The Higher Education Bubble

4 July 2009 at 8:27 am Peter G. Klein 24 comments

| Peter Klein |

Will it be the next to burst? Yes, say Joseph Marr Cronin and Howard E. Horton. “Consumers who have questioned whether it is worth spending $1,000 a square foot for a home are now asking whether it is worth spending $1,000 a week to send their kids to college. There is a growing sense among the public that higher education might be overpriced and under-delivering.” Of course it is, which explains the unbridled hostility of the higher-ed establishment toward alternative organizational models. Adds Mark Taylor:

Make no mistake about it, education is big business and, like other big businesses, it is in big trouble. What people outside the education bubble don’t realize and people inside won’t admit is that many colleges and universities are in the same position that major banks and financial institutions are: their assets (endowments down 30-40 percent this year) are plummeting, their liabilities (debts) are growing, most of their costs are fixed and rising, and their income (return on investments, support from government and private donations, etc.) is falling.

These commentators do not, however, speculate on root causes. There’s no doubt the traditional model for producing higher education is grossly inefficient and that there’s been tremendous overinvestment in facilities and staff (malinvestment, in Austrian lingo) over many decades. But why, and why now? One hypothesis is that the democratization of higher education that began in the 1960s not only increased enrolments, but created a wedge between expectations of faculty (we’re here to create and disseminate knowledge and to challenge, engage, and enlighten our students — in the humanities, to teach them political slogans) and those of students (we’re here to party, find mates, and prepare for the job market). Another possibility is that political correctness has distorted the curriculum, creating large and well-funded departments in ethnic studies and postmodern literature with high overhead and few students, leaving insufficient resources for, and interest in, traditional subjects like math and history. What are some other hypotheses? (Thanks to Dennis Lubahn for the pointers.)

Entry filed under: - Klein -, Education, Institutions.

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24 Comments Add your own

1. Steve Phelan | 4 July 2009 at 9:59 am

It’s the inevitable effect of the price of professional human services increasing faster than the overall CPI due to durable goods prices falling as jobs were exported to China. Doctors and lawyers are facing the same pressures.

If we export academic jobs to low wage countries then the problem will be solved :-) Given that 50% of PhD students (and thus teaching assistants) are foreign then perhaps we are already doing this to some extent

Check out this link if you can…

http://chronicle.com/weekly/v54/i14/14b00501.htm
2. Peter Klein | 4 July 2009 at 1:22 pm

One of the linked articles says the average cost of a four-year US college education has gone up four times as fast as the CPI over the last 25 years. Has the cost of other professional services risen that fast?
3. Rafe Champion | 4 July 2009 at 4:38 pm

More research is required.
4. Steve Phelan | 4 July 2009 at 9:49 pm

Here is the research as requested:

CPI DATA May 2009
(Index 1982-84 = 100)
http://www.bls.gov/news.release/cpi.t01.htm

SERVICES:
Hospital and related services: 564.11
Tuition, other school fees, and childcare: 540.50
Other Services: 302.13

GOODS:
New Vehicles: 135.16
Personal Computers: 84.37
Apparel: 121.75

All items in CPI: 213.86 (weighted)
5. Rafe Champion | 5 July 2009 at 3:05 am

Jacques Barzun shed some light on university finances as early as the 1950s when he described in “The House of Intellect” how private Philanthropy in the form of grants for special projects created onging budget problems, partly because overheads were overlooked and partly because there was an expectation that the additional staff should stay on when the grant expired.
In “The American University” (1968) he wrote more about the accounting feats that had to be performed to balance university budgets from year to year.
Part of the problem was the bewildering array of ancillary services that universities were expected to perform and provide in the wake of the explosion of numbers post WW2 – health and employment services, counselling, sports programs, urban renewall, missions to the Third World, bloated administration to account for funding from all sources especially to meet the regulations mandated to qualify for
Fedral dollars.
The machinery of affirmative action, in addition to the impact on the demand for courses and the content of existing courses.
The competition for academic stars – Stigler wrote an essay demonstrating the ruinous cost of trying to have world leaders in several faculties.
Credentialism – formal qualifications required for a whole new array of jobs and careers, then the degree was not enough and postgraduate qualifications became mandatory for many careers
6. Warren Miller | 5 July 2009 at 7:02 am

The CPI data are quite telling, but I see them in a different light. Perhaps “more research is required,” though some common sense and understanding of basic economics might well do the job, instead. Healthcare and “tuition” are two areas where federal taxing-and-spending policies have been especially active (pernicious?) in the last four decades.

