What Bad Students Know that Good Economists Don't By Bryan Caplan

The college premium skyrocketed over the last three decades. B.A.s now out-earn high school grads by 70-80%.* College graduation, in contrast, barely rose. In econospeak, the supply of college graduates looks bizarrely price-inelastic.

Over the last two months, I’ve read virtually everything ever written on this puzzle. All of the compelling stories converge on a single factor I’ve emphasized for years: The return to trying to get a degree is far lower than the return to successfully getting a degree. Why? Because marginal students routinely fail to graduate. The single best paper on this theme: “The Education Risk Premium” by Janice Eberly and Kartik Athreya.

Eberly and Athreya begin by spelling out the puzzle:

When measured by the ratio of hourly wages of skilled to unskilled workers, the college premium increased by nearly 20% between 1980 and 1996 (see Autor, Katz, and Krueger (1998)). However, enrollment did not respond substantially. Over the period 1979-2005, even though the fraction of young adults (29 years and younger) with a college degree rose by 9 percentage points (23% to 32%), the increase in male enrollment accounted only for one percentage point (Bailey and Dynarski (2009)).

Quick version of their solution: Expected returns heavily depend on graduation rates – and graduation rates heavily depend on students’ pre-existing academic ability.

The presence of failure risk generates asymmetric changes in the net return to college investment: those with low failure risk see a large increase in expected returns, but are inframarginal because they will enroll under most circumstances. Those with high failure risk see a much smaller increase in expected returns, and hence remain largely inframarginal.

Let me illustrate. Suppose you’re at the 90th-percentile of high school graduates, so your probability of graduating college if you enroll is around 90%. When the college premium ascends from 50% to 70%, your expected premium goes from 45% to 63%. In plain English, the payoff goes from very good to excellent. Either way, enrollment is a no-brainer.

If instead you’re at the 25th-percentile of high school graduates, your probability of graduating college if you enroll is around 20%. When the college premium ascends from 50% to 70%, your expected premium goes from 10% to 14%. In plain English, the payoff goes from really crummy to crummy. Either way, non-enrollment is a no-brainer… especially when you dwell on the fact that colleges don’t refund drop-outs’ tuition, much less the earnings and work experience they forfeited to attend.

Eberly and Athreya simulate college enrollment under a range of assumptions about the college premium and the completion probability. The right-most column shows the overall fraction of each cohort of kids

that enrolls in college as a function of the college premium. Here is wisdom: