Is There An Education Bubble?

Instapundit and many others certainly think so.  Anecdotally, it seems like there could be one given the prices that many colleges are charging.  Instead of thinking about it in terms of what people say, let’s look at some math.  Numbers sometimes bring clarity to a situation.

If you pull some free market logic from Finance and apply it to the education market, you might frame things differently.  Eugene Fama from the University of Chicago says that there are no such things as “bubbles” in financial markets.  If there are, you ought to be able to predict them and act accordingly.  He correctly points out that all publicly known information is incorporated into the price of an asset.  Are asset bubbles in financial markets directly comparable to intangible assets?  Probably not, but Fama’s theory on efficient markets should at least give us a touchstone to think about.

In this case, our asset is a college education.  The asset is not physical like a stock or a piece of real estate, but intangible.  Hence, there are properties to that asset that are subjective.  For example, what is the real value of the Coca-Cola brand name?  In turn, what is the real value of a college education-and within the finite range of colleges, what’s the individual value?

Here is the hypothesis:  We will assume that there is an education bubble.

What is our evidence?  The two forces that combined to create the housing crisis are doing the very same thing in education.  Cheap, easy money by the Federal Reserve, and a Federal Government that guarantees the entire loan system.

But, it’s not enough to say that it’s just expensive.  When did it become expensive, or in a “bubble”?

Here is the annual Fed Funds rate from 1955-2010.  The average Fed Funds rate from 1990-2010 is 3.866. You can see the high inflation of the late 1970’s-early 1980’s reflected in the rate.

The Prime rate is usually a point over the Fed Funds rate. But, because of default risk and other factors, college loans are taken out at higher rates. The average interest rate on a student loan is not so simple. Imagine that, something with a lot of government interference is not clear! There are subsidized and unsubsidized loans. The market is so murky, many sites tell people to assume that the interest rate will be 8%. But after doing a couple of searches at Edulender, a 10% rate is a better implied rate.

Now that we at least have a firm foundation on borrowing costs, we can look at what we will spend the money on.

It’s funny, when I speak with men and women about college costs, they speak different languages. Men almost always quote “all in” costs, tuition, room and board, books, etc. Women break it up. To a man, Harvard costs 50 grand, to a women it’s 35k for tuition, and 12k for room and board, but I know that I can save some money on food! Men know that you gotta eat-plus pay for a little beer too. That 12k can grow in a hurry!

For our purposes, we will make the women happy and just look at tuition. The average tuition rate at four year public colleges nationwide last year was $7,605 for in state students. Private colleges charge an average tuition of $27,293. Private is almost four times as much as public. In 1990, the average public ticket was $2,035, and average private was $10,348. Twenty years ago, private college was five times more expensive than public! Annual inflation as measured by the Consumer Price Index (CPI) from 1990-2009  was 2.79%. If tuition rates rose by the inflation rate, you would expect the public number to be $3,528.  The private number would be $17,942

Yowza. By that measure there may be an education bubble!

However, there is much more to the analysis of the problem than that. It pays to look at salaries. Here is a chart of median weekly earnings based on degree, and the corresponding unemployment figures.

This chart is more dramatic, because it charts the growth of income with a degree over time

The real interesting facet of this chart is looking at income, and what was going on in the underlying economy. In 1986, the slope of the graduate degree line started to increase. In 1990, the high school degree line started to decrease. This can be explained by our economy transitioning from a manufacturing based economy, to a knowledge based service economy. Over a person’s lifetime, a college grad will earn 75% more than an non-college grad.  That 75% is the opportunity cost of not attending college, along with longer time on unemployment, and status.  College matters.

Researchers have also tried to delve into the subject of which college matters. Ivy League schools supposedly carry more “respect” among the populace, so demand for top tier institutions exceeds demand at other schools. While all schools have raised tuition significantly, many of the top tier schools are able to raise it more.  It’s important to note, none of the data I have cited incorporates the “upper tier bias”, a satellite state school looks just like an Ivy.

These underlying economic changes changed the demand curve for college. Tangible evidence could be physically seen with standards of living and income. Additionally, communism fell in eastern Europe in 1989, allowing a new crop of foreign students access to US schools. This combined with Deng Xiaoping liberalizing force in China, and a large influx of immigrant students from India has also moved out demand for a US college education, especially graduate school.

