Tuesday, June 22, 2010

Becker vs. Posner on For-Profit College

by Daniel L. Bennett

I normally read the the Gary Becker-Richard Posner blog with great interest, eager to find out what these 2 great thinkers have to say about various economic topics. This past weekend, they posted a pair of essays discussing for-profit higher education. Both offered some interesting perspectives, with Posner generally taking the Steve Eisman gloom and doom view of the industry, while Becker offered a more balanced view.

Posner wrote:
The colleges are also very profitable, so most of them will be able to survive with lower tuition—which is a bit of a puzzle, since one expects competition to drive the average price of a product or service down to cost (including an allowance for profit, viewed as the cost of equity capital). It is possible, however, that the industry faces a sharply rising average-cost curve, so that the costs of the efficient firms are lower than the market price. In addition, demand for for-profit college education has been rising rapidly, and when demand for a product rises at a fast rate profits may rise because of delay in expanding supply.
Posner makes some good points concerning supply and demand, but he doesn't mention that government involvement and regulations, specifically 90/10, of the sector have contributed to higher tuition since for-profits serve a demographic that is largely dependent on federal aid as its means to pay tuition, and there are significant barriers to entry in the industry.

There is evidence that just as in the case of the marketing of mortgage loans during the housing bubble of the early 2000s, the for-profit colleges use aggressive advertising to attract students from low-income families that lack financial sophistication and the ability to evaluate the benefits of attending a for-profit college. These people—who may be the only people who would consider a for-profit college, because no other college would admit them—almost by definition have little information about higher education and are therefore prey to skillful marketing that even if literally truthful may create a misleading impression of the benefits of attendance at a for-profit college. For-profit colleges often pay recruiters by the number of enrollments that a recruiter generates.
Misleading advertising and paying recruiters based on enrollment are forbidden with the exception of 12 safe harbors, which ED has proposed eliminating. I do however believe that there are still problems in the industry and that more information ought to be provided to prospective students to help them make better decisions when selecting a college.

An alternative possibility, however, is that most of the people who attend a for-profit college understand the risk of failure but prefer to gamble on succeeding in obtaining a college degree and using the credential and what they have learned to obtain a much better job as a result—a job that will enable them to repay their loan and derive a net benefit from having borrowed it

College graduates earn substantially higher salaries than less-educated workers, but it is doubtful whether, in the aggregate, graduates of for-profit colleges earn enough more to compensate for the costs and the dropout risk.
This is certainly an area in need of research, but Posner is misguided in suggesting that the dropout risk is higher among profit-seeking colleges. Retention rates at for-profits are actually higher in aggregate than public schools, and part-time student retention rates are highest in the for-profit sectors. And while it may be true that bachelor's degree seekers at for-profit schools graduate at lower rates than they do at private nonprofit or public 4-year schools, the completion rate at for-profit schools offering 2-year degrees and certificates is actually the highest among any sector. We should therefore not attempt to discern cost-benefit comparisons by profit status, but rather but program type. A significant proportion of the industry offers career-focused training that is much different than academic education. Grouping the two types of education together simply because they both seek profit would not result in a meaningful comparison.

Becker offers a different and perspective, taking into account market distortions and suggesting that public and nonprofit schools are not angelic either:
comparison of default rates between for-profit colleges and public colleges is not the right measure of how much government subsidies they receive. All public colleges and most private ones receive large direct subsidies from various governments that enable them to offer much lower tuition levels than are offered by for-profit colleges. Many students in public colleges, especially the lower quality ones, also drop out without finishing, and also receive low earnings, after having been generously subsidized by governments. The right comparison between for-profit and public schools might be the increase in earnings of students per dollar of government subsidy, no matter what form these subsidies take. The for-profits may still look worse on this measure than do the public colleges they compete against, but the difference would be much smaller than the differences in default rates.

Some argue that for-profits can only compete by misleading students into believing they will benefit much more from such an education than they will actually benefit. Clearly, some of that does occur. However, even some of the best colleges and universities are quite misleading in their advertising and other attempts to attract students. For example, very few philosophy, French, or English Lit departments warn incoming students that jobs in their fields are scarce, and that most entering students may never get a decent job using their specialized training.

So my conclusion is that while stiffer default rules on government subsidized student loans are needed, for-profits should not be discriminated against in these rules since they offer valuable forms of education. Moreover, public colleges receive substantial direct government subsidies that for-profit colleges do not receive. With lower allowable default rates, for-profit (and other colleges) would cut back on the number of students accepted whom they expect to eventually default on their student loans.
I generally agree with Becker's analysis and his recommendation that default rate standards should be stricter. I would note however that it would be advisable to look at default rates by program level and type, rather than simply by institution. It may be that some of an institution's programs lead to great outcomes while others lead to horrible outcomes. In such a case, it would be best to identify which programs add the most value and work to revise or eliminate those which add little value.

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