Wednesday, January 26, 2011

Always look to the margin

Richard Vedder again reminds us that deciding whether enough folks are going to college requires looking at effects for the marginal entering student, not results for the average graduate.
An even-handed interpretation of the data is that college is “worth it” for some significant number of young people, but is a far more problematic investment for others. The call by President Obama, the Lumina and Gates Foundations, and many higher education advocates to rapidly and radically increase the number of college graduates is fundamentally off-base.

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For years, economists have written that the rate of return on college investments tends to be high -- 10 percent is an oft-cited estimate, greater than the average investor is likely to earn in alternatives such as stocks, bonds or real estate. Thus the studies have concluded that going to college typically makes sense, independent of any non-pecuniary advantages college offers. Yet these studies have failed to account for the added risk associated with it -- the probability of dropping out.

Two new studies have attempted to correct for this problem, one by Gonzalo Castex and the other by Kartik Athreya and Janice Eberly (both are available for download here). They suggest that the reported superior rate of return on investing in college disappears when investments are adjusted for risk.

At the individual student level, it is possible to reasonably estimate the risk. A student who was at the top of her class at a top-flight suburban high school, had a composite SAT score of 1500, and plans to attend a private college with relatively low dropout rates is probably going to get a reasonable return on her investment, although even that is no certainty. By contrast, a student who is below average in his graduating class from a mediocre high school, has a combined SAT score of 850, and is considering a college with high dropout rates is very likely not to graduate even in six years, and probably will get a very low return on his college investment. That student might well do much better by going to a certificate program at a career college, learning to be a truck driver, or becoming a barber, for example.

In short, a good maxim is “different strokes for different folks.” A one-size-fits-all solution does not work as long as human beings have vastly different aptitudes, skills, motivations, etc. On balance, we are probably over-invested in higher education, not under-invested. The earnings data reflect less about human capital accumulation imparted to college graduates by their collegiate experiences than the realities of information costs associated with job searches.
I would warn strongly, and perhaps self-interestedly, against applying any of this to New Zealand.

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