Supply is constant. No new colleges have been built. Here is a graphical explanation of what happens to price(tuition) when supply is held constant and demand is increased.

Then comes the US government trying to “do good”. What does the US government do? It increases subsidies to education. What happens when you subsidize a market? You get more of whatever it is you are subsidizing. In this case, because supply cannot increase, it puts upward pressure on price (tuition). President Jimmy Carter created the Department of Education. Since it’s inception, we now spend 30 billion dollars a year on higher education in subsidies.

This puts upward price pressure on tuition.  Along with that, the cost of the subsidies are not borne by the beneficiaries.  This causes economic imbalances.  In a nutshell, blue collar workers are subsidizing the college education of future higher income workers.  Also, the students in college don’t pay for the true cost of the subsidy, since they have access to grants, loans and tax credits.

Increased demand from more people, increased subsidies, no new supply and boom, significantly higher prices. But the increase can almost be entirely explained by government intervention!

One can look at average cost data to see the inflationary effect of rising student aid. From 1987 to 2007, there was a strong upward trend in average per-student costs of private and public universities (tuition, fees, and room and board). However, if you subtract from those costs federal grants, loans, and tax benefits, there has been only a modest increase over two decades.

Consider four-year private colleges and universities. The average real cost (in 2006 dollars) per student rose from $18,122 in 1986 to $30,497 in 2006, a 68 percent increase. But students didn’t bear that large increase because of grants, loans, and tax benefits. After these benefits, the cost grew from $10,943 to $14,158, a much more modest 29 percent increase. A similar pattern holds for price increases and public institutions.

Salaries earned are so variable, it’s tough to tease out statistics that are meaningful.  Here are two examples.

The median salary lawyers earned in 2008 was $110,590 per year.  Law school between private/public schools average about $150,000.  If you borrow the entire amount, which a lot of students do, it takes quite a bit of effort to pay of your loans, but still it’s worth it over the course of an entire lifetime.   You will have to payback about $350,000.

Average salary for a person with an MBA in 2008 was $104,000.  The average cost of tuition at an elite school in 2008 was more than that, around $125,000.  But, over a person’s lifetime, the payback was still worth it, even assuming small raises of 3% a year (or the rate of inflation)  The highest payback using Edulender was $292,000.

Both scenarios put a flutter in your gut.  The numbers are so big.  But, under each there is always the potential to do better than the average.  Plus, the argument is the knowledge learned will cause you to think differently, and able to take advantage of unique opportunities that other people less educated will not see.  That supposition is highly variable.

It has been found at many institutions all across the country that colleges have used government dollars not to increase options and improve facilities, but to increase headcount among staff. All of this extra overhead adds to the fixed cost of college. The cost is not just in salary, but guaranteed pension benefits that accrue to the staff members no matter what.

In summary, the college market is efficient. Supply has not increased, but demand has. Subsidies have increased. This has put extraordinary upward pressure on the price of college.

There are two ways out of the problem, and we ought to do both.

First, build more colleges. This increases the supply and tempers demand, dropping prices. At the same time, remove the stigma of going to a community college. Going to a two year school will also relieve demand pressure on four year colleges, allowing prices to stagnate.

The second solution sounds cold hearted. But in order to make college more affordable for everyone, government ought to get out of the higher education subsidy business altogether. Blue collar workers will thank them for removing this hidden tax burden. Colleges will run leaner, and the federal budget deficit will drop.

tip of the hat to Instapundit, thanks for the link and welcome to his readers

hello Commonplace of Magpie readers, have a look around.

thanks for the mention eWallstreeter’s

A P&F welcome to the cerebral crowd from the Pope Center!

UPDATE

I am getting some pushback in the comments, and on Points and Figures Facebook page that supply has increased. Sure, some colleges have expanded.  But, they have not expanded nearly enough to meet demand.  The other point people have made is I discounted for profit colleges, and online colleges.  I would concede that point.  Most for profit colleges don’t offer a liberal arts type college experience.  They are focused programs that concentrate on one specialty, nursing or some technical training. Online colleges are too new, and not readily accepted by the general public.  When someone mentions “college”, online schools are not what comes to mind.

