Lately, a con­ver­gence of events — grad­u­a­tion sea­son, impend­ing expi­ra­tion of a sub­sidy on stu­dent loans, and an elec­tion year — have led to a broader dis­cus­sion about the over­all econ­omy of higher edu­ca­tion. In par­tic­u­lar, some have sug­gested that we have an “edu­ca­tion bub­ble”. How accu­rate is this sug­ges­tion? And, if it is, what are the poten­tial impacts of it bursting?

To answer this, we should start by exam­in­ing the mean­ing of an eco­nomic bub­ble. His­tor­i­cally, eco­nomic bub­bles were referred to as “booms”, and their pop­ping as “busts”. Only the ter­mi­nol­ogy has changed.

Booms are caused when credit grows rapidly in a par­tic­u­lar mar­ket, lead­ing to ris­ing prices, and over­ex­pan­sion. Even­tu­ally this leads to a point where the return on invest­ment is no longer assured, which causes the credit to quickly dry up, and the mar­ket to then col­lapse (the “bust”). The credit for the boom can come from many dif­fer­ent sources, but typ­i­cally the late stages of the boom are funded by pri­vate creditors.

We saw this hap­pen with Inter­net com­pa­nies in the late 1990s, as their stocks sky­rock­eted from a tremen­dous influx of pri­vate invest­ments. We saw it hap­pen more recently with real estate, as home prices sky­rock­eted from a tremen­dous influx of pri­vate invest­ments in credit default swap–backed col­lat­er­al­ized debt oblig­a­tions, which funded the mort­gages that funded the real estate pur­chases. In both of these cases, the credit dried up when spec­u­la­tors were no longer able to turn prof­its by reselling the invest­ment property.

What about higher edu­ca­tion? An imme­di­ate dif­fer­ence should come to mind. Unlike a stock or house, you can­not resell your edu­ca­tion to some­one else. Your value-​​add from the edu­ca­tion, then, is greater value of your labor. This pre­cludes spec­u­la­tors from enter­ing the market.

A sec­ond con­sid­er­a­tion is whether the return on the invest­ment is pos­i­tive. Aside from some short-​​term effects dur­ing a reces­sion, even with the steady increase in real tuition costs over the past few decades, stud­ies indi­cate that degrees remain prof­itable invest­ments. From a purely market-​​driven per­spec­tive, a degree that pro­vides sig­nif­i­cantly bet­ter net present value of increased income poten­tial than the total cost of the degree itself sug­gests that there is room for increases in tuition costs. In other words, in a free mar­ket one should expect the price of a degree to be roughly equal to the life­time increase in earn­ings one receives by virtue of hav­ing the degree.

Of course, if degree costs equaled the net present value of increased future earn­ings, there would be lit­tle incen­tive for those not in wealthy fam­i­lies to go to col­lege. And that would mean that our soci­ety would miss out on a lot of poten­tial minds.

Yet, on the other hand, across-​​the-​​board sub­si­dies of insti­tutes of higher learn­ing makes it less expen­sive for every­one. When that hap­pens, it doesn’t max­i­mize soci­etal ben­e­fit, since the dol­lars get spread across all stu­dents, regard­less of mar­ginal util­ity. That is, there are those who would have gone any­way, and so it makes no changes in edu­ca­tional out­come for those peo­ple. Where it mat­ters is with the ones that wouldn’t be able to go with­out a subsidy.

But regard­less of the types of sub­si­dies we have, they do increase the num­ber of peo­ple get­ting degrees, and that does some­what devalue each of them. Sim­ple sup­ply and demand: the greater sup­ply of peo­ple with these degrees, cou­pled with the same demand for them, will result in lower com­pen­sa­tion for those who have them.

None of this, though, means that we have any­thing approach­ing a bub­ble. As I said before, since the degrees are not trans­fer­able, we’re not going to have spec­u­la­tors dri­ving up the prices to unsus­tain­able lev­els. The worst that can hap­pen with an indi­vid­ual is that the out­stand­ing loans don’t get paid back. The worst that can hap­pen nation­ally would be an elim­i­na­tion of the mar­ket for future edu­ca­tion loans.

The loss of the entire edu­ca­tion loan mar­ket would be unfor­tu­nate, but the impact on the broader econ­omy would be min­i­mal, com­pared to the sort of impact of the dot-​​com bub­ble bursting…and infin­i­tes­i­mal com­pared to the impact of the real estate bub­ble burst­ing. After all, it’s not going to bring down the likes of Bear Stearns.

So where does that leave us? The idea that we have an edu­ca­tion bub­ble is mis­lead­ing at best. But we may want to recon­sider the way that we’re cur­rently spend­ing our higher-​​education dollars.

What do you think?

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