Making the Grade: The Economics of Education Chief of Staff Retreat February 24-25, 2006

1

Making the Grade: The Economics of Education

Chief of Staff RetreatFebruary 24-25, 2006

copies of this presentation can be found atwww.business.duq.edu/faculty/davies

2

Tuition & Fees (4-Year Institutions, $ per year)

$-

$5,000

$10,000

$15,000

$20,000

$25,000

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Private Consumer Prices

The cost of private college has increased 7.9% annually while consumer inflation has averaged only 4.4% annually.

Source: Statistical Abstract of the United States, 1995-2006; Current Population Reports, Bureau of Census, 1978-1997; Annual Survey of Colleges, The College Board, 2002

3

Tuition & Fees (4-Year Institutions, $ per year)

$-

$500

$1,000

$1,500

$2,000

$2,500

$3,000

$3,500

$4,000

$4,500

$5,00019

76

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Public Consumer Prices

The cost of public college has increased 7.8% annually while consumer inflation has averaged only 4.4% annually.


4

Tuition and Fees as % of Median Household Income(4-Year Institutions)

0%5%

10%15%

20%

25%30%

35%

40%45%

50%19

7619

7719

7819

7919

8019

8119

8219

8319

8419

8519

8619

8719

8819

8919

9019

9119

9219

9319

9419

9519

9619

9719

9819

9920

0020

0120

0220

03

0%

2%

4%

6%

8%

10%

12%

Private Public (right scale)

The cost of private (public) college has grown from 20% (5%) of household income in 1976 to almost 50% (10%) in 2003.


5

Benefits of a college education vs. a high school education

1. Difference in entry-level compensations.

2. Difference in the growth rates of wages over the course of a career.

3. Difference in the likelihoods of employment.

6

Median Compensation for 18-24 Year Olds (2003)

$-

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

High School Diploma College Degree

Source: Statistical Abstract of the United States, 2004-2005

Starting compensation is 85% higher for degreed workers.

7

Annual Real Growth in Median Wages from Age 24 to Age 65

0.0%

0.2%

0.4%

0.6%

0.8%

1.0%

1.2%

1.4%


Annual Real Growth in Median Wages from Age 24 to Age 65 (2003)


Real salaries grow faster for degreed workers by almost 1% annually.

8

Likelihood of Employment (2003)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%



Likelihood of employment is 11 percentage points greater for degreed workers.

9

Median Probability of ExpectedCompensation Employment Compensation

High School Diploma $45,685 70% $31,947College Degree $96,728 81% $77,983

Education

(Compensation) (Probability of Employment) = Expected Compensation

• The median working college graduate earns 112% more than the median working high school graduate.

• Accounting for the likelihood of employment, the median college graduate earns 144% more than the median high school graduate.

10

Cumulative Expected Compensation and Tuition (2003)

-$100,000

-$80,000

-$60,000

-$40,000

-$20,000

$0

$20,000

$40,000

$60,000

$80,000

$100,000

18 19 20 21

Age

High School Graduate Private College Graduate

$170,000 difference by age 21

High school graduate enters workforce at age 18 and begins to accumulate earnings.

College student starts college education at age 18 and begins to accumulate debt.


11

Cumulative Expected Compensation and Tuition (2003 vs. 1977)

-$100,000

-$80,000

-$60,000

-$40,000

-$20,000

$0

$20,000

$40,000

$60,000

$80,000

$100,000

18 19 20 21

Age

High School Graduate (2003) Private College Graduate (2003)High School Graduate (1977) Private College Graduate (1977)

In 1977, difference was $47,000


12

Cumulative Median Expected Compensation for 18 Year Olds in 1977

-$500,000

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65

Age

High School Graduate College Graduate

Cumulative expected difference was $360,000 in 1977

After finishing college, the college student’s earnings begin to outpace the high school graduate’s earnings.


13

Cumulative Median Expected Compensation for 18 Year Olds in 2003

-$500,000

$0

$500,000

$1,000,000

$1,500,000

$2,000,000

$2,500,000

$3,000,000

$3,500,000

18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65

Age

High School Graduate College Graduate

Cumulative expected difference was $1.9 million in 2003


14

Three ways to evaluate the benefit of an investment

1. Breakeven Point

2. Internal Rate of Return

3. Net Present Value

15

Breakeven PointHow many years (from matriculation) will it take to recoup investment?

ExampleInvest $10,000 and receive $1,000 each year for 20 years.Breakeven = 10 years

1977 (public college costs)Cost of college plus lost compensation $40,000 (in 1977$)Benefit of college $360,000 (in 1977$)Breakeven: 9.1 years

2003 (public college costs)Cost of college plus lost compensation $105,000 (in 2003$)Benefit of college $1.9 million (in 2003$)Breakeven: 8.1 years

16

Expected Breakeven on Education @ Age 18

7.0

7.5

8.0

8.5

9.0

9.519

77

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Public College

Using public college costs, the breakeven period on a college education has fallen from 9.1 years (from matriculation) in 1977 to 8.1 years today.


