Is There a College Tuition Bubble?

Andrew Gillin at the Center for College Affordability and Productivity released an interesting paper this week exploring the parallels between the housing bubble and ever-rising college tuition.

The comparison is imperfect, because the higher education market lacks the crucial leavening ingredient of naked greed--you can't get rich quick by speculating on a college education, since you can't sell your ownership of the asset. And while student loans are often securitized, government guarantees against default reduce the dynamic of banks and rating agencies conspiring to develop and sell exotic, over-valued financial instruments with a hidden risk of collapse.

But, as Gillin explains, there are a number of similarities. As with the (recent) mortgage market, higher education lenders have little incentive to enforce lending standards, since the government pays off on loans that go bad. Student loan interest rates, like mortgages, also enjoy substantial public subsidies. As a result, demand increases and more people want to buy higher education than otherwise would.

This, of course, is precisely the point, and there's a powerful societal and moral argument for expanding access to higher education. But it has consequences that ultimately play out in the form of inflated tuition, largely because higher education doesn't behave like a normal market.

When the government subsidizes a normal market, the end result is greater production and consumption with both the producer and consumer getting some of the government money. But that depends on a reasonably elastic supply--the ability and willingness of the producer to ramp up production to meet increased, subsidy-driven demand.

Higher education doesn't work that way--the sector is substantially unable and unwilling to increase supply, particularly in the short term. Unable because there are major regulatory and cost barriers to entry--building a new college or university is massively expensive and time-consuming, and involves jumping through a lengthy, hoop-laden accreditation process. Unwilling because the vast majority of higher education institutions aren't profit-maximizing institutions--they're prestige maximizers. Their response to increased demand is to keep production (enrollment) constant, thus improving their admissions selectivity and the "caliber" of student they educate and as a result becoming a more elite institution. Meanwhile, the lack of objective information about quality makes price and quality synonmous, so institutions have to raise prices in order to compete.

So in the end, all the subsidies ultimatlely go to the institutions in the form of increased prices, and the consumer is no better off than when he or she started. Consumers who lack subsidies, meanwhile (mostly middle-income students who don't qualify for need-based financial aid) are worse off. So political pressure mounts to increase subsidies through aid, interest rate reductions, etc. in order to amelioriate spiralling prices, and the whole cycle repeats itself.

This can't go on forever, because there's a limit to how much money the government can or will spend to subsidize higher education. In the meantime, the negative impact of constantly increasing higher education costs are being hidden in part by an overly-simplistic conception of what higher education financial aid is for.

The goal of aid is nearly always framed as access, as in "all students deserve an opportunity to go to college." The problem (only in the sense of an already hard-won success) is that the large majority (nearly 80%) of high school graduates are in fact going to college, a number that has changed little even as costs have risen, a number which is (more or less by definition) an understatement of the percent of people who should go to college who do.

The real issues of concern relating to increasing college prices are threefold:

1) Where students go to college
2) Whether they graduate
3) What happens to them once they leave

Rising prices push non-wealthy students out of presitigous, expensive four-year colleges into cheaper, less-prestigous four-year colleges, and out of the four-year sector into the two-year sector. They also reduce the chances that people who begin college will graduate, because they force students to work nearly full-time (a major risk factor for dropping out) and increase the cost in the cost/benefit equation of staying in school. Finally, they force more borrowing, which narrows post-graduation (or non-graduation) career choices, increases the risk of costly loan default, and simply takes money out of the pocket of people who need it more than their alma mater.

A crucial element of solving the college cost problem lies with policymakers recognizing the link between rising costs and the lack of data about quality, and talking about the issue in more than just simple access terms.