Cost Versus Enrollment Bubbles

Sep 07, 2011 | 

Andrew Gillen , Richard Vedder

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Cost Versus Enrollment Bubbles

Sep 07, 2011 | 

Andrew Gillen , Richard Vedder



Richard K. Vedder is a senior fellow at The Independent Institute and Edwin and Ruth Kennedy Distinguished Professor of Economics and faculty associate, Contemporary History Institute, Ohio University, Athens, OH 45701-2979; vedder@ohio.edu. He is the author of Going Broke by Degree: Why College Costs Too Much (AEI Press, 2004).

Andrew Gillen is the research director at the Center for College Affordability and Productivity, 1150 Seventeenth Street, NW, Suite 910, Washington, DC 20036; agillen@centerforcollegeaffordability.org.

Introduction

Bubbles are a rare but increasingly frequent phenomenon. In their book Manias, Panics, and Crashes, Charles P. Kindleberger and Robert Aliber document the most famous financial bubbles, including  

  • the Dutch Tulip bubble in the 1630s
  • the South Sea Company bubble in 1720
  • Japanese and Nordic real estate and assets in the 1980s
  • the Dotcom bubble in the 1990s[1]

Recent events will undoubtedly add the recent housing bubble in the U.S. to the list. We argue that higher education in the United States is experiencing a bubble as well.

The Case for the Existence of a Bubble in Higher Education

The defining characteristic of a bubble is unsustainable growth that eventually reverses. Bubbles typically arise when uncertainty leads to unsustainable trends,[2] and we argue that there are two areas in which higher education has experienced what appear to be unsustainable trends, namely, college costs (the costs to students, parents, and taxpayers of attending college, or alternatively, the spending of colleges) and enrollment. It is interesting that it is not clear which one really is unsustainable. If college costs are not a bubble, then it is likely that there is an enrollment bubble. On the other hand, if there is a bubble in college costs, then it is quite likely that there is not an enrollment bubble. Before discussing the interaction between the two, we will first present the argument for each separately.

A College Cost Bubble

The first potential bubble in higher education concerns college costs. Institutions of higher education have been spending and charging students, parents, and taxpayers ever more for a college education. Figure 1 compares two measures of the growth in college costs (spending per student and net price for students) to the growth in housing prices.

Figure 1: Housing Bubble vs. College Cost Bubble*   

Sources: Standard and Poor, Digest of Education Statistics, and authors’ calculations.

*Home Prices are the seasonally adjusted Q1 values of the U.S. National S&P/Case-Shiller Home Price Index; Higher Education Spending per Student is expenditures by all postsecondary degree-granting institutions divided by full-time equivalent enrollment; and Net Price for Students is the total cost of attendance at four-year institutions minus all grant aid, veteran’s benefits, and tax benefits. Data on Net Price is only available for 1987, 1990, 1993, 1996, 2000, 2004, and 2008—all other years were assumed to increase or decrease linearly to the next data point.

With the benefit of hindsight, the housing bubble is easily identified. And yet the now greater (and continuing) increase in the cost of college is not widely thought of as a bubble. While there are complicating factors, the general trend of a more costly college education remains.

There are three common arguments for why the rise in college costs and spending is not indicative of a bubble. The first tries to explain why net price has increased so much. The argument is that the financial burden of college attendance has merely shifted from state and local governments to students and their families. There is a bit of truth to this argument. In constant 2010 dollars, educational appropriations per student did drop from $7,993 in 1987 to $6,951 in 2009, with further declines likely in 2010 and 2011.[3] But this just means that the net price for students could be expected to increase by about $1,000, whereas they actually increased by $5,050. Thus, the decline in state and local support still leaves the vast majority of the increase in net price unaccounted for.

The second is a common explanation for the increase in spending per student. The argument is that the costs of running an institution of higher education continually increase for reasons beyond the college’s control. The main drivers of higher costs are higher wages for labor-intensive activities (commonly referred to as the “Baumol Cost Disease”), and higher institutional financial aid requirements. Again, there is an element of truth to these factors (note the steady increase in spending per student rather than a sharp rise). But average faculty salaries have not increased by enough to explain the increase in spending. Moreover, relying on average faculty salaries does not take into account the widespread trend towards greater reliance on adjunct and other low-cost faculty. Thus, most scholars conclude that even after accounting for higher labor costs “a large share of the increase in college tuition remains to be explained.”[4]

A third common argument for why higher costs are not unsustainable is that the returns to education are high and rising. Again, there is some truth to this, as the average return to a college education is positive and has increased at times.[5] But while a positive and increasing return to education explains why more people want to attend college, it does not explain why it should cost more. Just because people are willing to pay more does not imply that they should in fact pay more. For instance, most of us would be willing to pay thousands more than we currently do for clean water and sewer systems. The reason we don’t have to is that it does not cost thousands of dollars more to supply those things. In general, the price of a good or service should closely track the costs of production.