17

Expected Breakeven on Education @ Age 18

7.0

7.5

8.0

8.5

9.0

9.5

10.0

10.5

11.019

77

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Private College

Using private college costs, the breakeven period on a college education has remained steady at approximately 10 years (from matriculation).


18

Internal Rate of ReturnThe benefit represents what rate of return on the investment?

ExampleInvest $10,000 and receive $10,800 back one year in the future.IRR = 8%1977 (public college costs)Cost of college plus lost compensation: $40,000 (in 1977$)Benefit of college: $360,000 (in 1977$)Real rate of return (return less inflation): 17%

2003 (public college costs)Cost of college plus lost compensation: $105,000 (in 2003$)Benefit of college: $1.9 million (in 2003$)Real rate of return (return less inflation): 21%

19

Expected Return on Education @ Age 18 (2003$)

15%

16%

17%

18%

19%

20%

21%

22%

23%

24%

25%19

77

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Public College

Using public college costs, the nominal return (at 2003 inflation) on a college education has risen from 19% in 1977 to almost 24% today.


20

Expected Return on Education @ Age 18 (2003$)

12%

13%

14%

15%

16%

17%

18%

19%

20%

21%

22%19

77

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

Private College

Using private college costs, the nominal return (at 2003 inflation) on a college education has held steady at approximately 18%.


21


Average Nominal Rates of Return (1977 through 2003)

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

6 M

onth

CD

s

20-Y

ear

Tre

asury

Bills

AA

A B

onds

S&

P 5

00

DJIA

NA

SD

AQ

Cost

of

Private

College

Cost

of

Public

College

22

Net Present ValueThe net future benefit is equivalent to what lump-sum amount today?

ExampleGiving up $10,000 today and receiving $1,000 each year for 20 years is the same as receiving $2,462 today (assuming 5% market interest).1977 (public college costs)Cost of college plus lost compensation: $40,000 (in 1977$)Benefit of college: $360,000 (in 1977$)Net Present Value: $165,000 (in 1977$)

$480,000 (in 2003$)2003 (public college costs)Cost of college plus lost compensation: $105,000 (in 2003$)Benefit of college: $1.9 million (in 2003$)Net Present Value: $830,000 (in 2003$)

23

Expected Net Present Value of Education @ Age 18 (2003$)

$0

$100,000

$200,000

$300,000$400,000

$500,000

$600,000

$700,000

$800,000

$900,000

$1,000,000

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

NPV @ Public College Costs NPV @ Private College Costs

The present value of a college education net of tuition has increased by 70% over the past 25 years.


24

Question

If higher education is such a good value, why the controversy over the cost of education?

Problem is not cost vs. benefit, but cost vs. liquidity.

Liquidity pain points

1. Amount of loan2. Duration of loan3. Interest rate4. Co-signer requirement

Summarized in the monthly payment

25

0%

4%

8%

12%

16%

0% 2% 4% 6% 8% 10% 12% 14%

Loan Interest Rate

Lo

an P

aym

ent

as %

of

Gro

ss In

com

e

Median Student Debt After Private CollegeMedian Student Debt After Public College

Low Pain

Moderate Pain

Self-Reported Pain from Student Loan Payments (college graduates)

High Pain

Source: Trends in Student Aid, The College Board, 2005; College on Credit: How Borrowers Perceive their Education Debt, Nellie Mae Corporation, 2003

26

Liquidity pain points

1. Amount of loan2. Duration of loan3. Interest rate4. Co-signer requirement

Summarized by the monthly payment

Survey of graduates who are now paying on student debt indicates that, for most students, monthly payments are not a major source of pain.

This suggests that co-signer requirements may be the source of perceived illiquidity.

27

Sources of Aid as % of Total Aid

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Loans Grants Institutional Aid Other

Source: Trends in Student Aid, The College Board, 2005

Sources of aid have exhibited little proportional change.

28

Sources of Loans as % of Total Loans

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Stafford Alternative PLUS Perkins

Source: Trends in Student Aid, The College Board, 2005

Despite the fact that PLUS loans carry more attractive rates than Alternative loans, as Stafford loans decline, students are shifting toward Alternative loans.

Alternative loans have co-signer release option, but PLUS loans do not. Thus, perceived illiquidity may be due to parents being unwilling to co-sign debt long term.

29

Since 1995, PLUS loans have grown 360% while Alternative loans have grown over 1,000%.

PLUS Loans• Deferrable• Lower subsidized interest rate• No co-signer release option

Alternative Loans• Not deferrable• Higher market interest rate• Co-signer release option

30

Making the Grade: The Economics of Education

Chief of Staff RetreatFebruary 24-25, 2006

copies of this presentation can be found atwww.business.duq.edu/faculty/davies

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Making the Grade: The Economics of Education Chief of Staff Retreat February 24-25, 2006

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