A few years ago two economists at Princeton did an experiment. They wanted to see how thinking about money affects our intelligence. Does thinking about money make us dumber? It turns out, it doesn’t. Except for people with low incomes. When low income individuals were prompted to think about a large car repair cost their IQs dropped a full 10% during tests. That’s the equivalent drop of going an entire night without sleep. The amount was $1500. Other economists have found similar results in India. They found large drops in IQ with low-income farmers before the harvest, just when stress about money is highest. Money challenges matter, especially for the most vulnerable among us.
Low-income individuals aren’t the only ones making mistakes around money. Behavioral economists have replicated many experiments where individuals are so afraid of losses and so short-sighted that they reject even the most attractive investments. John List at University of Chicago and Michael Haigh found that even professional traders do this in the lab. Our forthcoming research with List and Rob Metcalfe (also at University of Chicago), show even traders at large investment banks underinvest on virtually sure-thing investments when the stakes are meaningful in a real trading environment. When it comes to money and risk, people are not robots.
For the last 50 years in the United States, the government has treated prospective college students like robots. Last month the White House’s Council of Economic Advisers (CEA) published an 80-page report on the virtues of investing in college in response to growing pressure to address the rising costs and debt associated with college in the US. The CEA explained the received view: Bachelor’s degree holders in the United States earn $1 million more on average in their lifetimes than those with only high school. The college wage premium is perhaps the most well-documented finding in Labor Economics. The White House’s argument was simple. Even though the cost of college is high — close to $100,000 in total — the investment is worth it. Students should embrace debt finance as a firm would do when facing what the Brookings Institution has called the best investment of any major asset class.
Many students do not feel comforted by these figures. 40% of college students are working more than 35 hours a week to support themselves. Ask them why and they will tell you: they feel they must. A suspiciously similar 40% of those that start college quit and never finish. The biggest cited reason: financial distress. While preparedness may factor in, as we know it’s very hard to think when money is on your mind, not to mention juggling classes with a full-time job. Those who never attend point to finances as the number one deterrent.
What we are left with is nothing short of an economic paradox. In a country with the highest college wage premium of all developed nations, only 40% of 18–24 year olds are in any form of schooling. There are some communities where only 20% of high school students go to college. Some renowned scholars have started producing papers showing that a main driver in inequality may come down to holding a 4-year degree.
Why are so few young people going or finishing? Perhaps junior can’t borrow. While financial constraints were a reality last century, there has never been more money available to students. The federal government gives out up to $30,000 in very attractive loans for undergraduate degrees. Grants cover the expenses of many low-income students and there is a competitive market for private student loans. All federal loans can be paid back based on income, removing the stress of low incomes immediately after school finishes. With some effort, college is in reach for most Americans. Still, many don’t go. What’s going on?
The campaign of Bernie Sanders struck a nerve with many young people in regards to higher education. His promise, which has now been modestly adopted by Hillary Clinton, is that college tuition will be free at public universities. From an economist’s standpoint, the striking fact of his proposal is not its audacity but exactly the opposite. Whether college is called “free” and the money is taken from tax revenues, it is virtually the same as paying for college with loans and paying back on an income-contingent basis. If anything, the Bernie proposal is potentially even regressive: both those who went to college and those who didn’t must pay taxes to support only those who actually get the college wage premium. If everyone goes to college, the proposal is identical to loans plus income contingent repayment — a system that is largely already in place. By asking for free college, people are in effect asking the government to hide the cost.
Does framing the costs differently matter that much? According to 50 years of economic research: yes. Thaler et al (1997) found that by increasing inflation in a simulated stock market game to the point where nominal losses were impossible, people took 40% more risk. Simply the illusion of not experiencing a loss makes people much more willing to invest in the future. Dan Ariely famously found that calling cupcakes “free” increased demand dramatically more than larger price decreases above 0. Marketing matters. In the early 2000s, Latin American students used riots to force their governments to provide “free” schooling. The result was paradoxical: overall funding for higher education actually went down but people were happier.
It’s possible that forcing students to make the investment themselves is driving students away. Never before has so much money been available to so many students. Postgraduate income information is widely available. Nonprofits and social enterprises seeking to increase access to higher education exist in droves. Still, how many of us can think of a friend that decided working at the grocery store was a better investment than going to class? Where are they now? There are some published qualitative studies where not a single student among hundreds carefully considers the financial costs and benefits of college.
