The Education Bubble?

A couple years ago, my colleague Mike wrote an entry called something like "Does Education Still Pay?" At the time, I wrote comments stating that graduates still earn more than non-graduates over their lifetimes, plenty enough to pay for the cost of school, and that, as long as it continued to make economic sense, people would still pay. I stick to that analysis, because I find it is pretty hard to argue with it, but nuances can get lost in the general statistics, and bubbles can happen even with continued demand (people still buy houses, after all).

A bubble happens in economic terms when something pushes up demand to unsustainable levels, causing rising prises, the expectation of future rising prices, and investment in expanding supply. The bubble pops when demand suddenly fails to grow as rapidly as supply, and too much of the product or service is being sold to too few people, causing the price to fall precipitously.

The housing bubble, for example, was caused by cheap mortgage rates and banks from areas where no one was building buying mortgages from places where people were, keeping rates in booming places lower than before. (It's not important to understand why or how that all happened, just know that rates, due to myriad factors, even having to do with China's trade surplus, were lower than normal for a long time in booming places.) In addition to low rates, banks, encouraged by the government, were lending money to less credit-worthy people than ever before. This meant that as prices rose, more and more potential home buyers showed up as banks loosened their lending standards. That meant more demand and higher prices.

Well, we know what happened next: at some point, the houses were so expensive that more people decided not to buy. The market slowed, and builders had nothing to do. To get rid of the excess houses, prices were slashed. People who'd bought at the peak of the boom were now sitting in houses worth less than their mortgages. The bubble had burst.

So, is there an education bubble? Let's count:

• Steadily rising demand for places at universities? Check.
• Rapidly rising prices for higher education? Check.
• Steadily rising demand for graduates with specific skills, leading to the expectation that education will continue to become more important? Check.
• Government policies that support demand? Check. (I'll explain in a bit.)
• Education has a finite value, beyond which it would not be worth one's while to buy it? Check (like all goods).
• There is a limited number of potential buyers (students)? Check.

It seems we certainly have the basic ingredients needed to have a bubble. But that's not enough. All this could happen, and then prices and demand could level off smoothly. This does sometimes happen. It's hard to spot a bubble while it's forming, even though it seems obvious after it bursts. There are three ways I see this ending.

The non-bubble scenario: demand increases begin to slow, and the supply of university places begins to come in line with demand. At the same time, more universities put in cost-saving measures, like reducing administrative costs, using technology, etc. Universities begin to have to compete more for students in general, not just the good ones. Their budgets get a bit squeezed, and they begin to compete on price.

Bubble scenario 1: Similar to the above scenario, but supply outstrips demand more rapidly, causing tuition fees to drop fast.

Bubble scenario 2: This is the scarier one, and it could be starting now. Former students with lots of loans to pay find they are unable to get jobs that pay well enough to pay back loans. The government has set up loan forgiveness programs for public sector and non-profit workers and whatnot, so many take advantage of this (my plan for myself, actually). In fact, many more than the government intended. Amid continued economic weakness, budget deficits, and battles in Congress, the cushy student loan provisions are cut. Prospective students are suddenly unable to finance their future studies. Demand falls off precipitously. Tuition fees stabilize or fall. There are more unskilled workers as a result, causing further wage stagnation or even declines in the services and retails sectors. At the same time, the skilled workers companies want are even harder to find, increasing wages in those areas, widening income inequality and sewing unrest.

So, there are at least these three possibilities. The current spiraling prices are in part fueled by government programs to allow students to borrow money on good terms to go to school (much like the cheap mortgages for poorer people that fueled the housing bubble).

When going to college doesn't pay off, or doesn't pay off enough to make the extra work and risk worth it, students will stop going. If this were any other market, this would be no big deal. We would call it a correction and it would mean the price of education had risen to reflect its value to its consumers. There's a problem, though: education has a wider value to society, too, which is not captured entirely by the student. This means that society is better off with more students, and that education is worth more, on the whole, than the additional money or job satisfaction received by those who take it on.

Take one of the most obvious areas: engineering. An engineer may love her job and be paid well. But engineers are also vital to society. If an engineering degree became so expensive that not that many people got one, society as a whole would suffer. We also, of course, benefit from scientists, music majors, linguists, and, of course, international relations specialists, even if its harder to see. This all means that subsidies for education make sense. This is why it's not wrong that government does this, because education is worth more than what the educated get out of it themselves.

But demand-side approaches, like giving students access to cheap loans on nice terms, fuels price increases. These increases may actually negate the effect of the loans. It might be better to act on the supply side of things. State universities already do this, using taxpayer money to reduce tuition fees. I don't know if these are in place, but there should be cheap loans for university expansion, grants for measures that save money, and inducements for offering well-priced, high-quality education.

I will probably end up only paying 1/3 of my student loans back, depending on what Congress decides over the next 100 years while I'm finishing up. That's a big hit the government will take. Multiply that by the loads of others doing it, and it's massive. I wouldn't be able to afford to study without it, though. Nonetheless, the debt pile I'm building causes sleepless nights, something shared by a lot of students out there. So maybe switching things to the supply side to drive down upfront university costs would be more sensible. Then, students would get unforgivable private-sector loans, but have much less debt to pay off. At the same time, the increased supply of places would insure that the country gets the graduates it needs, and that these, with lower debts, can start getting mortgages and things like that earlier on, helping to boost the economy.

Would all this mean higher taxes? Well, probably, a bit. But I'm actually proposing shifting the costs from one place to another, subsidizing the universities (per student, dependent on quality and tuition fees, etc., to create good incentives) rather than subsidizing the students with scary and uncertain loans.

There will only be a bubble when there are too many graduates. From the looks of things, we have quite a ways to go before that happens. The global economy is changing, and rich countries need to change, too. We have the benefit of capital and education, so we need to invest in the latter. That and infrastructure in the US, as I've said before. Overfilled highways, slow trains, patchy internet and cellular connections, and bridges that collapse and kill people from time to time can really crimp business. These are the areas where we should be spending money, not on random tax loopholes and overly expensive health care (my post on what we might start to do about that).

We need to invest in the future (infrastructure and education), not the past. We started doing that in the early 20th century, and rode the boom throughout the rest. Towards the end, gains came from deregulation (much, but not all, of which was a good idea) and more and more debt. That can only go so far. It's time to start at the beginning again.