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the college education bubble

Over the last year, entrepreneur Peter Thiel has been making headlines by slamming college education. I’m sympathetic. I’ve said in the past that we definitely have too much college education. But I am not sure I agree with Peter Thiel on a number of points.

For example, he focuses a lot on the fact that college education is expensive. He’s making a mistake that many people make. They read the NY Times and think that all kids are aiming for Columbia or NYU. And yes, the elite colleges and leading private schools will give you a $250,000 bill after for year. However, most students do not attend these schools. Most public schools and junior colleges charge way less. For a nice description, see Kieran’s “U Shaped Theory of College Education.” Regular college really isn’t expensive, but there is definitely a luxury market.

Perhaps a more fundamental mistake that Thiel makes is that he calls higher education a bubble. I think this is in error. A bubble is when prices go up because of speculation on a commodity, rather than a genuine change in the supply or demand for the product.* Higher education is not a speculative business in the same way that real estate is. You can’t buy a college degree and then “flip” it in a secondary market.

If it’s not a bubble, what is it then? My view is that education has both a labor market component and a consumption component. The labor market requires a college degree for multiple reasons. Often, it’s a test of IQ and conformity. For some fields, like engineering and accounting, it’s human capital. At the same time, higher education is consumption. Rich smart people want to hang out with other rich smart people. If we want a special job (e.g., political leadership), it helps to hang out with these people. So it’s a non-exchangeable  investment and consumption good.

Let me end with why I think college prices are going up, which motivates Thiel’s claim that higher education is a bubble. Prices are going up in the top of the market because college education is actually under priced. Yes, my claim is that the market price for college education is probably much higher than what we have now.

How much do you think people would pay to have their children live in nice housing, eat prepared food, and hang out with the world’s leading scientists for a year? How much would people pay to be part of an elite? Well, we know the answer – at least $2-$3k per month, the price of a private college. The fact that Ivy League still turns away droves suggests that the real number may actually be higher.

In the end, the solution isn’t to complain about high prices. The solution is to use the cheaper alternative. As long as people keep enrolling, nothing will change.

* Yes, we can argue about “genuine” changes in demand. But the term bubble suggests that prices are driven by speculation rather than consumption. Just work with me, people!

Written by fabiorojas

April 12, 2011 at 12:33 am

Posted in economics, education, fabio

13 Responses

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  1. This is an interesting post, especially the argument that the actual market for elite higher education is significantly under-priced. In fact, prices have risen pretty dramatically over recent history, perhaps catching up to their ‘true’ value?

    Also, I think you ignore some market conditions exerting downward pressure on the price — in particular the shared social understanding that education institutions provide public good rather than private good. Elite schools would face some sort of social sanction if it raised prices immediately to what you view as their ‘true’ value. However, over time, yes, I see your point. I find myself agreeing the rising prices probably do not represent a bubble.

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    Austen

    April 12, 2011 at 3:15 am

  2. Austen – you are correct. Speak to administrators. They will usually admit that public pressure pushes prices down. A college in the Ivy League that charged the true market price would lose legitimacy real fast.

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    fabiorojas

    April 12, 2011 at 1:01 pm

  3. I think some colleges are way overpriced, but they’re not the Columbias or NYUs of the world. The real price gouging happens in the bottom of the pool where the educational value of students’ education is low and prices are still high. Making it worse is the abundant availability of student loans – most of these colleges employ an army of student advisors who do nothing but help student secure more student loans – makes the price seem cheap to students in the short run while they’re actually accumulating huge amounts of debt that will cripple them financially in the long run.

    And if there is a bubble it’s in the market for student loans. Eventually the financial market will have to come to term with the many worthless loans it’s issued to students who probably won’t be able to pay those loans back because the jobs these schools promise will never materialize. I think that this expansion of “education” to the masses is misleading and shameful.

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    brayden king

    April 12, 2011 at 1:31 pm

  4. Fabio, I agree with your points but I think the reason Thiel calls college education a bubble is different – he points to the overall student loan debt which has been rising and the inability of some students to pay off their debts, either because they can’t find jobs paying enough to do that, while also getting into additional debt post-college (like buying a house, having kids, etc). So, his argument I think goes back to the federal funding for college education and how it is propping up a bubble, just like those on the right argued that federally guaranteed mortgage loans were to be blamed for the real estate bubble.
    For people who think like him, your argument won’t be convincing. You will have to address head on this idea that we should just let the market do its magic.