This raises the issue of how much it costs to provide an education relative to how much students pay. While the data needed to gauge these values with precision remains elusive, two recent analyses indicate that the costs of providing an education are already lower than the payments colleges receive. Bob Samuels, president of the University Council–American Federation of Teachers, has found that the “total average annual instructional cost per student is $1,456” and yet “public universities charge on average $7,000 per student and they get another $8,000 per student from the state.”[6] This shocking finding is confirmed by a recent analysis that included other valid educational costs, and yet still found that the majority of students attended institutions that were paid more to provide an education than their actual educational spending.[7]

Colleges receiving more in payments than it costs to provide an education would only be sustainable under certain conditions. For instance, if competition is severely limited either because there is a monopoly provider or because there are insurmountable barriers to entry, it is possible to enjoy abnormal returns. There is clearly no monopoly in higher education, and while there are significant barriers to entry for new institutions, such as accreditation, there are fewer barriers to expansion of existing ones.

Another source of a sustainable wedge between price and costs would be if some institutions have permanent advantages over their competitors. For example, in agriculture, farmers with the most fertile land will persistently have lower costs of growing crops than others, and will earn Ricardian rents or sustained above-average profits as a result. This too is unlikely for higher education. It is in the nature of education for knowledge to be shared, meaning that profitable trade secrets are unlikely to be a source of permanent advantage.

Thus, we are left with colleges being paid more to provide an education than they spend providing an education, a fact that none of the standard explanations for a divergence between cost and price can explain.[8] It is therefore very likely that the divergence is unsustainable, which is strong evidence that higher education is witnessing a bubble in college costs.

An Enrollment Bubble

If our arguments about college costs are incorrect, and there is no cost bubble, then that merely shifts the bubble to another area, enrollment. Unless the benefits of obtaining a college degree increase sufficiently, even necessary cost increases imply that fewer people should be attending college on cost-benefit grounds.

The first piece of evidence of a potential enrollment bubble is atrocious graduation rates. Only 57.3 percent of students complete a bachelor’s degree within six years of enrolling.[9] Such a high attrition rate raises the question of whether too many individuals with poor chances of success are encouraged to attend college.

Another reason to suspect an enrollment bubble is the fact that even if they do graduate, many graduates cannot find jobs that utilize their degree. In 2008, 17.4 million college graduates had jobs that, according to job classifications of the U.S. Bureau of Labor Statistics, did not require a college degree.[10] Nor is this a new phenomenon. A Department of Education survey of college graduates four years after graduation indicated that only 60.8 percent were employed in jobs that required a college degree.[11]

Thus, out of every hundred students who begin at a four-year college, 57.3 manage to graduate within six years. Even if we assume that all of those 57.3 students are employed, four years later, only thirty-five have managed to find jobs that require a degree (and some of those are in areas unrelated to the students’ field of study). In other words, only about one-third of college entrants are able to complete and utilize a college degree. This begs the question of whether the resources spent sending the other two-thirds to college are a wise investment. Even when reasonable allowances are made for desirable redundancy and experimentation, it seems likely that there is an enrollment bubble.

Bubbles Meet the Highlander: There Can Be Only One

There is very likely at least one bubble in higher education. What is slightly unusual is that there are two possible bubbles and they are not independent of each other. In fact, if one truly is a bubble, it weakens the case for the other being a bubble. It is quite likely that enrollment either is or will soon be too high, given current cost trends. If higher education costs continue to increase (per student spending was just under $30,000 in 2009), then college attendance makes sense for fewer people. Thus, if current cost trends are unavoidable, it’s likely we are witnessing an enrollment bubble.

However, we don’t believe that current costs and trends are unavoidable, especially given the revolutionary promise of information technology in lowering costs. It is likely that the divergence between the costs of obtaining a college education and the costs of providing one is unsustainable. If that is the case, then the costs to students (and governments) of attending college will fall, and as those costs fall, the optimal number of college attendees increases—lessening concern about an enrollment bubble.

