Are student loans pushing up US college fees?

This article is published in collaboration with the Washington Center for Equitable Growth.

Bemoan the high price of college tuition these days and someone might remind you that you’re probably talking about the gross price of tuition. Once you include financial aid, such as student loans, the net price of tuition isn’t as high. Harvard University economist Greg Mankiw, for example, cites data showing a 70 percent increase in gross tuition turns into a smaller 32 percent increase in the net price for the student.

It’s clear that financial aid and student loans may ameliorate the sticker shock of college tuition. But what if the student loans—one of the tools to decrease net tuition—were actually increasing the gross price in the first place? A growing body of research is showing just that.

The idea that increased access to student loans pushes up the price of tuition is not new. The former U.S. Secretary of Education under President Reagan, William J. Bennett, first floated this notion back in 1987. In short, Bennett found that if consumers are less price-sensitive when choosing which college or university to attend, the school will use this inattention to cost to increase prices. If the amount of credit available to the student increases, so will the tuition.

Now almost 30 years later, a new paper by economists Grey Gordon of Indiana University and Aaron Hedlund of the University of Missouri seconds Bennett’s findings, pinning the vast majority of the increase in net tuition on the increase in student loans. In fact, the authors calculate that it’s responsible for 102 percent of the net tuition increase from 1987 to 2010. The other major factor is the increase in the college wage premium, which is responsible for a 24 percent increase in net tuition. Baumol’s cost disease, however, doesn’t seem to be a major contributor to the increase.

It’s also interesting that the increased credit supply doesn’t seem to increase school attendance. It’s unclear why that isn’t happening, but perhaps some students realize they wouldn’t get a great return on investment.

Gordon and Hedlund’s finding echoes a paper earlier this year from David Lucca, Taylor Nadauld, and Karen Shen at the Federal Reserve Bank of New York. The three economists find that increases in credit supply boost tuition, while grants—straight cash transfers to the student that don’t have to be paid back—don’t have any effect on tuition. Mike Konczal, a fellow at the Roosevelt Institute, interprets this result as saying that efforts to “complete” the student credit market would actually increase the net tuition students have to pay.

Not only does higher net tuition bite into the pockets of students attending school, but student loans are clearly not a well-targeted policy. The providers of higher education capture a large portion of student loan subsidy, and students get saddled with debt instead. Of course, the students who end up defaulting are more often those with smaller burdens. But large debt burdens in the name of an inefficient program seem to be a problem in and of itself. Policymakers and researchers should start thinking about other ways to make higher education more affordable without negative unintended consequences.

Publication does not imply endorsement of views by the World Economic Forum.

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Author: Nick Bunker is a Policy Analyst with the Washington Center for Equitable Growth.

Image: A graduate wears a houndstooth ribbon on her graduation cap. REUTERS/Marvin Gentry