The two drivers of demand are increase by foreigners and indigenous Americans because they see the financial benefits of a degree, and government subsidies.  Eliminate all government subsidies and costs will stabilize.  (They won’t go down)  The supply side and rest of the market will eventually catch up.

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  • blackmart

    Thank you for addressing this topic from an interesting angle. Great read! But still do you think that education is in a bubble? I know its not as simple as Yes or No and is quite complicated to answer. I believe the over-arching question we need to answer is: Is an economy that is overly reliant on consumption and a service oriented labor market sustainable? Will the world of tomorrow need lawyers, financial engineers, graphics designers, etc..? As we witnessed in last month’s economic report almost half of the 103k jobs created were in service/hospitality.Sounds like we’re going back to our old ways and the status quo hasn’t changed. If we (the subsidizers & students) are “investing” in a structurally unsound employment asset and a large enough portion of that asset collapses because sustainable jobs aren’t at the end of the tunnel to get a consistent return then isn’t that a bubble?I guess the 1 saving grace is that you have to repay federal student loans and since Sallie Mae is the only game in town there is some security that the government will get it’s money back. Although I hear there is a growing push to allow judges to restructure this in bankruptcy court. Anecdotally I know a lot of college grads & even ones with higher degrees working at Starbucks, waiting tables or bartending. Your thoughts?

    • The answer is as you say not clear. “It Depends”. There are other things that the government can do to make an education more valuable. For example, reduce tax rates and spending to make the economic environment more hospitable to entrepreneurs.

      Second, I wouldn’t go to college and major in sociology. Major in something that forces you to critically think. Or, major in something that is concrete-engineering, accounting, economics.

      Our economy needs to be a LOT more entrepreneurial, with start ups etc. Merely majoring in engineering isn’t enough. The Groupon guys were history majors that went to law school.

      But, soft do nothing majors seem to me at least to be a waste of time.

      The other concept that needs to be explored that I didn’t but have in other posts is that we need to be teaching entrepreneurship in our grade schools and high schools. Instead, we are trying to program kids with community service. They’d be better off teaching them to run a lemonade stand.
      What is better? Learning to ladle soup at a soup kitchen and feeling guilty-or starting up a business and employing the person standing in line……..

      I think that we ought to be encouraging kids to go to college. They learn a lot, as long as they pursue the right course. College has gotten to be such bunk-bring back a core curriculum, teach some big thoughts, teach them to critically think-and then turn them loose on society.

      The bubble comes from one thing, government subsidies. Get rid of them and the bubble will pop.

      • David Davenport

        They are other paths, but people who went to a JC are seen as somewhat inferior compared to people that went to 4 year schools.

        But do these people who go to a junior college really need to start at a four year college instead of a jc?

        people who went to a JC are seen as somewhat inferior …

        So what? Are taxpayers supposed to spend more and more to improve the poor darlings’ self-esteem?

        Explain that, please.

        • No, but until we change the way society views community college demand won’t change.

      • Underpaid Graduate

        Couldn’t the increase in tuition be explaind something else? For example, if the cost of educating went up (price of inputs). If teacher salaries/exec salaries and facilities all are more costly now than in previous years, why is that not the reason for the increase in tuition – with the loans/subsidies simply sopping up this extra cost?

  • “The second solution sounds cold hearted. But in order to make college more affordable for everyone, government ought to get out of the higher education subsidy business altogether. Blue collar workers will thank them for removing this hidden tax burden. Colleges will run leaner, and the federal budget deficit will drop.”

    What’s more coldhearted: telling a person to rack up thousands of dollars in debt (and to your government, no less) to get the hopes that you might make more money in your future years, or to tell that person he should go work for a few years, gain some experience, and if a position he is looking to get requires a college education, to go then?

    Liberalism is the philosophy of the coldhearted, but conservatives always take the blame.

    • brosenga

      Your telling me you are not wiling to admit that any conservative ideals are coldhearted either to its core or due to the ideal’s effect.

      If I recall nether party has taken a major action to try and make sense of the costs of a higher education.

      -BAR

  • Anonymous

    The Efficient-Market hypothesis is only meant to be applied to public markets like the stock market, futures markets etc. It asserts that that bubbles cannot form in such markets because the markets collect and transmit information about value and risk “efficiently” because that is what those markets are meant to do. As such, it doesn’t apply to a market like education were the processing of information about value and risk take decades instead of minutes.

