Higher education, jobs, and moral hazards

02/05/13 23:03:00    

By Michael Mealling

In yesteday's Wall Street Journal Jane Shaw has an article(sorry about the paywall) discussing recent comments by North Carolina Governor Pat McCrory suggesting there is a disconnect between what is being taught in colleges and what skills are needed for a modern job. The gist of his statements was

Referring specifically to North Carolina's 16-campus state university system, Mr. McCrory wondered if state funding incentives should encourage areas of study that align with the job market. Other disciplines, such as gender studies, Mr. McCrory said, might be subsidized less. The funding formula, he said perhaps a bit indelicately, should not be based on the number of “butts in seats, but how many of those butts can get jobs.”

As expected, the higher education community went ballistic. How dare someone suggest that higher education is about anything more than the pure pursuit of knowledge? But that isn't the question, is it?

Higher education stopped being the pure pursuit of knowledge when the Federal Government assumed the risk by underwriting the loans students use to pay for that education. In economic theory, a moral hazard is a situation where a party will have a tendency to take risks because the costs that could incur will not be felt by the party taking the risk. The economic crisis of 2008 demonstrated a particular class of moral hazards where, even though the party assuming the loan is supposed to be responsible for paying it, the fact that the loan is underwritten by the Government removes any need for the person approving the loan to evaluate the other parties ability to pay. Mortgage agents new they could write just about any loan because ultimately Fanny and Freddie “had their back”. Now we have student loan officers telling students to use subsidized loans to pay for an education with no regard for their ability to pay. There is no impact to the school if the student has no ability to pay. This also means the school is incentivized to push as many students through the system since the quality of the education has no bearing on whether they're paid.

If our country is comfortable with public subsidies for higher education and higher education is OK with taking that money then higher education is going to have to realize that it now has public responsibilities. Those subsidies and guarantees come with strings. The biggest is the requirement that the outcome be aligned with the economic needs of the country. But that's the problem with a moral hazard: incentives are misaligned.

There is little debate that we are in the midst of a higher education bubble. The question is how to deflate it slowly. Pat McCrory is suggesting that we start looking at those incentives and yes, that does mean rewarding rigor and skills over political correctness. Other suggestions include mitigating the moral hazard somewhat by making schools partially responsible for repaying a loan if the student can't, tying the loan rate to degree type, and removing the government from the process entirely. While I personally prefer the last it is unlikely to happen. Tying the rate to the type of degree doesn't work if there is no ability to repay at any interest rate. Putting schools on the hook creates a strong incentive for the loan officer to advise the students more realistically.

Are there other ways of solving this problem?