Monday, May 9, 2011

Rent Seeking in Higher Ed

The Economist's Schumpeter columnist is having a lot of fun awakening the grumpy, overfed dragons of academia and getting them to gnash their teeth. Simply put, he's got a whole lot of people riled up about a possible "bubble" in tertiary education. The argument has a lot of different threads; also, being a business columnist, he focuses on business education. The comment threads are really amusing as they tend to involve exchanges between professionals who agree that undergrad b school education sucks and indignant b school students who drink on weeknights.

One of the reasons Schumpeter is so concerned about a possible bubble is cost inflation. Everyone knows college has gotten a whole lot more expensive in real terms. Inflation in the price of a college since 1978 has outpaced currency inflation by over 400%. A big question for me is, how the hell are colleges able to pull that off? For-profit colleges like the University of Phoenix are making a killing and not necessarily providing the best service - after all, a degree from MIT costs the same as one from U of Phoenix. Why are costs increasing so much, even at non-research, for-profit universities?

It's not a trivial question to answer. People keep going to college and paying the fees, regardless of their actual ability to pay at that time. The average college student is charged $23k a year, and much of that is taken out in loans. Student loans are non-forgivable, even in bankruptcy. There are cases emerging now of thirtysomethings with liens on their salaries to repay delinquent student debt, even as they work at minimum wage jobs.

When I think about the fundamentals of this question, I think of consumer surplus. Is the student getting more value out of a college degree than they are paying? For the past 50 years, the answer has almost certainly been yes. But now I'm not so sure. Costs are high enough that I'm wondering whether the arbitrage condition has been exceeded. But back to value.

The value of a college degree comes in the signalling value of the degree itself and the education you receive. The former comes in handy for obtaining employment, probably partially due to the reputation of your college and partially for the certification in your major (whatever it is) that it implies. The latter will save you some grief at work and give you intellectual satisfaction. Both of these, I think, are falling, while tuition costs are consistently rising. However, I think the real monetary value of the degree comes with the signalling value - let's face it, few people study for the sake of knowledge anymore.

The signal of a college degree has historically been that the bearer of ye olde diploma was
  • able to do a decent amount of work
  • certified in whatever discipline they had on the diploma
  • sharp enough to get through college
The second point is really only relevant to engineering, science, and other professional-oriented disciplines, and I don't think it's much of a problem. Any employer worth his or her salt can simply look up the accreditation of a college's program to figure out if the degree means anything. The first and third points are more interesting, however, if viewed from a historical perspective. For one thing, it's somewhat true that college has become easier. I don't mean any specific college, but college in the aggregate. For another, it's definitely true that you no longer have to be the sharpest tool in the shed to get through college. This I think is the result of a demographic trend.

In the postwar baby boomer years, the people who went to college were pretty much at the top. I don't remember and am unwilling to look up the proportion, but it was under 30% of the population. Fast forward to post-GenX, and almost 50% of the population is going to college. As the population of collegiate students has increased, the number of colleges has increased. Most of these are not community colleges. Call me elitist, but I don't think that the 50% of people who go to college today are as intelligent, on average, as the >30% who went before. It stands to reason then that a whole proliferation of second- and third-tier colleges have now sprung up to cater to these demographics. Not only do they provide lower quality education for those students who are presumably less mature, less intelligent and less motivated, but they also give degrees to them that are in many ways indistinguishable from what might be issued by a genuinely good institution. Both of these results are making a degree less worth it. Employers are beginning to catch on.

So bringing this back to the big picture, we can say two things that gave a degree value in 1950 no longer really apply. First, it's no longer a good measure of innate ability, maturity, or motivation, because the pool of graduates has been so diluted. Second, it's no longer a good signal of "this person won't need that much on-the-job training."

Now look at this from the modern student's perspective, using an unrealistically simplistic thought experiment. When s/he makes the decision to go to college, consciously or unconsciously s/he tries to factor in the benefit that could accrue. However, the historical data on the value of the college degree that the student reviews is flawed: the value of the college degree in the past (in terms of income increase, etc.) encompassed the returns both to superior ability and good education, two things which do not necessarily exist today. Furthermore, the superior ability bit applies after college too, and often cannot be isolated from the income increase data at all. So the prospective frosh goes ahead and merrily assumes a value for a college degree that is unrealistically inflated.

All that speaks to one reason I think colleges have been able to get away with providing shitty service (or virtually the same service) for such a high price: Rent-seeking. I'd be disingenuous to suggest that it's the only reason, but I'd wager its the primary driver of scams like U of Phoenix. Basically, the idea would be to keep adding the price increases to capture as many returns from people's expectations of the value of a college degree as possible. That's how so many universities can get away with this.

Of course, I think that MIT, Harvard, and others don't have this reasoning at all. Their growth in tuition is probably driven by the desire to Do More Research rather than educate, and expand at a rate beyond what their alums can provide in donations. I think that other shittier places are using the top-tier schools' price increases as a signal that they can move up too, to capture more rents.

This is just one small part of the higher education bubble argument. I'd really recommend that anyone interested in this argument go ahead and read Schumpeter's column in The Economist, but I'm going to go ahead and say that I buy it. Most of the evidence I have is anecdotal, but I have a strong suspicion that Schumpeter is right and that some time in the next decade or two college prices are going to collapse.

The other implication of this is, I think, that colleges will try harder to develop a brand to improve the signalling value of their own degrees to put themselves above the languishing generics. I predict more screwing of mildly undesirable students and more shameless self-promotion from all. Ugh.

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