Education

Where Higher Education Went Wrong

A forum on the failures and future of the American university

Popping the Higher Education Bubble

Glenn Harlan Reynolds

The economist Herbert Stein once said that something that can't go on forever, won't. That observation, sometimes called Stein's Law, could well turn out to be the theme for the current decade. But nowhere is it truer than in higher education. American higher education is first in the world, but it can't go on forever on its current path.

Colleges are raising tuition and fees every year, at a rate of increase that far outpaces any reasonable expectation. One might think this is the kind of thing that couldn't continue forever, but that's precisely what has been happening over the past several decades. Prices have gone up, and buyers have poured in anyway, buoyed by a flood of seemingly cheap government money in the form of student loans.

As with any bubble, there are doomsayers who are mostly ignored and cheerleaders who say that this time it's different. But—as with any bubble—reality is starting to intrude.

Though people have been talking about a bubble in higher education for a while, one major indicator that the swelling is approaching its limit was found in last year's Occupy protests. While the protesters represented a diverse array of grievances, one common thread was that many had run up huge student loan debts for degrees that weren't capable of generating sufficient income to make the payments.

At an annual growth rate of 7.45 percent, tuition has vastly outstripped both the consumer price index and health care inflation (see chart). The growth in home prices during the housing bubble looks like a mere bump in the road by comparison. For many years, parents could look to increased home values to make them feel better about paying Junior's tuition—the so-called "wealth effect," in which increases in asset values make people more comfortable about spending. Or at least they could borrow tuition costs against the equity in their homes. But that equity is gone now, and tuition marches on.

So where does that leave us? Even students who major in programs shown to increase earnings, such as engineering, face limits to how much debt they can sanely amass. With costs exceeding $60,000 a year for many private schools, and out-of-state costs at many state schools exceeding $40,000 (and often closing in on $30,000 for in-state students), some people are graduating with debt loads of $100,000 or more. Sometimes much more.

That's dangerous. And the problem is not a small one: According to the Ohio University economist Richard Vedder, writing in the Chronicle of Higher Education, the number of student-loan debtors now actually equals the number of people with college degrees. How is this possible? "First, huge numbers of those borrowing money never graduate from college," Vedder explains. "Second, many who borrow are not in baccalaureate degree programs. Third, people take forever to pay their loans back."

Total student loan debt in America has passed the trillion-dollar mark. That's more than total credit card debt and more than total auto loan debt. Students graduating with heavy burdens of student loan debt must choose (if they can) jobs that pay enough money to cover the payments, often limiting their career choices to an extent they didn't foresee in their undergraduate days.

Even students who can earn enough to service their debts may find themselves constrained in other ways: It's hard to get a mortgage, for example, when you're already effectively paying one in the form of student loans. And unlike other debt, there's no "fresh start" available, since student loans generally aren't dischargeable under bankruptcy. The whole thing looks a bit like the debt slavery schemes used by company stores and sharecropping operators during the 19th century.

Now the whole scheme is starting to break down. In my own world of legal education, applications have plummeted over the past few years. According to the ABA Journal, there has been a 22 percent drop this academic year alone, and they're down almost half from 2007. Business schools, with declining pay and employment prospects for MBA graduates, are experiencing similar declines. Even in undergraduate admissions, colleges are losing the ability to set prices as applicants become more value-conscious. These trends have led the Moody's rating service to downgrade the outlook for the entire higher education sector to "negative."

Some in higher education are offended. College should be about improving your mind, they say, not about future salaries. But a recent study of more than 700 schools by the American Council of Trustees and Alumni found that many have virtually no requirements. Perhaps that's why students, on average, are studying 50 percent less than they were a couple of decades ago.

When higher education was cheap enough that students could pay their own way by working part-time, "study what interests you" was reasonable advice. When the investment runs well into the six figures, students would be crazy not to worry about the return. If there's no return, it's not an investment; it's a consumption item. A six-figure consumption item is well beyond the resources of most college-age Americans; nobody would advise an 18-year-old to purchase a Ferrari on borrowed money. But if a college education is a consumption item, not an investment, then they're basically doing the same thing.

