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READ: Return on Educational Investment and the Student Loan Crisis by Prof. Jay Prag
Published on Monday, May 20, 2013
by Jay Prag
Inland Valley Daily Bulletin
Pasadena Star News
Former Secretary of Education Bill Bennett is promoting his new book, "Is College Worth It?: A Former United States Secretary of Education and a Liberal Arts Graduate Expose the Broken Promise of Higher Education," using the flashy headline that only 150 of 3,500 colleges "pay off" according to a well-known finance metric, return on investment (ROI).
I have discussed misguided education spending quite a lot in speeches and op-eds, so this sounds like confirmation of my perspective. And, in the most recent ranking, the highest ROI was at Harvey Mudd College in Claremont, a school where I teach economics and leadership classes. So I should be beaming with pride and agreeing with this headline whole-heartedly.
But this ROI approach for measuring educational outcomes is tricky. Return on investment is a straightforward measure when used in the business world. If I pay $1 million for an asset and sell it a year later for $2 million, my ROI is 100 percent, i.e., I made a $1 million profit on $1 million investment. For-profit businesses need to invest in positive ROI assets in order to survive, because they need to repay their investors with interest.
When applied to education, ROI analysis would go something like this: If I pay $100,000 in tuition to get an engineering degree, and it increases my lifetime salary by $1 million, the ROI is positive. I made $900,000 on a $100,000 investment. Clearly the tuition expenditure paid off, and this is true even after correcting for the timing of the payments using present value analysis.
This ROI approach makes a lot of sense if the student borrowed the tuition money. A positive ROI college degree will allow the student to pay off the student loan with the higher lifetime wages. It's all very logical and, on the surface, a very good use of business analytics. But ROI analysis doesn't necessarily apply to a college education. What does a college education produce on a good day? It produces a smarter person, a better human being, a better citizen, a member of a better society. Higher wages are nice, and they usually do accrue to college degrees, but they are not all we get from a college education.
Statistically speaking, college graduates have much lower unemployment rates, much lower incarceration rates and much higher rates of social participation, such as voting, community involvement and so on. I'm guessing they also have much better "scores" on diversity and social acceptance issues. These "payoffs" make a direct application of ROI impossible. College education does much more for society than simply increase wages. Following the business approach, if we invested $100,000 in a college education and lifetime wages did not increase by at least $100,000, we get a negative ROI. But the person could be better in other ways such that the expenditure still pays off.
Put differently, suppose we don't educate people. They might end up in jail or on welfare or doing some other activity for the rest of their life that costs society.
For a business, the worst possible outcome is this: I invest $1 million in an asset and its value goes to zero. I lose all on my money. For a society, the uneducated human asset can actually have an enormous negative value. We can't simply say that an uneducated person will earn the minimum wage. Probabilistically, uneducated people cost society money.
So now we have an interesting problem. If a college education does not pay off in dollars, how can students pay for that education with student loans? That's easy - they can't.
The government helps by subsidizing student loans, keeping the interest rates low, and subsidizing tuition at state-run schools, but wages will still have to be higher than they would be without the college degree to pay off the
student loan. Given these subsidies, the ROI approach appears to be appropriate and it explains why many students cannot repay their student loans.
Scholarships and grants are part of the answer. If the payoff isn't in dollars, we can't expect the student to repay a loan. So we have to cover the costs in a way that does not have to be paid back. Grants and scholarships do that.
When a scholarship or a grant is awarded, the funder, whether it's the government or a privately run foundation, is expecting something in return other than cash - that better society I mentioned earlier. If grants and scholarships are allocated competitively - given to those most likely to make society better - then this works great. But for these students, ROI analysis of their college education is inappropriate.
If the local church awards a scholarship to someone to go to an expensive Ivy League divinity school and become a minister, the ROI is likely negative. But saving souls, the payoff, will make society better and from the perspective of the local church, the scholarship money was well spent. There are ultimately two key factors in the ROI approach to education. First, did the education educate? Did we make a better person? Second, did we pay for that education correctly? Student loans can only be used if the payoff is in dollars. Scholarships and grants must be used if the payoff is a better society. The student loan crisis that we're currently facing can be traced to these two factors: Either the education that students got had no value, or, more likely, its value is non-cash, and thus should not have been paid for with student loans.
Jay Prag is a clinical associate professor at the Peter F. Drucker and Masatoshi Ito School of Management at Claremont Graduate University. Prag also serves as academic director for the school's Executive Management Program, and can be heard weekly on "Inland Empire News Hour" on
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