The Other False American Dream, the Other American Bubble

While watching Frontline’s “College Inc.” a couple weeks ago, I was reminded of a post by Peter Schiff that touched on the topic of rising college tuition.  Before I could get to this topic, I had to first post about how policy decisions of our federal government have, in an attempt to prop up a false ideal, created a market bubble (the housing bubble). There is a second false American Dream, and it’s higher education.  In the same way that politicians have promised us the dream of a house for all, they’ve promised us that no person should be denied a college education because of inability to pay for it.

In a later post, I’ll cover why I believe higher education is a ‘false’ ideal, another misplaced object of the American Dream.  In this post, I’m going to explain how monetary policy is directly causing the runaway cost of college tuition.Harvard tuition increase

The first question we need to address is if there is a tuition bubble at all.  The attached chart on the right,  is from “The First Measured Century,” on the PBS website.  A good benchmark, as it is much less affected by public funding, Harvard University tuition, in inflation corrected dollars, has increased over 700% since 1900.  If we don’t trust the indices of inflation, another way to measure this is tuition relative to mean annual incomes.  By that method, the annual tuition has increased over 500%.

Some argue that the true value of higher education has increased, justifying the increased cost.  Tim Roeper points out that the lifetime earnings of college graduates still outweigh the costs, making it a good long term investment.  This is supported by plenty of data, but I doubt these studies are able to control for factors such as student intelligence, social position/network, and other factors that would ultimately contribute to higher earnings, regardless of the degree.  Complete refutation of this idea is planned for a later post.

Another powerful argument is that university administration costs have risen.  The costs to provide the same services have increased, therefore either the taxpayer or the student must pay more and more. I have no doubt that university operating & equipment expenses have grown, but I see no justification for why they have swelled so much more than prices in other areas.   One of the specific excuses offered by university administrators is that the cost of technology (for example, providing computers for the students) is a new and added expense in recent years, but businesses have faced the same modernization challenges, yet have turned this technology and capital into efficiency generators.  There is no legitimate reason that universities cannot do the same.

That being said, my primary objection against the argument that increasing costs must lead to increasing tuition is this: increasing costs are not justified.  By defining the problem in this way, we are actually missing the point.  I believe that in a market where the government was not providing a crutch for tuition, university services would be reduced, to keep tuition from increasing at such a rate.  Irrelevant and pointless courses would be dropped.  Students would be asked to learn more material in less time (just like in the old days), thereby reducing the total number of course hours needed for a degree.  Non-academic benefits provided by the university would be reduced.  This logic can be carried throughout the gamut of university services.  Rising expenses force businesses to go back to basics.  Determine what are the product benefits that are most necessary, and strip away the excess.  In the face of rising costs, universities have done the opposite, they have offered ever increasing services and auxiliary student benefits.  How is this possible?

Just like the housing bubble, it is possible because everyone acts in their own interest, and the lending policy supports ever higher prices.  The easier that money can be obtained, the more that can be paid to universities.  Universities have no incentive to reduce tuition, because the tuition is not being payed by the students, it is being payed by the government subsidized loans.

Before we continue, there is an important distinction to make.  Grants are different from loans.  All student aid is not as insidious as the loan programs.  Many have confused this fact, but we cannot.  Grants go directly to the university, in which case they do not obscure the cost or source of funding, or they go to students, who have an incentive to spend them judiciously.

For the simple reason that government student aid in the form of subsidized loans does not pay the student, it pays the university, the university is encouraged to raise tuition.  The actual cost to the student is not substantially increased, if he plans to finance his tuition.  If he would like to be responsible, earn his tuition and pay cash, he is at a significant relative disadvantage.  This is another way the current monetary policy encourages spending and borrowing in lieu of saving and trading.

Some have acknowledged this problem, but believe it is either unsolvable or that additional meddling can correct it.  This is a backwards attitude.  They advocate price ceilings on tuition and complex systems of enacting them.  Pell grants should be capped at certain levels, if tuition exceeds certain amounts, with complex exceptions to the already twisted set of rules (see Kenneth Cole’s suggestions in the comments section below this article).  How this system is efficient or desirable in any way is beyond me.  No one would imagine trying to control the housing bubble in this way.  Why would we consider this strategy for higher education?

Let’s go back to the root of the problem: monetary policy.  Our Harvard tuition chart begins in the year 1900.  Interestingly, this is the year the US adopted the gold standard, which will play a part in the story.  During both WWI and WWII, tuition declines, likely caused by simple supply and demand.  During WWI, the US significantly increased the monetary supply to provide funding for our allies, and later, our war expenses.  In a futile effort, We temporarily propped up the British currency.  We provided even more funding to Germany for her rebuilding efforts.  The monetary policy at this time directly led to the stock market bubble, crash, and great depression.  When Europe could not repay her debts, things began to unravel.  The pressure finally forced us to drop the gold standard in 1933, devalue the dollar, and give the government more power under the Bretton Woods system.  The inflationary pressure of the money supply was temporarily curtailed by the severe economic slowdown and eventually, WWII.

During this time period, primarily caused by WWII, America went from a creditor to a debtor nation.  Hence begins the policy to favor debtors and irresponsible spending.  In 1944, we passed the GI bill, allowing returning soldiers to receive tuition directly from the government (and the US taxpayer).  This enabled veterans to go to universities at whatever cost the universities were charging.  Combined with the already imminent increase in demand from returning soldiers after the war, we see the first major and long term change in the rate of tuition increases.  To exacerbate the issue, in 1958 the federal government initiated the subsidized loan policy, which would later be called the Perkin’s Loan.  The floodgates were open.

In 1971, the Bretton Woods system came crashing down and we moved to a complete fiat currency.  This gave the federal government unprecedented power to manipulate the value of the dollar.  In 1972, the student loan policy was broadened to include junior colleges.  In 1980, Pell grants were initiated.  Despite this, a gradual shift in funding from grants to funding from loans occurred during this decade.  These factors all enabled the next shift in slope on the tuition cost curve.

In 1993, lending limits were extended, and eligibility rules broadened to include even more students.  Finally, in 1997, tax credits were instituted for tuition costs.  These factors provided even more funding for tuition.

I think, from this timeline of events, it is clear that the tuition costs are being propped up by a gradual process of increasing subsidies for student loans, enabling universities to raise tuition without fear of elastic demand.  The cost to the taxpayer has been great.  The cost to the students has also been significant.  The parallels to the housing bubble are uncanny, with one exception, the tuition bubble has not yet burst.

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2 responses

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    3 December 2010 at 6:30 pm

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    19 December 2010 at 12:35 am

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