    People cannot evaluate the cost benefit of education until a decade or two after they get out of school. By that time, economic conditions might have changed so young people currently in school can’t use their elders experience as guiding mechanism.

    Your analysis of income and unemployment isn’t complete. To measure the truth economic benefit of a higher education, you have to subtract the cost of lost wages while in school and the burden of debt acquired getting the education. A doctor for example may have to spend 10 years in school forgoing hundreds of thousands of dollars in income in the process. Then the doctor may run up hundreds of thousands of dollars in debt to pay for the education. Accurately accounting for all that cost would significantly reduce the apparent economic benefit of an education quite a bit in many cases.

    We have expanded our college capacity enormously mostly by expanding existing institutions. So your arguments about supply don’t really apply.

    Lastly, I think the “education bubble” argument really only applies to the liberal arts. I don’t see many people complaining that they paid to much for their scientific, engineering and business degrees. Those degrees provide tangible and marketable skills. A liberal-arts education, by contrast, really only trains you to be a college professor. To many people in their early 20s are running up large debts for an education with no practical use or expected economic reward.

    The education market in the liberal-arts shows every signs of a classic bubble. There is a disconnect between cost and final values. People are entering the market largely just because everyone else is. Lastly, the education market is constantly portrayed as a “sure thing” that will always pay off.

    • EMH is a useful way to think about education though. EMH doesn’t work in futures markets-because they are highly margined. I have heard Fama lecture on EMH and housing, there is no reason we can’t apply at least the concept to higher education.

      I do mention the opportunity cost of college, but you correctly point out that I failed to add in the lost wages of the four years. The median I found was $377/wk which is ~78k over four years.

      I think the supply argument really does make sense, because demand is outstripping supply. They are other paths, but people who went to a JC are seen as somewhat inferior compared to people that went to 4 year schools.

      There is also Univ of Phoenix. But, will you send your kids there vs a place like Northern IL?

      I also disagree on evaluation of the benefit. People make economic choices based on future expectations. They internalize data based on those expectations and the economic choices laid out in front of them.

      As I said in the post, income is highly variable. But, we have to use some sort of stat. Income, degree status, and looking at time unemployed in 2008 is extremely interesting. It paid big to have a college education, regardless of the degree.

    • mg

      Labor markets are similar to housing markets in that they take a long time to clear, as SL suggests. In fact economists (notably Sherwin Rosen at Chicago) sometimes use “cobweb” models to study markets that adjust so slowly.

      That said, labor economists also estimate return on investment in education by including opportunity cost, and have done so for over 50 years. There is a vast literature on ROI in education, on the job training, & health – all investments in human capital.

      In fact, there has been a dramatic increase in relative compensation for skilled people worldwide since about 1980. This appears to be tied to the IT revolution – IT is complementary to skilled workers. This has in fact raise the ROI for education over time time. We haven’t seen such a dramatic change in returns to skill investments since the Industrial Revolution.

      That in turn has no doubt increased the cost of education, by pushing out demand. No doubt too, subsidies for student loans & so forth do the same & are to some extent passed thru to universities. Thus, the cost of education has increased.

      However, as I said there is a vast & continuing literature in labor economics on returns to educational investments. There is no evidence that it suddenly went negative, or anything even close. It is still by & large a good investment, one of the best available (as are investments in health). The best inheritance you can give your children is the best education you are able to provide them.

      I do agree that a better way to think about this is where investments in education have higher or lower returns. I would be amazed if the professions (MD, law, business) are bad bets for most students, though there are obviously cases where things don’t turn out as hoped. I agree that the liberal arts are likely to have the lowest ROI. A PhD in English literature is simply almost certainly a poor economic choice, though someone might find it worthwhile for other reasons.

    • Ben W

      I have to disagree. A liberal arts education is designed to develop intellectual capabilities such as reasoning, communication, critical thinking, reading comprehension, etc. To the extent to which this is successful, a liberal arts education is tremendously useful in business, science, and engineering, all of which need good critical thinking skills for good performance.

      But obviously, some liberal arts degrees will be more fiscally valuable than others – and here I agree with you about the utility of science vs. english degrees.

