Living in a bubble: Why the higher education bubble is going to burst and UA will be covered in suds

November 23, 2011 § Leave a comment

Whenever the economics of a given problem are to be properly evaluated, there are certain economic laws which can’t be ignored. Thomas Sowell[1] probably put it best when he wrote:

“Economics is more than a way to see patterns or to unravel puzzling anomalies.  Its fundamental concern is with the material standard of living of society as a whole and how that is affected by particular decisions made by individuals and institutions. One of the ways of doing this is to look at the economic policies and economic systems in terms of the incentives they create, rather than simply the goals they pursue. This means that consequences matter more than intentions and not just immediate consequences, but also the longer run repercussions of decisions, policies, and institutions. [Emphasis mine]”

As Sowell suggests, in order to fully understand the complications of any policy, one must first evaluate both the intended goals of said policy as well as the eventual outcome, whether that outcome was expected or not. This is what Bastiat[2] would have referred to as That which is seen, and that which is not seen[3].

Without a doubt, the American higher education system is a perfect representation of this phenomenon. Every facet of society has forgotten the words of Bastiat and ignored the advice of Sowell. Indeed, no group has been immune; students, administrations, politicians, and most regrettably, much of academia have ignored the basic economic laws which once formed the basis of western society.

This blatant neglect for basic economic laws has adversely affected the higher education industry (as well as many other industries) in America. There are certain basic principles which must be understood before one can understand the true cause of the current woes of higher education.

Everyone seems to agree that the current higher education system is flawed. Thus, it logically follows that the debate circles around how society should go about correcting these “flaws”. Naturally, that leaves two choices: more government intervention, or less government intervention. Some may suggest that ideology will dictate which direction an individual deems to be the “correct” choice. While that is certainly true, there are economic laws as well as historical trends that suggest that those who favor decreased government intervention hold the solution to these issues.

Indeed, when Americans complain about the high costs of a college education, they are correctly identifying a symptom of a larger economic issue. However, the mistake is made when these same Americans then clamor for more government subsidies in the higher education market.

At face value, it sounds like a very reasonable solution. If college prices are rising, it makes sense for the government to step in and help every student finance their college education. What could be wrong with such a common sense solution?

Well, there are a number of issues with this “solution”, but the most prominent issue involves the basic economic laws that govern every human society. Namely, that government intervention actually increases prices. It’s understandable that such a statement seems counter intuitive. How could government subsidies for education increase prices? After all, government subsidies in the form of loans and grants are merely giving more resources to the student so that they can more easily handle rising costs. What’s so bad about that?

It is at this point that we are forced to reiterate the ideas surrounding Bastiat’s brilliant work, That which is seen, and That which is not seen. In the case of college subsides, that which is seen is the increased wealth given to students, who in turn use this wealth to pay off student debt(among other things, but we will get to that later on). That which is not seen is summarized well by The Freeman:

“One of the simplest of all economic lessons is that when government subsidizes something, more of it is produced than otherwise. That’s because subsidies upset the natural calculation of costs and benefits that people make. The subsidized thing becomes artificially more attractive to consumers; as they buy more of it, resources are drawn away from nonsubsidized things. Subsidies cause inefficiency.”[4]

In other words, government intervention causes a misallocation of resources in the economy. As The Freeman points out, this draws resources in the economy away from more productive sectors. But there is an even more important point to be made. In the case of higher education, this artificial manipulation of the market creates a ‘boom’ that is unsustainable. As government subsidizes higher education, more high school graduates enter college. Basic supply and demand tells us that as the demand for a product or service increases, so do prices. In other words, by subsidizing higher education government is effectively encouraging more high school graduates to enter college, thus raising the price of attending college.