Higher education needs to be cheaper, more flexible, and better. It's possible that technology will show the way: With the proliferation of online courses, some offered by major brand-name schools like Harvard, MIT, or Georgia Tech, there's no reason why students should have to go into massive debt. And while an online degree from MIT (when such becomes available) probably won't be worth as much as traditional MIT sheepskin, it may well outperform degrees from many less prestigious brick-and-mortar schools.

Alternatively, universities could become leaner. Fueled by the bubble, they've piled on staff (mostly non-teaching administrators, who now outnumber faculty in many institutions), constructed buildings and palatial athletic facilities, and paid almost no attention to costs. A few science and engineering courses may have inherently high equipment costs, but there's no reason why it should cost more in constant dollars to get a degree in English literature today than it did 50 years ago. Schools that get costs under control will have a huge advantage. Those that don't, will suffer.

Today's university is a knowledge industry using a 19th-century model in the 21st century. If that doesn't suggest a need for updating, what does?

Glenn Harlan Reynolds is a law professor at the University of Tennessee, and the author of The Higher Education Bubble (Encounter).

The Government Yoke

Richard Vedder

American higher education offers students relatively little education at a rapidly rising cost. It produces reams of irrelevant research, operates with breathtaking inefficiency, and treats its customers arrogantly. This sorry state of affairs has worsened markedly over the last half century, propelled largely by increased government involvement.

Start with higher education outcomes. There is a growing body of evidence that the "value added" of college in terms of knowledge acquisition and enhancement of critical thinking skills is embarrassingly small. The 2011 American Civil Literacy Report, using a test that the Intercollegiate Studies Institute gave to thousands of students, showed that seniors on average know little more than freshmen. In their careful 2011 study Academically Adrift, sociologists Richard Arum and Josipa Roska demonstrated that the writing and critical thinking of seniors are only slightly more advanced than that of freshmen.

Students do less yet are rewarded more. Several recent surveys have concluded that undergraduates study less frequently than their parents did (fewer than 30 hours a week on all academic chores, including class attendance, paper writing, etc.), but get higher grades: above a "B" average for all students, compared with a "C+" to "B-" average 50 years ago. Results are similarly dreary on the research side; Mark Bauerlein of Emory University has demonstrated that the vast majority of published work in his discipline, English, is rarely cited, even by other scholars in the same field.

This is bad, but what makes it scandalous is the rapidly growing amount of money spent to obtain these poor results. Tuition fees have skyrocketed, at both state and so-called "private" schools. When I started at Northwestern University in 1958, the tuition was $795 a year. Now it is $43,380. In inflation-adjusted terms, the sticker price has quadrupled. At the rather typical mid-quality state university where I have taught for more than 47 years, Ohio University, tuition has risen from $450 in 1965 to $10,216 today, tripling in real terms, growing far faster than incomes over that period.

This academic arms race is largely financed by taxpayers. In 1970, the federal government's student financial assistance programs totaled a bit over $1 billion. Last year it was $173.8 billion. Ostensibly, this increased funding provides improved access by allowing those of modest incomes to attend college. But the proportion of recent college graduates coming from the bottom quartile of the income distribution has actually fallen sharply since 1970—from 12 percent to a bit over 7 percent. Former Secretary of Education Bill Bennett was right in 1987 when he hypothesized that higher federal student loans would merely lead to higher tuition fees. Colleges, not students, capture the money.

What have the schools done with the funds? Mostly, they have hired lots of staff. The enrollment-adjusted number of "non-instructional professional" personnel has roughly doubled since the mid-1970s. Meanwhile, professors have been given reduced teaching loads—the proportion of instructors who teach four hours or less per week has more than doubled since 2000.

Administrators also pay themselves handsomely. It's not just football coaches who make million-dollar salaries these days; some university presidents do as well, with fringe benefits that can include mansions, chauffeured cars, club memberships, copious first-class or private jet travel, even payment of income taxes.

