Is higher education a bubble?

By R.A. | WASHINGTON

MY COLLEAGUE at Democracy in America draws attention to an ongoing debate over the nature of higher education and, in particular, steady increases in the cost of getting one. The question of the hour is: is higher education a bubble?

Consider:

“If you can only afford to go to a state university, don‘t fret about it too much.” Except this: Kevin Drum went to a state university that does not exist anymore. When he graduated from Cal State Long Beach in 1981, he paid $160 in fees. If he graduated from the same institution today, the tuition he would have paid for this year would be $4,335. They officially call it “tuition” now, because it's not meant to be a nominal “fee” anymore. It's simply the price you pay for your education, as a customer, and next year it will be higher, a lot higher. Unless the direction of things change soon, it will be $6,450. And the year after that? It will be even higher. Fees/Tuition in the Cal State system have risen significantly every year since when Kevin Drum went there, and they have risen by around 400% since 2002. Given the complete intransigence of California republicans, tuition will most likely rise by another 32% next year.

And:

A diploma is a polymorphous investment. It is a guarantor of higher lifetime earnings: The "college wage premium" for highly educated workers is in the tens of thousands of dollars per year. It is also an insurance policy against unemployment, a signaling device to employers and peers, a prestige line for your resume or New York Times wedding announcement, and a place to make friends and connections. Most importantly, it is a way to learn new skills and information.

It could be that Thiel is right, that college students, en masse, are overpaying for their educations. But it seems more likely that some college students attending certain types of schools are overpaying. If you want to be an aerospace engineer and have the chops to get into Caltech, the quality of the education, contacts, and fellow students on offer might really be worth $200,000 to you. A diploma from the school practically guarantees a good salary.

It's much harder to talk about a bubble in education than it was one in housing. In housing, there was a clear metric: prices, in absolute terms and as a ratio of just about everything, were soaring. And there was a clear debate: are these increases justified by some real economic shift or are they a bubble associated with new mortgage products and loose credit. In higher education, the questions are much more difficult.

For one thing, it's hard to agree on what price should be the focus. Advertised topline tuition? Few people pay that. Average tuition paid? Average student loan debt? Is the bubble in higher education present at all universities, or just top universities, or just for-profit universities? And how is whatever rising price that is the focus connected to changes in the benefits of a higher education? Indeed, what are those benefits?

The ultimate benefit seems to be a substantial wage premium, and comparisons of that premium to average levels of tuition or incurred debt make college look like an incredibly good deal. The tricky thing is that there may well be an identification problem: it could simply be the case that students who go to college earn more, because the types of students that go to college are the types that have characteristics (intelligence, discipline) that translate into higher earnings. University degrees could simply be expensive signaling mechanisms at best, in this world, and massively wasteful cultural institutions at worst.

Because we can't select high school seniors at random, send some to universities and some into the workforce, and see what happens, we're going to be limited in what we can say about the extent to which this is true. But let me tell you how I think about this.

I think the gains from higher education are mostly, though not at all entirely, about actual learning, though I should say that a healthy portion of these learning gains aren't academic in nature, but have to do with things like social capital. Given the cost of higher education, it seems unlikely that signaling can be the main value of a college degree. There are so many other available means to accomplish the same thing. Why wouldn't an employer be as happy with a set of scores on the SAT and GRE and a letter of acceptance from Harvard? The potential market for a cheaper means to signal worth and to network seems so large that its absence is just very difficult to explain.

Meanwhile, it isn't impossible to skip the full university experience. Indeed, we're constantly presented with the example of men like Bill Gates as evidence for the idea that college isn't a necessity for many talented people. But surely the striking fact is how rare the Gates experience is. Most of the country's most talented young people opt to go to college.

There are highly successful firms that do opt to recruit large numbers of skilled young people away from universities and toward an early professional career: America's professional sports teams. Why haven't other companies followed suit? If college doesn't teach anything, how can we explain this enormous market failure?

One potential explanation is that there are multiple equilibria and at present we are stuck in a bad one. So long as the vast majority of talented youths get traditional college educations, it is too risky and costly for young people to defect from the higher-education strategy. Defection could, indeed, signal a lack of professional fitness. But this is a very vulnerable equilibrium. If even a small number of those students accepted to top universities opt instead to strike out on their own, the stigma of missing out on college could quickly erode (not least because the defectors would probably be the subject of massive New York Times trend pieces, increasing their exposure and their likelihood of success). One can even imagine a young student leaving to pursue an entrepreneurial vision directly targeted at potential college dropouts—setting up support networks, alternative signaling mechanisms, and so on.

But why hasn't this already happened? My guess is that most people, including parents, students, and employers, consider a university education to be a good value. The full set of returns to the investment—signaling and networking, yes, but also the actual investments in intellectual and social capital—justifies the sticker price, and certainly the $20,000 or so in average student loan debt.

What would we look for in a higher education bubble? A sharp rise in cyclically-adjusted loan default rates is one possibility. Certainly that was a part of the housing bubble. I think we'd also expect to see an increase in enrolment rates. But I don't think an increase in tuition or debt alone is sufficient to declare a bubble. Rather, these increases look to me like a reduction in subsidies and a shift in the distribution of the surplus created by the education investment. College educations have long been incredibly cheap given the (apparent) long-run benefit to the degree-holder. Students today are now paying for a larger share of the benefit they receive. And in some cases, universities appear to be getting better at extracting some of the surplus created by degree completion.

Is this problematic? There is a positive societal spillover to higher education, and so students (many of them anyway) should continue to receive some subsidy. And it is in society's interest to ensure that deserving poor students have the same opportunities as richer ones. But broadly speaking, I don't know if we can say that higher education has gotten too expensive or has become a bubble.