The Economics of a Four Year Degree

By Bob Gariano

Last week the Federal Reserve Bank of New York reported that total outstanding student loans have now reached $956 billion in the United States and that debt is growing. Later this year for the first time in history, American students will owe more than one trillion dollars for student loans. Student debt has tripled in 8 years and the delinquency rate now exceeds 11%.  Many of these loans were extended with only the most cursory review of the capability to repay the loans.

This level of student debt is reverberating throughout the economy as new graduates with large outstanding educational loans are much less inclined to purchase homes or automobiles immediately after graduation.  This traditionally fertile market for big ticket consumer goods has dried up as new graduates delay purchases while they try to pay down their college loans.

Even though the unemployment rate for college graduates is one third of that for high school graduates, it is appropriate to ask whether the escalating cost of an undergraduate degree is a financially astute investment. From a purely arithmetic standpoint, the answer may be surprising.

In order to analyze the value of investments, financial people use an idea called net present value or NPV. This is simply a method for expressing the current value of some amount that will be paid in the future in return for some investment made today. For instance, consider an investment that promises to pay $106 at the end of a year and where there are other low risk ways to earn 6% on those funds. In that case, the net present value of $106 paid in one year would be $100 today.

Such an analysis of net present value can be applied to the costs and returns associated with an undergraduate education. This year, the average cost of a four year degree in a private college in the United States is $240,000 and at a public institution is $140,000. This is a minimal estimate for several reasons. Those investment amounts do not count inflation which drives these numbers inexorably higher, even during the time spent in school. College costs over the last three decades have been increasing at a 6.6% annual rate, roughly double general economic inflation in the United States.

Neither do these costs reflect lost earnings from an occupation that might have been pursued during those four years. Additionally, this cost does not consider that the average time to get an undergraduate degree is now 4.6 years. This added time adds 15% onto the initial investment estimate.

Even ignoring these considerations, any calculation of return on educational investments should at least include tax affects. The $140,000 or $240,000 numbers are after tax amounts. Parents or students must earn $200,000 to $320,000 before taxes to have enough after tax money to pay for these college costs.

On the payoff side, the numbers are also obvious and compelling. The US Census Bureau reports that the average wage earner in the United States makes $41,000 annually and a college graduate with a four year degree earns an average $14,000 more than that average each year. Post graduate education adds another $24,000 each year but that is another analysis. As an aside, these census numbers strongly reinforce the importance of high school education. A wage earner without a high school diploma will earn on average only $17,000 annually or $24,000 less than the national average.

But to return to our undergraduate college investment, fortunately there is some standard software that calculates the net present value of future payouts. Most spread sheets have such built in formulae. Using such tools, a person can calculate the value of the additional $14,000 of yearly earnings for a college graduate over a 45 year career. Using the student loan rate of 6%, the net present value or NPV of the $14,000 increased earnings each year over 45 years is $210,648.  This can be compared to the investment of $200,000 to $320,000 initially. It seems that we are reaching a so called tipping point where even an optimistic evaluation of the investment in an undergraduate education may not represent an attractive payoff in future earnings, especially at a private college.

None of this arithmetic argues for less education. Instead, it may suggest that we begin to approach undergraduate education in a more efficient manner. These improvements may also create a more egalitarian system that promises the availability of higher education to many more people around the world.

Such renovation is already underway and will only accelerate with these economic catalysts. Programs like the Massive Online Open Courses offer courses from the most respected educational institutions and from elite professors to people around the world via the internet. MOOC allows the best teachers to lecture huge numbers of students while avoiding infrastructure and other costs associated with a university system that was, after all, developed and has remained largely unchanged since the middle ages.

The economics of higher education will accelerate these new learning models. Traditional issues like enabling credentials and testing capabilities of students enrolled in these programs will be solved. Both the economics of higher education and the hunger of more people to access college level learning will promote these developments. The future of these programs is already being designed and implemented by forward thinking educators.