Friday, May 13, 2011

The Higher Cost of Higher Education

Ryan Avent draws our attention to a debate going on this week about the extremely high price of education in the US. To focus the conversation he asks "Is higher education a bubble?" In partial answer to the question he writes:
It's much harder to talk about a bubble in education than it was one in housing. In housing, there was a clear metric: prices, in absolute terms and as a ratio of just about everything, were soaring. And there was a clear debate: are these increases justified by some real economic shift or are they a bubble associated with new mortgage products and loose credit. In higher education, the questions are much more difficult.
I agree, but I would put it even more strongly: it is simply not possible that the high cost of higher education in the US is a bubble the way that the housing market was a bubble, because it is not really possible to have "bubbles" for things that are not assets -- at least not the way we traditionaly understand the meaning of the term "bubble".

A speculative bubble, such as we saw with housing during the mid 2000s or with the US stock market in the late 1990s, is usually defined as a situation in which the price for something becomes detached from its underlying true value because people suppose that they will be able to resell the item for an even higher price at a later time. With real estate, for example, people paid more than houses were worth in 2003-06 (and often more than they could afford) because they assumed that they would be able to resell the house in the future for an even higher price than they paid for it. Once you think you will be able to resell something in the future at a higher price, then you become willing to pay more than its underlying value would actually recommend.

But with services such as education, there's no way to store the purchased item and resell it later. So drawing an analogy between price increases for services and price increases for assets doesn't really work.

Instead, if we want to understand why competition doesn't seem to work to bring down the price of education, we need to think in terms of market failures, just as market failures explain why competition doesn't work to bring down healthcare costs in the US. The types of market failures that may exist in the market for higher education are likely to be different from those that permeate the market for health care, but they still exist. And understanding exactly what they are will be the key to understanding the high cost of higher education.

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