The High Cost and Low Productivity of Our Higher Education System: What it Means for America

Note: Ohio University professor Richard Vedder was the keynote speaker at the annual Pope Center Conference held Oct. 8 at the Hilton-Raleigh-Durham Airport at Research Triangle Park. Here is the text of his remarks during the luncheon.

I am honored by the invitation to speak to you today. The Pope Center is a very positive force in rethinking higher education in America. I am somewhat surprised, frankly, that I was invited to speak, since I am an economist, and economists suffer from two defects. First, they are deadly dull. It is usually more fun watching paint dry than listening to an economist. Indeed, it might even be preferable to have a hemorrhoid operation without an anesthetic from an unlicensed French physician to having to listen to an economist pontificate.

The second problem with economists is that they are often wrong, sometime spectacularly so. Two examples will suffice. In October 1929, the dean of American economists, Irving Fisher of Yale University said, “the stock market is on a permanently high plateau.” Within days, the market started falling, and over the next three years, the Dow Jones Industrial Average fell more than 80 percent, by far the largest decline in its history, before or since. In 1985, the Nobel Prize winning economist Paul Samuelson, in his famous best selling textbook, said “the Soviet planning system is a powerful engine for economic growth.” Within seven years, the Soviet Union had disappeared, and to claim Soviet planning promoted economic growth is, to put it mildly, something of an overstatement.

Nonetheless, you got me anyway, probably because I am cheap. Getting serious for a few minutes, we are all aware of the major problems confronting higher education, some of which I will review for you. Less obvious, however, are the solutions. Today I will conclude by thinking out loud about some ways to deal with some issues facing the academy. Recently, Secretary of Education Margaret Spellings appointed a commission to explore the future of higher education, and I was put on it, so I am pondering with renewed intensity issues relating to our system of colleges and universities.

Let us list and then talk a bit about some of the bigger problems.

1. American universities are becoming increasingly costly and unaffordable.

2. Productivity in higher education is falling, probably sharply relative to other parts of the economy.

3. There are wide variations in higher education participation by gender, race, ethnicity and other demographic characteristics; the underserved population is large.

4. There is a huge college dropout problem. Many students completing college take five or six years to do so, instead of the usual four.

5. There is a growing perception that college students are not challenged, do not work hard, and are abysmally ignorant about basic aspects of our heritage and our civilization that they normally would be expected to pass on to future generations.

6. American universities are losing their claim to worldwide leadership in several ways. We no longer lead the world in college participation. Several European nations have as large of a proportion of young citizens receiving a degree as we do. Our nation is starting to lose our leadership in science because of lagging enrollments and, some would argue, research support.

7. There is some indication that, for all of its celebration of diversity, the academy is becoming less tolerant, suppressing some unpopular thoughts that are politically incorrect but which deserve to be aired. In short, academic freedom is less secure than it was, say, 30 years ago.

This list is arbitrary. Others would cite the growing arrogance and elitism of universities. Still others would note the declining public support of state and local governments. Some would cite the growing quality gap between public and private institutions. Unfortunately, time limits what I can talk about, so let me comment briefly only on the seven points that I have listed, emphasizing the problems of rising costs and stagnant productivity, the topic of today’s talk.

There are two things that families buy that have been rising sharply in price for decades. One is health care, and the second is higher education. It is no accident, I think, that both of them are services produced in markets with very significant governmental financial involvement and regulation. In both areas, third party payers, either government or others such as private philanthropists or insurance companies, foot a large proportion of the bills. Third party payments have propelled the rise in demand for services in both industries. Universities have raised their prices because they can get away with it, just as doctors and hospitals have.

While some, including my fellow commission member David Ward, the president of the American Council of Education, have argued that the double digit annual percentage increase in federal student assistance payments over the past decade has had no bearing on tuition and fee increases, don’t believe it. These programs have enhanced the demand for higher education relative to the supply, raising the price. When someone else is paying the bills, at least temporarily, the customer becomes less sensitive about prices and universities have taken advantage of that by raising their tuition.

