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Community College as a Steppingstone

Economic Brief
December 2022, No. 22-50

This article explores a model based on a theory of education in which high school students face three choices upon graduation: Join the workforce, enroll in a two-year college or enroll in a four-year university. In this model, academic two-year colleges can act as a steppingstone. Students enrolled in these two-year colleges can learn about their academic skills in a less expensive environment and transfer to a four-year university with a portion of their credits. This model finds that the options such as transferring and dropping out explain a large portion of the return to enrollment in higher education institutions.

The earnings gap between four-year college and high school graduates has doubled since 1980, as noted in the 2022 paper "Community Colleges and Upward Mobility." In response to this trend, various policies have aimed to increase four-year college access and completion rate by increasing the funding of two-year colleges. These colleges provide a less expensive environment (compared to four-year colleges) for students to receive feedback on their academic ability. Enrollments at these two-year colleges are open to everyone, and a fraction of accumulated credits can transfer to a four-year college.

Providing students with feedback on their academic ability may be an especially important function for two-year colleges. There are many reasons why people may drop out of college or even forego it altogether. One potential reason is heterogeneity in academic ability, which will be what we tackle in this article.

I (Nicholas) developed a model — which can be further explored in my 2015 paper "Stepping Stone and Option Value in a Model of Postsecondary Education" — in which high school graduates face multiple options. After graduation, they can either join the workforce — which can include attending a vocational school — or pursue higher education. In the latter case, they choose between attending a two-year college or attending a four-year college.

Attending a two-year college is considered less risky than a four-year college because of its lower tuition and less demanding learning environment. In this setup, students can learn about their academic ability while attending two-year colleges and assess their options in each period of their tenure as a student.

Modeling Higher Education

The economy is populated with high school graduates who have different college aptitudes and are uncertain about these abilities. However, factors such as high school success and the educational success of their parents provide some insight about these abilities. These individuals sort across educational institution types with respect to their beliefs about their likelihood of success:

  • Pessimistic grads join the workforce.
  • Optimistic ones enroll in four-year colleges.
  • Those with intermediate beliefs enroll in academic two-year colleges.

Although true academic ability is unobservable, as students progress through school they accumulate credits, which provide information used to update their beliefs about their academic ability, inducing a decision to drop out or transfer. Those enrolled at two-year colleges can opt to transfer to four-year colleges with some of their credits. In this sense, academic two-year colleges act as a steppingstone.

Some Striking Facts

This higher-education model is calibrated using the data from the National Longitudinal Study of the High School Class of 1972 (NLS-72). NLS-72 follows the educational histories of the senior class of 1972 from graduation through 1980. A final wave of this study was performed in 1986 to acquire long-run job market information. We distinguish between high school graduates who join the workforce directly after leaving school and who join postsecondary institutions and don't have gaps in their college careers.

Only half of the sample pursue higher education after high school. Among them, 20 percent enroll in vocational school, around 30 percent enroll in academic two-year colleges, and the rest attend four-year colleges. Dropout rates are higher in two-year colleges (60 percent) than in four-year colleges (40 percent).

Transfer rates are important in academic two-year colleges: Evidence from the NLS-72 data shows that about 32 percent of students who initially enroll eventually transfer to four-year colleges. This is especially important when considering graduation rates. Graduation rates are higher in four-year colleges, with 56 percent of those enrolling straight from high school eventually graduating. At two-year colleges, however, only 5 percent of those initially enrolled eventually graduate from them.

However, it's important to note that official graduation rates only reflect the experience of first-time and full-time students who graduated within six years of their initial enrollment. As many students at two-year colleges attend part time, have been previously enrolled at other institutions or have dual enrollment, the graduation rate might not cover the whole student body enrolled at two-year colleges. The Richmond Fed has developed a survey that includes a tool for measuring the success (including graduation rate) of students enrolled in two-year colleges, which can be used in future studies.  

The NLS-72 data also shows that the return from graduating a two-year college lags far behind the return from transferring to and graduating from a four-year college. This means that academic two-year colleges can play an important role as a path toward more financially rewarding environments such as four-year colleges.

A big value of attending two-year colleges is the option of transferring to four-year colleges. For those students following this path, 56 percent obtain a degree from the four-year college — the same share as those initially enrolled at four-year colleges.

We also note that students who graduate from four-year colleges earn the same wage after graduation regardless of whether they transferred in or attended there for their entire college careers. This favors the ideas that initial enrollment choice does not hinder the probability of graduating from four-year colleges or that people initially enrolled in two-year colleges are not intrinsically "worse off" than those directly enrolling in four-year colleges.

Low enrollment and high dropout rates in higher educational institutions can be associated with the risk and cost attached to education. Costs include forgone earnings (income streams that students "lose" by attending school) and direct costs of education that include tuition, fees and housing. Using NLS-72, the cost of attending a four-year college (including tuition, room and board and measured in 1984 dollars) is $5,039, while the cost is $2,730 for a two-year college. Since four-year colleges cost twice as much as academic two-year ones, students might find it optimal to enroll in academic two-year colleges.

