Grey Swan

According to Wikipedia the number of H-1B Visas the US grants each year are decreasing. An H-1B visa permits educated non-citizens the right to work in our country. The concept is that these visas are necessary for the United States to stay competitive in high knowledge industries. Unfortunately, the current system both exploits Americans and under-utilizes foreigners.

The H-1B is essentially a reverse brain drain system. Since everyone agrees a brain drain is bad for a country, isn’t the reverse good? Maybe. If the foreign nationals move to our country to work, pay taxes, and live here permanently, it’s probably a good idea. If they come for a few years to work, pay taxes, get educated, and leave, it’s bad. Unfortunately the latter description seems to be true. While nearly 90 percent of undergrads in top schools are Americans, at the grad level only 50 percent are. The key problem is:

If foreign nationals crowd out American students from top schools but eventually return home, they are actually reducing the long term pool of educated workers. This is exactly what the program is intended to avoid.

What we need are more educated (and smart) Americans, not less. Why? People who produce more than they extract are increasing the average wealth of our country. The current program does this in the short run, but not in the long run. How do we fix this problem?

1. H-1B Visas need to be contain a path to citizenship. We want smart foreigners to stay in America and pay taxes year after year after year.
2. There should be more H-1B visas to garner more of the worlds best and brightest.
3. Universities should be required a maximum amount of foreign students. E.G. 20 percent. This way we give an incentive for foreigners to use their own education systems before coming to America. It would also prevent the crowding out of long term educated American labor.

N.B. The problem is that it takes a while for an H-1B visa holder to repay the cost he imposes on Americans. E.G. they consume subsidized education (many schools claim the cost of an education is below there full bill charge), they crowd out places in univerities, they out-compete Americans for jobs, etc. In the long run these policies work because unlike gardening, ’smart’ jobs tend not to be zero-sum, so wages of Americans ought not to be depressed.

I used data from the National Longitudinal Survey of Youth to examine how IQ affects income. The survey takes a set of young people in 1979 (late teens to early twenties) and interviews them on a broad range of issues every few years. While surveys have continued beyond 1996, I only have data up to that year.

In the simple linear regression of Income vs. IQ a clear trend emerges – income diverges by IQ as we age*. This may seem counterintuitive – doesn’t raw intellect matter less and less as we get older? Apparently the answer is no. Perhaps this is because the smartest people continue learning at a faster rate as they age, or perhaps this is because it takes a while for there salary to catch up to the value of work produced. E.G., A McDonalds employee is unlikely to be paid below the value of their production. However, many financial companies use strongly hierarchal structures that effectually underpay recent college graduates. Adoption studies confirm a similar trend: Adopted children’s financial outcome decreasingly correlates with their adoptive parents and increasingly correlates with tested aptitude.

What about education? The problem with controlling for education in the data is that smart people tend to get educated more. Anyone with an IQ over 130 who fails to graduate college likely has other uncontrolled variables that decrease their income outlook. Consequently, we would expect a systematic downward bias in our results. Running the regressions shows just this – IQ decreases in importance but continues to be important.

The unfortunate aspect of the above analysis is that education matters less than many people think. Spending more and more on education meets decreasing returns because the raw material – the people who are being educated – stays the same.

*Note that IQ only explains about 15 percent of all variation in income – other factors continue to be very important.

In my previous blog I examined two types of students, those who pay full bill and those who do not. I proceeded to show that State schools are generally a better investment for wealthier students, financially. All of this reasoning assumed ceteris paribus. Today I want to refine this argument based on the non-financial value of top schools.

When examining the non-financial argument, we have to look at how much utility a person derives from a decision. For example, certain students value the ’status’ of a top school more than others. Some students find the access to supposedly ‘better’ education rewarding whether or not it provides substantial financial rewards. To simplify this argument, I assume that there is no bias in students preference for non-financial reward based on wealth. Consequently, utility derived from college is constant across the spectrum of the population. The COST of college varies greatly, and it varies percentage wise differently than it varies in absolute numbers. This is important because most economists believe that each additional dollar provides less happiness than the previous dollar. For example, if Bill Gates earns an additional 10,000 dollars in a year, this makes little difference. If a struggling family earns 10,000 additional dollars, this would likely ease their life significantly and provide great utility. The result is that the same quantity of money means a different amount to different people.

A family that earns just enough to pay full bill for college will need to sacrifice a great percentage of their income to send their child to a top school. A really wealthy family, however, will sacrifice very little income percentage wise. Consequently the utility cost of money differs from person to person. However, since the value of college remains the same per person, it is those families who pay a proportionally larger share of income for college that have the greatest incentive to attend a state school. This makes the argument that the ‘middle class’ is hurt the most by college financial policies very true. In order to reduce this affect, the progressivism of college cost would need to be expanded across a much larger income range, and would probably need a higher start point (not zero dollars). Currently both the poor and the very wealthy have the greatest incentive to attend a top school. The upper middle class, the very people that top schools are best a producing, are penalized most.

There is a pervasive belief in America that attending a top college is the key for financial success. Moreover, the wealthier the family, the stronger this belief tends to be. Is it true?

Academic institutions have increasingly instituted price discrimination based on the wealth of students and their family. Currently, Ivy League institutions cost about 170,000 dollars to attend for four years without any financial aid. With full aid, College is virtually free. At state schools, costs are much less disparate. Four years of college may cost about 60,000 dollars at a state school, and be significantly less in certain areas. This means that the difference in cost for a top student attending a top school versus a state school is diferent depending on the students wealth. Consequently, wealthier students have a much greater incentive to attend local colleges than poorer ones.

Consider that attending a state school saves a wealthy student about 110,000 dollars. In order for an Ivy League education to be worth while, it would need to grant the student more than 110,000 dollars of present value future earnings. There are several different ways a different education may affect earnings. It may affect earnings rate per year (which may also vary at a different rate), it may affect initial earnings but have no affect on future earnings, or it may be some combination of both. Let me examine one possibility.

Using a 8 percent discount rate (the rate of the market, which is more comparable in risk to a persons earnings than the risk free rate), we find that a student would have to earn about 12,000 dollars more a year for attending an Ivy League institution than attending a state school, starting in year 1 (and assuming retirement at age 65).

How likely is it to assume that a student will make more because he attends a better college? Well, it is hard to say. Better students tend to go to better schools because they are thought to provide a better education with better financial prospects. However, if we keep the student constant, an average student a Princeton is likely to be a top performer at a SUNY. In fact, studies suggest that attending better schools provides only small gains in earnings. As the difference between the price of state school and top institutions increases, wealthier students will have more and more incentive to save money and go ‘local’. Poorer students, however, will have greater and greater incentive to attend an Ivy League, as they will continue to pay nothing.

The stopgap of this argument is that there are reasons to attend top colleges that (may) trump financial reward. For example, it is possible that the social benefits derived from attending a top school (such as status) outweighs the financial costs of doing so. Unfortunately students may simply be unaware that the school that is attended is less important than the student who has attended the school. If they become more savvy, top colleges will lose many of their paying students. Since these students are most likely to contribute after graduation, schools will also lose alumni funds.

More tomorrow….