These small biases have lifelong effects across our entire population. 3 million seniors graduate high school every year. Almost 1.5 million of those do not start higher education or do not finish. These individuals experience the worst of the American machine. They disappear from the workforce, experience higher rates of incarceration, lower health, and higher rates of unemployment. They report being less happy.
The research and the data are screaming: individuals have trouble taking big abstract risks for the future. It’s not fear of debt. Canadian researchers have shown debt attitudes do not affect college attendance. Payday loans and credit card usage are ubiquitous among low-income communities. A huge percentage of US households have mortgages. Debt itself doesn’t seem to be the issue. Investments that only happen in the future seem unique, however. Economists have shown for decades that individuals dramatically underinvest in the stock market, a very abstract concept. In fact, the “equity premium puzzle” may be the most studied puzzle in all of economics. The future is uncertain and people only have one life to live.
College is a huge investment whose benefits often do not show up until 10 years after the student finishes. That $1 million premium occurs in individuals’ 30s and 40s. It is likely the largest investment a person will ever make and it does not always turn out great. There is risk of not finishing or not getting a better job, not just right out of college but ever. All the statistics for the private benefits of college are averages and medians. There is a chance, albeit very remote, that a student will get the short end of the stick and actually be worse off. This risk is very real for young people. The effect is powerful. Even the remote chance of failure is leading almost half our nation’s youth to forgo the surest path to economic mobility ever devised by a modern society.
Where something is good but risky, the government is well placed to smooth outcomes. Modern welfare states shine in this respect. If the benefits of schooling are as high as claimed, the government could not only give students free education but pay for their living costs. Not only do income gains repay the government in taxes, but the indirect benefits end up saving the government costs in reduced incarceration, higher population health, higher life satisfaction, lower unemployment, and higher civil engagement. A program called ASAP in New York State paid most costs associated with junior college for students when they attended full-time. The result was a 100% improvement in completion rate and researchers concluded that upfront costs more than paid for themselves in the form of lower incarceration, higher health, and lower unemployment. Nonetheless, as it stands, our system is more comfortable paying room and board for inmates than for college students.
Our government may not have the power to help our students. Large democracies like the United States face enormous pressures to control costs. In our country in particular, even passing legislation that would only simplify the current education finance system requires herculean efforts. Where extra costs are involved, the feat is largely impossible. Some politicians have devoted significant portions of their political lives to merely simplifying a single government webpage.
The result is crisis. Each passing year, 1.5 million high school seniors are deciding college is too expensive for them. They are entering a world with automated checkouts and self-driving cars. This brave new world is very unkind to unskilled labor. Many of these individuals end up in long-term unemployment or disappear from the workforce entirely into our growing disability state. We are witnessing the rise of extremism from ordinary people who have decided the system has failed them, a huge portion of which only have high school degrees and the ever-growing number of those with ‘some college’. They are right, the system has failed them. The state has ignored the worries and concerns of its people.
We have an answer. We have created Leif. Leif covers the cost to attend one of the schools we’ve carefully selected for quality and return on investment. To receive funding, students commit a small percentage of their income for up to 5 years until a maximum payment amount is reached. That percentage sits around 15% for most students. Because the payment is capped, the funds are usually not worse than borrowing directly from the federal government or through private loans, but with the added security of removing default-risk if a student experiences low income. Complexity is removed, school is simply free. Riskiness is removed, payments are always tied to income and never a burden. Leif stands out from firms that have attempted similar models. Leif is for the public interest.
Leif combines the Left’s drive for free university, with the cost transparency of the Right. Leif is sustainable. Leif attracts capital from institutional investors at a competitive cost, pays students’ costs, and collects their income, paying returns to institutional investors, who invest through various fund structures. Our model has been used in Hungary for the last ten years and the entity broke even or better while paying down its debts to creditors through the financial crisis. Hundreds of thousands of students have benefited. Hungary’s program is open to everyone. The German Education Fund is experiencing similar results.
Leif can also grow fast. Not only are we unbound by the slowness of our government, but we can provide additional beneficial services to students that attracts equity capital even when we break even on our main financial activity. Business model innovation allows us to scale much faster than purely charitable models.
Leif is a distinctly American solution to a very American problem. An entire generation of financial expertise exists to create financial products such as ours. We have learned from past mistakes: instead of land, we will invest in our children. The team, although small now, will grow to accommodate the huge amounts of expertise needed to send our children into the future. We are not building a startup, we are building an entirely new education-industrial complex: The New Deal in Higher Education. And as Franklin D. Roosevelt said almost 100 years ago, “the only thing we have to fear is fear itself.” Leif is ending the fear once and for all.
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