Indeed, a look at college prices since government involvement started to increase paints a statistical picture that supports these claims. It wasn’t until 1944 that the first major subsidy for students was created in the form of the G.I Bill, which allowed World War II veterans to attend college at no cost. Further major subsidies were enacted in 1958 and 1965 in the form of the National Defense Education Act and the Higher Education Act, respectively. Indeed, the Higher Education act of 1965 marked the beginning of widespread government grants and loans in the higher education market. As the Cato Institute explains:

“Since 1965, the federal government has provided increasing amounts of funding for higher education as grant and loan programs have been expanded, and new programs added. Federal aid for higher education soared from $10 billion in fiscal 2000 to $30 billion in fiscal 2008.”[5]

This increase in government intervention had obvious effects on the higher education market. At the end of World War II, less than 1 in 10 high school graduates enrolled in post secondary education. By 2010, about 70% of high school graduates enter higher education after high school. Some might say this is a good thing. After all, more of our youth are receiving a higher education—shouldn’t this be applauded? The answer is an resounding “no”. This increase in education has come at a price. That price is the increased cost of tuition that has resulted from these subsidies.

From 1958 to 1996, tuition at American Universities has risen at a rate almost double the CPI. [7]This should be alarming to anyone. Many mainstream pundits have tried to blame this increase on an increasing number of generations X and Y entering college and driving up prices. As CNN Money points out, this alone cannot explain the incredible increase in college tuition:

“Normal supply and demand can’t begin to explain cost increases of this magnitude, though. If the usual rules applied, tuition would eventually stop rising because families would cut back enrollment, especially at the most expensive private schools, just as they curtailed consumption of gas once prices hit $4 a gallon.

Colleges would then be forced to cut costs or entrepreneurs would flood the market with lower-cost alternatives. But for the most part – all those invitations you see to get your degree online notwithstanding – that hasn’t happened.”[6]

This suggests that there is something else at play which is causing such a drastic rise in college tuition. Indeed, it is apparent that the increased government subsidies lead to increased enrollment (demand), which in turn increased the price. The increased enrollment and the subsequent increase in prices are directly related to increased government subsidies beginning around the same time.

Such an explanation may seem too simple for some. Alas, economics is not as complicated as some want to make it. Regardless of whatever complex empirical equations modern economists bandy about, all basic economics rests on the simple principles of supply and demand. Thomas Sowell says it best:

“In short, complex effects may be a result of either simple causes or or complex causes. The specific facts can tell us which. A priori pronouncements about what is “simplistic” cannot. An explanation is too simplistic if its conclusions fail to match the facts or its reasoning violates logic. But calling an explanation “simplistic” is too often a substitute for examining either its evidence or its logic.”[8]

The Bubble

There is an obvious moral hazard created when the above situation occurs. A sort of self-perpetuating spiral occurs. First, the government subsidizes higher education, thus attracting increasing rates of students out of high school and into the higher education system. Next, this artificial increase in demand increases prices. Private investors realize the incredible market for student loans that higher prices have created. As prices increase, more students are required to look elsewhere for ways to finance their education.  Private banks and Sallie Mae step in and provide the loans necessary to make up for the increased prices. Similar to the home loans handed out like candy during the housing bubble, there is a sense that an education is an investment that will pay for itself. Thus, both students and private lenders hand out and receive loans without much thought. Colleges see increased enrollment, and an incredible amount of student loans being provided from both the private and the public sector. This gives them an incentive to raise prices.

The government sees prices increasing, so they decide to “solve” the problem by increasing subsidies to higher education. It’s not too hard to see where this is headed. As government keeps interfering further into the market, prices continue to increase. After decades of this process, the end result is a disproportionate number of college graduates who took out loans and can’t pay them off. The bubble inevitably bursts when the large numbers of unemployed graduates can’t pay off their loans, and the market becomes flooded with loans that can’t be paid back.


Irrational Motivations

Sometimes, in the face of all the evidence given thus far, certain individuals will simply throw all logic out the window. Instead of facing up to the fact that such a system is unsustainable, they will merely resort to an appeal to emotion.[9] “But we must provide an education for everyone”, some might argue. “Education is a right!” is another common phrase bandied about by proponents of government intervention.

