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Rise and Fall of a B.A.'s Return On Investment

July 18, 2016.

The Good Old Days of Rising Returns

The payoff from investing in a bachelor's degree (B.A.) is the earnings premium: the difference in earnings between a B.A. recipient and a terminal high school graduate. In 2001 the average earnings premium outweighed the cost of college by such a huge margin that a B.A.'s Return On Investment (ROI) reached 17% (Chart 1). Since that peak, ROI has sagged.

ROI is simply the degree's net payoff expressed as a percentage of college cost:


According to this ratio, rising costs have a depressing effect on ROI. Yet from 1980 to 2001 ROI managed to increase despite the relentless rise in tuition costs. That's because the Earnings Premium (blue area, Chart 2) grew faster than costs.

The widening earnings premium in the 1990s was generated by a growing demand for advanced skills associated with the digital revolution. Business and government needed college educated workers to effectively assimilate the new technology; and in the process, the skill requirements of many routine jobs were upgraded.

Chart 1

BA degree ROI and net tuition

The New Era of Eroding Returns

By the millennium, applications of the new technology had become more routinized, which dampened demand for high-level skills as well as B.A. earnings. So while the earnings premium (blue area, Chart 2) stagnated after 2002, net tuition costs continued to creep upward, and ROI slipped to 13% by 2013.

Chart 2. Mean Earnings

mean earnings BA vs HS

Without another technological revolution to raise productivity and reinvigorate demand for college-level skills, the earnings premium will increasingly depend on the falling wages of those without a degree.

The Median Earnings Premium: A Tale of Falling Wages

The statistical mean (average), used to measure earnings in Chart 2, is highly skewed by the astronomical remuneration of top 0.1% of college educated workers, and therefore overestimates the earnings of the typical (median) worker. So, when we reexamine the earnings gap through the lens of median wages, a different picture emerges.

Chart 3. Median Earnings

median earnings BA vs HS

After a big jump in B.A. earnings in 1986, the earnings gap widened only slightly; and after peaking in 2000, the gap shrank a little and stagnated. The wages of B.A. graduates actually trended slightly downward after 1986. So it was not the rising fortunes of college graduates that propped up the college premium. Rather it was the declining wages of high school graduates; their earnings sank 25% from 1980 to 2013.

Indeed, for today's typical college student, the promise of a B.A. is not a salary escalator, but a rescue from the economic abyss of those without a degree -- which is why today's 13% ROI is less cheery than it appears.

B.A. Employment Migrates Down the Occupational Ladder

The earnings of B.A. graduates started to slide around 2001, well before the great recession. One explanation is that by the end of the 1990s the digital revolution had become routinized, and demand for high cognitive skills cooled, or even reversed.

If that's true, then how are college graduates able to maintain such a high employment rate?

Because employers are requiring a B.A. for "mid-skill" jobs that otherwise would be filled by high school graduates. In fact, 73% of all the jobs regained since the bottom of the Great Recession were taken by workers with at least a bachelor's degree; less than 1% went to high school graduates. In effect, the high school grads are being bumped down the occupational ladder. As more and more of them chase low-level jobs, their wages continue fall, and many drop out of the labor force altogether.

To attract college grads into mid-skill jobs, employers have to pay them a wage that reflects their superior productivity. While that wage is higher than what a high school grad would get, it is lower than a high-skill job. So, the growing presence of B.A.s in mid-skill jobs explains the sagging earnings of college grads since 2002.

Why are employers hiring B.A. graduates for mid-skill jobs?

The "upskilling" of jobs is certainly one reason. But it's also true that employers are raising their credential requirements simply because they can, thanks to the high ratio of B.A. graduates in the labor market. This "credentials inflation" benefits employers in several ways.

  • Now that 91% of today's young workers have completed high school with inflated GPAs, the diploma is a worthless indicator of a job applicant's potential. So employers look to a B.A. degree (along with an academic transcript) as a cheap and reliable way to screen for the ability to succeed on the job.

  • But wait! Instead of raising the credentials-bar, why not screen job seekers by means of an in-house qualifying exam? Because that would expose employers to very expensive civil rights lawsuits if the in-house tests are shown to have a "disparate impact" on minorities. So the B.A. requirement is a cheap way to avoid legal jeopardy.

  • Compared to Europe, American employers are reluctant to invest in training. The high school diploma is such a lousy predictor of an applicant's potential that employers end up wasting a lot of money training workers who wash-out. So if they must hire an inexperienced person, they prefer someone who can "learn the ropes" with minimal supervision, i.e., someone with a college degree.

Will ROI continue its decline?

If the cost of college attendance continues to rise while the earnings premium remains stagnant, ROI will surely erode. Recently, however, enrollment growth has slowed significantly, and demographics suggest that it will remain flat or even decline for a while. This falloff in demand is likely to weaken colleges' ability to raise prices. Or maybe not: if the gov't increases student grant-aid, which is likely, colleges will seize it as an opportunity to raise tuition. Taxpayer generosity feeds the beast's addiction to rising costs. Maybe its time to tame the beast.


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