    • Ben W

      I have to disagree. A liberal arts education is designed to develop intellectual capabilities such as reasoning, communication, critical thinking, reading comprehension, etc. To the extent to which this is successful, a liberal arts education is tremendously useful in business, science, and engineering, all of which need good critical thinking skills for good performance.

      But obviously, some liberal arts degrees will be more fiscally valuable than others – and here I agree with you about the utility of science vs. english degrees.

    • Ben W

      I have to disagree. A liberal arts education is designed to develop intellectual capabilities such as reasoning, communication, critical thinking, reading comprehension, etc. To the extent to which this is successful, a liberal arts education is tremendously useful in business, science, and engineering, all of which need good critical thinking skills for good performance.

      But obviously, some liberal arts degrees will be more fiscally valuable than others – and here I agree with you about the utility of science vs. english degrees.

    • Ben W

      I have to disagree. A liberal arts education is designed to develop intellectual capabilities such as reasoning, communication, critical thinking, reading comprehension, etc. To the extent to which this is successful, a liberal arts education is tremendously useful in business, science, and engineering, all of which need good critical thinking skills for good performance.

      But obviously, some liberal arts degrees will be more fiscally valuable than others – and here I agree with you about the utility of science vs. english degrees.

    • Ben W

      I have to disagree. A liberal arts education is designed to develop intellectual capabilities such as reasoning, communication, critical thinking, reading comprehension, etc. To the extent to which this is successful, a liberal arts education is tremendously useful in business, science, and engineering, all of which need good critical thinking skills for good performance.

      But obviously, some liberal arts degrees will be more fiscally valuable than others – and here I agree with you about the utility of science vs. english degrees.

  • Gobuybl

    “All of this extra overhead adds to the fixed cost of college. The cost is not just in salary, but guaranteed pension benefits that accrue to the staff members no matter what.” The school is a business, it they thought that hiring more staff would decrease their profit, they wouldn’t do it. It cost them nothing compare to what a student have to pay these days. Six student would pretty much cover a professor’s salary for the year, you do the math.

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  • Laura

    Too many stupid people attend college already, often leaving with a Mickey Mouse diploma. We do NOT need more bricks & mortar campuses — high school and college campuses are underutilized in the evenings, and more and more courses will be offered online in the future. More should be done to combine high school and college, so that people graduate after fewer and cheaper years in school. Also, allow employers to administer IQ tests to potential employees. If people could get a decent job without college, many would choose to do so. Do CLEP tests still exist?

  • David Davenport

    Too many stupid people attend college already, often leaving with a Mickey Mouse diploma. We do NOT need more bricks & mortar campuses …

    I agree. Mr. Jeff Carter fails to make the case that that the quantity of four year colleges ought to be increased.

    • That’s not my point. The high cost of college can be mostly explained by demand, and the govt. subsidies.

      You could make the argument that if govt ended subsidies, all costs would go down. (borrowing and tuition)

  • pay as you go

    “Along with that, the cost of the subsidies are not borne by the beneficiaries. This causes economic imbalances. In a nutshell, blue collar workers are subsidizing the college education of future higher income workers. Also, the students in college don’t pay for the true cost of the subsidy, since they have access to grants, loans and tax credits.”

    This is factually incorrect. It is well established that the top 0% of income earners pay 90% of taxes in this country. Blue collar workers mostly don’t fit into this group.

    This

    • pay as you go

      sorry for the typos… the comment editor is hard to use on this site (white space not tall enough to see all of your words…

  • pay as you go

    “Along with that, the cost of the subsidies are not borne by the beneficiaries. This causes economic imbalances. In a nutshell, blue collar workers are subsidizing the college education of future higher income workers. Also, the students in college don’t pay for the true cost of the subsidy, since they have access to grants, loans and tax credits.”

    This is factually incorrect. It is well established that the top 20% of income earners pay 90% of taxes in this country. Blue collar workers mostly don’t fit into this group.

    • Ruralcounsel

      Except the government education subsidies, mostly in terms of student loans, don’t cost the taxpayer so much as they indenture the student who takes out the loans. We have oversold the value of higher education. We have legions of blue collar families letting their kids go into lifetime debt in order to get an education that they likely never get to use.