Colleges and universities, echoed and abetted by politicians like President Barack Obama and education-cheerleader groups like the $1.4 billion Lumina Foundation, promote the notion that nearly every American should have a post-secondary education and that we need to regain world leadership in the percent of young adults who have bachelor's degrees. Yet labor market data show that a large portion of those with bachelor's degrees have jobs that do not require a college education. (A forthcoming Center for College Affordability and Productivity study puts the portion at around 48 percent.) There are more than 115,000 janitors, for example, with bachelor's degrees.

The feds encourage students to borrow money for college, run up huge debts, and then, increasingly, get low-paying jobs upon graduation. The default rate on student loans is above 12 percent, exorbitantly high by commercial lending standards. The more students borrow, the easier it is for colleges to raise tuition fees to pay for the comfortable lifestyles of administrators and professors.

Colleges have no skin in this game. They often use federal monies to lure students whom they know have a high probability of not graduating, then suffer no consequences when students default.

Even so-called "private" schools are corrupted by government funding. Princeton University receives vastly more government subsidies per student than the nearby state school, the College of New Jersey. Tax deductions and exemptions (e.g., on capital gains from endowment income) give private schools a privileged status. Federal research dollars with generous overhead allowances add to the fact that prestigious private schools, with a few exceptions such as Hillsdale College, are heavily beholden to the government.

This brief tour de horizon skips some areas of dys­functionality, such as the vast underutilization of campus facilities, taxpayer-subsidized country club–style recreational centers, and more. So what is the solution?

As long as governments, particularly the one in Washington, heavily subsidize higher education, it is likely that reform efforts will be futile. For starters, we need to get the feds out of the student financial assistance business, and start privatizing state universities. Schools such as the Universities of Virginia, Michigan, and Colorado, where state subsidies amount to very small portions of the budget, would be good places to start looking for reform models. Because start we must.

Richard Vedder directs the Center for College Affordability and Productivity, teaches at Ohio University, and is an adjunct scholar at the American Enterprise Institute.

Poisoned Feeder Schools

Lisa Snell

Since 1970, K-12 education spending in the United States has tripled in inflation-adjusted dollars. Yet American 17-year-olds score no higher in reading and math on the National Assessment of Education Progress than they did 40 years ago. The United States ranks second behind Switzerland in education spending for K-12 out of 28 Organization for Economic Co-operation and Development (OECD) countries, yet exactly in the middle of 49 developed and newly-developed countries when it comes to gains made by 4th and 8th graders since 1995, according to a 2012 study by the Harvard-based journal Education Next.

This crisis in public-school productivity has followed American students into higher education. Colleges spend more than $3 billion dollars annually on remedial education, with more than 1.7 million students a year needing help getting up to speed in basic reading, writing, and math. Of the more than 50 percent of students at the community college level who start in remedial courses, fewer than 1 in 10 ever earn a two-year degree. Less than one-third of students who start in remedial classes at four-year colleges ever earn a bachelor's degree.

If we ever expect to get real value for both the $185 billion in post-secondary student aid each year (49 percent of which came from the federal government in 2012) and the additional $114 billion spent on government and private student loans in 2012, we must first improve the productivity of K-12 education.

Public school choice and competition may be the key. There are now 29 school voucher and tax credit programs and more than 6,000 charter schools in the United States, enrolling nearly 3 million students. School choice has led to the rapid growth of niche schools that focus on college readiness and college credit completion during high school. There are more than 200 Early College high schools that allow students to enroll in college courses during their junior and senior years, with many kids completing a two-year Associates degree even before they graduate from high school. These students save parents and taxpayers the first two years of college tuition.

Many choice schools use college readiness as one of their most important performance metrics. For example, the Alliance for College Ready Public Schools, a group of high-performing charters in Los Angeles, explicitly measures how their students perform on the California State University early assessment exam, which is used to determine which high school grads will need placement in remedial education. The goal is not just to enroll their students in college, but to reduce the number of kids who will need extra help once they get there.

The United States spends more than almost any other country in the world on elementary and secondary education, then we spend money all over again trying to get those students up to college standards after they have already arrived on campus. If we want to improve the quality of higher education we must improve the performance of K-12 education through school choice.

Lisa Snell is the director of education at the Reason Foundation.

