Is College Education Worthwhile?

Is College Education Worthwhile? Rashida Grant (rmg20) Zachary Easterling (zde) David Nowlin (dwn1) Sylvia Telesz (sat2) Department of Economics The University of Akron Fall 2008 Abstract The rising cost of college education in the past twenty years has been significant and has left students, parents and economists with the realization that the opportunity cost of pursuing undergraduate and graduate studies is high. Although the value of a college education increased in value in the 1980 s, the 1990 s witnessed a change in the labor market which amounted to a narrowing of the hourly wage gap between the college educated and those equipped with a high school diploma. (Barrow, 2005) The hourly wage gap between those with college education and those without, which had grown by 25 percentage points in the 1980 s, grew by only 10 1

percentage points in the 1990 s. 1 (Barrow, 2005) Although the fluctuation in wage difference can be the result of a decrease in demand for employees with a college education it can also be attributed to the increase in supply of college graduates. An analysis is crucial in determining the benefits and costs of pursuing and acquiring a degree. This paper examines the present and future value of a college education, or the lack of it, and how it affects human capital stock. Introduction Since increasing college costs, as well as foregone wages, consist of the commitment of completing a college education; it is necessary to examine if college education is a good investment. Certainly, factors of prestige, expectations of others, how much education is valued personally and what level of education was achieved by the students parents is influential in making the choice to pursue college. The returns of a college education can include the obvious form of attaining higher earnings, which economists typically interpret as a measure of the greater productivity of more educated individuals. 2 (Topel, 2004) But other benefits, such as being a more efficient and organized producer in the market as well as being personally more efficient, making better consumption decisions and having increased overall health as well as better access to healthcare all contribute as factors in choosing a college education. The most significant marginal benefit here includes the present value of the annual increase of life-time earnings which exist because a college degree is attained. The marginal costs which counterpoint the benefit, at least in the short-run, consists of the cost of four to five years of tuition and the loss of income and benefits due to not working full-time. Theoretical Overview There s an urban legend that Albert Einstein once said compounding is the most powerful force in the universe. Whether or not he really said it, it has become my financial motto. I strongly suggest you adopt it. (Sangrillo, 2006) In her article Sangrillo outlined some of the most prominent monetary economic ideas; she discussed compounding, discounting, present, and 1 Barrow, Lisa; Rouse, Cecelia Elena, 2005, Does College Still Pay? The Economists Voice, http://www.bepress.com. 2 Topel, Robert, 2004, The Private and Social Values of Education, Education and Economic Development, http://www.clevelandfed.org. 2

future values. But in her entire commentary on financial freedom, interest, and wealth she missed the most important part; how to start. According to the Bureau of Labor Statistics hourly wages depend on industry of employment, type of position, and level of competence. In their 2006 survey of jobs in the Akron-Cleveland area, they outlined thousands of employment positions and quantified their worth by giving them average hourly rates. This excel model uses the following formula to calculate the net present value which is the present value of all future cash flows, discounted at the appropriate discount rate then summed together. The following formula depicts the process in which discounting and summation takes place. In this model, NPV is the accumulated value of all net income discounted by the average inflation rate. This formula also includes a cash flow at time zero (C 0 ). For college graduates this cash flow is actually a separate reverse annuity. This formula shows the initial outflow for a student working on a bachelor s degree. Students working on advanced degrees would extend loan amounts over seven years. C 0 = L 1 *(1+r) 5 + L 2 *(1+r) 4 + L 3 *(1+r) 3 + L 4 *(1+r) 2 + L 5 *(1+r) Where L i is the annual amount borrowed. Payments are made on the loan by both bachelors and master s degree holders in the following manner. NLA = {GLA -[(GI * 0.08) (GLA * 0.0421)]} New net loan amount NLA is equal to the residual monies left over from a payment derived from 8% of total Gross Income after paying 4.21% interest on a federal student loan subtracted from the previous gross loan amount. 3

