Submitted by Omid Malekan,

Imagine for a moment that you are the owner of a popular restaurant located on a street with many restaurants. You do your best to provide the best experience to your customers while staying ahead of the competition by keeping your prices down. You try to avoid spending too much on labor, and do as much of the work yourself as you can, often putting in long hours. Although there is a good wholesale market nearby, you drive an extra hour to another market just to get your ingredients a little cheaper.

One day a wealthy patron who is a big fan of your cooking announces a new idea. Because he wants as many people as possible to enjoy your food, he is going to pick up the tab for most of your customers. You can just go on doing what you always do, but when the check arrives for many tables, this wealthy patron will pay the tab. The next day, your waitress complains that there are too many tables and you should hire more help. What would you do?

Normally, you would try to find a way to avoid hiring another person as it would eat into what little profits you make. But now you realize there is another solution. You can just raise prices. Since most of your patrons are not paying for their meals, your place will still stay popular and you won’t have to worry about losing business to your competition. So why not hire another waitress? While you are at it, why not hire a manger so you don’t have to be there all time, and stop driving to the further market?. Whatever increase in costs you suffer you can make up for by raising prices more and more.

Now imagine all your competitors also have wealthy benefactors picking up the check for many of their customers. You can all raise prices constantly without losing any sleep – or business.

This scenario is effectively what America’s higher education financing system has turned into. There are many reasons why college tuition is rising faster than virtually anything else, from more applicants than ever to state budget cuts for public universities, but all of those factors are allowed to persist because often times the person getting the degree is not the person paying the tab – not for today anyway.

Presently over 60% of all undergraduate students receive some sort of Federal aid for their education, and the amount of money the government has shelled out for student loans is now over a trillion dollars, double what it was just 7 years ago. Like the hypothetical wealthy patron in the example above, the government doesn’t ask for much when it gives out the money – neither from the student nor the University. If our wealthy patron had said “I will pick up the tab so long as you keep your low prices” then we would have a reason to keep prices down. But by fully removing the value of what customers get from the equation, all incentives point towards inflation.

One of the toughest questions to answer in the rising cost of education debate is exactly why Colleges and Universities are raising prices so fast. Yes, demand has gone up, but that doesn’t lead to price spikes unless supply is kept low. After all, as our society has grown richer, demand for all sorts of things from cars to eating out have also gone up, but their prices haven’t spiked because supply has grown as well. So why hasn’t supply of higher education kept up – as evidenced by collapsing acceptance rates?

Its not an issue of their product, because knowledge is infinitely scalable. Think of your typical undergrad 101 Rhetoric or Chemistry class. Its not hard to keep hiring more instructors and offering more sections. It would be one thing if it was hard to find more instructors, but thanks to our current PhD. glut, the opposite is true, and the market is oversupplied with people who would make qualified teachers. Putting all of this together, we observe that at a time when demand for higher education is higher than ever, and the supply of would-be educators is higher than ever, Colleges are choosing to keep the number of spots available to students relatively low, and raising tuition prices instead. But why?

One good way of answering questions of rising prices is to ask “how can they get away with it?” Going back to our hypothetical restaurant, we can get away with keeping supply fixed and constantly raising prices because our customers are not paying for their meal, a third party is. If not for our benefactor, even in the midst of success we might choose not to increase prices. We might instead decide to open another location to offer more of the same food at the same price, or try to prepare the food faster so we serve more steaks per day. But as long as the person getting the product doesn’t care about the price because someone else is paying, why bother? That’s just more work and more stress for us. We are better off keeping supply fixed, raising prices and then spending that money on things that make our life easier, like more waitresses. While we are at it, why not also use some of the money from our inflated prices to pay ourselves a higher salary. After all, its not like our customers will feel the difference.

This is exactly what’s happening at America’s major colleges and universities. As shown by the chart below, which was put together by the American Association of University Professors, since the 1970s positions for non-faculty professionals have seen the highest growth for jobs at American Universities.

Meanwhile, University Presidents and other executives have been giving themselves big raises while leaving the professors and their assistants in the dust.

The peculiar places tuition money has been flowing to is further discussed in this fascinating paper by the Delta Cost Project.

We could debate all we want about how much a University should spend on professors, secretaries, sports facilities or free unlimited Nutella, but that would be a waste of our time, just as it would be for the patrons of a restaurant to debate how many waitresses there should be.

Imagine if suddenly our wealthy restaurant benefactor declares he’s going to stop paying for peoples meals. Given our now sky-high prices, our tables would be empty and given all these new expenses, like more waitresses and shopping at the closer market, we’d go out of business. To survive, we’d have no choice but to get leaner and enter the murky waters of business uncertainty, where every decision is complicated and viewed through the lens of “what can I get away with?”

As long as the majority of the cost of college education is not born directly by students but rather by Government loans and grants, our institutions of higher learning will not be forced to adapt and find innovative ways of delivering quality education to more students at a decent price. They will go on keeping supply low, tuition higher and expenses growing. If we care about our children and want them to stop taking on more and more debt to get a degree for a tougher and tougher job market we need to break the current cycle.

The kindest thing our government might do for our kids is to stop throwing money at inefficient Universities in their name, or at least demanding more from those institution in return for that money. Imagine for a second if college loans were given to the school and not the student, and tied to metrics of success, like whether the student graduates and how good a job they land afterwords. Much like our restaurant, in such a world the school’s focus would then shift to keeping prices down while offering good value.