Setting aside the fact that subsidizing education actually increases the price and thus makes it more out of reach than it was in the first place, it’s worthwhile to also look at reasons why statements such as those listed above are simply false. Below is a large excerpt from an article in The Freeman. The author details a formal debate he took part in. First, he outlines the many claims given by those in favor of higher education subsidies and the advantages to a college degree. Then, he outlines his retort:

“The affirmative debaters contended that college education:

  • raises people’s incomes substantially; graduates on average earn nearly a million dollars more over their careers than nongraduates;
  • provides people with the skills they need to succeed in “the knowledge economy”;
  • opens up opportunities for people to advance, especially those from poor backgrounds; and
  • will help America remain competitive with other nations.

Professor Vedder and I took issue with these claims.

First, we contended that the “earnings premium” argument is fallacious. Even though it’s true on average that people with college degrees earn more, that isn’t necessarily true at the margin. That people with college degrees (many of them earned decades ago when standards were higher) have high earnings on average tells us nothing about the next student who gets a degree. Since many people who obtain college degrees today wind up working in low-skill, low-paying jobs, there is no basis for the assumption that college education raises incomes.

Second, we argued that college coursework doesn’t automatically improve an individual’s skills and knowledge. Although some students benefit greatly from their studies, many others enter college with very poor capabilities and graduate with little or no improvement. Most employers aren’t looking for in-depth knowledge that only a college-educated individual could have; rather they are looking for good basic skills and trainability—and they complain that many students are lacking in that respect.

Third, we argued that having a college degree doesn’t necessarily open up any opportunities because bachelor’s degrees are so common now that having one is no distinction. Moreover, there are other and often more effective ways for people to advance than going to college. Many vocational paths are less costly and offer better long-term prospects than a college degree.

Fourth, we argued that since we already have a glut of college graduates in the labor force, adding to it does nothing to make the United States more competitive. Furthermore, there is no causal link between increasing numbers of people holding college degrees and the creation of high-skill, high-paying jobs.

Finally, we argued that putting more and more people through college exacerbates the problem of credential inflation—that is, employers’ insisting that applicants have college degrees to be considered for jobs that don’t require any academic training. Credential inflation already shuts out individuals who don’t have college degrees from many jobs they could easily do.

In response to our case against the resolution, the affirmative side said nothing.”[10]

  In the thick of things

My university, the University of Akron, is by no means exempt from the crisis outlined above. Indeed, Akron is the very poster child for the problems within American higher education system. As part of the University president’s bold new plan (Called, ironically, ‘The New Gold Standard’), the University is attempting to “establish new performance standards for excellence.”[11] Although it’s primarily management doublespeak, the ‘bold’ new plan essentially deemphasizes admissions selectivity and emphasizes collaboration with industry, government, etc. It sounds like a great idea, but it’s actually part of the problem.

Rather than focusing on decreasing the student body, and spending more resources per student, the University has loosened its admissions criteria to the point that just about anyone can get in. According to the University’s website:

“Students will be considered for general admission to Summit College’s Student Success Program if they have a cumulative high school GPA lower than 2.30 or received lower than a 16 ACT or 650 SAT score, or if they are deficient in completing the core curriculum for college preparation.”[12]

A cumulative high school GPA below 2.30 is terrible. Likewise, anyone scoring below a 16 on their ACT should seriously consider another route towards a career. Eventually, it all boils down to the fact that college isn’t for everyone. There is certainly no shame in learning a trade, shadowing a professional, working up the ladder the old fashioned way, or even attending a community college. As was mentioned above, if society would quit holding higher education on a pedestal, then it would be much easier for new high school graduates to take these routes. Given the current state of the economy, it certainly seems like some of the 20 something’s that passed on college are doing better than their peers—they’re actually making money, rather than piling up debt.