Literature Review It is not surprising to see the relationship between higher earnings and education. There is usually a consensus that college remains a good investment. While the research surveyed has focused on college education specifically, it is evident a common thread exists between individuals with focus and determination and higher life time earnings. It can be inferred that individuals who pursue college are more focused and determined than those who do not choose that route. Education creates positive externalities which can be passed as a benefit to future employers as well as peers and personal relationships. Topel (2004) argues that while the most studied benefit is higher earnings, there exist intangible benefits such as being a more efficient parent who makes better use of producing his or her own child s human capital or that person A, for instance, may benefit from person B s schooling by making person A more productive. It appears that the efficiency of an educated person may influence family members as well as peers, in addition to higher efficiency in the workplace, because the effect of an education on an individual is internalized by others. Trostel (2007) maintains that the fiscal impacts on college attainment reveal that college students generally pay much more in taxes than those not going to college. 3 Since government expenditures are less for college graduates than for individuals without a college education, that is, total government spending per college degree is negative, 4 (Trostel, 2007) this in addition to increased productivity reveals that college education not only pays for itself, but increases standard of living. Because higher earnings genuinely reflect the skills learnt in school, wage comparisons across education and age levels are likely to yield reliable estimates of the benefits of schooling. 5 Method 3 Trostel, Philip A., 2007, The Fiscal Impacts of College Attainment, New England Public Policy Center, Federal Reserve Bank of Boston, http://www.bos.frb.org. 4 Ibid. 5 Levin, Henry; Belfield, Clive; Muennig, Peter; Rouse, Cecelia, 2007, The Costs and Benefits of an Excellent Education for All of America s Children, Columbia University, http://www.cbcse.org. 4

Using the Consumer Price Index provided by the Bureau of Labor Statistics and averaging inflation from 1990 to 2008, research has shown that the mean inflation during this period is 2.94%. As the discount rate, this will be used to appropriately reduce future cash flows in order to measure the expected salary of several entry level positions against the expected salary of a college graduate in nominal terms. As a high school graduate there are several main fields of employment that are open. This paper will use the six main fields: clerical, data processing, factory labor, fast food/counter sales, retail, and non-commission sales as proxies for non-college education employment. College education will be measured by a lump-sum salary which will be dynamic in the accompanying spreadsheet. According to Ken Abosch, the head of Hewitt Associate's compensation practice, the average salary increase in 2008 was 3.8% expected to rise to only 3.9% in 2009. Using this information the excel model will show that indeed it is not worthwhile to attend college on a 12 year horizon. And while nominal annual payment for a college graduate is as much as three times that of an entry level worker, the debt incurred while going to college makes a short term look at higher education very bleak. Using the BLS information, entry level clerical workers were given an average starting salary of $9.83, $10.40 for data processing, and $14.18 for factory labor. Fast food/counter sales earned the least taking home only $7.62 an hour, retail sales was second from the bottom making only $9.70, and non-commission sales positions earned the most averaging $19.94 per hour. These non college graduates were also given a maximum hourly rate for their different employment positions. In this model it is possible for these entry level workers to top stop, reaching a plateau of earning. For the college graduate, undergraduate expenses were based on a $5000 semester, which included $500 in supplies, outlined as books, computer programs, and lab expenses. This is represented in the model as college expenses (Annual). Expenses for college were expected to rise 8 % until graduation. After graduation this model also includes Masters Level education, adding 20% to the base college expense. Data The net present value model, the sum of all the future cash flows discounted back at the appropriate discount rate then summed together, reveals that the present value of a bachelors degree, assuming that the initial salary is $34,000 and retirement age is 67, is $2,108,935.14; future value would be $8,286,555.96. The compounding nature of the discount rate severely reduces the actual value of a dollar at this point on a timeline. The net present value of a master s degree assuming an initial salary of $47,900 and the same retirement age would be 5

$2,574,689.75. The future value of these dollars would be $10,598,558.20. Again, the compounding nature of a discount rate cuts the future value into approximately one quarter. As for student loans, this financial model reveals that depending on the initial salary, the expected payback period can be shortened or lengthened drastically. A prospective bachelor would expect to pay back college loans in less than 10 years. In reality, the combination of increasing tuition costs during college with compounded interest on unpaid loan amounts will extend the pay back period to just under 25 years. True costs of the loan become $61,135.85 in principle and $45,468.74 in interest for a 24 year total of $106,604.59. Master grads fair slight better owing a total of $180,914.90; earning $84,391.62 in interest and $96,523.28 in principle loan amounts, paid back in only 27 years. The increased initial salary of a worker with a master s degree allows them to pay back their more expensive loan in less time because of their ability to apply more money against their principle loan amount. Coming out of college a graduate entering the work force with a bachelor s degree will expect to immediately earn more than clerical workers, data processors, fast food/counter sales, and retail workers that all have five years of job experience. Unfortunately due to their late start, bachelors degree holders must wait 12 years to overtake non-commission sales workers and 20 years to earn more than factory laborers. Those with master s degrees are immediately rewarded; earning more than five of the six categories immediately upon entering the work force. They will surpass the non-commission sales agents the following year. Overall lifetime earnings for college students are slightly convoluted based on the idea of lost revenue stemming from a late entry into the work force. Not only do college students have to pay back hundreds of thousands of dollars in student loans, they must also contend with being at least five years behind in the work force. All workers who enter the labor market immediately upon graduating high school have some positive cash flow. The opportunity cost of attending a college or university for a worker is foregoing the first five to seven years of fruitful employment. Assuming lost income from working at a retail sales position, it will take 30 years for someone with a bachelor s degree to surpass the accumulated earnings of a clerical worker. Including a discount rate into those calculations, that period is lengthened to 35 years. The following table describes additional earn back and discounted earn back time frames. Table 1: Total and Discounted Equal Earnings of College Graduates and Non-Graduates BA/BS Total Earnings BA/BS Discounted Earnings Master s Total Earnings Master s Discounted Earnings Clerical 30 Years 35 Years 30 Years 35 Years Data 30 Years 35 Years 30 Years 35 Years Processing Factory 45 Years 55 Years 40 Years 45 Years 6

