Monday, January 9, 2012

When Markets Fail

Washington Post's Wonkblog today highlighted a Daily post on the rising cost of a college education (h/t Evan):

The Daily crunches the numbers on rising university tuition costs and finds that, if they keep growing at the same rate they have for the past three decades, a four-year degree at a private institution will cost $274,684 by the time a baby born this year is ready to enroll, in 2031. At the top 10 most expensive, private universities, one year of tuition would come with a $110,432 price tag.

That would, incidentally be nearly double the projected annual income of a family with a child under 18, of about $58,000 if income continues rising at the same rate it has since 1987.

Most troubling is not the eye-popping six-digit figure, but that even at that level, it's likely underpriced! The market at top-tier schools doesn't clear--supply provides the limiting constraint. Harvard, for instance, has an admissions rate of around 6%. It could easily raise tuition and maintain a full enrollment without any material impact on the quality of its incoming class.

I don't see this trend as abating. Americans treat education as a status good. People don't want to get a good education--they want (or want their kids to get) an education that's considered better than others. People don't choose Harvard because they'll learn more than they would at Big State U--they choose Harvard because employers perceive students learn more at Harvard (or believe graduation from Harvard signals other qualities they covet). This leads to arms race among parent and school administrators to top the school next door.

This undercuts one of the major justifications for having a market-based economy--prices serve no role as an information revealing mechanism. The market telling Harvard it's underpriced doesn't lead Harvard to create more seats--indeed, the majority of the value of a Harvard degree derives from the fact Harvard doesn't let in everyone willing to pay. Nor can an entrepreneur capitalize on Harvard's reluctance to admit more freshman. People want a degree from Harvard, not Gary's Roadside Edu-mart.

This suggests only radical reform can stem the ever increasing rise of tuition rates. We need to reassess our assumptions about how our education system should function. Should free public education end after high school? Should our education system be so geography based (the importance of a "good" K-12 education system just leads to wasteless bidding in the real estate market)? Should spots in college be awarded on the basis of "merit"--maybe schools should award spots based on chance (which would, of course, reduce the signaling value of a degree from any given school)? Is education even a good that should be bought and sold? There's a risk this leads to another wealth-based form of signaling, but if we're serious about giving everyone an affordable college education, they're questions we can't ignore.

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