questioning the higher education bubble

I was recently quoted in the Huffington Post in a story about Thiel’s claim that higher education is a bubble. I was quoted as one of the skeptics. Later that day, Thomas Gorkey, who teaches at Syracuse, read the article and wrote, I said that higher education wasn’t a bubble in the normal sense of the word because education is not a commodity that you can trade:

This doesn’t seem right to me, but I’d love for you to convince me that I’m wrong! To me it seems that students (and mainly parents) do in fact treat college as a tradable commodity. They trade thousands of dollars (that they don’t have) for an education that is supposed to land them a job that pays even more than what their education cost.

I think this deserves a response. In my response, I relied on a distinction made by the economist Gary Becker: physical capital vs. human capital. Physical capital is some physical object that allows you to produce more goods and services for sale on the market. Human capital is the skill that someone has that allows them to gain income from the market. Becker’s argument was that education resulted in higher income because schools trained people in various skills and thus create human capital.

Now let’s get back to the higher education bubble. When people say “bubble,” they usually mean “an unsustainable rise in prices,” which is often, but not always, due to speculation. The reason that prices have to eventually go down is that the underlying value hasn’t risen. The gap, as I mentioned, is often attributed to speculation. People consistently buy something hoping to quickly sell it off.

Notice that in this description of a bubble, some commodity is circulated and there’s a consistent error that pushes the price up and up each time the commodity changes hands. This describes the housing bubble well. People (including banks) started believing that housing prices would just go up and up, which then justified all kinds of crazy loans. However, college education is a form of human capital. The stuff you learned can’t be transferred to another person, no matter how much they pay. So it can’t be a bubble, at least they way most people talk about bubbles.

Thus, something else is happening in higher education. For a certain segment of the market, there is a huge over investment in human capital. As in some bubbles, people are making some sort of gross over estimation of how much some economic resource is worth. But the difference is that there’s no Ponzi scheme since you can’t sell or transfer your college degree to someone else for an even higher price. Human capital simply can’t be transferred. I agree with Thiel that something is very much wrong in higher education, but it’s not quite analogous to the housing or dot-com bubbles.

Let me end with a few hypotheses about why some people – mainly middle class people sending their kids to private colleges – are paying way to much for college. (a) Can’t say no. (b) They simply don’t understand that their kids won’t make the income to cover the loan. (c) Emulation of the wealthy. (d) Consumption good – they simply value the four years a lot. (e) Myopic preferences – people seriously underestimate long term costs.