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    orgtheory reader

    April 12, 2011 at 2:11 pm

  5. What about real estate? I was under the impression lots of people finance college education with their home equity (http://familyinequality.wordpress.com/2010/08/25/home-school/). Does this portend ill?

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    Philip Cohen

    April 12, 2011 at 2:46 pm

  6. @orgtheory reader: Good point. The student loan side is a huge issue.

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    fabiorojas

    April 12, 2011 at 3:22 pm

  7. Thiel calls college education as an investment as a bubble — not college education as a good for consumption.

    As a market good, as Fabio points out, college education is quite underpriced for many elite schools (how many students would go in debt to go to Harvard?). Ivy Leagues, essentially, are a luxury product.

    Analysing education as an investment though, is more difficult — there is an obvious bubble in the humanities/social sciences where student loans are bigger than average mortgages and the debtors are not breaking even. There might not be in engineering or health professions — where the return on investment is easily worth the cost. The returns are different for Ivy League vs non-elite schools.

    Like all investments, however, the returns fluctuate with the market. Law school used to be a great investment with a great return — this is why law schools, even lower-ranked ones, charged a huge amount to enroll. They justified tuition increases because the RoI was still good for student-to-be-lawyers. Then the economy soured and now we have prices that don’t reflect the change in demand.

    Thus, law school has become a bubble because students continue to enroll and schools continue to charge — until it bursts!

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    keith

    April 12, 2011 at 6:21 pm

  8. Regarding the availability of higher education to most students at non-elite colleges, what should we make of the report from the NYT today that student loans have finally surpassed credit cards as the chief source of debt among Americans? The article makes a number of good points- notably the differences in scale for students from working class backgrounds who are unable to afford elite colleges and face rising costs in public education. This, combined with the (likely) end of Pell Grants this (or next) year may call for a serious re-appraisal of the possibility of a bubble- at least in future years.

    Link to article here:

    http://www.huffingtonpost.com/2011/04/12/student-loan-debt-may-top_n_848093.html

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    Chris Bail

    April 12, 2011 at 7:49 pm

  9. There are interesting parallels here: the rising prices and the rising debts in three “markets” – housing, education, health care. I am not 100% sure but if we have the data for debt on health-related costs we would probably be facing a pretty similar picture – ever-rising costs and people trying to catch up on consuming more or better housing/health services/education. I think investment is the right framework here, because consumption implies a one-time transaction with short-term benefits while investment implies long-term benefits and multiplier effects. So, it is a nice investment if you can get it. For many people it is increasingly difficult to get it, so they become sub-prime borrowers. Government gets involved in trying to help more people get more of these services and creates more incentives for lenders to make money available to borrowers. Hence, the bubble metaphor. But as Fabio points out, bubble is a metaphor that shapes our thinking in the wrong direction. A bubble implies some sort of irrational craze to get a specific commodity. However, housing/health/education are not standard commodities (yes, they are produced on a mass scale but the point is that their consumption has profound effects on life-course outcomes). If we go with the commodities / consumption framework then it is fairly simple to just say that certain people simply don’t “deserve” or don’t “have to” get them. If we go with investments, then it is a different story. This is a very interesting discussion and I am following with much interest, even though education is not my field of research.

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    orgtheory reader

    April 12, 2011 at 8:36 pm

  10. Watch Peter Thiel discuss Rewards for Students to Drop Out of College, Democracy Failing As a Technology, Libertarians and Women, and take questions during his interview (3/23/11)- http://f4a.tv/e8PHHL

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    Monica, CA

    April 12, 2011 at 9:16 pm

  11. In most investments, the outcome does not depend on the investor (other than the input of money) – the stock, real estate, bond, derivative success or fails on its own. The wise investor collects objective external data, decides on the likelihood of making a profit, and invests (or not).

    Education as an investment – which is how we present it – is fundamentally different. At least half of the value of the investment depends on the investor – the student. While we do have objective external evidence about the likelihood of a first level of success – graduation – human beings are psychologically ill-equipped to make use of it. The college completion rates are lower for first generation students, and even more so for students with poor reading and math abilities. Our developmental programs are so boring and keep them from engaging in anything that seems related to their ultimate success that they may leave before accumulating and real college credit.

    The bubble here may not be in evaluating the value of a college degree, but in the choice to make an investment when one’s chance of getting the degree is demonstrably low.

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    edithosb

    April 17, 2011 at 2:13 am

  12. […] of Higher Education to the New York Times. I highly recommend OrgTheory’s discussion of these topics as one entry point. *** This statement may be more than a little optimistic. No program is […]

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  13. […] the college education bubble (orgtheory.wordpress.com) […]

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