Gordon and Hedlund On Financial Aid And Rising College Tuition

Over at Marginal Revolution, Alex Tabarrok discusses a new NBER paper, Accounting for the Rise in College Tuition, by Grey Gordon and Aaron Hedlund:

Grey Gordon and Aaron Hedlund create a sophisticated model of the college market and find that a large fraction of the increase in tuition can be explained by increases in subsidies.

With all factors present, net tuition increases from $6,100 to $12,559. As column 4 demonstrates, the demand shocks— which consist mostly of changes in financial aid—account for the lion’s share of the higher tuition. Specifically, with demand shocks alone, equilibrium tuition rises by 102%, almost fully matching the 106% from the benchmark. By contrast, with all factors present except the demand shocks (column 7), net tuition only rises by 16%.

These results accord strongly with the Bennett hypothesis, which asserts that colleges respond to expansions of financial aid by increasing tuition. Remarkably, so much of the subsidy is translated into higher tuition that enrollment doesn’t increase! What does happen is that students take on more debt, which many of them can’t pay.

In fact, the tuition response completely crowds out any additional enrollment that the financial aid expansion would otherwise induce, resulting instead in an enrollment decline from 33% to 27% in the new equilibrium with only demand shocks. Furthermore, the students who do enroll take out $6,876 in loans compared to $4,663 in the initial steady state….Lastly, the model predicts that demand shocks in isolation generate a surge in the default rate from 17% to 32%. Essentially, demand shocks lead to higher college costs and more debt, and in the absence of higher labor market returns, more loan default inevitably occurs.

Read the whole post, along with some caveats on the results, here. And the full paper here.

Comments

[Douglas Levene]

Of course, this is exactly what the supply-demand curve predicts will happen when you goose demand and supply is held constant. The additional revenues can't be distributed to shareholders as profits, since the universities are not-for-profit, so instead they are distributed to other "stakeholders" via more and higher paid administrators, lower teaching loads for tenured faculty and lavish physical facilities for students.

[Kim Krawiec]

But that is exactly what is interesting about the findings, I think -- that supply is constant. Given that the rationale for much financial aid is increased access . . .