What the Model Tells Us

The model identifies the value of each option — staying in the current institution, dropping out to join the workforce, or transferring to a different type of institution — and measures the degree of substitutability between two-year colleges and four-year ones. Moreover, the paper estimates the learning process in which students update their beliefs about their higher education ability in two- and four-year colleges. Overall, the findings suggest that exams at four-year colleges produce more information than those from academic two-year colleges. Two-year colleges are easier and thus provide information in the left tail, while four-year colleges are harder and thus provide information in both the left and right tails.

The return to enrollment in a particular type of higher education institution includes the return after graduation and the return of having the options to drop out and to transfer. The decomposition of returns to enrollment shows that, in an academic two-year college, the dropout option accounts for 31 percent of the full average return to enrollment, while the transfer option accounts for 69 percent. In other words, almost no one would enroll in an academic two-year college if these two options were not available. This is consistent with the finding that very few people graduate from academic two-year colleges. For four-year colleges, the dropout option accounts for 87 percent of the average return to enrollment, while the rest is explained by simple human capital accumulation that follows from enrollment until graduation.

The model also accounts for the wage differential to graduation at both academic two- and four-year colleges, relative to joining the workforce without holding a degree. For high-ability graduates at a four-year college, the wage difference relative to joining the workforce is three times larger than the wage difference between a high-ability graduate at a two-year college and an individual with no degree. This finding suggests that students with high academic ability currently enrolled in academic two-year colleges can potentially increase their future wages by transferring to and graduating from four-year colleges.

As mentioned above, students cannot observe their true academic ability. However, they can estimate it. The belief (p) is a number between 0 and 1. As students engage in higher education, three things happen:

  • After updating their beliefs, students potentially drop out if their exam scores cause them to lower their belief score enough.
  • Students at two-year colleges transfer up to four-year colleges if they receive good grades and accumulate enough credits, while students in four-year colleges remain and graduate if they receive good grades
  • As students accumulate credits, they move closer to graduation and, thus, some final reward.

Figure 1 below illustrates the thresholds of each option (drop out, stay or transfer) given students' beliefs about their academic ability (p) and accumulation of credits (s) in both two-year and four-year colleges.

The left panel shows different regions at two-year colleges, and the right panel shows four-year colleges. As we see with both institutions, the lower a student's belief (p) is about her academic ability, the higher the chance of her dropping out. Also, the plot shows that, for those students attending academic two-year colleges, there is large region of beliefs (approximately above 0.5) where it's optimal for the student to transfer up to a four-year college.

The model finds a high degree of substitutability between two-year and four-year colleges. If two-year college tuition decreases by 15 percent, a large fraction of students who generally enroll in four-year colleges would now enroll in these two-year colleges. If the tuition of academic two-year colleges rises to the level of four-year colleges, most of the students enrolled in two-year colleges would now enroll in four-year colleges. In this case, total enrollment in postsecondary education would decrease marginally from 43.1 percent to 40.3 percent. These findings suggest that the main reason high school graduates enroll in two-year colleges is affordability.


More than half of undergraduate enrollment comes from two-year colleges, and funding from local, state and federal taxpayers totaled more than $50 billion in 2012-2013.1 Thus, it's important to incorporate these two-year colleges into higher education economic models and investigate their dynamics with four-year colleges.2

This model of postsecondary education explores the dynamic interaction of academic two-year colleges and four-year colleges. In related literatures, ladders have been associated with skill growth. Lower steps of the ladder are characterized as steppingstones because they provide less risky environments in which to accumulate skills compared to higher steps. As students acquire skills, they move up the ladder.

The process that starts after high school graduation and culminates with a four-year college graduation is a ladder with two steps. The first step (the steppingstone) is an academic two-year college. The second step is a four-year college. But there are also ways of going down. First, a student at a four-year college can transfer to an academic two-year college. Second, a student can drop out. In other words, they move on once they acquire the necessary skills.

The main purpose of enrollment in academic two-year colleges is to learn in a less expensive environment and eventually transfer to four-year colleges with a fraction of the already accumulated credits. The model confirms that among those initially enrolled in academic two-year colleges, more-able students are less likely to graduate or dropout and are more likely to transfer. Similarly, among those initially enrolled in four-year colleges, more-able students are more likely to graduate and less likely to dropout or transfer. Finally, there is a high concentration of high-ability students among transferees, which shows that two-year colleges play the role of a steppingstone, especially for high-ability students who are not sure about their academic skills.

Samira Gholami is a research associate and Nicholas Trachter is a senior economist in the Research Department at the Federal Reserve Bank of Richmond.


For more statistics about community college expenditure, see "Digest of Education Statistics, 2015 (PDF)," starting with page 747.


For a review of literature on the benefits — economic or otherwise — of attending community college, see the 2011 paper "The Benefits of Attending Community College: A Review of the Evidence."

To cite this Economic Brief, please use the following format: Gholami, Samira; and Trachter, Nicholas. (December 2022) "Community College as a Steppingstone." Federal Reserve Bank of Richmond Economic Brief, No. 22-50.

This article may be photocopied or reprinted in its entirety. Please credit the authors, source, and the Federal Reserve Bank of Richmond and include the italicized statement below.

Views expressed in this article are those of the authors and not necessarily those of the Federal Reserve Bank of Richmond or the Federal Reserve System.

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