27 October 2019

Are Bad Financial Aid Packages Driving Inequality And Reducing GDP In The U.S.?

The model correctly reaches the somewhat obvious conclusion that the U.S. is not fully meritocratic and that this suppresses our GDP. Its econometric estimate that current measures alleviate a third of current negative effects of financial aid induced inequality is plausible although subject to large margins of error.

But, like most model driving economics papers, this one is somewhat naive and overlooks key points. Most importantly, it overlooks the fact that not everyone can benefit equally from higher education, and that IQ, socio-economic merit, and social class are correlated, although hardly identical. It also overestimates the extent to which higher education spending is causally connected to higher education outcomes for students.

This paper studies the role of the higher education system, including government financial aid and transfers to colleges, in shaping income inequality and intergenerational mobility. I introduce a model of college choice with overlapping generations of heterogeneous households subject to a borrowing constraint and with heterogeneous colleges that maximize quality. 
First, I show that in response to the observed rise in the return to human capital the model yields predictions consistent with increases in five outcomes in the U.S. since 1980: income inequality, tuition, the dispersion of spending per-student across colleges, the exclusion of low-income students from top colleges, and the intergenerational elasticity of earnings (IGE). I quantify the model with rich micro-data from the U.S. About 6% of the observed increase in income inequality results from changes in how students and resources are allocated across colleges
Second, I use the model to run policy counterfactuals. If all students received the same higher education, the Gini coefficient and the IGE would decrease by up to 9% and 33%, respectively. Current government interventions—financial aid and transfers to colleges—decrease the Gini coefficient by 3% and the IGE by 12% compared to a laissez-faire policy. Need-blind admissions can be particularly useful at increasing mobility and correcting for the misallocation of students and resources, thereby increasing GDP, at the expense of slightly higher income inequality.
Damien Capelle, "The Great Gatsby goes to College: Tuition, Inequality and Intergenerational Mobility in the U.S." Princeton University Job Market Paper (October 23, 2019).

My own impressions about what is wrong with the higher education system in the U.S. are as follows:

* The system seriously harms the country by causing non-affluent students not to pursue higher education to their full potential. This is mostly driven by bad financial aid support and not by need driving admissions. Robust, full ride aid packages to less affluent students with academic merit could solve this at a lower cost than the current very inefficient method of partial state support for in state students  regardless of likelihood of success. Europe does not have this problem, while Japan and South Korea have it almost as seriously as the U.S.

* Lots of higher education funds are misspent on students who are likely to drop out because they aren't academically ready for college, and by spending on marginal students from affluent families. Too many students attend before they are academically ready, and many will simply never be academically ready. We would be better off is less higher education spending were targeted to these students and more high school and higher education spending were targeted to more academically capable students. This problem is much worse in Europe than it is in the U.S., but it is less of an issue in Japan and South Korea than in the U.S.

* Higher education overspends on administration and underspends on professors.  Continental Europe, Japan and South Korea all tend to have inferior instructional quality at the higher education level to the U.S., however, one area where the U.S. system shines.

* Our society incurs actively produces suboptimal outcomes for students at the high school level by pushing a liberal arts college preparatory curricula on students who are unlikely to graduate from a four year college, or to benefit greatly from attending a four year college and dropping out, when preparation for a "middle skill" career would serve those students better. The total public spending needed for a non-college preparatory curriculum might even be modestly higher than the existing watered down college preparatory curriculum taught to middle of their class students, but the returns of an alternative to the students and to society would be much higher. Europe, Japan and South Korea all do a better job of creating viable career paths for people not bound for traditional four year curricula than the U.S.

* Our society incurs lots of unnecessary higher education spending by favoring credentials in hiring that individually make sense to obtain, but which had little value to the economy collectively. This is true in academia itself even. Lots of people who would make good instructors who have only masters degrees are squeezed out of that work over people whose teaching abilities are inferior with PhDs. Too many people in the applied health professions like physical therapists are pushed to get PhDs that add little value. School teachers likewise get lots of higher education that adds little value. This is more of a problem in Europe than in the U.S., although the gap is closing, and is less of a problem in Japan and South Korea.

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