Thursday, 17 March 2016

Tuition Fees - And Why They Don't Matter

Yesterday a group of loud leftists paraded across University of Sydney's campus crying their usual platitudes about stopping restructuring, opposing staff cuts and tuition increases. And not long ago, I had a couple of discussions about higher education IRL and in the blogosphere (here for instance, following Morehouse's post), so I reckon it's time for some back-of-the-envelope calculations.

Before we get started, university tuition in Australia is already heavily subsidised, added to a HECS debt account with interest-free government schemes, automatically deducted from your future salary once such salaries exceed a certain amount. Like in the U.K., students won't pay for their university degrees unless their income exceed a certain level (40k/year, I believe). And apart from that, there are tons of scholarships and Commonwealth-supported places etc.

In order to show how irrelevant tuition is, I'm going to compare two hypothetical individuals, one of whom went to university for some degree whereas the other one got a job and started a career that way. My point is a simple economic concept of Opportunity Cost: doing one thing excludes you from doing another. By attending university, you lose out on the experience, skills, abilities and ultimately income that you would have earned had you not gone to uni.

At USYD, tuition fees are based on what kind of degree one is pursuing. To make things easier, I averaged it to $8,500/year and assumed a 4-year degree, which works out to a price tag of $34,000. Assuming an active working life from 22 years of age until 70, that works out to about $700/year, or $60/month for the rest of your career. Peanuts.

Enter Sara & Johnny. Sara is dead-set on university and Johnny can't wait to get a job and earn an income. I'm abstracting from inflation, and assuming a yearly wage increase of 1,5% - think of this as the average of lifetime promotions, bonus, new jobs, advancing career, etc. Research shows that the college wage premium (i.e. how much more somebody with a university degree earns over high school degrees only) is somewhere around 60-85% in median hourly wage, but that exaggerates the actual value of university degree, since the groups are not identical; it is reasonable that university students are on average smarter than non-university students, and so would have reaped a higher life-time income should they not have gone to uni. To account for this, I'm arbitrarily gonna use 35% as a wage premium instead (the point still stands, as I will show).

Johnny gets a decent full-time job of $22/h, for a yearly income of $44k. Not bad, but hardly astonishing. For the first four years he earns in total around $180k and loves his job. Sara spends her first four years in a university library, restlessly learning and absorbing skills and knowledge. Her tuition amounts to $8,500/year, for a total of $34k over the first four years. Here's the first lesson; Even if the Saras of the world were not on average smarter, better employees than the Johnnys of the world (and so she could earn the same Johnny did), the real cost of university is the wages foregone (180k) plus tuition (34k) for a sum of 214k. That is, tuition accounts for some 15% of the cost - i.e., not a big deal, really.

Now, why in the world would Sara go to uni, knowing that it would set her back by hundreds of thousands of dollars in foregone wages?

Simple: her future earnings will be that much higher than they otherwise would have been - and so it justifies taking on loans, paying tuition, foregoing earnings etc. Johnny's lifetime earnings amount to something like 3,3 million dollars, whereas Sara's - although she started her working life much later than Johnny - lifetime earnings sum almost another million ($4,25m). It takes her about 12 years to catch up with Johnny after she finishes uni (and so "breaks-even") after which her university degree really starts to pay off.

Now, can Sara pay her tuition fees of 34k with this extra million in lifetime earnings? Yup. Does it matter to her if tuition doubles to 68k? Not really. The share of costs are tilted slighty (27% of real cost of uni rather than 15%), but the main factor is still foregone earnings. And her future earnings still easily cover it.

Final question, what wage premium is required for Sara to have the exact same lifetime earnings after deducting this increased tuition (68k)? I.e., when is it no longer financially worth it for Sara to attend uni? A surprisingly low number actually: when the college wage premium falls below 6,25% Sara will have a lifetime earnings minus tuition costs equalling Johnny's lifetime earnings. Current research, as mentioned, show such numbers in and around 60%.

These sort of comparisons can be made almost infinitely complicated, adding inflation and taxation, cost of living, opportunity cost of investment, likelihood of unemployment, part-time jobs during university years, separating university degrees from one another (engineering is typically more valuable than art history), separating prestigious universities from less-prestigious universities etc. The kind of degree obviously matters (go play around with Payscale's numbers for particular degrees), which is echoed in the Fed research:

At the forefront of this literature is the choice of a college major. The availability of new data has highlighted the wide variation in wages across college majors, which in many cases is as large as the college wage premium itself. 

But the above suffice to get my point across; the amount of money generally paid in tuition is emphatically not the big cost of university. Increasing tuition might even be beneficial, as it could deter some people for whom the degree is a net loss, and promt them to work or advancing their careers instead.

1 comment:

  1. This is a good article, and raises some good points (the reason I don't think tertiary education should be completely free).

    But the analysis assumes everyone is rational. In reality, this is of course not true and results in the wealthy being benefited. Here are two reasons (there are more) why. 1) Generally people make the decision to go to uni based of what their expectation of it is. This means that people from wealthy backgrounds, who are usually surrounded by people who have uni backgrounds (and have reaped those rewards) are more likely to see those benefits and make the decision you have outlined. Conversely, low-SES individuals are less likely to see these benefits and thus not take them on personally. 2) Just comparatively, to a wealthy person the $16,000 are going to seem much less significant than it would to a less wealthy person. Psychologically, this would mean that the less advantaged see the opportunity to go to university as more expensive and thus a less worth while investment (even if we assume the investment would have equal benefits for people regarding of their initial standing)

    I think you have fallen into the trap that many economists fall into -- assuming everyone know as much about economics as you and makes decisions like you.

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