom, lower student loan debt or no student debt at all, or even tuition free public universities, will only help you, along with everyone else.

    I mean, you say “the economy is growing slowly”……well, of course it is….. you are defending the people and corporations and institutions that get rich off of making citizens poorer, rather than defending the citizens and advocating for things that put more money in their pocket to GROW THE ECONOMY.

    Obviously the corporations and wealthy are not helping to do that. Funny, we are the richest country in the world. You’d think we’d be able to grow our economy faster…I wonder why we can’t? Maybe it has to do with wealth being hoarded, instead of it being used to grow the economy….