Category: Education

Traditionally universities have charged every student the same tuition/price regardless of major. Under budget pressure, however, differential pricing is becoming more common. Differential pricing is tending to reduce the peculiar cross-subsidies that currently exist as pointed out in a new working paper by Kevin Stange (earlier version):

Higher education in the United States is heavily subsidized, both through direct support for institutions by state governments and private donors, and through federal and state support
directly to students. There are also substantial differences in the extent of subsidization across
institutions and sectors, with students at selective private institutions more heavily subsidized
than those at less selective institutions(Winston 1999). Less commonly noticed, however, is that
there are also large cross-subsidies between students within the same institutions due to the
conventional practice of charging similar tuition fees to all undergraduate students regardless of
the cost of instructing them. The cost of instruction differs tremendously between upper and
lower division coursework and across programs even within institutions. For instance, recent
analysis of cost data from four large state post-secondary systems (Florida, Illinois, New York‐
SUNY, and Ohio) indicated that upper division instruction costs approximately 40% more per
credit hour than lower division instruction, and that upper-division engineering, physical science,
and visual/performing art was approximately 40% more costly than the least costly majors
(SHEEO, 2010). In fact, an earlier but more extensive cost study found that more than three-fourths of the variance in instructional cost across institutions is explained by the disciplinary
mix within an institution (U.S. Department of Education 2003). The consequence is that lower division students subsidize upper-division students and students in costly majors are subsidized
by those in less expensive ones.

This pattern of cross-subsidization generally runs counter to differences in post-schooling
earnings and ability to pay. Lower division includes many students who eventually drop out,
while students that have advanced to upper division are more likely to graduate and earn more.
Engineering, science, and business majors tend to earn more and have higher returns than
education and humanities majors, even after controlling for differential selection of major by
ability (Arcidiacono 2004).

I have argued for targeting education subsidies to the majors that are most likely to have the greatest positive spillovers. Differential pricing moves prices closer to costs which opens up the possibility for more rational pricing but notice that it can in some cases move prices away from optimal subsidy levels.

Hat tip: Dubner at Freakonomics.

Peter Orszag considers that possibility in his recent column.  About one in four bartenders has some kind of degree.  Orszag draws heavily on this paper by Beaudry and Green and Sand, which  postulates falling returns to skill.  It’s one of the more interesting pieces written in the last year, but note their model relies heavily on a stock/flow distinction.  They consider a world where most of the IT infrastructure already has been built, and so skilled labor has not so much more to do at the margin.  This stands in noted contrast to the common belief — which I share — that “IT-souped up smart machines” still have a long way to go and are not a mature technology.  You can’t hold that view and also buy into the Beaudry and Green and Sand story, unless you think we have suddenly jumped to a new margin where machines build machines, with little help from humans.

Rather than accepting “falling returns to skill,” I would sooner say that education doesn’t measure true skill as well as it used to.

The more likely scenario is that the variance of the return to having a college education has gone up, and indeed that is what you would expect from a world of rising income inequality.  Many people get the degree, yet without learning the skills they need for the modern workplace.  In other words, the world of work is changing faster than the world of what we teach (surprise, surprise).  The lesser trained students end up driving cabs, if they can work a GPS that is.  The lack of skill of those students also raises wage returns for those individuals who a) have the degree, b) are self-taught about the modern workplace, and c) show the personality skills that employers now know to look for.  All of a sudden those individuals face less competition and so their wages rise.  The high returns stem from blending formal education with their intangibles (there is also more pressure to get an advanced degree to show you are one of the privileged, but that is another story.)

This polarization of returns — among degree holders — explains both why incomes are rising at the top end, and why the rate of dropping out of college is rising too.  At some point along the way in the college experience, lots of students realize they won’t be able to “cross the divide,” and the degree alone won’t do it for them.  They foresee their future tending bar and act accordingly.

Too many discussions of the returns to education focus on the mean or median and neglect the variance and what is likely a recent increase in that variance.