That brings me to a second characteristic that is shared somewhat with the health care industry – most higher education providers operate on a non-for-profit basis. These providers generally have few incentives to reduce costs, unlike the private sector. In the private sector, reducing costs or enhancing revenues through improved product quality leads to higher profits, and that means greater profit sharing bonuses for key employees, bigger capital gains for managers with stock options, and higher dividend income. A significant proportion of the firm’s labor force benefits from the gains arising from efficiencies that lower costs. Wal-Mart and the University of Phoenix have a well-defined bottom line – stock prices and earnings. By contrast, most universities have no clearly defined bottom line. Did Duke have a good year in 2004? Who knows?

The lack of a bottom line serves to reduce accountability as well. It is hard to reward good performance and penalize poor work if there are few if any objective ways of measuring the quality of outcomes. Moreover, universities are organized in a way that tends to reduce consequential oversight. The governing boards are typically made up of unpaid volunteers who are happily co-opted by the administration that is theoretically subservient to them. The trustees typically have few incentives to rock the boat, and lack important information even if they want to effect serious change. There are no stockholders who could potentially cause a proxy fight for control. In public institutions, the governor and legislature largely leave the universities alone, accepting the view that institutional independence is necessary to preserve an atmosphere of academic freedom and unfettered scholarly inquiry. At the instructional level, tenured professors are relatively immune from pressures to change their ways, and, unlike in other sectors of the world, they can and often do tell their bosses that they simply will not do what the management wants. Accordingly, the lines of authority are blurred.

Yet it is human nature to want to rank and evaluate institutions. Parents want to send their kids to the best universities. Absent objective market criteria, private entrepreneurs fill the void. In higher education, the most famous rankings are no doubt those of US News & World Report, although there are several others. Speaking of the US News rankings, a large proportion of the evaluations are based on the quantity or quality of inputs or resources used, not a measure of output or outcomes. Thus, the more you spend on faculty, the better your ranking. The higher the quality of students coming in to a university, the better is that institution’s ranking. Yet spending on faculty and the quality of the student coming in says little about what an institution does during the student’s stay to make that person better, a more informed citizen, or a more productive worker. When Consumer Reports rates automobiles, they drive the cars. When US News rates universities, they look at the quality and quantity of raw materials used in making the product.

Rising college costs, then, reflect the importance of third party payments and the lack of incentives to contain costs given the non-profit nature of most higher education institutions. But there are other aggravating factors as well. Let me briefly mention three: cross-subsidization, price discrimination, and successful rent-seeking behavior. By cross-subsidization, I mean taking resources from one activity and giving them to another. During the last several decades, a smaller proportion of budgets at colleges have gone directly into instruction, particularly of undergraduates. At a typical university today, the instructional component of the budget is usually only around one-third of the total. Yet a very large portion of third party payments, especially government subsidy payments and private scholarship grants, are made in the name of improving instructional opportunities. Often universities have successfully appealed for additional monies from third parties to promote instruction, and then used the funds largely for other purposes. Universities have increased the proportion of budgets going for administration and for research. The research might be justified, particularly when funded by outside agencies, but the large increase in administrative bureaucracies seems to be largely without justification. At some private research universities, undergraduate students literally subsidize graduate programs, and increasingly schools are devoting resources to subsidizing intercollegiate athletic programs. We hire graduate students and pay them perhaps $15,000 a year to teach undergraduates, and pay senior professors $125,000 a year to teach small numbers of graduate students. Except at the private liberal arts colleges and the community colleges, undergraduate students are often neglected, seldom if ever coming into contact with senior faculty. For many members of the faculty, it is considered a degrading punishment to be assigned to teach survey courses to large numbers of undergraduate students. Prestige on campus is inversely proportional to the number of undergraduate students taught.

