Historians, both famed and anonymous, have developed theories that try to explain the course of history. The “Whig theory” of steady progress was widely shared until the horrors of the twentieth century demolished it. Marx’s theory of one class replacing another had a long run. The “Great Man” theory (now, Great Person theory) still has some adherents.
I too am trying to develop a theory of history, but not a grandiose one. I’m trying to figure out if there are consistent ways to better understand certain historical outcomes. Why was St. Louis an “also-ran” to Chicago? Why did so many orphans work in the early factories of the Industrial Revolution? Was soil exhaustion a contributor to the Civil War?
In answering such questions, I borrow tools from my friends the economists. Economists don’t spend a lot of time digging into the past but when they do they come up with surprising findings. When Deirdre McCloskey explained the scattered private fields in medieval England, she solved a mystery that had stumped historians for decades, and Eric Edwards and Walter Thurman just revealed an explanation for the U. S. Corn Belt that historians have largely ignored.
So let me see if a few basic economic tenets can expand our understanding. Here are three important ones (from the book Common Sense Economics).[1]
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- Incentives matter.
- Too often long-term consequences and secondary effects are ignored.
- Unless restrained by constitutional rules, special-interest groups will use the democratic political process to obtain government favors at the expense of others.
I will apply them to the student debt problem, which I discussed in a review of Josh Mitchell’s book The Depth Trap.[2] In this short space I can only highlight aspects of the extremely complicated history.
Student Loans: The Background
In the 1960s, there was growing interest in college. The Soviets had just sent a satellite into space, arousing concern that the United States was falling behind technologically. Parents were sacrificing to pay for school for their children. Wives worked while their husbands completed college. Some high school graduates went to cheaper colleges than they wanted and some didn’t go to college at all.
Some students (or their parents) borrowed money for college, but until 1965, loans were hard to get, because 18-year-olds with no financial track record are not “safe” risks.
(There was one private student-loan program. Richard Cornuelle, a libertarian who wanted to show that the private sector could solve “public” problems, had begun a nonprofit organization [USA Funds]. It guaranteed bank-provided student loans if the admitting school approved the student for a loan.)
The “Answer”
The “answer” to the problem of insufficient funding began in 1965. Under President Lyndon B. Johnson, the federal government started guaranteeing bank loans to students (which it had been doing on a limited basis since 1958).
Even so, banks were reluctant to issue loans in a big way during the inflationary 1970s. The interest rate guaranteed by the government wasn’t high enough. Important politicians wanted the loans to expand but they didn’t want the funding to boost the federal budget.
So the Nixon administration created a quasi-private organization (“Sallie Mae”), which borrowed money from the government at very low interest rates (which the banks could not do) and lent it to the banks, which then lent it to students. The government covered any student-loan defaults, another bonanza for the banks.
According to Josh Mitchell, this “convoluted” channeling of funds was designed “solely to keep the student loan program off the federal budget.”[3] It led to higher costs for the taxpayer, but the taxpayer and many congressmen didn’t know much about it.
Sallie Mae became an active lobbyist with Congress, to keep the lending on track. USA Funds continued and it, too, became highly profitable—an unseemly fact because it was a nonprofit organization (Cornuelle had left).
And some borrowers never paid back the loans. So in 1976 Congress eliminated bankruptcy for student loans.
When Bill Clinton became president in 1992, he pushed to get rid of Sallie Mae, which he viewed as unnecessary and corrupt, and to have loans issued by the federal government. Over time, Sallie Mae “went private” and USA Funds’ profits went to a new foundation. Today most student loans come directly from the federal government.
The crisis, if it is one, is that the loans amount to some $1.75 trillion in total (compared , say, with national credit-card debt of $986 billon), with the average student loan at $29,000. President Biden has proposed a $400 billion loan forgiveness plan and the issue is before the Supreme Court.
Quite an entanglement. What can economic principles tell us about how this happened?
First, incentives matter.
Lyndon Johnson was responding to the incentive of reelection by championing student loan guarantees. (Joe Biden too was responding to an election incentive when he proposed forgiving student loans in 2022.)
With funds readily available, more students had an incentive to borrow for their education. The resulting higher demand gave colleges an incentive to raise tuition; a good portion of the student loans went toward higher tuition rather than saving students money.