For instance, if the feds offer a higher-ed tax credit, why wouldn’t the typical university raise its tuition by the amount of the credit? If the feds offer funding incentives for, say, “ADHD,” surely there will be a community of physicians, shrinks, and other groupies with their appointment books at the ready, eager to diagnose the presence of rampant immaturity as ADHD, the better to (a) increase their own fees, (b) generate a stream of referrals from other parents who cannot or will not redress their own parenting deficits, and (c) ingratiate themselves with the educrats.

While we’re conducting additional research, perhaps we should also encourage the federal government to quit distorting markets with its intrusive taxing-and-spending policies. Then, and only then, will we get an accurate reading on the economics of healthcare and of higher education.

For the record, the U.S. is not exporting jobs to China, India, or elsewhere. We have a slew of government policies ranging from rotten “public” (a.k.a. government) education at the primary and secondary levels to special-interest groups (e.g., unions) clamoring for limits on visas and work permits for foreign nationals. When we combine the dumbing down of America’s young people with the misguided actions of career politicians whose ONLY objective is re-election, why are we surprised that we have such predictably disastrous results? We are simply getting the outcomes of the behaviors that the incentives have encouraged.
7. Michael E. Marotta | 5 July 2009 at 11:34 am

I completed a bachelor of science in criminology in April 2008. I am 60. I transferred in over 150 credit hours because I always made use of education. I took classes in desktop publishing, Japanese, engineering, etc., for professional development. That’s me.

The police chief in Ypsilanti returned to Concordia in Ann Arbor to earn a master’s in public administration.

At Eastern Michigan University, we fill up 8 to 12 sections of “Reseach Methods in Social Sciences” every summer session because of the demand from working professionals.

Then, consider bookstores, books on tape, lectures and concerts, reading clubs, museum sessions. Tourism and travel especially to ancient places must count, as well.

For all of that, in addition, the USA draws people from all over the world. Basically we “export” education by bringing them here. Much of this is because the nominally public universities all compete against each other in a nominally unregulated. This is different from nations that have unified university (and secondary) systems.

One of my young colleagues could have gone to work after his BSc in criminology, but he re-upped: “The master’s is the new bachelor’s,” he said.
8. Ben Rast | 5 July 2009 at 1:09 pm

The three areas where government has been most aggressive in promoting consumption, housing, healthcare, and education, are also the three areas that have seen the most rapid price increases. What do these areas have in common?

First, they have been promoted as unqualified social goods. More is always better.
Second, in the name of social improvement, government created specialized currency in various forms (tax credits, tax deductions, low cost loans, etc.) specifically for the purchase of these goods.
Third, given specialized purchasing power, and promised that they were purchasing an unqualified social good, consumers purchased.
Result: consumer overconsumption, producer malinvestment, and an industry bubble.
9. Steve Phelan | 5 July 2009 at 3:22 pm

You make some good points, Ben. Your theory explains the proliferation of colleges but why should the tuition price go up faster than the CPI? I don’t buy that the availability of low cost loans or tax credits necessarily leads to higher tuition prices. The prices have been rising much faster than the expansion of loans and credits.

Warren, can you explain again how China has nothing to do with lower durable goods prices and downward pressure on wages?
10. Ben Rast | 5 July 2009 at 3:31 pm

Steve,
When government creates money, it creates inflation. When government creates specialized “education currency,” it creates tuition inflation.

Are you sure that the growth of “education currency” has not tracked the growth of the price of university and college tuition? I smell a pretty interesting paper here.
11. Steve Phelan | 5 July 2009 at 4:19 pm

I agree!
12. Warren Miller | 5 July 2009 at 9:53 pm

Steve, I don’t believe that I tried to explain even once “how China has nothing to do with lower durable goods prices and downward pressure on wages,” so I doubt that I can explain it again. Bright guy that you are, though, I’ll bet you can. I look forward to that! I don’t mind eating my own words. I find them rather delectable on occasion. But being forced to eat someone else’s, even yours, would give me indigestion.
13. libertyfirst | 6 July 2009 at 3:21 am

Interesting post.

