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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