Even if one ignores the irrational view that education “is a right”, it’s important to understand the economic implications of such an idea. By lowering the bar for the higher education system, administrators are allowing for easier access and thus a further increase in the artificial demand that has already been shown to increase prices. Furthermore, because many of the students that barely meet admission requirements aren’t likely to be prepared for the rigors of a college education, there’s a higher chance that they will drop out before graduating. This would mean that University funds as well as taxpayer funds (in the form of grants and loans) will be wasted.

Artificial boosts and subsequent extravagance

The education bubble is still inflating, but it’s getting closer to its popping point every day. With the increases student loans across the nation, and the corresponding increases in enrollment, both students and the colleges that they attend are living “high off the hog”.

The University of Akron recently spent $60 million on a new football stadium. Inside HigherEd describes the precarious fashion in which the new stadium was financed:

“Akron’s annual debt payment for the bonds that financed InfoCision Stadium-Summa Field is $4.3 million, according to Brian Davis, the university’s interim assistant vice president for finance and administration. He noted that the athletics department is responsible for $2.2 million of this payment. Davis said the department expected half of this to come from ticket sales, but that the actual ticket sale revenue this season is projected to be about $400,000 short.”[13]

According to the article, about 70 percent of the Athletic budget is funded by student fees separate from the overall tuition. How does the University plan on handling its touchy situation? According to Greg Bach, the athletics department spokesmen:

“We had a first-year coach, and we also weren’t as competitive on the field as we’d hoped for,” Bach said. “That resulted in lower ticket sales and lower ticket revenue. That’s disappointing to all of us. But, when we look two, three and four years down the road to where we think the program will go, we think we’ll make our revenue goals and hopefully set off some of the losses we’re seeing now.”

In the time since that comment was made, Akron football has only won a single game. Their current record is 1-9, which means this will be the programs third straight losing season since the new stadium opened.  Attendance is at record lows, and it’s likely that the program won’t see a winning season in the foreseeable future. For the sake of brevity, let’s just say that the future doesn’t look very bright.

It isn’t just athletics that have seen investment. The University has spent $600 million since the year 2000, most of which was financed using bonds. The University has built new dorms, a new student center, and the multi-thousand square foot student recreation center. Almost all of which was financed by bonds. Why would the University be so intent on new construction? Most university studies and proposals cite the “growth” in student population that has occurred in recent years. There is no doubt that the new construction has helped increase the student population at the University, but at what expense? In 2008, the University was given a caution[14] on its bond rating. Such a warning is probably just a small peek into what the future holds for the University as a whole. Furthermore, how many of the students that currently make up the increasing enrollment should actually be there? How many will graduate? How many are wasting valuable time, money, and resources that could be better allocated if not for the false incentives provided by the federal government?

As if the effects on the University weren’t enough, the city of Akron is seeing some of the effects of the artificial boom as well. The Mayor of Akron has only precipitated the problems. He recently gave sweetheart deals [15] to a few of his local buddies who built large private student apartments which charge prices much higher than the local market rate[16]. The new apartments make up the heart of downtown, and include dance clubs, bars, and restuarants. In short, the foot traffic downtown has been increased signifigantly in the short run. But in the long run, this ‘boom’ will only last as long as the bubble stays afloat. Not to mention, the city is on the cusp of some serious economic problems itself.[17]

What happens when the student loan market comes back to reality, and every student can no longer enter college after high school? What happens when this decrease in student enrollment results in a decrease in student fees that make up a majority of the athletic budget? What happens when the bond market reacts to this obviously precarious scenario? What will happen to the empty student apartments that currently make up the heart of downtown when the students can no longer afford to pay such rents? Will the property owners be forced to default on their own mortgage?

These are questions that will inevitably answered when the unsustainable student loan market collapses and the government inflated bubble finally pops.

Here’s to hoping I’m out of town by then.

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