All Commentary
Tuesday, December 14, 2010

Education: Investment Versus Spending

Bypassing market feedback.

Thousands protested in London last week against a proposal to reduce subsidies to education.  The plan, part of the austerity measures by David Cameron’s Conservative government, would raise the cap on university tuition from roughly £3,000 to £9,000, or from about $4,700 to $14,000.  The measure passed by a small margin.

Under the new law the maximum tuition a British student attending Cambridge or Oxford would have to pay beginning in 2012 would be about $14,000.  By comparison an American student attending Harvard today pays over $35,000 in tuition.  (Having recently put a son in college, I can tell you that figure is fairly representative of selective liberal-arts colleges in the United States.)

Human Capital

This is my 25th year as a college professor, but I’m still idealistic about what a college education represents.  I’m disappointed when a student, particularly a good one, is motivated to study because she wants to get a good-paying job after graduation.  Of course, having a regular income is important for happiness, but as one of my respected colleagues once said to me, “A liberal-arts education gives you something to think about when you’re not working.”  Indeed, I try to tell my students, especially the freshmen and sophomores, that they should try as much as possible to study and do things in college that are highly impractical because most of them will have to spend the rest of their lives being very practical.  (A friend of mine recently told me of a Stanford MBA who said the most valuable course he took in college was art history.)

At the same time, I recognize that the market for skilled labor, like the market for anything else, is a matter of supply and demand.  The choice of whether to major in chemical engineering or Renaissance literature or economics has to take into account not only what you love to do and are good at (these typically overlap), but also what you are willing or not willing to give up to do those things.

As the great Austrian economist, Ludwig von Mises, often pointed out: “There is only one efficacious way toward a rise in real wage rates and an improvement of the standard of living of the wage earners: to increase the per-head quota of capital invested.”

So investing in capital, in this case human capital, is essential to promote one’s material well-being.  But, as Mises well knew, the capital invested has to be appropriate to the particular circumstances of time and place.

Appropriate Investment

There are many horror stories of where it wasn’t.  Jane Jacobs relates how, for example, in the early 1960s the Rockefeller family tried to build a factory in India to produce “intrauterine loops” for birth control.  There were at least two things wrong with the project, however.

First, as Julian Simon tirelessly argued, human intelligence is the “ultimate resource” and the fountainhead material progress.  Thus instead of investing in birth control, it might have been better if the Rockefellers had bolstered their investments in things that boost the production of food, housing, and medicine.

Second, and Jacobs’s main point, the Rockefellers tried to build this factory in a rural area.  Their intent was to create jobs and alleviate poverty outside the large cities.  However, in the countryside such things as the proper tools, electrical and other infrastructure, and the knowhow to repair equipment were hard to find.  Many small things went wrong because they lacked the local knowledge of the communities they were trying to help.  Eventually, after trying for a year and spending a lot of money, they moved the factory to a large city, where it was up and running in six weeks.

As a largely a private humanitarian venture (although it had the blessing of the Nehru government), it had something that a government program usually doesn’t: a relatively hard budget constraint.  Even though the benefactors were Rockefellers, competition for scarce investment capital meant there was a bottom line.  Without it, there is no telling how long the factory would have languished in the Indian countryside.

Inappropriate Human Capital

So, returning to our subject, when is investment in education “inappropriate”?  Well, one might say when it moves some to acts of violence against the innocent.  (I understand, however, most of those protesters in London were less violent.)

But State subsidies, even those that use taxes to cover the difference between tuition and the expense of running a university, are not really investments at all.  They are expenditures.  And what guides political spending on education or housing or just about anything else is usually expediency.  Politicians consider rate of return on investment when making spending decisions about as often as they consider moral principles:  rarely.

Some could argue that from an economic point of view, subsidizing education is not as disruptive to the market process as, say, monetary manipulation or price controls.  But on this point a recent story from the New York Times caught my eye – “China’s Army of Graduates Struggles for Jobs”:

In 1998, when Jiang Zemin, then the president, announced plans to bolster higher education, Chinese universities and colleges produced 830,000 graduates a year. Last May, that number was more than six million and rising.

Many Chinese parents did make financial sacrifices for their children’s education, so universities are not entirely state subsidized.  But was the education appropriate to market demand?  There have been unintended consequences:

It is a remarkable achievement, yet for a government fixated on stability such figures are also a cause for concern. The economy, despite its robust growth, does not generate enough good professional jobs to absorb the influx of highly educated young adults.

Graduates migrate to Beijing looking for opportunities that match their aspirations but are increasingly disappointed.  Ironically, workers with traditional skills have been doing better:

Between 2003 and 2009, the average starting salary for migrant laborers grew by nearly 80 percent; during the same period, starting pay for college graduates stayed the same, although their wages actually decreased if inflation is taken into account.

Like all other goods, the demand curve for education slopes downward.  Artificially lowering the price – in China, the United Kingdom, or the United States – is bound to create an excess demand for a university education now and surpluses of increasingly disappointed graduates in the years ahead.  If the violence in London (as well as in some parts of California where students were also protesting tuition hikes) is an indicator, the future is not bright.

  • Sanford Ikeda is a Professor and the Coordinator of the Economics Program at Purchase College of the State University of New York and a Visiting Scholar and Research Associate at New York University. He is a member of the FEE Faculty Network.