Why Easing Education Debt Won’t Necessarily Help the Economy

Student loan debt has become the scapegoat for nearly all that ails the U.S. economy, from depressed home ownership, to lower rates of entrepreneurship, and even the sluggish recovery from the great recession.  The problem with all of this blame is that the accusations are difficult to substantiate.  Much of the discussion about the effects of student loan debt focuses on comparing outcomes faced by individuals with student loan debt to those of individuals without student loan debt.  The differences in observed outcomes are cited as evidence of an impact of student loan debt.  But, there are two reasons why this approach doesn’t tell us what we need to know about the effects of education debt. 

First, the population of individuals who take on debt to pay for college is different from the population of individuals who take on little or no education debt.  These differences are sometimes observable and sometimes not.  This means that outcomes faced by borrowers and non-borrowers are likely to differ for reasons that are unrelated to the debt itself.  In order to effectively measure the effect of debt, we would need to be able to control for all of these differences.  This presents a methodological challenge because not all of the differences are observable.     

Second, the population of borrowers (and non-borrowers) has been changing over time.  This means that longitudinal studies comparing borrowers and non-borrowers are difficult to interpret.  The changes in behavior, such as home ownership, that occur over time may be due to trends in borrowing, but could also be due to the changing characteristics of the borrowing population. 

Due to these challenges, we’ve yet to pin down the answers to our questions regarding these relationships.  Understanding the relationship between student loan debt and economic outcomes is difficult, but certainly not impossible.  Until more robust evidence is available, we should resist the temptation to draw conclusions.  Our education system has evolved quickly to one that relies heavily on students taking out loans to finance their investments in education.  Surely the growing phenomenon of large debts at the start of one’s career will have very real effects, but the truth is that we don’t know just yet what those effects are. 

More research is needed before we can begin to draw conclusions about the relationships between student loan debt and economic outcomes.  In addition to the methodological challenges already discussed, an important consideration in measuring the effect of debt is how to define the counterfactual.   In particular, how might a reduced reliance on debt be achieved and what circumstances would replace the status quo?  

One option would be for the federal government to give money to individuals holding education debt (through credits or refinancing).  As the popular logic goes, graduates would then have less to repay after graduation and would keep more of their paycheck to spend on things like cars and houses.  The problem is that this ignores the cost side of the equation.  While education grants and debt forgiveness may increase consumption among those who receive them, they necessarily decrease consumption among those who pay for them (through higher taxes).  Debt relief amounts to a transfer of wealth from one group to another, which means that while one group benefits from the transfer, another pays the price.  The net effect of debt relief would depend on how the relief was structured.  In particular, who would reap the benefits and who would pay the price. 

An alternative counterfactual is that student loan debt is reduced by discouraging spending on education.  This would be likely to occur if loan limits in the federal lending program were tightened, or if aversion to debt increased.  In this context, the impact of less debt is apparent.  For most students, investments in higher education pay large personal dividends that work to stimulate the economy as a whole.  While seemingly expensive on the front end, college degrees translate to higher earnings in the future that more than offset the cost for most students.[i]  The additional earnings, beyond what is needed to cover the cost of college attendance, mean additional spending.  Without access to debt (or willingness to take on debt), this source of stimulus would not exist.  There are reasons to think that student debt might depress consumption (e.g. psychic costs of debt),[ii] but they must be weighed against the economic benefit that comes from greater investments in education.

Yet another alternative counterfactual to consider is that smaller debt burdens could be achieved if the cost of college were lower.  This could occur through some combination of slowing tuition inflation and students choosing lower cost institutions.  The effect on borrowers’ consumption is unambiguous; they would have more income left for consumption or other investments, assuming they were able to achieve the same quality of education at a lower cost.  However, this doesn’t necessarily imply that reduction of debt through this manner would be a boon for the economy.  Money spent on education doesn’t fall into a black hole.  Tuition dollars are used to pay salaries, build infrastructure and finance investments – all activities that stimulate the economy just like consumption spending by graduates.  Lowering the cost of college would positively affect those who pay the price of admission (which may be the desired objective), but the net effect on economic activity is not obvious.  It would depend on a number of factors including: the impact on educational investments; the impact of savings on student consumption; and the impact of institution spending on the economy.  In short, it depends on the distribution of costs and benefits.

If we are concerned about the effect of student loans on the broader economy, we must consider all of the economic effects of policy prescriptions, not just the benefits for students who will have lower debt burdens.  These apparent benefits to students are often mitigated by the less apparent costs to those who pay the bills.  None of the counterfactuals to the status quo offer an improvement of circumstances for the population as a whole, i.e., a world with less education debt is not indisputably better.  Since the alleviation of education debt cannot be a costless exercise, policy makers should be cognizant of the full ramifications of any intervention and recognize how the costs and benefits will be distributed.  This is not a simple task, but it will be made easier as new research generates the evidence needed to inform the unanswered questions in this debate.    

[i] See Carnevale, Rose and Cheah (2013) for evidence on the economic returns to higher education.

[ii] See Field (2009) and Rothstein and Rousse (2007) for evidence on the psychic cost of education debt.