What Bubble?

According to Peter Thiel, the founder of PayPal and sponsor of fellowships that pay entrepreneurial minded students to drop out of college, higher education is the next bubble that will burst in the U.S. economy. The Economist's Schumpeter blog summarizes his argument this way: "tuition costs are too high, debts loads are too onerous, and there is mounting evidence that the rewards are over-rated. Add to this the fact that politicians are doing everything they can to expand the supply of higher education … much as they did everything that they could to expand the supply of 'affordable' housing, and it is hard to see how we can escape disaster."

Bubble talk of this sort -- and Thiel is hardly alone in his theory -- is a great example of abusing the evidence to support a hyperventilated hypothesis. This may sell magazines, but it does not make for good public policy.

Any meaningful discussion of an economic bubble has to start with a definition. Here’s a good one from Charles Kindleberger in the New Palgrave Dictionary of Economics:

A bubble may be defined loosely as a sharp rise in price of an asset or a range of assets in a continuous process, with the initial rise generating expectations of further rises and attracting new buyers – generally speculators interested in profits from trading in the asset rather than its use or earnings capacity. The rise is usually followed by a reversal of expectations and a sharp decline in price often resulting in financial crisis. (Volume 1 page 281)

College training, of course, is not an asset that can be sold off to gullible investors like a rare tulip bulb or a Florida townhouse. The monetary value of education accrues over a lifetime of potentially higher earnings. But let’s dig deeper and look past this minor overselling of the bubble analogy.

In any bubble story, rising demand supposedly fuels an upward price spiral. Yet rising demand for college-level training does not lead to higher cost per student. Most colleges can add 5 percent to their enrollment without adding any more than 5 percent to their costs. For many smaller colleges, with excess capacity in facilities or faculty members, if they doubled in size their cost per student actually would fall. These small colleges choose to remain small because they are convinced that increasing their size would depersonalize the campus in ways that decrease the quality of the whole college experience.

The idea that rising demand pushes up price is rooted in a belief that the number of seats available at colleges and universities is relatively static. But the supply of places in higher education is rather elastic. In 1970, 8 million students were enrolled in two thousand American colleges and universities. Today, over 18 million are enrolled in roughly 4,300 institutions. There has been a veritable explosion of places at for-profit and nonprofit institutions alike. To take one example from the traditional non-profit sector, the University of Central Florida has mushroomed from a startup in 1968 to the second largest university in the nation.

The number of places at Stanford and Princeton Universities may be inelastic, but if the bubble story is about the elite institutions that serve a tiny fraction of the college-going population then it is of little policy relevance.

If rising demand isn’t the driver of college tuition, what is? There are three reasons why the cost of providing a college education has gone up so much since 1980, and all of them reflect broad economic forces buffeting the entire U.S. economy. First, the costs of employing a highly educated workforce have risen substantially over the past 30 years. This has affected all industries that use a lot of highly educated labor.

Next, the productivity of that highly educated labor has not increased in most personal service industries, and this includes higher education. Universities have not figured out how to double class sizes without negatively affecting quality, and new approaches like distance learning have not yet provided any magic bullet. Lastly, the costs of keeping a college education up to date have increased as new technology filters into the workplace students enter once they leave the ivied halls.

Tuition has risen for two additional reasons besides changes in cost. First, for public universities, states have reprioritized spending away from higher education. Rather than raising taxes, over time state legislatures have allowed tuition increases that shift more of the burden of the college bill onto families.

And lastly, public and private universities alike have pushed up the list price paid by the most affluent families so that they can discount the bill for other students. Tuition discounting can help the least affluent attend pricy institutions, but it is also a tool colleges and universities use to craft the freshman class in other ways. A lot of this discounting is a merit aid arms race that does not create access to college for students who otherwise could not afford to attend.

The bubble analogy simply does not work, and higher education is not the next housing bust. Still, what can we make of Thiel’s three contentions? Does his indictment of higher education stick?

First, tuition costs are too high – compared to what? List-price tuition has indeed risen rapidly over the last 30 years. But the data in the College Board’s Trends in College Pricing show that the average net tuition and fees, accounting for grants and tuition tax credits, actually has declined recently at both public and private institutions. The net tuition picture is not as clear as many people think it is.

Second, debt loads are too onerous – compared to what? Again a College Board study is instructive. In Education Pays 2010 the College Board demonstrates that a typical student with a B.A. will have enough cumulative earnings by age 33 to catch up with a typical high school graduate even if the college graduate had to borrow and pay back every dollar spent on tuition and fees. After age 33 the college graduate out earns the high school graduate by a significant margin.

The third claim is that the rewards of earning a college degree are overrated. Again, compared to what? The median real earnings of individuals aged 25-40 with a B.A. or higher have indeed shown only scant increases in recent years. But the median real earnings of those with less than a B.A. have fallen significantly over the same time period. As a result, the college wage premium has continued to rise.

Bubble talk also includes the claim that a college education no longer is a guarantee of success. But a college education never has been a guarantee of financial success. Some high school graduates will out earn even the high flyers of the college-educated population, while some college grads will fail even to match the median earnings of the group that earned only a high school diploma.

Using census data from the March Current Population Survey, we can calculate the percentage of college graduates who earned less than the median income of high school graduates. In 1980, 28 percent of college graduates between the ages of 25 and 40 earned less than the median income of people in the same age range whose education stopped with a high school degree. By 2010, that number had fallen to less than 18 percent. Even today a college degree is no guarantee of financial success, but over the last 30 years, earning that degree has become a progressively better bet.

Peter Thiel doesn't just talk about a higher education bubble. He has put up some of his own money to demonstrate that college isn't the right investment. He has selected 24 people from a pool of 400 applicants to receive $100,000 over two years if they agree to opt out of college to focus on their entrepreneurial ambitions instead. There is little doubt that most of these individuals will succeed. After all, Thiel’s group is a more selective bunch than Harvard’s entering freshman class.

What we will learn from their success is that talented and motivated people are likely to succeed. We won’t learn a thing about the value of college training to the average person. We won’t even learn whether this talented 24 would have accomplished more, or lived more satisfying lives, had they remained in college. On average most of us are average, and the data show that college is a very good investment for the average person.