Fast Food/ 20 Years 25 Years 25 Years 30 Years Counter Sales Retail Sales 25 Years 30 Years 25 Years 30 Years Non- Commission Sales 40 Years 50 Years 35 Years 45 Years Results While being limited to a 12 year horizon, the idea of going to college would not be favorable to most. College graduates start out in the workforce behind all other categories when looking at net present value. However when extrapolating the data out along the timeline the model shows that college truly is worth it in the end. Net present values of both the bachelors and masters degrees are higher than the net present values of any of the other categories. Not only do the higher salaries of college graduates lend themselves to be desirable; college graduates have more opportunities for investment, further increasing the gap between themselves and their nongraduate counterparts. Summary In constructing a time-line between high school graduates who attain employment upon graduation and college students who defer compensation to invest in an education, we hoped to gauge the efficiency of choices made relevant to factors such as the present value of salary, the net present value of income, future earnings and the ability to pay debt secondary to earnings potential. We used the discount rate of 2.94 percent, the average inflation rate from 1990-2008, to determine the present value of future cash flows or salary purchasing power. Annual raises were constructed at 3.9 percent. We used the initial salary figures of an Economics graduate with a Bachelor s degree at $34,000, and the initial salary of an Economics graduate with a Master s degree at $47,900, according to Bureau of Labor Statistics Data in 2006, as comparison against earnings made by high school graduates receiving salaries upon high school graduation. We found that, as with any investment, a college education requires the expense of time, cost and foregoing immediate earnings and delivers benefits of higher earnings potential due to increased productivity. Based on our future value calculations, a high school graduate employed in retail has the earning potential or a lifetime income of $829,000. Likewise, an Economics graduate with a bachelor s degree has a lifetime earning potential of $2.1 million and an Economics graduate with a Master s degree can potentially earn $2.57 million. 7

The value of focus, discipline, and determination defined within the parameters of education yields higher earnings and benefits than hard work alone. References Barrow, L., and C. E. Rouse. 2005. Does college still pay? The Economists Voice 2, (4): 1-8. Levin, H., C. Belfield, P. Muennig, and C. Rouse. 2007. The costs and benefits of an excellent education for all of America s children. Retrieved March 17, : 2007. Topel, R. 2004. The private and social values of education. Education and Economic Development: 18-9. Bureau of Labor Statistics. National Compensation Survey 2006. http://www.bls.gov/ncs/ocs/sp/ncbl0848.pdf (1 December 2008). Bureau of Labor Statistics. Consumer Price Index - All Urban Consumers. US Department of Labor. http://data.bls.gov/servlet/surveyoutputservlet?data_tool=latest_numbers&series _id=cusr0000sa0&output_view=pct_1mth (10 November 2008). Bureau of Labor Statistics. Occupational Employment Statistics. http://www.bls.gov/oes/current/oes_oh.htm#b13-0000 (6 December 2008). Dr. Al, Lee. Finding Percentages in Salary Increase for 2008. Payscale: Ask Dr. Salary. http://blogs.payscale.com/ask_dr_salary/2007/10/finding-percent.html (6 December 2008). Sangrillo, Karen. All About Free Money, and How to Earn It. Bucks County Courier times, 5 November 2006. Trostel, P. A. The fiscal impacts of college attainment. US Department of Education. Federal Student Aid. http://studentaid.ed.gov/portalswebapp/students/english/ffel_dlinterestr ates2008-09.jsp (3 December 2008). 8