The Decline of Liberal Arts

Naomi Schaefer Riley

Last fall, Florida Gov. Rick Scott released plans for re­­vamping his state's higher education system. Among other things, Scott proposed charging lower tuition rates to students who major in the more potentially lucrative STEM fields—Science, Technology, Engineering, and Mathematics. The chairman of his higher education task force explained the comparative price increase of humanities degrees this way: "The purpose would not be to exterminate programs or keep students from pursuing them.…But you better really want to do it, because you may have to pay more."

It's not clear that such measures would do much to stem the tide of students pursuing useless degrees. After all, the market already sends strong signals to students that engineering is worthwhile. But kids are idealistic and impractical. In her new book Mission Adulthood, about the struggles of Generation Y, journalist Hannah Seligson profiles a woman who graduated from a no-name liberal arts college with a degree in "Peace & Conflict Studies, International Studies, and Women's Studies." She paid $40,000 a year for the privilege, and has been struggling ever since to land a full time job in her career of choice—abortion counselor.

Even if students recognized before graduation that positions in their chosen field might not even cover their loan payments, they might not have the preparation to choose more potentially lucrative majors. According to a 2011 study by ACT Inc., less than half of U.S. high-school graduates who took the ACT test were prepared for college-level math, and fewer than a third of tested high-school graduates were ready for college-level science. And it's no secret that humanities and social science courses tend to be easier than their math and hard science counterparts.

It is certainly possible to receive a strong education in the humanities and social sciences, but the vast majority of American colleges are not providing one. According to the American Council of Trustees and Alumni, fewer than two in five colleges require a single literature course, fewer than one in five require American history or government, less than 14 percent have an intermediate-level foreign language requirement, and less than 5 percent require basic economics.

Employers do value the skills that one can gain from a strong liberal arts education. A recent op-ed in The Wall Street Journal quoted a successful Silicon Valley tech entrepreneur as saying, "English majors are exactly the people I'm looking for." Prospective bosses are searching for people who can write well, but those are pretty hard to come by. Which is not surprising, given how many professors are too busy writing obscure articles in dreadful academic lingo to help students who are struggling with basic sentence construction.

All this will probably get worse before it gets better. In the past year, one social science professor at a public research university told me her department instructed her to stop assigning papers and just give multiple-choice exams, in order to reduce the workload of grad students. Another was told by an administrator to stop correcting grammar in his students' essays, because the kids don't like all that criticism, and besides, it's not an English class.

There's no need to "exterminate" programs in the social sciences and humanities. But if they continue down their current absurd path, few will mourn the thinning of their ranks.

Naomi Schaefer Riley is the author of The Faculty Lounges… And Other Reasons Why You Won't Get the College Education You Paid For (Ivan R. Dee).

Humanities Under Siege

Nick Gillespie

Universities existed long before the federal government began bankrolling the higher education bubble. In the West, higher education has been around for more than 1,000 years; in America, the first colleges opened their doors long before the Founding Fathers were even born.

Even after the bubble bursts, and the government money begins to dry up, the university will endure. In the words of the founder of Faber College, the fictional school in Animal House, "Knowledge is Good." The market for people who are inquisitive and interested in learning will always be bullish.

The real existential threat to higher ed comes from folks who conceive of college as a sort of high-end vocational-tech program. Right-leaning critics such as Naomi Schaefer Riley, Richard Vedder, and Charles Murray complain about feel-good majors that don't help fill the nation's need for STEM-related graduates. Left-leaning commentators such as Richard Arum, Josipa Roska, and Christopher Newfield fear that college is becoming more expensive for students even as it teaches them little or nothing of value.

These sorts of critiques are wrong for two reasons. First, they assume that education, especially college, should somehow be related to employment. While that has always been an expectation—most of America's colonial colleges started as seminaries—it long ago stopped being the rule. In a 2011 Pew Research survey, 74 percent of college graduates called the experience "very useful" for their "knowledge and intellectual growth" and 69 percent said it facilitated their "personal growth and maturity." A relatively puny 55 percent said college was very useful as "preparation for a job or career."

