Interest rates have been in the news again so for this week’s column I thought I’d do a little back-of-the-envelope economic analysis.
What Does this Sound Like to You?
The government artificially lowers interest rates for borrowers who want to invest in a particular sector of the economy. Other things equal, that will increase the demand for assets in that sector as borrowers are misled into believing they will be worth more in the future than they actually will be. The current price of those assets will climb as will the quantity supplied (i.e., the demand curve slides up the supply curve). Borrowers will then clamor to keep borrowing rates low (or even lower) so they can afford to complete their investments, although that would also attract new borrowers. So pressure on demand continues and investment costs soar as asset prices and output keep rising.
Now, because government has kept interest rates artificially low—below the rate that would accurately reflect the actual supply and demand in the loan market—there is too much investment in those assets in relation to the actual demand for it. That means when investors try to sell their assets they will find no market for them. At that point the bubble bursts, bringing complementary sectors down with it.
If the Shoe Fits …
If you think this describes the housing market from 2001 to 2006, you’d be right. Just substitute housing/houses for asset/assets and “financial sector” for “complementary sectors” in the above narrative and you would get an accurate (though incomplete) summary of the recent housing boom and bust. (For an excellent discussion of this episode, see Peter Boettke and Steven Horwitz’s essay.)
But you could substitute “higher education” into the story as well.
As an author of the Economix blog over at The New York Times reports, data from the Bureau of Labor Statistics show that “college tuition and fees today are 559 percent of their cost in 1985. In other words, they have nearly sextupled (while consumer prices have roughly doubled).” There’s a nice diagram in the post illustrating this. Tuition has been far outpacing price increases over time for consumer items, medical care, and gasoline.
Author Catherine Rampell argues, however, that “the main cause of tuition growth has been huge state funding cuts.” As an employee of a state university I can confirm that these cutbacks have indeed been taking place over the past couple of decades. The author offers some evidence to support her claim, but if you look closely, the dramatic rise in tuition still seems to outstrip the relative fall in state subsidies.
More importantly, if what she argues is true, why is it that college enrollment over the same period has been rising?
In basic economic terms, she is arguing that because the colleges are bearing more of the actual costs, the supply curve for college education has been shifting upward and to the left—causing tuition to rise and enrollment to fall. But the evidence points to a rightward shifting demand curve (like the narrative I sketched at the outset), which accounts for both the higher tuition and higher enrollment.According to the National Center for Education Statistics,
The Stafford loan program, which subsidizes student loans, began in 1988.
If Rampell is right, then shouldn’t enrollment be falling? Instead it is rising disproportionately. Just as the housing bust left tracts of houses unused, a higher-education bust would create a small army of unemployed young people.
An Act of Independence?
But just as overbuilt housing can be used for some lower-valued purpose than it was intended for, investment in education—which is sometimes more accurately described as “spending on a credential”—often goes “underemployed.” So growing underemployment of college grads is something we should keep an eye out for.
According to The Huffington Post, “half of recent grads are working jobs that don't require a degree, according to research from the Center for College Affordability and Productivity, released in January.”
The same article notes, “In 2000, before the economy fell into a recession, the share of recent college graduates who were either jobless or underemployed hit an 11 year low of 41 percent, according to the Associated Press.”
Now, as an article from The Washington Post makes clear, that’s not necessarily a bad thing: Some jobs don’t require a specific degree. Also, it’s unrealistic in a dynamic economy to expect the major you choose when you’re 20 to match what your comparative advantage will be later in life.
Still, it’s probably true that many young people who would otherwise get the training they need for productive jobs from trade schools and community colleges are applying to and getting into four-year colleges, as the lower rates tend to offer a higher subsidy to the latter. (Example: The savings from a lower rate on a $50,000 liberal arts college loan is greater than the savings on a $10,000 loan for community college.)
This week Congress takes a holiday to celebrate Independence Day. One of the things they’re leaving undone is negotiating a measure to keep the rates on Stafford loans from rising from 3.4 percent to 6.8 percent. Given the very real possibility of a bubble in higher education, that may actually be a blessing.
The first step to avoiding a huge bust, though some kind of correction seems to be inevitable, would be to let the Stafford-loan rates rise to reflect the realities of the loan market. That could mean a significant break in the vicious boom-bust cycle in higher education. The question is, does Congress have the will to do nothing?