The Academic and Curricular Impact

The cost and enrollment bubbles have had significant indirect academic and curricular consequences on American higher education. The increase in enrollment at colleges and universities has led to an increased proportion of students of lesser academic ability and performance as colleges draw from deeper within the academic achievement/cognitive ability pool. The lack of academic achievement criteria as a condition of receipt of federal funds has enabled many academically mediocre students to attend college. The evidence is clear that students on such modern-era, federal need-based programs as Pell Grants typically fare far less well academically than other students who don’t require such aid.[12]

The increase in the proportion of students of more marginal academic potential has led to several developments in higher education that we regard as unfortunate. First, more and more students have difficulty mastering courses of high levels of academic rigor, leading first to a watering down in those courses (less reading, fewer papers, etc.), and second, to grade inflation. It is no accident that the huge growth in federal financial aid programs roughly coincides with the era of grade inflation.[13]

An additional consequence of this shift in the student mix is that students with limited capacity to master the critical thinking skills and comprehension of complex abstract concepts previously expected of college graduates seek refuge in degree programs lacking substantial academic rigor. Thus, in Academically Adrift: Limited Learning on College Campuses, sociologists Richard Arum and Josipa Roksa find business administration students, along with education majors, to be the students who study the least and acquire the lowest level of critical learning and writing skills.[14] It is no accident that the number of college students majoring in business has soared in the years since the inception of massive federal student financial aid.

Jackson Toby has suggested, we think correctly, that another unintended consequence of the decline in college standards has been the erosion of standards in secondary schools.[15] Why demand that high school students learn lots of math, foreign language, and other moderately rigorous subjects when colleges (or at least some colleges) increasingly enroll nearly anyone? In 1970, about 10 percent of students graduated with degrees in the natural sciences; in 2008, about 7 percent did. In the same period, the percentage of students graduating with a degree in business rose from 14 percent to 21 percent. College is increasingly viewed as a form of vocational training for specific types of jobs rather than as preparation for leadership and good citizenship through the pursuit of a meaningful general education with a rigorous curriculum.

The decline in academic quality has had far-reaching consequences. At least one highly regarded labor economist has suggested that the rather abrupt productivity decline observed in the U.S. after 1973 was the result of declining learning in public schools, as evidenced by falling SAT and ACT scores.[16] By extension, the decline in collegiate expectations accompanying the enrollment explosion of the 1970s and beyond may well have led to declining secondary-school performance that contributed to a slowdown and perhaps even a reversal in the growth in the nation’s human capital stock (the knowledge and skills of the labor force). Employers increasingly complained that newly hired workers lacked even rudimentary mathematics and communication skills.

Finally, as standards have fallen with rising numbers of less qualified students attending college, colleges have increasingly become social clubs rather than learning communities. Data from the U.S. Department of Labor “American Time Use Surveys” and other sources show that students spend more time partying, engaging in recreational activities, etc., than they do studying.[17] A hedonistic atmosphere, always present to a modest extent, has become a dominant part of the culture on many college campuses.

Reversing the bubble in higher education therefore very well might have the desirable spillover effect that it would also help to reestablish colleges as genuine and serious learning communities. And any improvement in academic atmosphere, most of the community of collegiate scholars would probably agree, would be a good thing.

Conclusion

As bubbles inflate, it is easy to rationalize continuing trends and mock critics as doomsayers. But bubbles are always obvious in hindsight. For those still not convinced, consider this. The best estimate of the instructional costs for current students is $23 billion per year, which is less than what the country spends on Pell grants each year. Suppose this estimate is off by a factor of two (e.g., that instructional cost per student is $3,000 rather than $1,500) and that other valid educational expenses increase per student expenditures by another $7,000, giving total educational costs per student of $10,000. There are roughly fifteen million full-time equivalent students. That should require around $150 billion dollars in educational spending, even at our generous estimate of appropriate spending. In 2009, higher education’s actual spending was $461 billion.[18] Even subtracting academic research and development spending (assuming that it held steady at 2008 levels of $52 billion)[19] we are still spending $409 billion on higher education when it should cost around $150 billion. That strikes us as unsustainable.

 


[1]Charles P. Kindleberger and Robert Aliber, Manias, Panics, and Crashes: A History of Financial Crises, Wiley Investment Classics, 5th ed. (Hoboken, NJ: John Wiley & Sons, 2005).
 
[2]See Andrew Gillen, A Tuition Bubble? Lessons from the Housing Bubble, policy paper (Washington, DC: Center for College Affordability and Productivity, 2008), http://www.centerforcollegeaffordability.org/uploads/Bubble_Report_Final.pdf .
 
