Education Subsidies and Bad Schools: Breaking the Causal Link

Abstract

Government subsidies for higher education suffer from serious design defects that contribute to seemingly contradictory problems — (1) too few individuals earn college degrees because the United States underinvests in prospective students and (2) too many students enroll in bad schools that leave them and society worse off than before they enrolled. Why would students overinvest in bad schools while underinvesting in education generally? Regarding underinvestment, many scholars have commented on how current aid is poorly targeted and fails to adequately encourage potential students who would otherwise not enroll in and graduate from an institution of higher education to do so. Regarding overinvestment, while many theories have been proposed, such as misleading advertising, an important but overlooked reason is that too high a percentage of student aid ends up encouraging prospective students to invest in bad schools. This misdirected aid exacerbates other problems that can lead prospective students to enroll in bad schools and can even be the sole reason a student chooses to enroll in a bad school. And while government regulations do attempt to prevent bad schools from receiving aid, those regulations are not working. To succeed, policymakers need to clearly define what a bad school is and understand bad schools’ root causes. After proposing a definition (a school in which the aggregated matriculating students’ estimated return, including personal consumption, is negative), I argue that bad schools are generally caused by two problems — unprepared students and underperforming schools. Schools target unprepared students who will not benefit from enrolling to obtain government aid. Unprepared students enroll due to a combination of market failures and badly designed subsidies. Schools are also able to underperform compared to their peers because of the flawed design of subsidies and related market failures. Current government regulations somewhat target these problems, but struggle due to the lack of a coherent underlying philosophy and a failure to more directly target the underlying issues. After discussing how the design of subsidies contributes to the problems, I propose possible reforms, including adding several indicators of school performance to the Government’s Gainful Employment Rule, which currently has just one real proxy (debt-to-earnings).