University presidents and economists like David Feldman and Robert Archibald often cite the Baumol Effect (named after a Princeton economist) as a key reason college costs keep rising. They argue that higher education is a service industry where it is inherently difficult to raise productivity by substituting machines for humans. Teaching is like theater: it takes as many actors today to produce King Lear as it did when Shakespeare wrote it 400 years ago. While there is some truth to the argument, in reality technology does allow a single teacher to reach ever bigger audiences (using everything from microphones to streaming video). Moreover, a majority of college costs today are not for instruction –the number of administrators, broadly defined, often exceeds the number of faculty.
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The second explanation comes from former Education Secretary Bill Bennett: rapidly expanding federal student financial assistance programs have pushed up college prices, so the gains from student aid accrue less to students than to the colleges themselves, financing an academic arms race. Recent studies support the Bennett Hypothesis. Student aid has fueled the demand for higher education. In the market economy, increased demand for a product made by one company (say the iPhone) quickly spurs competition (other smart phones), so prices do not rise. That fails to happen in higher education, as many providers restrict supply to enhance prestige. Harvard has an Admissions Committee, McDonald’s does not.
Here are 12 expressions that help explain the college cost explosion:
1. Third party payments. When someone other than the consumer is paying some of the bills, the customer is not very sensitive to prices. Health care prices have soared for that reason, and it is contributing to the college price explosion as well.
2. Lack of information. For markets to work effectively, buyers and sellers need lots of information. Yet colleges (in the information business) and their customers, are remarkably ignorant about key aspects of higher education. Do seniors know more or think better than freshmen? Does the senior year add as much value to a student’s knowledge, sense of right or wrong, leadership or critical thinking skills, etc., as the sophomore year? How much do students apply themselves? Do they like their school? What do they earn five years after graduation? Does a sociology degree have the same vocational relevance as a degree in accounting or mechanical engineering? Answers to these and many other questions would help students and academic administrators make intelligent resource allocation decisions – yet no answers are available.
3. Most higher education is not for profit. While most academics view that as a great virtue, I don’t. The lack of a profit motive reduces incentives to cut costs, improve product quality, and other things necessary to make profits and enhance wealth in the private market economy.
4. Closely related is the term bottom line. General Motors and Wal-Mart have well defined bottom lines –the stock price and profits. What is the bottom line for Harvard or Slippery Rock State? Who knows? How can you achieve goals if you don’t know, in a well defined sense, what they are? How can you get “more productive” when you cannot even measure your outputs well?
5. Resource rigidities are a problem. Tenure makes it hard to move faculty resources from areas of low demand to those of higher demand. Faculty with lifetime appointments can fight innovation and change with relatively few adverse consequences, stifling innovation. Universities own large buildings that are often underutilized, particularly after changing consumer demand renders some of them obsolete.
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6. There are problems with barriers to entry and restrictions on competition. Both accreditation agencies and regulators make it difficult for small but innovative new institutions to begin. For example, proposals to require “state authorization” of on-line instruction in every state in which an institution operates forces smaller on-line companies out of the market in some states.
7. The public nature of support and control of schools containing most students means that higher education is now, in some sense, politicized. Universities have to conform to rules in order to get government grants or allow students to receive student loans, and these rules do not always make sense, having a “one size fits all” dimension to them.
8. Universities try to charge what the traffic will bear, engaging in massive price discrimination, favoring some students (poorer ones, extremely bright ones, students of color) more than others (more affluent, less bright kids, white students.)
9. Universities engage in rent-seeking – receiving more payments than necessary to provide services. Workers sometimes receive inflated salaries not justified by market conditions or merit. Salaries are higher for those who get research grants for time off from teaching to do research, compared with those who continue to teach full loads.
10. Many schools, especially large research universities engage in massive cross-subsidization, showering vast resources on some activities, such as graduate education, while providing little for, say, undergraduate instruction. Lower teaching loads to promote research are subsidized by tuition fees ostensibly paid to provide for student instruction. This increases tuition sticker prices.
11. Ownership of universities is murky. Many groups think they own “their” school –the faculty, the trustees (the legal owners usually), the alumni, state government officials, sometimes even students. This leads to turf wars and unproductive wastes of resources; for example, the chemistry department might forbid others from using “their” building, even though it might be wiser to use some of the space for other needs.
12. There are often massive governance problems. Who runs the schools? There are several who claim that right, leading to murky decision-making, often by committees (“shared governance”) of a non-innovative nature to appease all powerful claimants.
What to do? The key to change is found in three “I” words – information, incentives, and innovation. Information is key to making intelligent decision-making, yet often the incentives are lacking to do the cost-cutting, innovative things necessary. If good information and incentive systems are in place, innovation will take place automatically: necessity is the mother of invention.
This piece originally ran on Minding the Campus.
Richard Vedder directs the Center for College Affordability and Productivity, teaches economics at Ohio University, and is adjunct scholar at the American Enterprise Institute. He is the author of Going Broke by Degree.