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January 10, 2005

Student Loans-- Becker and Posner, Investment vs. Consumption

The Becker-Posner blog has an interesting discussion of student loans (see Becker and Posner), inspired, I bet, by a WSJ article I read today or yesterday giving sob stories of people pressed to repay the government money they took and used for education.

I am surprised that neither Professor Becker nor Posner highlight the crucial difference between home mortgages and student loans: student loans are profitable for the borrower, but home mortgages are not. (Both are, technically, investment, but a home loan is investment only in the sense that it pre-pays for housing consumption.)

This strengthens Becker's point that people would be willing to take out large student loans since they are willing to take out even larger mortgages. The student loans, unlike the mortgages, actually increase the borrower's ability to repay, by increasing his future income.

This weakens Posner's point that if lack of bankruptcy protection is appropriate for student loans, it ought to be appropriate for mortgages too. One reason it makes a difference is that we might think that because of consumer ignorance or transaction costs the default rule should be bankruptcy protection for consumption loans but no bankruptcy for investment loans. Why, then, would education investment be different from, say, investment in apartment houses? -- Because the purchased capital can be used as security if it is an apartment building instead of an improved brain.

Of course, not all student loans are for investment. Some do *not* increase earning ability-- maybe. Loans to people getting B.A.'s in English come to mind. But, first, I'm not sure such a degree doesn't have a high material return. If you looked at English majors 20 years down the line, I would not be surprised if you found they had, on average higher incomes than business majors. The reason is not necessarily that English is so useful in making money, but that it may be that the kind of people who major in English are those with the intellect and family background to be successful in business.

Second, I think it would be appropriate to deal separately with education that does not have the high material return that most education does. The easy justification for most government-aided student loans is that they are loans that have positive return to the borrower, and are merely filling in for market failure arising from bankruptcy. This is Becker's main point-- that this is legitimate, but it doesn't need any government subsidy on top of special repayment rules. The more difficult justification is that even non-income- generating education has positive externalities. That may be true, but it surely depends on the type of education. If so, we should target the subsidy to the externality-generation kind of education. Training to become a research scientist has positive externalities; training to become a diesel mechanic probably doesn't.

Posted by erasmuse at January 10, 2005 10:12 PM

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