The result of this subsidization is more students attending college than they otherwise would have. I'm sure affordable education sounds great to many people - just as many lauded the government's efforts to make housing affordable. The housing bubble's burst should be a history lesson. Unfortunately, many Americans chalked it up to capitalism and decided the answer was more government interference in the market. On the other hand, some, predicted that the Federal Reserve's credit creation, coupled with the Community Reinvestment Act, would create a housing bubble that would inevitably bust. They couldn't have been more right.
How were these economists able to predict such events, and how might we predict the consequences of other market manipulations? For the answer, we must look to Ludwig von Mises, who originally developed Austrian Business Cycle Theory, and F.A. Hayek who would expand upon the theory in 1967. Mises and Hayek asserted that interest rates are important signals to investors throughout the economy, and that interest rates are not arbitrary numbers that can be manipulated without consequence.
Under natural market conditions, interest rates will be lower during times of economic prosperity. This is because there will be an abundance of wealth, much of which will be saved in banking institutions. With more money in hand, banks will be willing to make more loans and loan at lower interest rates. These lower rates send a signal to potential investors. Entrepreneurs are encouraged to initiate expensive projects that require funding through loans, like building homes. Under natural economic conditions, this activity is magnificent. These interactions display the beauty of the free market. Entrepreneurs would be investing in projects precisely when consumers have high demand for them (i.e., when the economy is booming).
Conversely, if the economy is in a recession or slower growth period, money and savings will be scarce. The result would be higher interest rates, which encourage the savings required to rebuild the economy, and discourage investment spending.
This is contra-logical to mainstream economics, which is heavily influenced by John Maynard Keynes, a contemporary of Mises and Hayek. Keynes believed that during recessions the central bank should encourage spending, and the government itself should engage in spending. However, Keynes failed to understand that when investment slows in a free market system, it does so for a very good reason. Encouraging or engaging in investment during a contraction will result in mal-investment, that is, investment in projects which are not worth the cost.
Now, let's return to the main issue, the subsidization of higher education. Interest rates for educational purposes work similarly to interest rates for investments. After all, education could be considered a personal investment. Just as is the case throughout the entire economy, interest rates for education will naturally be low during periods of prosperity. These low rates encourage students to invest in their education or professional training. Again, this is a truly magnificent market interaction. More students are receiving training and education, at just the time when wealth is abundant. During time, there is a strong demand for high quality labor. For one, people can afford to pay more for improved labor. Secondly, the abundant wealth makes it possible for entrepreneurs to open businesses, which will require different types of specialized labor.
Personally, I wouldn't describe our current economic condition as prosperous (not by U.S. standards, at least). Yet, we are faced with low interest rates for higher education as a result of government interference. Indeed, college education is being encouraged, and we are seeing higher enrollment figures across the country. However, this is not the time that the free market would encourage investment in education. Wealth is not abundant. Unemployment is high. The demand for high quality labor is not sufficient for the excess amount of degree-earners. This does not mean a college degree will be worthless, but it does mean that, for many, their degrees will not be as valuable as they expect them to be. Therefore, it is highly likely that many people are spending more time, effort, and money on their education than it will actually be worth. This is mal-investment.
There is another aspect of the issue that may be unique to education. With the price of attending college being artificially lowered, many students whom would not have enrolled otherwise, are now enrolled. The very best students would have most likely went on to further their education, with or without government subsidization. The students at the margin are those that did not preform as well in high school, on the SAT, or on the ACT. Generally, these students are less likely to be prepared for college. In order for a college degree to maintain its value overtime, a degree must only be given to the students that meet a certain quality standard. Maintaining this quality standard, with an influx or less-prepared students, would mean failing a higher percentage of students. However, professors may be unwilling to do this. Failing a large amount of students could result in complaints or poor student evaluations, which in turn could affect a professor's pay or job security. For this reason, I believe the mal-investment in higher education is coinciding with grade inflation, which will make college degrees less prestigious.
If I am correct in my analysis of the higher education bubble, then much damage has already been done. As Mises wrote in Human Action:
There is no means of avoiding the final collapse of a boom brought about by credit expansion.
However, the damage can be minimized if the government would cease to manipulate the market. In a wildly popular episode, President Obama recently appeared on Jimmy Kimmel Live. The President pleads the case for maintaining low interest rates for college education. While this is clearly a popular political move, it is immoral and foolish to continue to mislead people as to the value of a college degree. Manipulation of interest rates effectively steers people away from their best interests, and towards the ends that the politically elite desire.
Mises and Hayek did not develop Austrian Business Cycle Theory in an attempt to discourage government-backed student loans. The theory is most concerned with the entire monetary system and the economy as a whole. With that said, the same logical tools that were applied to ABCT, can be applied to the higher education bubble. I can't see a reason to not use the methods provided by such great economists.