      I thnk the real tragedy is that college is now treated like a trade school. You go through it, and when you come out you believe you should have a job that pays X. Education may be necessary for success, but it is not sufficient. Success requires something more. Perhaps it is true that we have created a non-manufacturing service-oriented society in which there is a very finite number of jobs needing a higher education, and we are oversupplying that job market. We only need so many people selling eachother stuff that no one in this country made.

    • Ruralcounsel

      Except the government education subsidies, mostly in terms of student loans, don’t cost the taxpayer so much as they indenture the student who takes out the loans. We have oversold the value of higher education. We have legions of blue collar families letting their kids go into lifetime debt in order to get an education that they likely never get to use.

      I thnk the real tragedy is that college is now treated like a trade school. You go through it, and when you come out you believe you should have a job that pays X. Education may be necessary for success, but it is not sufficient. Success requires something more. Perhaps it is true that we have created a non-manufacturing service-oriented society in which there is a very finite number of jobs needing a higher education, and we are oversupplying that job market. We only need so many people selling eachother stuff that no one in this country made.

  • Anonymous

    This is fine, but we need to be careful about the relation of education to higher income. Years ago, lots of smart and industrious people never got beyond high school or some college but still did well in life because they were smart and industrious. Today, much higher percentages of smart and industrious people will have graduated from college. Much of the effect may come from moving people into different categories rather than from any value added by the actual education.

  • Anonymous

    This analysis leaves out declining state subsidies for higher-ed. In aggregate, is this decline significant relative to the increased federal subsidies? At the university where I work, state funding has declined from 80+% of our budget to just under 10% since the late 80’s. The budget gap has been closed by higher tuition (mostly subsidized). Does it make any difference whether the subsidies comes from the state or the feds? It seems to me that the figure of merit is expenditures/student less pass through funds. The Goldwater report on administrative bloat showed that expenditures/student has grown about 1.5%/yr from 1993-2007 at public schools. I’m not sure if that growth includes endowment financed construction during that era. Nevertheless, is 1.5% growth relative to the CPI enough to inflate a bubble? Does it matter who is paying for this increase as far as the makings of a bubble are concerned?

  • Qsiemer

    So, how do you remove the stigma of a community college? If you go on to a four year college the stigma is removed. If you take a degree leading directly to a job, say nursing, there is less stigma. But if you take a degree that normally would lead to a four year degree than the stigma will remain If you don’t go on,and you have probably wasted your money. My son did the latter but then took a 12 week course and became a professional diver, making six figures. Did the associate’s degree help him? Probably, but not as much as the twelve week course. I think that it is not the fact that you have a degree but what you have it it in, English majors starve while accounting majors flourish.

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  • Jerry M

    Professor Vedder at Ohio University makes a strong case that we are producing more college graduates than the job market for college degrees can absorb. This will only get worse as time goes on. In addition to the ever increasing cost of tuition, students are having to spend five or six years to complete a degree because of insuffucient capacity to offer as many classes as are needed. Those extras years without a job add tens of thousands of additional cost represented by the loss of income. More students should be thinking about vocational/technical education, which is a great strength of community colleges, than about traditional four year degrees which many start but never complete.

  • The supply of college places is not constant. Many public colleges and universities have expanded to meet rising demand. In addition, the for-profit sector has created many more places for students.

    • The expansion has been far short of what was needed for demand. But, government subsidies are the main driver of higher prices.

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  • Fx

    educations is an invaluable asset so long as it teaches you. you cannot compare the mentality of a ‘charge it’ student with one who earns through school. the latter is much better prepared for work and life in general.
    and if you look at the ‘actual room and board’ component, you see many colleges have bcome 4 or 5 star long stay hotels. these shall not be subsidized, it creates a perverse reality wherepeople get accustomed to lifestyle their future income cannot possibly support.

  • Fx

    educations is an invaluable asset so long as it teaches you. you cannot compare the mentality of a ‘charge it’ student with one who earns through school. the latter is much better prepared for work and life in general.
    and if you look at the ‘actual room and board’ component, you see many colleges have bcome 4 or 5 star long stay hotels. these shall not be subsidized, it creates a perverse reality wherepeople get accustomed to lifestyle their future income cannot possibly support.

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