“Good afternoon, sir. I’m a broker with Churnham & Burnham, and I’d like a few moments of your time to discuss an extraordinary investment opportunity. It’s an asset that everyone is buying—your friends, your neighbors, teachers, firemen, doctors, lawyers, and even your humble broker.
“Not only that, but it’s an exceptionally long-lived asset. Once you own it, you’ll be getting dividends for your entire working life.
“While it’s not as cheap as it used to be—in fact, it’s going up in price at about twice the rate of inflation—it’s never been easier to get government-subsidized loans to purchase it. In fact, third parties may pay for some or all of it for you!
“The asset is, of course, a college education. Now, wouldn’t you like to review the prospectus?”
If you’re an average American, an undergraduate degree is the second biggest purchase you’ll make, after a home. It’s well-known that a college degree is an investment with a positive return. Most successful people are college graduates, and most desirable career tracks require at least a college degree.
But I contend that college is not a good investment. It’s a bubble. Why?
1. The price of college is continuing to rise faster than the rate of inflation.
2. There is empirical evidence that the dollar value of a college degree is flat—or possibly declining.
3. If college loses its signaling power, this will make past degrees retrospectively worth even less.
What is the Return on Investment for a College Degree?
I’d like to preface this by noting that I don’t think all degrees are a bad investment. A technical degree at a decent school is almost always worthwhile. It’s very hard to do a decent job at a top-tier school and not end up with a degree worth having. That said, most of the growth in the college population comes from:
1. Lower-tier schools expanding their classes. (Arizona State has grown from 26,000 to 68,000 students since 1970. Yale’s undergrad class grew from about 5,000 to 5,300 in that period.)
2. New schools. The University of Phoenix was not exactly a major force a few decades ago. Meanwhile, schools rarely shut down.
Actual return data are hard to come by, but one source is to look at the difference in earnings between college graduates and non-graduates.
This data has an interesting feature: it’s based on average earnings over a ten-year period. That has two effects: first, to the extent that college degrees are for signalling, rather than for skills, it will exaggerate their effect; if you’re a smart engineer with no degree, it might take you a couple years to get the job you would have gotten out of school, but you’ll get it eventually. The more pernicious effect is that if college degrees are suddenly worth less, it will take a while for this to be reflected in the average. In a worst-case scenario, where the implied value of a college degree spikes and then plummets (the way technology stocks did in 1999-2002, or housing did in 2000-2009), this effect won’t show up in median earnings.
The government data table is missing two columns: first, the average difference between college grads and high school grads. And second, the growth rate of that difference. Add them, and the result is striking:
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College was a great investment in the early 80's (when, incidentally, parents who are paying for college now probably formed their picture of the value of a degree). But now the cost of a degree is rising at twice the rate of inflation—while the return on that investment is rising by half the rate of inflation.
What is a "Degree," Anyway?
If tough degrees from good schools aren't numerous enough to match the demand for college education, that demand will be expressed elsewhere. As mentioned before, this can show up in the enrollment growth at lower-tier schools. It can also show up:
1. In the growth of lower-income, less demanding degrees. According to the National Center for Education Statistics, the number of Engineering degrees granted grew by 53% from 1970 to 2008. The growth in psychology degrees: 142%. (Math and statistics, by the way, has declined 38% during this period, though it used to be a proxy for computer science, too.)
2. In the growth of for-profit schools.
All of these factors change the definition of a "degree," and not in a positive way. According to the same NCES data, Engineers made around $58,300 a year in 2001; psychology majors clocked in at $35,100. 87% of engineering grads were employed full-time; 76% of psychology grads were. For-profit schools don't release numbers on their students' incomes, but from the résumés I've seen as a recruiter, the numbers are not likely to be impressive.
In other words, the growth in the number of people who have a degree has coincided with a decline in the average value of those degrees. The class of 1970 was comparatively more likely to go to an Ivy-league school, major in math or engineering, and get a job. The class of 2011, God help them, is more likely to go to a state or for-profit school, graduate with a degree that has a lower expected salary, and have trouble finding employment. And all else being equal, more subsidies for higher education will imply more of all this—it is vastly cheaper to get another sociology major into Capella University than to get another Astrophysics major into Princeton.
Popping the Higher Ed Bubble
The bubble in higher education is fueled by culture and subsidies. Culturally, college fits in about where housing did until very recently: it is simply something you do. If you've succeeded in life, you've gone to college and paid for your kids to do the same. It's hard to change that perception; if Bill Gates didn't, Mark Zuckerberg won't.
But what we can change are the policies that subsidize college. Student loans should be drastically curtailed, especially for the "at-risk" groups (which are also the fastest-growing). Loans to students at for-profit schools have an appalling 40% default rate. While I can't find data for degrees, I suspect that hard science graduates default more rarely than social science graduates (except for education, where the compensation is nothing if not reliable).
This is a bubble like any other bad bubble (i.e. a credit bubble). It ultimately rests on the twin mistakes of extrapolating based on bad data, and assuming that investments will behave the same way when they're made en masse and by default, rather than individually and with great care.
The solution is to pay attention. There shouldn't be a "higher education" bubble, because higher education shouldn't be treated as a single aggregate entity. As long as it is, we'll have a surplus of degrees from the University of Phoenix—just as the last bubble gave us a surplus of suburbs outside of, well, Phoenix.
Full Disclosure: Depending on how you calculate this, I own a little more than half of a degree in economics or math. Basically all of my friends have degrees, including postgraduate degrees. Everyone I've ever hired or been hired by has a degree. I haven't found a way to short higher education as a whole. If you can think of one, let me know.
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I'm currently the Co-Founder and CEO of a startup providing equity research and M&A due diligence to investors analyzing online businesses.
