Avoiding student debt may limit opportunities in developing economies

New research from Vanderbilt University finance professor Miguel Palacios finds survey participants less likely to finance education if a contract is labeled as a loan.

Rating agency Standard & Poor’s recently warned that student-loan debt could become the next asset bubble to burst in the United States as tuition costs climb and household incomes stagnate.

But further south, in countries like Mexico, Columbia and Chile, students may be so hesitant to borrow money for higher education, they could risk undercutting their future productivity and earning power.

Miguel PalaciosThat’s according to new research co-authored by Vanderbilt University finance professor Miguel Palacios in a working paper for the World Bank measuring student aversion to debt.

“Pursuing a higher education degree is one of the largest investment decisions that most individuals face,” Palacios and his co-authors write. “The investment appears to offer large risk-adjusted returns, so missing the opportunity to pursue a higher education degree can potentially have large welfare consequences.” And despite S&P’s warning in the U.S. about student debt, Palacios says graduating from a reputable college or university anywhere is still one of the best long-term investments someone can make.

Measuring attitudes toward debt

In survey of students and alumni who had applied for higher education financial aid through Lumni, a for-profit student-financing company co-founded by Palacios, respondents were asked to choose between economically equivalent income-contingent loans.

One was described in terms of a traditional loan, in which fixed payments were due unless income dropped to a certain level; the other was framed as a contract in which borrowers would repay the note as a percentage of their income. In addition, the researchers tested whether visually labeling the contracts as a “loan,” or Human Capital Contracts (“HCC”), made a difference.

Without a label, about 2% of the respondents chose the option framed as a HCC over the loan. But when the documents were labeled, respondents were 8% more likely to choose the HCC over a loan.

The researchers also wanted to know how much of a financial premium survey participants would pay to avoid contracts labeled as debt. To test for this, respondents were asked to provide the monthly payment amount where they would feel indifferent if a contract were a fixed amount or a capped percentage of income. In this case, the content of the agreement was the same, but one was labeled as “debt,” and the other as a “different contract.”

The results indicate that participants would pay a 4.5% premium to avoid contracts labeled as debt.

The sample included 767 respondents, drawn mostly from Mexico and Columbia, responding to a 15-question survey delivered via email.

While the researchers outline several potential flaws due to the small sample size, they suggest that these initial findings have implications for policymakers promoting access to higher education and providers of student financing.

“The label of the financial mechanism seems to matter to achieve (students’) goals,” Palacios and his co-authors write. “More broadly, this finding suggests that debt aversion may act as a self-imposed borrowing constraint affecting agents’ portfolio decisions and, indirectly, asset prices.”

Published Feb 17, 2012 in Vanderbilt Business Intelligence
Contact: vbintelligence@owen.vanderbilt.edu
Copyright 2012 Vanderbilt Owen Graduate School of Management