Other forms of cross-subsidization exist as well. At my university, for example, the intercollegiate athletic program loses about $11 or $12 million annually, close to the budget of some of the more important academic colleges within the institution Other institutions subsidize recreational facilities, although it is common to charge extra fees to support the increasingly country-club like maze of rec centers, student union buildings, and athletic facilities that grace the contemporary American campus.

Price discrimination exists when people pay differing prices for the same service. Universities have become far more aggressive in charging high prices to those students who strongly want into a particular institution, and lower prices to those the university wants and who other schools are also competing for. Thus rich students pay more than those from less affluent families, good students pay less than those more marginal academically, athletes pay less than nerds, and nonwhites pay less than whites on average. The government financial disclosure forms facilitate this process. What if you went into your local Ford dealer and asked what the price of a Ford Explorer is. What if the dealer said he could tell you that only after you filled out a form telling what your income, assets and debts were, how much alimony you paid, and so forth. You would be furious and might even complain to the Attorney General and sue. Yet that is standard practice in higher education. I have often mused about what would happen if the federal government abolished the FAFSA financial aid form and made it illegal for colleges to require applicants to provide usually highly private financial information. My guess is that posted tuition fees would fall relative to what otherwise would be the case.

Rent-seeking is economist jargon for efforts on the part of people to redistribute income to themselves without working for it. If you are willing to do a job for $100 but someone offers you $120, the $20 payment beyond that necessary to get you to do the job is economic rent. Rising demand for higher education induced in part by third party payments increases not only the quantity of kids going on to college but also the price they pay. This adds up to more revenue for universities. How have they used this extra income? Very little has gone for instruction. And much has gone for higher salaries and fringe benefits for employees.

To be sure, wages and salaries have risen throughout the economy with economic growth, and to remain competitive you have to increase salaries to keeping attracting newcomers to college teaching and administration. Yet my reading is that college personnel have taken really good care of themselves, particularly at the senior levels. Superstar professors, top administrators, and big-name athletic coaches all command salaries of hundreds of thousands of dollars annually, dramatically more than a generation ago, even correcting for inflation.

Even the more average faculty family lives dramatically better than two generations ago. I grew up in a large and important university town in the late 1940s and the 1950s. My friends whose fathers were professors led a rather austere life of shabby respectability, living in modest three bedroom homes, driving one fairly old car, and seldom taking much of a vacation. Today’s faculty at the same institution live in large four bedroom homes, have two cars, travel frequently, and have all sorts of gadgets to enrich their lives. Part of it is the natural consequence of economic growth, and part of it results from the rise in the labor force participation of females, but part of it is that faculty and administrators have not been bashful about seizing some of the dollars dropped out of airplanes over their campuses for their own use. Full professors at major research universities make at least 50 percent more in inflation-adjusted terms than in 1980, for example, and that excludes the even larger growth in fringe benefit payments.

Moreover, today’s faculty members teach far less than at the middle of the last century. The average teaching load for full professors at major research universities is about five hours a week, for perhaps 32 weeks a year. They are in the classroom 160 hours a year. My guess is that in 1950 that figure was more like 8 or 9 hours weekly. The same pattern is true at the lesser state universities and private liberal arts colleges. Supposedly, the reduced teaching loads are to allow for more institutional supported research, but much of the extra time is spent on golf courses or writing papers to give at extremely obscure academic meetings to an audience of five or ten persons. Most of this incremental research, at least in the social sciences and humanities, creates far less value for our society than teaching more undergraduate students.

That brings us to the topic of productivity in higher education, the second of my seven problem areas outlined at the beginning. In the economy as a whole, going back to, say, 1870, the productivity of workers has risen on average about two percent a year, with periods of higher growth, such as the 1950s and 1960s, and lower growth, such as the 1970s and 1980s, but averaging pretty close to two percent over the long run. The typical worker who stays in the same job throughout her career is producing twice as much when she retires as when she began work.

