The Costliest Bubble

While the bursting of the housing bubble has dealt the US economy a body blow, there may in fact be an economic bubble with far more substantial consequences to our prosperity:  the college education bubble.
Currently, consumer debt to pay for higher education has cracked the $1 trillion dollar mark, making the total larger than all outstanding credit card balances.   We have seen over the last few weeks that a lot of the personal angst that enrages Occupy protesters is driven by college loans that are too large for them to pay off and which can’t, by law, be discharged like other debt in bankruptcy.
Certainly the bursting of this education debt bubble will be costly, and may well require another large taxpayer bailout (since many of these loans are gauranteed by the government).  But the cost of failed loans will only be a small portion of the tally.  The more important cost will be from decades of mis-allocation of resources that likely is already costing our economy trillions in lost growth and productivity.  To understand why, we need to delve a bit into business cycle theory.
One of the topics I write about frequently is climate, and from my amateur study of climate I have actually learned a few useful lessons about economics.  First and foremost is this:  it is shear madness to try to attribute any event in a very complex system to a single cause.  Just as it is complete hubris to blame Hurricane Katrina, as Al Gore did, on the single variable of manmade CO2 in the atmosphere, it is crazy to try to blame a particular economic event, like a recession, on a single cause.
That being said, I find myself increasingly swayed by the Austrian economics school in arguing that an important, perhaps decisive, cause of many past recessions has been the mis-allocation of resources.  The Austrian school tends to focus on the role of government central banks in keeping interest rates artificially low, driving financial bubbles.  I tend to look at the mis-allocation problem more broadly.   Artificially low interest rates can certainly be a cause, but so can flawed growth assumptions (as in the Internet bubble), social policy (as in the housing bubble), industrial policy (as with MITI in Japan and the lost decade), and regulatory and accounting rules (in both the S&L crisis and the 1998 banking crisis).  Anything that distorts pricing signals and resource allocation makes the economy weaker.
Imagine your household received what seemed like very credible evidence that a natural disaster was coming, and that you need to stock up on water.  You run to the store, buying weeks worth of bottled water, probably paying inflated prices for it if you neighbors are all trying to do the same thing.  Then, suddenly, you find you were misled.  There is no disaster coming.  Now you have all your liquid assets (no pun intended) tied up in bottles of water for which you have no use.  You may have to cut back on other critical expenses for weeks or months until you can recover from this gross mis-allocation of your personal resources.  On a macro scale, many recessions happen the same way … you just need to substitute, say, “houses” for “bottles of water.”
The theme from all these failures is distorted signals and corrupted communication.  People, no matter how savvy, cannot possibly research every nook and cranny of the economy before making an investment.  They make decisions, therefore, based on signals – prices, interest rates, perceived risks, and the profit history of other similar investments.  If these signals are artificially altered or corrupted, bad decisions that destroy wealth and growth will result.
Which brings me back to education.    I will tell you something almost every business owner knows:  We business owners may whine from time to time that banks won’t lend us money, but what really is in short support are great people.  Nothing has more long-term impact on an economy than amount and types of skills that are sought by future workers.  That is why everyone accepts as a truism that education is critical to economic health.
Unfortunately, there is good evidence that our education policies have already done long-term harm.   The signals we send to kids making their higher education plans have disconnected them from reality in a number of fundamental ways, causing them to make bad decisions for themselves and the broader economy.  For example:

• We tell kids college is an unalloyed good to which everyone should aspire.  This is so startlingly similar to our telling everyone home ownership is an absolute good for everyone (a signal that ended with very bad results in the current recession) that we should be immediately skeptical. In fact, we now see dropout rates (the educational equivalent of a foreclosure) are soaring, because many folks are learning that 4-year college may not be right for them … but only after wasting several productive years and tens of thousands of dollars.  And more than half of the humanities (e.g. non-science) majors that do graduate end up in jobs that don’t actually require a college degree.   From an economic standpoint, their education investment in time and money was largely wasted.
• We signal to students that college is affordable, by giving them cheap and easy credit.   It shouldn’t be surprising that many students leap into deep debt without considering the long-term consequences — in fact, many adults with far more years of experience than an 18-year-old entering college have been fooled by easy credit into thinking certain purchases are more affordable than they are.
• We confuse students about their education goals.  We lure them into debt, telling them that college is an “investment” that will pay itself off through higher earnings, but then tell them that their degree choice does not matter  – that Mayan gender studies is as valid a degree as electrical engineering.  Look, if someone has the money to pay for college outright as a consumption good, then I would agree, they should study whatever gives them a charge.   But if a student is pursuing a degree under a punishing debt load, then the ability to monetize that degree better well be a factor.   The reality, though, as reported by Alex Tabarrok, is that all the growth over the last 25 years in college enrollment has been from students pursuing degrees in majors like visual and performing arts, psychology, and journalism.  Enrollment in more easily monetized degrees like chemical engineering, math, and computer science has been flat.

I would argue that many great colleges actively shield students from the reality of the job market and the economy.   Go ask an Ivy League college about what I have written and they will give you a disdainful “What do you think we are, a grubby trade school” look and argue that they are creating great human beings who are better prepared for society.
Are they?  Perhaps in some ways, but I am not sure their graduates are going to be very grounded in reality.  After all, how could any group that is at all in touch with the realities of the modern economy be doubling the number of journalists they produce while actually reducing the number of computer science grads?  Does anyone ever walk into a college freshman communications class and say “beware, everyone in this field is getting laid off”?  Or do they come in a praise everyone and tell them they are all going to be future world leaders?
Yes, we will have to bail out some student loans, and it will likely cost us tens of billions of dollars.  But that cost will be trivial compared to the toll that thirty years of mis-directed education will take on the economy.  Many folks on both sides of the political aisle are lamenting a stagnation in wages and productivity — can there be any doubt that there is a connection to our mis-allocation of education investment?