The Price of Everything

Economics of Art School

One basic difference between economists and the rest of the human population is how you answer the following question:

What is the purpose of higher education?

A non-cynical normal person answer is learning, or some variation on the theme of an investment to acquire useful knowledge through training and study in order to become a better, smarter, more employable person.

Yet economists answer in one of two ways.

The first is human capital theory, which is basically the normal person answer, but made fancy by pointing out the equivalence with a firm’s investment in plant and equipment. It argues that a rational student will invest in education because it raises their skills and productivity, which makes them more valuable to employers, raising their wages. Economic theory explains that the rational student will invest until the cost of an extra semester equals the expected extra benefit. You invest because it’s good for you and you keep investing until it’s not.

The second answer is more exotic. It’s called costly signaling theory, and it argues that the purpose of higher education is to show that you’re already smart and capable. You show this by doing something difficult and expensive that has the crucial property that someone who is not already smart and capable would find prohibitively costly. This then provides a reliable and honest signal between student and potential employer. You invest to show that you really are as smart as you say you are, and you keep investing until those that are lying drop out.

The reason this works is what is called an information asymmetry problem. You may know you’re smart and talented, but a potential employer can’t observe that directly. And more the point, when other people can also make that claim, employers face the problem of trying to figure out who is lying. The solution is to encode a “costly signal” in something that can be directly observed, namely education credentials.

According to this theory, investment in education continues until only those with “high ability” find it worthwhile to invest. Those with less ability are better off not investing at all, in that their total return is higher by accepting a lower wage, but not having to pay the cost of years of expensive training and lost income.

For high-ability students, they keep investing until the cost to low ability students is such that they stop investing. In equilibrium, the student’s level of investment thus reveals their true otherwise unobservable quality. This can work in signaling or screening mode, depending upon whether employers make the first move by offering a higher wage to those who obtain the qualification (screening), or whether students make the first move (signaling).

The actual economics is a bit hairy, involving concepts such as a “separating equilibrium”, and there is certainly debate about which theory the evidence supports. But this debate matters because a profound implication follows if signaling theory is true: it implies that higher education works even when what is learnt is completely useless. And moreover it implies that education investment can become a kind of evolutionary “arms race”.

In costly signaling theory, the purpose of higher education is not to provide learning, or “human capital”. Its purpose, rather, is to provide differentiation, which in turn solves an information problem to enable labour markets to function efficiently.

Which brings me to the economics of art school. The question now is what is art school for? Is it about human capital, or is it actually a species of costly signaling?

A central pillar of Australian arts and cultural funding is creative education, or the “art school” that runs from NIDA to TAFE courses in creative writing. Australian Government statistics report some 903,000 full-time equivalent tertiary students in 2012, of which 71,333 (about 8%) are enrolled in creative arts education. (A further 225,000 are enrolled in Society and Culture, a.k.a. the humanities.)

A few more can be added coming through specialist secondary schools. A rough back-of-the-envelope calculation puts this total yearly cost for core creative arts educational spending (including direct and indirect costs, both publically and privately funded) at about A$2 billion.

Is this too much or too little? Do Australian students over-invest in creative education, or under-invest? That depends on the answer to whether art school, broadly considered, is a form of human capital or a form of costly signaling.

We would expect creative education to have a costly signaling component because creative talent is hard to observe, and difficult to evaluate. We would expect some mechanism to emerge to enable employers to screen and true creatives to differentiate themselves.

Yet the entire economic logic of public funding and the tie-in with arts and cultural policy assumes, by default, that human capital theory is true and that art school is all about learning and acquiring skills. This line is often reinforced with claims about demand creation and preference education.

Several colleagues and I recently completed work seeking to answer this question, which is due to be published in the near future. We found, compared to other sectors, tentative evidence of under-investment in creative education. But this result came from the costly signaling model, not the standard human capital model.

Modern information economics suggests that we may be fundamentally misunderstanding the role that creative education is playing, and by ignoring the costly signaling model our policy discourse may be similarly misguided.