I would suggest that exporting (outsourcing) low quality jobs to the third world has increased the wedge between low and high skilled wages. This may have increased the demand for a degree, in order to avoid being hired at MacDonald’s, one of the few low-quality job that can’t be outsourced. This may have resulted in increased demand and increased tuition fees, because the benefits of having skills (and of signalling to employers) increase.
14. Steve Phelan | 6 July 2009 at 11:59 am

OK, Warren, my apologies. I guess I just wanted clarification on:

“For the record, the U.S. is not exporting jobs to China, India, or elsewhere.”
15. Richard Vedder | 7 July 2009 at 9:17 am

Peter Klein is right on target, as are the commentators who he quotes. Higher education is becoming wildly expensive in relations to the true benefits. However, higher education has been able to exploit the fact that learning about what individuals are competent is not costless to employers, and a college diploma provides a good proxy measure for intelligence, reliability, etc. The widening college/high school earnings differential has been exploited by colleges, even though much of the differential does not truly reflect learning acquired in college, but other attributes of college graduates (e.g., their superior cognitive skills in part genetically determined).

Peter is right on target in talking about the disconnect between the faculty and students, or, for that matter, between university administrators and the broader public. This disconnect is now causing a political reaction as state governments cut university appropriations.
16. srp | 9 July 2009 at 4:37 am

A number of different factors are in play:

1) The Baumol-Bowen effect, where labor-intensive craft industries such as the arts and education and much medicine have lower productivity growth and so their relative price rises

2) Government ubsidies to education in the face of somewhat inelastic demand

3) Collapse of screening function in high schools and effective outlawing of screening tests in employment gives higher ed an important advantage here

4) Higher returns to skill make investing in college more reasonable to the extent that human capital is accumulated
17. JC Spender | 12 July 2009 at 9:49 am

Given many of us on this blog are in or around BSchools, there’s a special interest in the volume, price and demand relationships. Doubly interesting given the low cost of ‘business education’ versus almost every other type of education. And triply interesting given the problematic nature of the product.

Several posts darkly imply the rise in HEd tuition is driven by the government’s pushing education … Duh! How many times have we heard that education is the best investment a government can make – even though there’s a healthy dispute in the human and social capital literature about whether this is a warranted claim?

For those who make this argument is the answer to cut back on higher education? How can one can justify that? How could there be an ‘efficient market’ in education when the costs and the benefits are so separated in time and happenstance? OK, it’s about ‘expectations’ but who shapes these?

On the one hand we have Mike Marotta’s note of ‘re-upping’, on the other srp’s arguments about relative price rises and the collapse of screening. These apply especially to BSchools.

There’s interesting research by Schleef (2000) in Sociology of Education 73, 3 that argues the MBA may have become the new liberal arts qualification for our greed-infused society – effectively bachelor degrees have been corroded/diluted into socio-economic insignificance i.e. you need an MBA to get a job, a liberal arts bachelor’s doesn’t hack it any more. Of course when we talk about ‘an MBA’ we are not talking about the ‘top 25’ and working at Goldman Sachs, we’re talking about the layers Cronin & Horton are discussing.

My ongoing interest is in discovering how we are to explain the staggering growth of business education (including that at the bachelor level). But given such demand, surely the price will rise until there are viable lower-cost providers? Note that U Phoenix is making some really interesting moves in Europe

For those interested in what’s happening to these ‘lower tiers’ of business education in the US I also heartily recommend Bethany Moreton’s (2009) To Serve God & Wal-Mart Harvard. Scary!
18. David Gerard | 13 July 2009 at 2:16 pm

My Pindyck & Rubinfeld intermediate text has a pretty nice little piece on this. At least with my alma mater, the facilities are nicer and far superior to what they were in my day, so costs are higher. Of course, government subsidies influence demand, but so do higher incomes and increasing skilled-to-unskilled labor premiums (and these premiums make the subsidies seem that much more ridiculous sometimes).

