Marketplace of Ideas: Free Market for Higher Education

William G. Stuart, a sales executive living in Cummaquid, Mass., has attended both public and private institutions of higher education. This article appeared in the December 1993 edition of The Freeman magazine.

Everyone who wants to participate in the system is eligible to apply, and most applicants who agree to abide by the program rules are accepted. Family income is not considered in determining eligibility. In fact, those with higher family incomes are much more likely to apply for and be accepted into this program than those with lower family incomes. Are you ready to move to Massachusetts to participate in this program? You do not have to move. Your state offers the same program—and you may have received benefits already.

This program is state-financed, state-delivered higher education. Few people view public higher education as a welfare program. In its design, however, it is like any other “collectivist” program in which people participate involuntarily: individual benefits in no way reflect costs; subsidized prices distort the decision-making process; and collective public political consensus is substituted for the private judgments of individuals.

At first, it seems outrageous to criticize something as imbedded in the fabric of American life as higher education. After all, land-grant universities were among the first institutions established by the governments of most post-colonial states. People understood that everyone usually benefits when more people gain more knowledge. A more educated society, the argument goes, translates into better civic decisions, better election results, and a more highly skilled work force—all factors that improve quality of life and positively affect the lives of every resident of a particular state.

Higher education, according to this line of thinking, benefits everyone, and society must find a way to support increased levels of higher education and design a mechanism whereby those who do not pursue higher education but receive the “spillover” benefits are assessed part of the costs of this windfall.

The analysis must not stop there, however. The state higher education system is a collectivist system. Government extracts money from all citizens according to specific formulas—such as income and sales taxes—completely unrelated to the benefits that they derive personally from a specific program such as higher education. Government then distributes benefits in this case, subsidized education—to specific members of the population, regardless of their level of usage. This system creates inefficiencies that distort economic calculations and make society poorer, not richer.

Public vs. private higher education
In a free education market, “consumers”—students and their families—make decisions based on the costs and benefits of each option. Most likely, they project the expected future income stream of the student both with and without higher education to determine whether that education is a sound investment. Inputs into this calculation may include the student's native intelligence, her preferred course of study, her determination and the projected job prospects in her field. (Other criteria, such as achieving a certain status or finding a suitable mate, may be included in this calculation; these factors are benefits that fit into a calculation of the economic value of an education.) Students and their families then evaluate the characteristics of various institutions to project which one will provide the greatest ratio of benefits to costs.

In the state-financed education market, the calculations are altered to produce vastly different results as inefficiencies are transferred from students directly to taxpayers. First, the family of a student is paying only a fraction of the cost of public higher education. This subsidy skews the analysis: Educating a marginal student may result in a positive projected economic gain with subsidized tuition, whereas the projected return on his education is negative when his family bears the entire cost. Second, courses of study that are less valued by free consumers and therefore provide a lower projected future income stream—the humanities or social sciences, on average, do not generate the same lifetime economic returns as do natural sciences and engineering—become more attractive because the cost of achieving that lower level of future income is itself reduced.

In a free education market, colleges compete aggressively for students. As with any other business serving consumers, they attempt to design a product—a combination of level of academic difficulty, tuition level, quality of student life, extracurricular activities, off-campus study programs, curricular innovation, financial aid, placement record at graduate schools and businesses, and other academic and social factors—that will appeal most to the consumers whom they are trying to attract. Colleges respond constantly to new academic, professional, and social trends in order to redefine their educational product to attract the students whom they want to enroll. The future success of these institutions largely depends on their ability to design an offering that meets the preferences of their target audience.

Public institutions of higher education distort this process. Because these schools are supported by taxpayers and therefore provide subsidized tuition, public universities have a competitive advantage relative to private colleges. Private colleges can design an educational product superior to a public institution in every way, including real costs, but because of subsidized tuition at public universities, many students choose the lower-priced option when the direct benefit-to-cost ratio is lower to them personally. The effect is to create a two-tier system of education, in which private colleges compete with other private colleges and public universities compete with other public universities. The benefits of pure competition to students as consumers are diluted by creating two separate markets.

Further, because public universities are operated by government, they are controlled ultimately by politics. Thus, students and campus administrators are robbed of the market mechanisms that create the most efficient allocation of resources and that allow private institutions to craft a product that meets student needs best. Decisions about where to locate a campus, which campuses in the system should offer which courses of study and what standards to impose at each campus are made by politicians rather than by students and their families. Changes in the product that an institution offers students ultimately are shaped by state legislators and state department of education bureaucrats rather than by the calculations of individual consumers. Administrators at these campuses are not able directly to control much of the product that they offer to students.

The system of financing public higher education places a further competitive disadvantage on private colleges. A family that wants to send a child to a private college must pay taxes to subsidize the educational costs of other students in public higher education and then must pay the entire cost of educating him at a private college. By contrast, the family of a public university student pays a subsidized tuition and taxes to support the subsidy—a total far less than the true cost of educating him.

A poor investment for taxpayers
The public higher education system is not a good investment for taxpayers. The system often is defended on the basis that people who acquire more education will earn more and therefore pay more in taxes during the course of their working lives, thus “paying back” the initial investment that taxpayers made in them. This argument misses the mark: The benefits and costs of higher education are in no way related. Because benefits are not tied to costs, and because there is no contractual obligation, any relation between direct taxpayer support of the system and indirect taxpayer benefit is purely coincidental.