[3]State Higher Education Executive Officers, State Higher Education Finance FY 2010 (Boulder, CO: SHEEO, 2010), 20, figure 3, “Public FTE Enrollment and Educational Appropriations per FTE, U.S., Fiscal 1985–2010,” http://www.sheeo.org/finance/shef_fy10.pdf.
 
[4]Caroline M. Hoxby, “How the Changing Market Structure of U.S. Higher Education Explains College Tuition” (working paper 6323, National Bureau of Economic Research, Cambridge, MA, December 1997), 5.
 
[5]See Gary S. Becker, William H. J. Hubbard, and Kevin M. Murphy, “Explaining the Worldwide Boom in Higher Education of Women,” Journal of Human Capital 4, no. 3 (Fall 2010): 203–41.
 
[6]Bob Samuels, “The Solution They Won’t Try,” Inside Higher Ed, June 4, 2010, http://www.insidehighered.com/views/2010/06/04/samuels.
 
[7]Andrew Gillen, Matthew Denhart, and Jonathan Robe, Who Subsidizes Whom? policy paper (Washington, DC: Center for College Affordability and Productivity, 2011).
 
[8] The best explanation for the divergence between price and cost is uncertainty about the quality of education, which gives rise to reputation-based competition. This is then exacerbated by a number of uncommon features of higher education, such as peer effects and college as a status good. For a more detailed treatment, see Promote Competition Based on Value, Not Reputation, policy paper (Washington, DC: Center for College Affordability and Productivity, 2010), http://www.centerforcollegeaffordability.org/uploads/25_Ways_Ch25.pdf.
 
[9]U.S. Department of Education, Institute of Education Sciences, National Center for Education Statistics, table 341, “Graduation rates of first-time postsecondary students who started as full-time degree-seeking students, by sex, race/ethnicity, time between starting and graduating, and level and control of institution where student started: Selected cohort entry years, 1996 through 2005,” Digest of Education Statistics, 2010 Tables and Figures, http://nces.ed.gov/programs/digest/d10/tables/dt10_341.asp.
 
[10]Richard Vedder et al., From Wall Street to Wal-Mart: Why College Graduates Are Not Getting Good Jobs, policy paper (Washington, DC: Center for College Affordability and Productivity, (December 2010), 4, http://www.centerforcollegeaffordability.org/uploads/From_Wall_Street_to_Wal-Mart.pdf.

[11]Laura J. Horn, Lisa Zahn, and C. Dennis Carroll, From Bachelor’s Degree to Work, statistical analysis report, U.S. Department of Education, Office of Educational Research and Improvement (Washington, DC: National Center for Education Statistics, 2001), http://nces.ed.gov/pubs2001/2001165.pdf.

[12]See William G. Bowen, Matthew M. Chingos, and Michael S. McPherson, Crossing the Finish Line: Completing College at America’s Public Universities (Princeton, NJ: Princeton University Press, 2009).
 
[13]Stuart Rojstaczer and Christopher Healy, “Grading in American Colleges and Universities,” Teachers College Record, March 4, 2010, http://www.gradeinflation.com/tcr2010grading.pdf.
 
[14]Richard Arum and Josipa Roksa, Academically Adrift: Limited Learning on College Campuses (Chicago: University of Chicago Press, 2011).
 
[15]Jackson Toby, The Lowering of Higher Education in America: Why Financial Aid Should Be Based on Student Performance (Santa Barbara, CA: Praeger, 2009).
 
[16]John H. Bishop, “Is the Test Score Decline Responsible for the Productivity Growth Decline?” American Economic Review 79, no. 1 (March 1989):178–97.
 
[17]“American Time Use Survey,” Bureau of Labor Statistics, U.S. Department of Labor, http://www.bls.gov/tus/.
 
[18]U.S. Department of Education, Institute of Education Sciences, National Center for Education Statistics, table 28, “Expenditures of educational institutions related to the gross domestic product, by level of institution: Selected years, 1929-30 through 2009-10,” Digest of Education Statistics, 2010 Tables and Figures, http://nces.ed.gov/programs/digest/d10/tables/dt10_028.asp?referrer=list.
 
[19]National Science Foundation, “Academic R&D Expenditures: FY 2008,” Detailed Statistical Tables, NSF 10-311, April 2010, http://www.nsf.gov/statistics/nsf10311/.

 

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