As the proud possessor of no fewer than four English degrees (a B.A., two M.A.s, and a Ph.D.) who paid my own way through every stage, I think these graduates have it exactly right. You should be going to college to have your mind blown by new ideas (read: whole fields of knowledge that you didn't know existed until you got to college), to discover your intellectual passions, and to figure out what sorts of experiences you might want to pursue over the next 70 or so years. And let me suggest that it's precisely the broad field of inquiry that takes the most abuse for being totally impractical—the humanities—that students should seek out most. Understanding history, literature, art, philosophy, and the like won't make you a better citizen, or a more responsible employee, or a happier camper, but those disciplines will give you the tools to figure out who you are and what you want to be if and when you grow up.

Second—and far more wrongheadedly—most critics of the contemporary university err in talking about the place as if it exists only or mostly to serve students, especially undergraduates. What actually sets institutions of higher learning apart from high schools, barbers' colleges, online academies, and various universities-in-name-only is that they are centers of knowledge production. That is, they revolve around faculty scholars who are actively expanding, revising, and remaking the received wisdom in their given fields. Active researchers, whether in astronomy or zoology or cultural studies or good old American literature, are the folks that make college worth a damn.

Yet these are the very people under siege. A 2010 study spearheaded by the University of Arkansas' Jay P. Greene for the Goldwater Institute documented "administrative bloat" at colleges and universities. Between 1993 and 2007, wrote Greene et al., student enrollment at leading research universities rose by 15 percent and the number of administrators per 100 students jumped 39 percent. The number of tenure-track faculty per 100 students barely kept track with student growth, rising just 18 percent. At Arizona State, the number of administrators per 100 students grew 94 percent while faculty slots actually shrank by 2 percent.

The best universities will be able to get by without Pell grants or guaranteed student loans or even public-sector research dollars. They will even figure out ways to keep themselves accessible to motivated students who, like me, didn't come from money. But none of them will survive the notion that they exist mostly to serve 18- to 21-year-olds kids who need high-paying jobs rather than limn the outer edges of intellectual possibilities.

Nick Gillespie is editor in chief of reason.com and Reason TV.

School Is for Signaling

Zac Gochenour

Why are people with higher-paying, more desirable jobs more likely to have a college degree? The answer has important implications for the future of higher education.

A popular answer among labor economists and the public is that education develops human capital. Students learn skills, develop propitious habits, become acculturated, improve critical thinking, or are otherwise transformed by college. This human capital means increased productivity, which is valued by employers, who in turn offer better compensation to the employees. Certain majors pay more because they teach more valuable skills; certain schools lead to better paying jobs because they literally provide a better education.

The issue of causation is more complicated, though, because traits like intelligence, conscientiousness, compliance, patience, and conformity influence both academic and professional success. The types of workers who have the ability to do well in school can often do well in work. So even though workers with college degrees earn more, they would have earned more even if they did not go to college. Schools and majors that churn out highly paid alumni are the ones that highly productive workers choose.

Whether or not employers value the specific skills learned at school, they might value the degree because of what it tells them about these traits. To some extent they can judge these traits directly, such as with test scores or in an interview, but for what they cannot observe they rely on signals such as the school's prestige and the applicant's major, grades, awards, and other activities. Employers pay more for signals that indicate high productivity, such as a tough major with good grades from a top school.

The relative importance of these distinct factors—human capital, ability, and signaling—will determine how the market for education and labor will be changed by technology and politics.

If higher earnings for college graduates are mostly due to the human capital they develop at school, then higher education is destined for obsolescence. Subsidies will not be enough to keep universities afloat and competing with the cornucopia of knowledge made available by modern technology. As effective alternatives become cheaper compared to university education, the traditional college apparatus will at least need a major overhaul.

If the earnings correlation is mostly due to ability and signaling, however, no upheaval need occur. Participation in educational alternatives such as online learning might teach the same skills as a traditional university, but also can't help but signal an unwillingness to conform with important societal norms. On average, good employees are known to prepare for college, go to college, and finish college. Employers will not be willing to pay the same premium for alternative educations if they do not signal the same traits as a traditional education. If public spending for education declines, society benefits: Fewer resources are being spent to do the same sorting. But so long as spending on higher education enjoys enduring popularity, there is no reason for the train to stop, or even slow down.

