Given the skyrocketing costs of higher education in the United States, it is worth asking whether there is a supply side deficiency in higher education, or is education a bubble that might or might not be particularly hard to pop? Especially given that student debt has surpassed credit card debt for the first time ever. Noah Smith raises this question on his blog in response to a Matt Yglesias post regarding human capital stagnation. I am intending this as simply raising questions about the subject. As you will note by the end of the post, I offer a hypothesis that broadly agrees with Noah.

Yglesias is, of course, completely right. In fact, human capital stagnation seems to me a much likelier culprit for a “Great Stagnation” than the dubious hypothesis of a slowdown in technological innovation. People can’t spend their whole life in school, so education really is “low-hanging fruit”.

The buildup of Noah’s post pretty much screams his conclusion: supply shortage. But why would there be a supply shortage at such high tuition rates?

The skyrocketing prices you see after 2000 does not reflect skyrocketing enrollment. If you look at his previous graph, enrollment in four-year programs has had a fairly uniform increase throughout the last half of the last millennium. Enrollment in two-year programs is essentially flat. If I showed you similar graphs regarding the housing boom vis-a-vis population (which Karl, in fact, has done!), you would likely immediately assume that there is a bubble. Enrollment, just like population, has grown fairly predictably. At least predictably enough for investment in educational capacity.

So no, I don’t really buy the supply story as a full explanation. But it is useful to ask why supply hasn’t expanded roughly congruent to the increases in price? One (I think powerful) explanation is that the fixed costs to education (the buildings, the teachers, etc.) is expensive, and that half (or more) of the battle is building institutional reputation. Private schools (like DeVry and Kaplan) have overcome the first barrier, but have largely failed to overcome the second. This is where the idea of the government (at least initially) funding a national university system actually has a lot of merit. The government is likely the only institution that can hemorrhage money at the rate it would take to build the institutional capital a successful, and respected post-secondary institution would need. As Noah notes, there is no shortage of Ph.D’s out there looking for work (but this isn’t, in-and-of itself a reason to hire them).

Another useful question to ask is, why don’t universities price based on demand for classes? Almost every university has a fixed tuition rate for every class, and then we try and shoehorn people into a financing option that satisfies said price. Our university certainly does, and it’s not at at clear that is the best use of resources. We often cancel classes that don’t attract enough students…but why? The professors don’t get allocated any differently, they just have one less class that semester. The marginal cost of educating a student is very, very low. Why not advertise a discount special, and fill those desks? You’re still paying the professor, and you already have the building (or online classroom, for that matter). It would be a golden opportunity for disadvantaged kids to snag education on the cheap. You may say that this would lead to many people putting off enrolling in classes until specials arise. It might (but excellent, consumer surplus and all), but that isn’t the experience of car dealerships trying to move inventory to make room for new inventory.

The answer to the second question, I suspect, has a lot to do with signalling…which could also be the driver of the inflation of education in a more broad sense. No one wants to have the status “discount school”.

Addendum: An alternative (and compelling) explanation has to do with the wage transmission mechanism between the financial sector, and finance/math/physics/econ professors. Their marginal productivity is literally based on enrollment, and largely fixed…and certainly hasn’t grown at an extreme pace. What has grown at an extreme pace? The salaries of their alternative options in the finance sector.

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