Politicians had an incentive to satisfy their constituents’ desire for education but also to hide the costs to the taxpayer. And once risk largely disappeared, banks had an incentive to issue as many loans as possible.
Second, too often long-term consequences, or the secondary effects, are ignored.
No one seems to have predicted what is obvious now: Some students went to college who would not be able to pay back the loans. Many 18-year-olds borrowed without realizing the potential costs or even the demands of college. It looked like free money, and colleges and universities often made the costs opaque.
These students dropped out. They took jobs paying far less than they expected—but they were tied to paying the loans for their blunted American dream. Others graduated, but had borrowed excessively for poor-paying majors or expensive post-baccalaureate degrees. With bankruptcy not an option, some young people are postponing buying a home, marriage, or having children because they can’t afford to do so. [4]
Thus, over the 58 years since the program started, its high hopes have been dashed.
Third, unless restrained by constitutional rules, special-interest groups will use the democratic political process to obtain government favors at the expense of others.
Here we get into the role of government. Once political forces controlled the plan, special interests intervened. Sallie Mae’s arrangement was so profitable that the entity obtained permission to accept private investment and became a Wall Street darling. (The chief lobbyist for Sallie Mae had a romantic relationship with the head of the key congressional education subcommittee. )
The banks, of course, benefited and strove to keep the program going. Colleges and universities not only raised tuition but hired more lobbyists—according to Mitchell, universities have more lobbyists than any industry except pharmaceuticals and technology. [5]
New for-profit colleges sprang up, taking advantage of the new funding. Some provided valuable education, but some did not.
The excesses of for-profit schools gave politicians in Congress a chance to gain publicity by attacking the schools. A long-running tangle led to the demise of many schools, leaving students in a lurch. That led to taxpayer-funded loan forgiveness under some circumstances. I could go on.
Conclusion
The economic principles underlying incentives, secondary effects, and special-interest lobbying do seem to offer insights into this problem. Is this the beginning of a (small but useful) theory of history? I welcome comments.
Notes
[1] James D. Gwartney, Richard L. Stroup, Dwight R. Lee, Tawni H. Ferrarini, and Joseph P. Calhoun, Common Sense Economics (New York: St. Martin’s Press, 3rd edition, 2016), 2, 106. See commonsenseeconomics.com.
[2] Josh Mitchell, The Debt Trap (New York: Simon & Schuster, 2021). Reviewed here.
[3] Mitchell, 44.
[4] Mitchell, 6.
[5] Mitchell, 8.
Photo is by Giammarco Bascaro of Unsplash.com.
Isn’t another vital element, “Penalty exemption”? (It could be called a form of incentive, I suppose, and it includes public choice economics.)
No penalty for making bad loans and throwing the cost on taxpayers.
No penalty for raising tuition and selling $10 textbooks for $150
No penalty for building lavish student unions and giant speaker fees, etc. and laying the costs on students
No penalty for politicians who fail to provide oversight and cut losses
No penalties for attracting students to courses that are fashionable but contribute little or nothing to loan payback ability
I’d suggest that any student subsidy program require colleges and universities to cap student costs–say to no more than the CPI or another reasonable economic index. Perhaps it should also require periodic evaluations of loan delinquency and post graduate earnings data.
It’s fanciful thinking but I’ll indulge anyway: Let’s have members of Congress publish every re-election cycle what bills and programs they voted for and how much these programs cost taxpayers.
Wallace, I agree that penalty exemption is extremely important. But why do these “exemptions” exist? My answer is that in many cases democratic government gives a “cover” to politicians and bureaucrats. By stating things in a positive way (“everybody ought to go to college”) politicians, bureaucrats, and special interests persuade the public that all is well, while they reap substantial rewards. Public choice economics, as you indicate, has useful explanations—the rational ignorance of the voter, the shortsightedness effect, etc.
When I first read you are trying to develop a theory of history, what popped into my head was “it’s called economics.” I think you are on the right track.
Mises (in “Human Action” Ch. 2) lays out just this position on relation between theory and history (or applied, empirical economics). He uses the more general term praxeology instead of economics, limiting economics to interpersonal exchange.
Jack Hirshleifer once said that when sociology and other social sciences start looking sensible it’s because they start looking like economics. I think the same is true of history.