Supply curve shifts left, demand curve shifts right, I’m willing to bet on higher prices. I would argue that it’s only a bubble if the premium from having a degree isn’t sufficient to cover the costs of the degree. I don’t know enough to comment on whether that is true. But the premium seems like it’s large and growing (via Katz and Goldin):

I doubt these college cost numbers don’t include the University of Phoenix. Just based on the sheer magnitude of folks who take classes and get degrees from there, I would expect increasing acceptance of these courses and degrees as “legitimate.” Perhaps not.
19. JC Spender | 13 July 2009 at 9:27 pm

Interesting graph – it seems my stock-picking matches my education picking – I’m the guy at the bottom of the dip circa 1958.

But seriously, all this stuff about supply and demand curves presupposes a product whose value is not too problematic. Surely the interesting thing about education – from an economic point of view – is that its value proves highly variable across disciplines, and curiously wobbly and likely to change without notice within them.

Perhaps it’s more of a gamble than an investment.

When I went to college, science was the thing (I became an engineer). But science went off the boil years ago. I gave up on science too and went into banking and consulting, skipping the MBA bit. But many of my peers and juniors did not skip, helping boost the BSchool intake.

We seem to forget the sheer volume of jobs created in the financial services industry over the last 15-20 years.
20. JC Spender | 13 July 2009 at 9:45 pm

On reflection, two questions. At first glance this graph looks pretty much like the housing market before 2008 – and I understand that is considered a bubble. Could the premium be a lagging indicator of the state of the economy and/or job market?

Incidentally, premium over what? Those without a degree? In what kind of job market?
21. David Gerard | 14 July 2009 at 8:34 am

Presumably, in the market for “skilled” labor (however defined), the price (wage) is a better reflection of the marginal value product than housing prices are.

As for measuring the premium, these data are from the Katz and Goldin book. If you have NBER access you can download chapters directly.

http://www.nber.org/papers/w12984
22. JC Spender | 14 July 2009 at 9:34 am

Yes, you’re right. What I wrote was pretty stupid, but I liked your graph.

I don’t have NBER access – but I learn from Wright’s review in the JEH that this is seriously interesting stuff. The Goldin-Katz hypothesis of a major historical break, if valid, is of major importance.

Re your earlier comment on distance learning and its value:

Bernard, R. M., Abrami, P. C., Lou, Y., Borokhovski, E., Wade, A., Wozney, L., et al. (2004). How Does Distance Education Compare with Classroom Instruction? A Meta-Analysis of the Empirical Literature. Review of Educational Research, 74(3, Autumn), 379-439.
23. jack goldman | 17 July 2009 at 9:18 am

Education has become a defacto form of segregation. Hebrews send 80% of their children to college and graduate 68%, the most segregated group in society. Africans, on the other hand, along with Native Americans and Latinos, do not send children to college in these numbers. College segregates jobs and income. Whites graduate 29% of their children from college. White women and Hebrews are the clear winners of 30 years of affirmative action racism and gender bias, promoted in colleges with quotas. Colleges are used to socially reengineer society. When college was 60/40 male female it was a social crisis. Now that college is 60/40 female male that is a social good, ignored and silenced. Specialized females are easy to manipulate and control. Employers love it.

It’s about the money, as always. All elite jobs require a college education. Hebrews and white females are the winners of thirty years of race gender bias and quotas. All other groups are the losers. Quotas and subsidies do work. Government picks winners and losers. Winners love it. Losers hate it.
24. JC Spender | 17 July 2009 at 12:29 pm

Well, these are deep and dangerous waters.

But there’s also a methodological issue. Do the data support your implication of ‘social engineering’? If so by whom?

Or do they support the notion that education is a public good taken up more effectively by some groups than others, and if so for what reasons (consider Coleman and others on this)?

If the city provides a basketball court on my New York city block I’m not going to use it – but if they help sustain a public library, I may well. In contrast the young man who famously interned at JP Morgan in London lat month and wrote a report on how he and his peers use ‘media’ would probably not respond in the same way.

Is this social engineering or freedom of choice?