That is clearly not the case in higher education. Productivity there is frightfully difficult to measure – our output takes the form of hard-to-measure teaching and even harder to measure research – and our output is largely not sold in markets which provide a valuation of it. With this caveat, it is my contention that only by making the most optimistic assumptions is it possible to see any productivity increase in higher education whatsoever, and with more realistic assumptions, it is fairly easy to observe moderately significant productivity declines, although less dramatic than Caroline Hoxby observes for K-12 education. Clearly, the productivity of higher education has fallen sharply relative to that it other sectors in the economy, the major factor in the rising cost of colleges and universities.

One thing is for certain –the ratio of employees to students has risen in American universities, probably about 20 to 25 percent or so since the 1970s. Whereas it takes fewer workers to make a ton of steel or even produce written documents of a given length, it takes more workers to educate a college student. The big increase is not in faculty – although the number of students per faculty member has fallen modestly over time. The big category of employee growth is in non-faculty professional workers – deans, librarians, computer specialists, affirmative action officers, public relation specialists, security personnel, development officials, coaches, and the like. In 1976, there were three of these types of employees for every 100 students in American universities –today, there are six –double the number. Since many of these are what you might loosely call administrators, there is a considerable basis to the near universal faculty complaint that there are too many administrators on the typical campus. At my university, the number of employees eligible to vote to elect members to what is called the Administrative Senate exceeds the number eligible to vote for the Faculty Senate. We could reorganize the university and give every faculty member his own administrator.

It is interesting that in periods of real serious budget stringency, universities typically find ways to reduce this administrative corps fairly significantly. University presidents complain that federal rules and regulations and other changes force them to hire more of these types of personnel, and to a point that is true. But while civil rights legislation may have made it a necessity for the typical midsize state university to have two or three persons monitoring compliance with federal laws, the typical university today has diversity coordinators and specialists in nearly every major unit of the institution – maybe 30 or even 40 persons. Whereas a generation ago, a university of this type might have four or five public relation specialists, today they might have 25, mostly serving smaller units rather than institution as a whole. I am convinced that the non-profit nature of the institutions, the lack of close outside scrutiny, and the rising demand induced mainly by enhanced governmental support have all served to create this massive new university bureaucracy.

Let me briefly touch on the other five problems I enumerated at the beginning, some of which relate directly to the economic issues of rising costs and falling productivity. Clearly that is the case with the access problem. The ratio of college attendees and graduates to the relevant population is still rising, but at much slower rate than previously, and far slower than in other countries. This is not altogether bad, as one can legitimately argue that it is a waste of resources to send some students to college, particularly those with severe handicaps that impede serious learning at an advanced level, or those too immature or undisciplined to do the work required.

Yet Americans have long justified public support of universities on the grounds that they promote social and economic mobility, and that even the poor in America can move up the economic totem pole. Yet the level of education participation among some groups is shockingly below average. The proportion of Hispanics in college between the ages of 18 and 25 today is lower than in 1976. The Hispanic participation rate is markedly below that of African-Americans, and is particularly alarming given the large growth in that population.

But the largest group for whom participation in college has stagnated, not growing in years, is males. Today, nearly 30 percent more women are in college then men. Since historically men have the highest rate of labor force participation, the sharp relative decline in male higher education involvement has ominous implications for the future.

The low participation problem leads us to a related issue, arguably a scandal. A huge proportion of kids entering college never finish – and this is not a problem confined to college athletes who, as a group, graduate about as much as non-athletes. While some fail to graduate because of financial pressures aggravated by rising tuition, others fail to graduate because they do poorly or simply feel they do not belong in a college environment. In measuring productivity change in higher education, the failure of colleges to graduate upwards of 40 percent of their students is a factor explaining the rather poor record. There is no positive relationship between state government spending on appropriations for their universities and economic growth, which is not surprising given the huge waste of resources in the academy, some of them going to unsuccessfully educate a large proportion of the students enrolled. Incidentally, this problem is not merely confined to two and four year associate and bachelor’s degree programs. Dropouts from doctorate programs are at least as great as from undergraduate ones.

