02/21/2013 12:12 pm ET Updated Apr 23, 2013

The Problem of Tuition


American higher education has a problem. It costs too much.

The hyper-inflation of tuition is well documented. By any measure, the cost of college attendance has increased dramatically. Higher education tends to be debt financed. The student loan bubble may well be like the subprime mortgage bubble -- only worse.

People favor stories. We like our explanations of the world around us to come in the form of narratives rather than analyses. The tuition issue has us hoping for a hero and looking for a villain. We prefer to identify the parties who are held to blame. It is preferable to an explanation that involves abstract patterns, structures, and forces. But thoughtful consideration may lead to the conclusion that college tuition is just like everything else; it is only a more extreme example.

For a long time, the leaders of schools believed in the "Chivas Regal effect." The brand of blended scotch was regarded as classy back in the day when it was advertised in men's magazines such as Playboy -- which also were regarded as classy. The concept was that consumers assumed products that were expensive were superior, because they accepted the opposite was true. Any product that was priced at less than a premium was perceived as inferior -- reflecting a lovely confidence in the mechanisms of the market.

The story that the owners of the actual Chivas Regal doubled their price and thus doubled their sales turns out, like most such stories, to be an urban myth.

Nonetheless, people dubbed this dynamic the "Chivas Regal effect." College presidents, believe it or not, referred to it by that name.

I doubt that more than a few administrators continue to believe they should promote that "Chivas Regal effect." It cannot justify the escalation of the costs of higher education. The public is protesting. The only people who continue to be willing to pay without hesitation are well-to-do foreigners who are enamored of American labels.

The trouble is we are human beings. We respond to clever sales tactics despite reason.

Here is what happens. We see a product with a regular price of $50,000, discounted to $25,000 thanks to a sale. We see an alternative with a regular price of $20,000, available at that price at all times. Everybody wants a deal; nobody pays retail.

Even if the decision is about commodities that are essentially the same, virtually every potential purchaser considers the $50,000 option with the $25,000 break better than the $20,000 option. It is easy to overlook the fact that the $50,000 option still costs $25,000, while the $20,000 option is cheaper -- "just look at how much we're saving!"

Applied to higher education, this phenomenon compels every school to raise tuition while offsetting it with the discount rate. Besides, almost all students pay less than the stated rate of tuition.

The ploy is to package financial aid so each individual feels special. An applicant looks at School X with tuition of $50,000, offering her a "merit" scholarship worth $25,000, compared with School Y with tuition of $20,000, refusing to provide enticements.

To the average student and her family, School X looks better. They cannot be faulted for their reasoning. It must be better, because others are willing to fork over $50,000 -- only a few really do that, but they aren't aware of the facts. They can brag to their neighbors that the more prestigious school -- more expensive ergo more prestigious -- seems to want them. Thus they feel good about spending more.

School X also usually has made capital investments. Its buildings with all the amenities further the illusion.

It is all a charade. In most instances, the "merit" scholarship is handed out for credentials -- predictors of future performance -- rather than performance itself.

What's more, if we want to be even more skeptical about this recruitment trick, it is not offered to the most meritorious students, meaning the most highly credentialed; in most cases, it is offered to those persons who are relatively meritorious, so they can be lured away not from the best schools (which the truly meritorious would not turn down) but only away from somewhat stronger schools. People fall for the deal when the choice is between the school ranked number 67 of 100 and the school ranked number 52, but many of them would walk away from both for the school listed as number 3 no matter the bill.

Each school enhances its institutional metrics slightly by stealing away from its near peers. Their own students are means to an end. None can afford to break out of what economists call a "prisoner's dilemma."

The irony is that exposing all of this doesn't improve the situation. People succumb to potent advertising even when they know that they are being pitched. Hype retains its power.

Our choices are complicated by the rankings of institutions of higher education. Suppose that the rankings were based on criteria that made no sense -- a supposition that may not be too much off of the existing reality. It wouldn't matter.

Here is an example. The rankings could be based on the average height of the faculty: the taller the faculty, the higher the ranking. Probably everyone would agree that this basis for assessing quality, though indisputably "objective," would have no correlation to anything that matters. (It also has a disparate effect in terms of gender.)

Yet soon enough, the perception could create its own reality. The school that had the tallest professors would attract the most highly-credentialed students, while boosting its reputation among observers in a feedback loop. As a consequence, it would eventually approach the best school. It wouldn't matter anymore that the origin of the reputation was dubious, exactly as we forget how the rich acquired their wealth.

The other factor is public funding that built systems envied the world over. There was a time when our shared ideals held up higher education as an opportunity rather than a reward. In a participatory democracy, it was said, it should be available to the many rather than the few. It benefits all citizens through the contribution to the economy, even if they are not themselves students within the system. Consistent with such idealism, campuses were given substantial funding, ensuring people who were strivers would be deservedly subsidized.

The disruptive idea for higher education must be the equivalent of the technological "killer app." Such ideas are not successful because they are better than the competition. They prevail because they redefine the rules of the competition, so they are never playing the conventional game. A school that is unique does that. It offers something not available elsewhere. As it is copied in turn, it innovates again.