What Free Market in Higher Ed?

President Obama couldn't have picked a more opportune time to put colleges on notice about their rising costs. Days after Mr. Obama threatened colleges with the loss of some federal aid during his State of the Union address, hundreds of private-college presidents descended on Washington for their annual meeting. A few of them stuck around for the annual meeting of Christian colleges, which followed a few days later.

The talk among the college presidents about the Obama administration's proposals was similar at both meetings. While they welcomed the potential additional dollars that were part of the proposals, they didn't like the strings that were attached.

"The very issue of setting tuition is the principal fiduciary responsibility of a college," David L. Warren, the head of the private-college association, told me.

During a panel discussion at the meeting of Christian colleges, a president challenged me on the need for additional government oversight. Let the "free market" correct rising college prices on its own, he said.

The problem is, the current financing mechanism for college is far from a free market. Government subsidies account for close to 90 percent of revenues at some colleges when you add up grants, loans, and research funds. Also, nonprofit colleges are exempt from paying many taxes, and they receive tax-exempt gifts from donors.

"In the absence of a government subsidy, most colleges could not fill up their seats," argues Ronald G. Ehrenberg, a higher-education economist and professor at Cornell University. "It's silly to think that this is a free market."

Even if higher ed were a true free market, more competition hasn't led to lower prices (as it has in many other industries) because consumers have so little information on which to judge the quality of colleges. Well-informed consumers tend to make rational decisions. But in the absence of good information about colleges, students and their parents are often irrational, selecting colleges based on low sticker price (rather than net price), athletics teams, geography, or brand name.

Going to college is an "experience good," meaning you need to experience it before you can determine its value, explains Justin Wolfers, an associate professor of business and public policy at the University of Pennsylvania.

"People are making the best decisions they can, given the circumstances," Wolfers says.

But for an expense that is among the biggest of a family's lifetime (perhaps second only to the purchase of a home), we should be able to do better than rely on annual rankings from a magazine that doesn't really publish anything beyond rankings anymore.

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