A Primer on College Costs

Editor’s note: This article is reprinted, with permission, from the introduction to Doing More with Less: Making Colleges Work Better, ed. by Joshua Hall and published by Springer Science+Business Media (New York).

The reasons for rising college costs are many; several people, including myself, have written whole books on the subject. But here is a handy list of a dozen expressions that economists use all the time to understand industries. Their peculiar application to higher education explains its rapidly rising costs.

Non-Profit. Most institutions of higher education, including so-called “private” schools, are non-profit in nature. They are not “owned” by someone who derives financial benefits from institutional success. In for-profit companies, owners and key employees enhance their incomes and wealth by reducing costs and/or increasing revenues through quality enhancements in products or services offered. Such incentives are largely absent in higher education. Indeed, perverse incentives often are present. For example, university officials deliberately try to increase costs by adding more staff, doing more travel, etc.

Bottom Line. The non-profit nature of higher education contributes to a lack of a “bottom line” –a measure of success or failure. A private company whose stock price and profits plummet is in trouble –and everyone knows it. Senior officials may well lose their jobs. There are real consequences of “failure.” There are no such indicators for most of higher education. I call this the Law of No Consequences—higher education leaders are largely immune from personal costs for failures (or rewards for success), simply because failure and success are not measureable. Did Slippery Rock University have a good year in 2009? Who knows?

Lack of Information. The bottom-line problem can be partly remedied by performance indicators, for example showing the “value added” by colleges to student knowledge, critical thinking skills, etc. Yet colleges for the most part have fought tenaciously against any sort of indicators that would help consumers evaluate alternative schools, or funders to assess whether they are getting a good return on their investment.

In the face of this lack of information, people rely on highly imperfect input and rankings based on reputation, notably those of US News & World Report, where “success” is measured in part by the amount of spending and anecdotal impressions of university presidents about schools about which they have no firsthand knowledge.

Third Party Payment. In the market sector, resources are allocated through the interaction of consumers’ preferences and providers’ willingness to supply services as influenced by production costs. In higher education, much like American medical care, “third parties”—especially governments but also private philanthropies and endowments—pay many of the bills. When someone else is paying for something, the customer and producers are far less cost-conscious.

Ownership. In free-market capitalism, there is little doubt who owns a business. Property rights are well defined. That is not usually the case with higher education. The chemistry department thinks it owns the building where its offices, classrooms and labs are—and even if space would be better utilized by others, it is hard to make it happen. Students think they own the university, as do university trustees (who usually have legal ownership), faculty, and sometimes prominent donors and alumni. Confusion and conflict over ownership contribute to inefficiency.

Governance. The faculty think they run the university, as do the president, the trustees, prominent alumni, and sometimes even the students. Blurred lines of authority make decision-making difficult and time-consuming. Most decisions are made by committee, and often are tepid compromises rather than bold innovative policy moves. Universities are the only places I know where subordinates (faculty members) often choose their own bosses (department chairs and sometimes deans) and often even evaluate them for salary increases.

Resource Rigidities. Many of the costs in higher education are fixed, making colleges a bit like capital-intensive public utilities. Tenure, which was designed to promote academic freedom, makes it difficult to reallocate faculty resources when needed. Thus universities are often slow to increase courses and faculty strength in areas of rapidly growing demand. The tenured faculty resists change, since it has a job no matter what courses are taught, and it prefers the status quo where its position is secure. Other rigidities come from enrollment restriction—where else do businesses deliberately turn away customers in order to promote institutional goals? Supply rigidities contribute to rising college costs.

Barriers to Entry and Restraints on Competition. Where in private business do competitors legally join organizations (e.g., accreditation associations) that can restrict new entrants into the field? Accrediting agencies are run as quasi-cartels by higher education personnel, as these agencies decide who can achieve the certification necessary for federal student funding. Accreditation standards pose a significant barrier to entry for newcomers. Additionally, school officials rarely want to offend old friends at competing institutions by engaging in price-cutting to win new business.

Public Support, Regulation and Control.  Universities maintain numerous personnel to meet governmental mandates regarding affirmative action, safety, hazardous wastes, staffing information, student performance, even admission standards. These restraints raise costs and potentially stifle innovation. State universities often face tuition caps, prevailing wage rules regarding building construction, restrictions on out-of-state enrollments, etc.

Rent Seeking.  Economic “rents” are payments to someone that have no impact on output; they are not related to productivity. Generous increases in third-party funding of colleges often lead to salary increases well beyond the minimum necessary to secure the personnel necessary to do the job (the level of salaries that typically operate in the private sector). The explosion in university president and senior professor salaries reflects this. Universities receiving big and increasing federal research grant money also report large growths in the salaries of faculty relative to schools emphasizing teaching, such as community colleges.

Price Discrimination. Charging customers different amounts for the same service is common in the market economy, and can promote efficiency (e.g., assuring full aircraft because people whose plans are flexible are charged less). Price discrimination, however, enables suppliers to collect more revenues from their customers. The Federal Free Application for Student Financial Aid (FAFSA) form provides colleges with detailed financial information about customers that allows them to charge whatever the customer will bear, with “scholarships” merely a form of tuition discounting used to facilitate price discrimination. Private enterprise is denied such private financial information, and thus has fewer opportunities to price discriminate.

Cross-Subsidization. At a typical university, the cost of educating undergraduates is dramatically lower than graduate students, but both pay about the same tuition fees (the graduate students actually usually pay less after aggressive tuition discounting). The student cost to take inexpensive English courses is usually the same as more expensive business or science offerings. At most schools, students subsidize various entertainments that often they do not want, most notably intercollegiate athletics.

So now you know why costs are continually rising in the higher education sector!