When Higher Education is Too High

Ingmar Empson

July 20th, 2017

 

 

It is no secret to parents and students that college is expensive. With more young people saddled with loan debt than ever before, college has become for many, one of the largest life expenditures. For family members helping subsidize the cost of tuition, this means less money in the bank for retirement or emergencies. For students, this means overwhelming stress and years of wasted paychecks spent trying to escape debt. These are the years so crucial for building stable finances, essential for purchasing a home and starting a family. In our society, these are seen as short-term costs, with the benefits of college seen as the long-term payoff of an investment. But if college is to be seen as an investment, it must be analyzed as one. This means plotting the total market value to see just how much things have gotten out of hand.

 

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The figure to the right shows two trends. The red line includes market-price valuation until 2015. Past 2015 is a forecasted market-price value given a continued percentage change in market value. The blue line is an estimation of the true value of the college market. It was found assuming prices were held constant. The increase in value comes from growth in student population. It does not account for inflation.

 

Since the 1980s there has been a relatively constant increase in the number of students attending 4-year public or private institutions.  If cost (adjusted for inflation) were to remain constant, the value of the market overall would grow at a fairly steady, manageable rate. That is to say that the blue line resembles how the value of the market should grow through 2030. However, what we see is a huge disparity between the real growth of the market (red) and what growth should instead look like (blue). If the college market continues to grow at the rate it has been for the past few decades, by 2030 the market would be valued at almost $800 trillion. This is almost $600 trillion more than the market would be valued if it kept in line with the growth in the number of students attending.                               

 

Here is the catch: one might argue that, just like companies, the market may grow because of a variety of reasons besides the number of customers. This might include innovation or demand for a product or service. To be fair, more jobs are likely to be filled by those with college degrees than in the 1980s. However, this actually reduces a university’s ability to get their students employed. More important, college is a singular industry where there has been almost no innovation for decades. The methods of teaching and services provided to students have for the most part remained unchanged. Yes, most large universities probably did not have a rock climbing wall for students 30 years ago, but how much does this really increase the value of a college education? The conclusion that can be drawn here is that almost all of the increase in market value comes from a rise in prices.

 

Even worse, these profits are not invested back into the school but instead used to fatten the pockets of university presidents and board members. The UC school system recently garnered attention in late 2015 when UC announced a 3% salary increase for the top 15 highest paid executives. The majority of these individuals already made over $400,000 annually. This does not even take into account reimbursements for basic living expenses such as transportation to and from work and “networking” expenditures. Unfortunately, this story is heard much too often throughout the American university system. This should make investors suspicious. In the stock market, it is a warning sign when a company’s value sharply increases without proper justification. It is also a warning sign when the executives start paying themselves more and more. It is no different in this instance. It would appear, that the college market is a bubble.

 

Bubbles may come in all shapes and sizes, but one commonality that holds true for each one is that they eventually burst. The American higher education bubble is massive and when it bursts, it will have long-term effects both domestically and internationally for years to come. Perhaps the most devastating in the U.S. will be the effect the crash will have on inequality. The disparity between the upper 1% of the U.S. and the rest of the country has been a source of contention for years. Not only do a few hold the majority of wealth, but they also hold the most valuable social connections, jobs and influential posts. The higher education crash will widen this gap because it will be triggered by a rapid decline in students attending college, despite a job market that will still value college degrees. Individuals will simply no longer qualify for higher paying jobs. Ironically, this problem will be most acute for the middle class. The reality is that the working class has greater access to the financial means necessary to attend college if accepted by a university. This is either through scholarships provided by the school or the government. Middle-class students, on average, do not qualify for merit based scholarships based solely on academic performance due to lower standardized testing scores than their upper-class counterparts. Nor do they qualify for need based scholarships given their slightly higher family income. When the middle class can no longer afford college, the result will be a work force that is severely under-equipped to perform in the global market and fewer individuals who will be able to provide a better standard of living for their children.

 

Fortunately, there are solutions to this problem that have been tested and proven successful. Perhaps the most obvious is the implementation of caps on tuition rates, as used throughout Europe.  These caps would simply limit the potential size of this bubble but have proven helpful overseas. Perhaps an even more effective approach would be to instill limitations on how much university board members and presidents could make. This would push universities to reinvest capital into the institution itself, versus lining the pockets of the already wealthy elite. These recommendations should not be seen by universities as barriers to overcome, but instead opportunities to improve the quality of the education and services they provide to those who attend. It is through taking these preemptive actions that we may preserve the American dream for further generations.

Disclosure:

Investing involves risk, including possible loss of principal. This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. Opinions reflect the market conditions when written.