Why? First, there is no guarantee that a student will work in the state in which he receives his education. It is quite likely in our mobile society that he never will “repay” as much in future taxes to that state as he took in subsidized tuition. Second, the taxpayers whom he supposedly will “repay” are not, in many cases, the same taxpayers whose money financed his education, inasmuch as these people move as well. Third, this argument treats all education as equal, when clearly it is not. A doctor or an engineer, for example, will return far more value, as measured by the income that free consumers choose to award producers, to society on average than will someone trained in Asian studies or art history. The public higher education system, however, does not distinguish between the returns of each academic field and thus does not capture the disparate economic impact of these different courses of study. Fourth, some students attend public institutions on a full-time or part-time basis for other than academic reasons—to develop an active social life, to find enrichment completely unrelated to their career interests, for example—and thus will not return to the state treasury any meaningful economic benefits from the public money spent to subsidize their educations.

The argument that society should subsidize higher education because everyone in society benefits indirectly from a more educated populace is not valid, either. Society benefits whenever someone develops a more efficient automobile or a more powerful personal computer, but the inventor or financial backer of the innovation benefits directly, and to a greater extent. Similarly, people who are more educated will, on average, achieve a higher level of income, a higher standard of living, and increased status for themselves and their families. There is no reason why the direct beneficiaries should not bear the entire burden of the investment required for them to achieve this direct, personal benefit. That everyone benefits indirectly from the success of those who are highly educated is no reason to require everyone to subsidize these specific individuals.

Those who defend public higher education make one final argument: that the subsidized tuition opens educational opportunities to many students who otherwise could not afford to better their stations in life. This argument is deceptive and misleading. First, public institutions generally offer less financial assistance than private schools. While a lower-income student often can attend a private college at little out-of-pocket expense, thanks to healthy financial aid endowments and budget commitments that result in a plethora of grants, scholarships, loans, and campus jobs, that same student may well find that the reduced level of aid at a public university actually will raise the out-of-pocket cost of the public institution above that of the private institution. Second, again, the subsidized public higher education system hides the true cost of the education. It forces taxpayers to subsidize the educations of all students, including the individual who cannot “afford” education because he cannot find an investor—relative, employer, or financial institution—who believes the benefit from that student's education never will equal the costs of educating him. Third, this argument ignores the reality that a family with $200,000 income pays the same tuition as a family with a $30,000 income—hardly a fair deal for taxpayers or low-income students.

What is the alternative?
Fortunately, there is an alternative to the current system that will improve the system by liberating consumers—students, their families, and their benefactors—and remove nonconsumers—politicians and taxpayers from shaping and financing higher education. The alternative is to abolish government regulation of higher education and sell public universities to private operators, who then will organize the institutions to compete effectively with private colleges for students. These operators probably will be similar to other non-profit organizations. Instead of focusing on the needs of wildlife or disabled people or victims of domestic violence or refugees, they will direct their efforts toward providing students with a portfolio of skills. As with existing private colleges, some will be affiliated with religious, service, or organizations and foundations, while others will be independent and self-governing. Some programs, particularly at the graduate and professional level, may be affiliated with, or owned by, particular companies or business associations to train students for specific careers. In all cases, the owners and operators will offer a product that prospective students and their families will be free to accept or reject—without being forced to support the product financially.

This new system will benefit nearly every state resident. Citizens who do not wish to purchase higher education will be relieved of the tax burden imposed to finance others' consumption of this product. Those parents who are supporting children in private colleges and universities no longer will have to be responsible for their children's education and a portion of the tuition of the children, parents, grandparents, aunts, and cousins of their neighbors. Education administrators and visionaries with market-based, rather than politically based, ideas about how to craft a higher education product will benefit by realizing new opportunities to respond to consumers.

As with any change, some people will be hurt by this new system. Politicians accustomed to wielding budgetary and regulatory power over the state university system will lose their ability to exert influence as consumers assume the decision-making authority. Perennial students who enroll in one or two classes to delay their entry into the working world will see their subsidized existence evaporate. Marginal enrollees who attend class for “enrichment” or “to meet people” or to “broaden their horizons” will find that taxpayers no longer will subsidize their hobbies. Administrators and faculty members who have built careers around responding to political influences will have to adjust their thinking as the market of free education consumers sets the rules and expectations in the new education market.

Another group of people—those bright students from families of limited means to whom a taxpayer subsidized education appears at first glance to be the only means of improving their stations in life—may appear to be harmed by the free market. In reality, these students will benefit from the new system in several important respects. First, with fewer marginal students pursuing higher education, the value of a degree will rise, thus increasing both entry employment opportunities and lifetime earnings projections of graduates, thereby justifying the higher levels of investment by the students or other investors. Second, these students will be able to keep more of their future income because succeeding generations of residents who want to purchase higher education will not be able to make an economic claim against their earnings. Third, entrepreneurs will create new opportunities for students to finance their educations. Colleges will become more integrated with work in cooperative education programs. Businesses will invest in students' educations in exchange for future employment service. Lenders will design loan programs with repayment based on lifetime earnings—thus creating a partnership between student and lender. Colleges will reduce costs by specializing in specific courses of study, limiting non-academic offerings, developing new modes of presenting information and redefining the notion of a campus. In short, entrepreneurs who see a group of attractive consumers—smart students—will develop programs to deliver an education product on terms that these students can justify in investment terms.

The final argument for this new (or, more properly, this return to the American) approach to higher education is the justification for personal freedom in every aspect of life. It is important to understand the precept of a free society—that no level of talent, achievement or need entitles a person to make an economic claim against an unwilling payer. Talented students, like talented actors, carpenters, or athletes, can realize a return on their talents in a free society only to the extent that they can direct these talents toward consumers who are willing to pay for them voluntarily.

An understanding and acceptance of this precept is the most important and valuable lesson that anyone in a free society can learn. What better way to learn that lesson than in the pursuit of higher education.