Monday, May 16, 2011



A Two-Pager by Ajit Chaudhuri – May 2011

‘The enemy of truth is not the lie but the myth’

I would like to introduce you to Peter Thiel, one of the promoters of Paypal and more relevant to this paper also known for having predicted the dotcom and housing bubbles in the US. When is a price rise normal interplay between supply and demand, and when is it a bubble that needs policy intervention? According to Thiel , a true bubble is when something is both overvalued and intensely believed – and that belief, while rooted in truth, gets pushed to unhealthy levels. He says that the next big bubble to burst will be higher education, with its too high and rapidly rising costs, the onerous debt levels that its consumers acquire, and mounting evidence that the rewards are over-valued. This paper looks to examine this contention.

A typical bubble has buyers thinking that they are buying something that will appreciate in value and make them rich in the future. The product grows more and more expensive. The expense is off-shored by easy credit. An increasing numbers of buyers buy at increasing prices in the expectation that the value will continue to increase. At some point, Stein’s Law (‘if something cannot go on forever, it will stop’) kicks in and the bubble bursts. Buyers dry up, sellers proliferate, the product’s value drops abruptly, and those holding it are left with a mound of debt that surpasses the value of the product. Larger bubbles take down entire financial systems, which is why central banks are supposed to keep a close watch on irrational exuberance within the economy.

Can higher education be a bubble? This is controversial! The Bennett Hypothesis of 1987 first identified the possibility, observing that college rankings are partially driven by spending levels, that higher tuition prices are correlated with perceptions of prestige, and that it is in colleges’ best interests to increase prices as long as financial aid ensures an ability to pay. Coupled with this is the widespread belief that, no matter what the cost, education is necessary for future prosperity. The ingredients for a bubble exist.

Several recent papers look into the possibility, and examine the price of higher education in the US, the demand for it, the returns to it, and the level of debt incurred to obtain it. This is disturbing stuff! Tuition fees have gone up at well over inflation, and demand for higher education has behaved similarly. Average salaries for new bachelor degrees have dropped. And the class of 2011 is the most indebted ever, with outstanding student debt surpassing credit card debt for the first time ever in June 2010. In a rapidly de-leveraging US economy, this is the only category of debt that is increasing.

The premise that higher education equals future prosperity too is being subject to scrutiny. The economist Paul Krugman questions the belief that progress increases job opportunities for those who work with minds and hurts those who work with hands, and others point out that the trend may be the opposite and that demand for truck drivers and manual labourers is likely to outstrip that for low-end white collar jobs (which can easily be Bangalored).

But is this a bubble? Higher education is not a typical product in that the buyer cannot subsequently sell it (necessary for a bursting bubble), only rent it for wages. Also, most economists do not think that the returns to higher education are falling in the long term, and do think that demand supply corrections should sort out temporary imbalances. This has already begun, with an 11 percent decline in applications to law school this year, mainly because students see no sense in piling up debt to join the legion of unemployed lawyers. Mid-ranking business schools too are seeing a drop in demand, masked by them taking weaker candidates. And an economic recovery should see demand for college graduates pick up, and a subsequent return to business as usual for the system. But this is by no means certain.

Why is this debate important for us here in India? Higher education was seen to have a strong public good component, and the state therefore provided the service and contributed a significant proportion of the cost. This thinking is changing to it being seen as a commodity in which all the benefits accrue to the one undergoing higher education, and s/he should therefore bear a larger proportion of the (rapidly increasing) costs. The demand and supply, in the mean time, are increasing significantly and the debate regarding increased tuition fees is couched in terms such as institutional autonomy and the need to ensure that any capable but broke person should have access to student loans. Proponents of the Bennett Hypothesis would feel a sense of déjà vu.

1 comment:

Ajit Chaudhuri said...

Another trend that has picked up in MBA admissions in the US is that most of those who join an MBA, even in top schools are those who are actually not doing well in their current career and want to correct
that. Some good candidates do join because the are enamored by the idea of being Wharton and Harvard alumni but those who are doing well in their career are not going for a two year MBA as they have corporate (inhouse) MBA options that major US firms offer. Mid-ranking business schools too are seeing a bigger drop in demand and they are taking even weaker candidates as a fallout. The job market is recognizing this fall in quality and this is impacting recruitment at the US business schools with many ending up without a job. What makes it worse is the major fall in quality of relevant teaching in business schools (as most faculty are far too research biased and have low level of industry exposure) as well as the huge grade inflation in the US business schools - almost everyone gets an A grade as faculty are down rated by students for being tough on grading. Therefore the actual best of them cannot leverage their grades or academic achievement to their potential employer. So it's a great downward spiral which is currently hidden and blamed on the general downturn in the job market. MBA applicants who actually join an MBA seem to believe that they are not the ones to get hurt - in any case the MBA itself makes them a tad over-confident anyway!

Data must be available to check on the above. All the above were picked from some source though I can't now recall the exact source.

Ganesh Prabhu