Even those who do not dropout often take five or even six years to finish, taking fairly productive persons out of the labor force for long periods of time. At the Ph.D. level, the average length of time from beginning the program to receiving the degree is now an unbelievable 10 years, an absolute scandal.

Productivity involves relating outcomes to the resources needed to get those outcomes. We have talked about the rising costs of the resources, or inputs, but said little about the outcomes themselves. Veteran professors like me will almost always tell you that today’s student does not work as hard as students did 30 or 40 years ago. They do not read as much. They spend more time partying. They get “As” and “Bs” with far less work than a generation ago – in part because of the tremendous amount of grade inflation. The emphasis on building country club like facilities on campuses make us wonder if we are now largely providing a publicly subsidized camp for relatively affluent kids, rather than a low cost, no nonsense education for those who otherwise would not get one.

Time is running out. My sixth point has already been covered: the U.S. is falling behind some nations in educational participation, and even our leadership in scientific research is being challenged, in part because of our failure to educate many Americans at a high level in the sciences and engineering. My last point is that we have a fixation with the diversity of skin color and sexual preferences and all sorts of other non-academic characteristics of our students, but we have become increasingly intolerant of diversity of opinions and ideologies – the very hallmark of modern universities as havens for free and unfettered discourse of ideas – popular and unpopular. This concerns me greatly, but I have little time to talk about it today.

What should we do about all of these problems? I am not sure I have any magic bullet solutions, but let me merely list a few possibilities that either likely will happen or should happen.

1. I would predict that the for-profit sector, with its greater market discipline and low cost structure, will continue to grow rapidly in importance, and that private colleges will gain market share relative to public ones. That trend has already begun.

2. While the tuition fees at universities will continue to rise faster than inflation, forces will probably work to moderate the increases somewhat, probably dropping those increases to no greater than the growth of income. The rise in earnings of high school graduates relative to college ones since 2000, accompanied by huge tuition increases, has significantly reduced the return on college investment.

3. As a consequence of the second point, traditional universities may be forced to cut costs by reducing or stopping the growth in non-instructional staff, rethinking tenure, using technology to lower costs rather than raise them, utilizing school buildings year round, increasing teaching loads, reducing subsidies of non-instructional activities and the like. The current trend of an increasingly inefficient operation is not sustainable in the long run.

4. There may be a move to partially or completely privatize some state universities, especially flagship operations. We have seen some moves in that direction at the University of Virginia and the University of Colorado.

5. A larger proportion of state and local governmental financial assistance will be directed towards students, not institutions; Colorado is leading the way in that regard with its new voucher program.

6. Some new constraints will be put on the federal programs of financial assistance that have grown at a double digit rate in recent years. Limits on loans to kids from relatively affluent families, denial of assistance beyond four years of college attendance, and other possible constraints could slow growth in these programs.

7. Efforts to integrate high school and college education will intensify, partly as a way to reduce the time spent in education, and partly to reduce barriers to entry and transfer to and between schools.

There are no doubt other changes in store. I suspect that, rightly or wrongly, that universities will move closer to a corporate model of governance. I believe college enrollments will grow, although at very modest rates over the next decade because of demographic considerations. An increasingly affluent America will continue to want to send their students to the best schools, benefiting the private universities and perhaps the very best public ones like the University of North Carolina at Chapel Hill, relative to other institutions. Every university will be trying to be like Duke or Chapel Hill, but few will be successful.

Whatever else happens, the American university will not disappear. The old lecture methods of students sitting at the feet of professors will not entirely disappear, if for no other reasons than some affluent Americans will always want their kids to get this expensive and relatively inefficient method of instruction. But big changes are coming to the academy. There will be blood on the floor at some campuses, their will be mini-civil wars, but change is coming to the academy, and I suspect on the whole it will be good for America. American universities have a sacred obligation to pass on the accumulated wisdom and knowledge of the past to future generations, and to expand on that wisdom and knowledge. That is essential to the preservation of Western civilization. I hope that our institutions are up to the task.

Thank you.