Zachary Gochenour is a Ph.D. candidate in economics at George Mason University and a researcher for Bryan Caplan's forthcoming book, The Case Against Education.

Tear Down the Clock Tower!

Michael Gibson

What is the oldest and most common architectural feature on college campuses? The clock tower. Why is this so, and what does it mean?

The widespread adoption of clock tower technology had profound consequences in the Middle Ages. It standardized time within a small geographic area. Bells chimed the hour, creating discrete, uniform time chunks within its earshot. This was the only way to reduce disagreement and disputes about time spent on any activity, as everyone began to operate on the same hour-length chunks. On nascent university campuses, it created a way for students, tutors, and administrators to coordinate lectures and meetings.

So dominant was the clock tower on campus that time became a proxy measurement for knowledge and skill acquisition. Students take credits measured in hours per week. Their abilities are tested at the end of a season with two-hour exams. A degree is a four-year course of study.

Future technology will undermine the notion that centralized, synchronized time should structure the learning process. The more precisely we can measure skill and knowledge acquisition, the less dependent we are on time as a proxy measurement. Education should not be based on how much time a student spent in the vicinity of a clock tower. It should be based on what is timeless.

Many cultural patterns that seemed normal in the past are absurd today. Behaviors like smoking on airplanes or using lead paint in the home now seem beyond the pale. After the discovery of penicillin, dying from an infected wound became unthinkable. Likewise, technology products such as mobile phones the size of a shoebox or mainframes the size of an SUV have all been rendered silly. Like these totems of the past, the clock tower, too, will crumble and soon seem ridiculous.

College students currently pay more than quadruple in real terms what their parents paid. In exchange they get a vague credential, poor job prospects (of late), and crushing debt. The essence of this system is an insane and perpetual Hunger Games–style competition where teenagers fight each other to gain access to dorm rooms within earshot of the highest-status clock towers.

Many experts will tell students how to pick a college. Fewer ask students to question whether they should go at all.

We think the future will be very different. In 2011, Peter Thiel started the 20 Under 20 Thiel Fellowship because he wanted to help young entrepreneurs and visionaries get started on their ideas as soon as possible, before they accumulated any debt and before they found themselves tracked into an uninspired career. During the two-year program, each fellow receives $100,000 and mentorship from our network of innovators, engineers, scientists, thought leaders, and business development experts.

Our first and second classes have started and sold companies, secured a book deal, raised a million dollars in venture capital, won international awards, and sparked a do-it-yourself education movement. We just closed the application season for our third class of fellows.

We are not telling all college students that they should drop out. Some universities may still offer community, great real estate, a fervent dating pool, and—in a few academic departments—valuable skill acquisition. But students should keep in mind that the "safe path" is quickly becoming the riskiest. Students who have entrusted their future solely to college administrators are marching to someone else's tune. They have forgotten why the tower chimes ring.

Michael Gibson is an associate at Thiel Capital and is VP of Grants for the Thiel Foundation, where he helps run the 20 Under 20 Thiel Fellowship.

The Competition Goes Online

Alex Tabarrok

Online education is a game changer for traditional universities. Almost a third of college students are now taking at least one online course (up from single digits less than 10 years ago). And traditional universities should take note that the competition is about to get much fiercer: online education radically lowers the cost of educational startups.

In October 2012 my George Mason colleague Tyler Cowen and I launched MRUniversity (short for Marginal Revolution University, named after our blog), with a full-length academic course on development economics. Today we have many thousands of registered students from all over the world, and are launching new courses. Inspired by Salman Khan and the YouTube tutorials he offers through his Khan Academy, we wanted to see what two individuals who enjoy teaching could accomplish without major financial backing.

Our experience has shown us many advantages of online lectures: They allow the best professors to teach many more students. They offer large time savings, since students can repeat sections of the lecture without slowing down other students or consuming instruction time. They offer lower fixed costs, since students no longer need to drive to and from campus. Lectures can be shorter, and consumed at any time, which means online universities are effectively open 24 hours a day.

