Magic Elixir for Growth or Economic Snake Oil?

Editor’s Note: This article is based on a new report by Jay Schalin entitled State Investment in Universities: Rethinking the Impact on Economic Growth.”

Can states spur their economies by investing in higher education?

You don’t have to spend much time in state political circles before you hear some version of “the speech.” It goes something like, “We have to invest more in higher education if we are going to compete in the knowledge-based global economy of the 21st century.”

At first glance, intuition suggests this is correct. After all, innovation and technical advances have been driving the economy for the last half-century, and universities both train young people for advanced careers and forward the progress of knowledge through research. It therefore stands to reason that, to promote economic growth, society should devote as many resources as possible to our public institutions of higher learning. At least, that has become the overwhelming consensus view.

The problem is that, sometimes, the consensus, or conventional wisdom, is more “convention” than wisdom. In this case, most people don’t think to question it, and those with doubts probably feel it’s best politically to ignore them. Still, amidst all the cries for more government spending on our universities to spur economic development, I came across an unpublished article by iconoclastic Ohio University professor Rich Vedder, who made a remarkable claim. He had created an econometric model that demonstrated that the relationship between state spending on higher education and state economic growth was negative—the more states spent on higher education in recent years, the worse their economies performed!

With that possibility in mind, I embarked on an investigation into the true relationship between state investment in higher education and the economy.

And my exploration uncovered a simple truth—that there is no single answer to the question that is valid all the time. Some investment in higher education almost certainly helps the economy. And the evidence of higher education’s positive influence on the economy is omnipresent.  Although not every research university is ringed with high-tech enterprises, it is accurate to say that high-tech centers are invariably located near major research universities.

Yet Vedder’s analysis is also likely to be true. Some factors that contribute to the negative effect of state higher education spending are readily identifiable. They include highly subsidized public colleges that expend great resources toward educating young people who are not really college material; wasteful, unnecessary research by faculty; excessive non-faculty staffing, and so on.

Furthermore, many of the studies cited by university officials and politicians are fundamentally flawed.  They supposedly quantify the impact of universities on local economies, but their results are often wildly exaggerated. They suggest that for each dollar invested, some magnificent sum will be returned. A 2006 paper entitled “The Economic Impact of Colleges and Universities” by John Siegfried, Allen Sanderson, and Peter McHenry looked at 67 university economic impact studies. The authors found that the returns for each dollar varied from $1.84 to $26—“a range simply beyond belief.”

The above researchers also commented on studies of Loyola University of Chicago and Northwestern University. The schools are nearby geographically and of roughly equal size, although Northwestern is more prestigious and more research-intensive. Yet Loyola’s supposed economic impact was $1.42 billion, while Northwestern’s was only $145 million. Only two conclusions can be reached from such a wild discrepancy: either one of the studies is nonsense, or both are.

Yet policymakers often seem blind to such upsetting anomalies. They prefer to discuss the success stories, such as software giant SAS’ s emergence from N.C. State University’s statistics department (funded by a federal grant) or Silicon Valley’s relationship with Stanford University during its formative years. 

While those success stories are real, they reflect very specific conditions of time and place. Research Triangle Park—one of three areas commonly cited as a model for state-academia-industry cooperation—was a unique idea that blossomed in a particular region of North Carolina with three world-class research universities in the 1960s. Today, politicians in every state are trying to replicate its success by pouring money into education and research, and they are likely to fail, for a variety of reasons.

For one thing, the principle of diminishing marginal returns sets in. Policy-makers, analysts, academic administrators, state bureaucrats, and even some business leaders often regard the last $100 million spent on higher education as no different than the first million dollars spent—a serious error in judgment. Nor do they grasp the principle of alternate uses. They beam with pride at the gleaming new buildings on campus, but do not see the thriving private office buildings and factories—which produce wealth rather than consume it—that would exist without the taxes needed to raise revenues for campus construction.

Also underlying the consensus view is a faith in the efficacy of government. Theoretically, it makes some sense to have our public institutions—government and academia—partner with private industry to further our prosperity. There has always been some collaboration between the three spheres, and universities have aided private concerns. Public land grant colleges were explicitly chartered in the 1800s and early 1900s to do so.

But the collaboration has been expanding unchecked for almost 70 years. The federal government’s heightened demand for advanced scientific and technical research after World War II meant a dramatic increase in funds available for university research. The economic malaise of the 1970s led to the 1980 passage of the Bayh-Dole Act, which was intended to spur economic development by enabling universities to profit from federally funded research more easily.

Private industry has also sought to mine the concentration of cutting-edge researchers in universities, and the three-sided partnership became known as the “Triple Helix” by proponents.  State governments have gotten in on the action as well, seeking to exploit higher education’s potential for innovation to improve local economies.

While the trend toward greater cooperation might seem to be all to the good at first glance, it has some disturbing implications as well. State universities are part of state government, and for them to be specifically funded to create jobs and businesses, as they are now called upon to do, is a tremendous expansion of government power. It smacks of centralized planning, with government making the investment decisions.

Some proponents of the consensus have suggested that government performs a valuable service by using public money to fund research projects deemed too risky by private venture capitalists. But such entrepreneurs are experts at assessing risks and gains. If they deem a project unworthy of investment, it is likely to fail. When a state puts money into such ventures as a rule, they are essentially subsidizing failure—a policy that can only have adverse results.

Additionally, states that hand money over to universities to create jobs are ignoring another important factor—innovation is random. For every university that comes up with a big revenue-producing idea, such as Florida State University’s discovery of the cancer-fighting drug Taxol, there are several who perpetually come up empty-handed. States funding university research to spur development often resemble gamblers more than they do prudent investors.

One insight I gained particularly urges caution about states investing more in higher education. I came across another unpublished paper by two economists, Bornali Bhandari of Fitchburg State College and Bradley Curs of the University f Missouri-Columbia, that corroborated Rich Vedder’s econometric model suggesting a negative relationship between state higher education spending and economic growth (I found no similar models that contradicted Vedder’s work).

The Vedder and Bhandari-Curs papers led me to the realization that state investment in higher education fits the classic “Laffer Curve” model for diminishing marginal returns (Laffer’s original model demonstrated that higher tax rates eventually led to lower tax revenues).  As states invest more money in university systems, the returns from each new dollar spent diminish. Eventually, the returns become negative, which, according to the two models mentioned above, is where most states are now. Quite likely, more spending on higher education will hurt, not help the economy. Of course, it all depends on the mix of expenditures—perhaps more spending on engineering education and less on English department research will improve the rate of return.

In summary, my investigation gave me a lot more questions than answers. But there are enough red flags indicating that the current levels of spending on higher education are already too much of a good thing. There needs to be a lot more research and discussion before states give themselves over to the consensus view.