Perry Gets It, Kind Of

The lack of affordability of higher education that I discussed in my article, Real Estate Opportunities for the Next Decade, Part 2: Classrooms, has already become an issue even for politicians, at least in Texas. Governor Rick Perry has called for lower-cost undergraduate degrees, with a target of $10,000 or less. Ten colleges, with total enrollments of more than 50,000 students, have responded to his call. Schools in Tennessee and New Jersey are also making an effort to reduce costs. In last week’s presidential debate Obama briefly mentioned the need for lower-cost and more relevant education and Romney agreed.

The $10,000 question is exactly how this cost reduction can be achieved. Obama clearly has a cost-plus conception of how markets work. He, along with many others, believes that firms begin with their production costs, all of which are similar, and then add on their profit margin to arrive at their prices. If this were the case, governments would always be able to offer lower cost products (both goods and services) because they wouldn’t have to add any profit margins. In fact, the cause and effect relationship of prices and profits work in the opposite direction.

Firms generally compete to offer the greatest benefits to their customers at the lowest prices. This competition creates a certain range of market prices, with more frequently traded products having a narrower range. For purposes of this discussion, we will ignore differences in benefits in order to isolate the price component. We now have a range within which each firm must set its prices. The firms now must lower their costs in order to create greater profits. Governments have no similar incentive to reduce their costs. This is one reason why both prices and costs of products provided by private markets are often lower than equivalent products provided by governments.

In the realm of education, policies based on Obama’s cost-plus conception have been driving prices up, whereas policies, or more precisely the lack thereof, based on an accurate conception of prices and costs will drive them down.

Perry’s no great economist but at least he has a general conception of the problem. His biggest error, as I see it, is attempting to convert existing public universities into institutions that are responsive to the needs of students. I don’t think that they will do this until competition from private and for-profit institutions forces them to change or close shop.

Doug McKnight has been a commercial real estate appraiser for 23 years. He previously served as a director for the national appraisal firm Marshall & Stevens. He is currently the managing director of CapStruc Advisors and is working on a book on the value of assets. Contact him at: doug.mcknight@capstruc.com.