A number of online course providers now exist, including Coursera, Udacity, and the Harvard-MIT project edX. These "massively open online courses," or MOOCs, have sought and received millions of dollars of venture capital and/or university funding.

The biggest hurdle for MOOCs is credentialing, which usually requires a business model and a partnership with a name-brand institution. The challenges here are not technical but bureaucratic. We have, however, seen universities move into this space at a pace unheard of for such normally slow-moving institutions. Antioch University, for example, is offering credit for some Coursera offerings and San Jose State University has recently partnered with Udacity to offer online mathematics classes for credit. Most worryingly for the traditionals, the San Jose online price will be less than half the price of an on-campus course.

It's not just the MOOCs that are competing with traditional universities. Online lectures are behind the astonishing rise of for-profit universities. Enrollment at the for-profits was less than 500,000 students nationwide in 2000, but that number doubled to 1 million by 2005, and doubled again to 2 million by 2010. Why? The for-profits pioneered online education, a product that appealed to non-traditional students who could not afford or did not want the five-year "edu-vacation" produced by more traditional universities.

The education establishment tends to dismiss the MOOCs and the for-profits as low-quality. There are legitimate complaints about for-profits, mostly stemming from the fact that the final customer is often not the student but the federal government, which supplies the bulk of loan money that students spend there. But it's inarguable that the sector has demonstrated a strong demand for online education. Low-quality entrants that disrupt established industries often improve their offerings over time. MP3s didn't sound as good as CDs, and audiophiles objected. But compressed digital sound is improving, and has already overtaken physical CDs in income generated for the recording industry.

Traditional universities should not assume that the quality of education at the MOOCs or the for-profits is or will remain low. In a 2011 interview with The Next Web, business guru Clayton Christensen, author of The Innovator's Dilemma, reports that the University of Phoenix invests $200 million annually on research to improve the quality of teaching. "That's $200 million every year just on making their teaching better," Christensen says. "Do you know how much money Harvard spends every year to make its teaching better? Zero."

Take those figures with a grain of salt, but the lesson about quality improvement is sound. When each teacher teaches only tens or hundreds of students, no teacher will invest millions of dollars in improving education. But when a single online course can reach tens or hundreds of thousands of students, it pays to invest in quality.

The real competitors to traditional universities may end up being neither the MOOCs nor the for-profits but entirely new educational startups. Online education replaces labor with capital, in the form of software. Online pioneer Marc Andreessen has argued that software is eating the world—if so, education is the appetizer. As software replaces labor we will see greater possibilities for productivity improvements in education. Incentives to invest in such improvements will expand with the size of the market.

What will a future "course" look like? One model is a super-textbook: lectures, exercises, quizzes, and grading all available on a tablet. The textbook's artificial intelligence routines could guide students to lectures and exercises designed specifically to address that student's deficits, and could call on human intelligence—tutors—on an as-needed basis. ("Click here to connect with a tutor; $5 for the first five minutes and 50 cents a minute thereafter.") A textbook of this kind would draw on content experts but also actors, animators, graphic designers, and experts in pedagogy.

Universities are not the natural producers of educational software. Instead think of video games. The process of developing the mega-hit video game Halo 3 provides a useful model: The development team at Bungie Studios analyzed 3,000 hours of Halo play by 600 gamers in order to suss out everything from preferences for weaponry to places where players are most likely to get killed. Then they did the same with their competitors. Wired sums it up this way: "It might seem like an awfully clinical approach to creating an epic space-war adventure. But Bungie's designers aren't just making a game: They're trying to divine the golden mean of fun."

A game like Halo must be difficult enough so that players feel challenged but not so difficult that they give up in frustration. Educators want a course with exactly the same characteristics. Game developers invest millions of dollars in producing and testing high-quality video games because the size of the market justifies such investment. Online technologies are bringing the same economics to the world of education. In the new world of online education, we will finally have courses that are as well designed and as awesome as video games.

Alex Tabarrok is a professor of economics at George Mason University and the co-founder with Tyler Cowen of MRUniversity.com. He writes regularly at the blog MarginalRevolution.com.