I wonder who Virginia Postrel thought she was writing for when she produced this Bloomberg piece on increasing college costs and student debt burdens:
Any serious policy reform has to start by considering a heretical idea: Federal subsidies intended to make college more affordable may have encouraged rapidly rising tuitions.
It’s not as crazy as it might sound.
It doesn’t sound crazy at all:
As veteran education-policy consultant Arthur M. Hauptman notes in a recent essay: “There is a strong correlation over time between student and parent loan availability and rapidly rising tuitions. Common sense suggests that growing availability of student loans at reasonable rates has made it easier for many institutions to raise their prices, just as the mortgage interest deduction contributes to higher housing prices.”
It’s a phenomenon familiar to economists. If you offer people a subsidy to pursue some activity requiring an input that’s in more-or-less fixed supply, the price of that input goes up. Much of the value of the subsidy will go not to the intended recipients but to whoever owns the input. The classic example is farm subsidies, which increase the price of farmland.
A 1998 article in the American Economic Review explored another example: federal research and development subsidies. Like farmland, the supply of scientists and engineers is fairly fixed, at least in the short run. Unemployed journalists and mortgage brokers can’t suddenly turn into electrical engineers just because there’s money available, and even engineers and scientists are unlikely to switch specialties. So instead of spurring new activity, much of the money tends to go to increase the salaries of people already doing such work. From 1968 to 1994, a 10 percent increase in R&D spending led to about a 3 percent increase in incomes in the subsidized fields.
“A major component of government R&D spending is windfall gains to R&D workers,” the paper concluded. “Incomes rise significantly while hours rise little, and the increases are concentrated within the engineering and science professions in exactly the specialties heavily involved in federal research.” The study’s author was Austan Goolsbee, then and now a professor at the University of Chicago but until recently the chairman of the president’s Council of Economic Advisers.
Goolsbee did similar research, with similar results, on the effects of investment tax credits for capital equipment. Much of the benefit of such subsidies, he found, goes not to the company buying the new equipment but to the manufacturers who make it. A 10 percent investment tax credit raises equipment prices by 3.5 percent to 7 percent.
Like the scientists and engineers who benefit from R&D subsidies, the workers who make capital equipment also capture many of the subsidies’ benefits. Their wages go up, Goolsbee found, by 2.5 percent to 3 percent on average and as much as 10 percent, depending on the workers’ particular characteristics.
Goolsbee declined a recent request to comment on the subject, but the parallels to higher education are hard to miss.
In the short-term, the number of slots at traditional colleges and universities is relatively fixed. A boost in student aid that increases demand is therefore likely to be reflected in prices rather than expanded enrollments. Over time, enrollments should rise, as they have in fact done. But many
private schools in particular keep the size of their student bodies fairly stable to maintain their prestige or institutional character.